Abstract
The authors study the performance of mean-variance optimized (MVO) equity portfolios for retail investors in various markets in the U.S. and around the world. Actively managed equity mutual funds have relatively high fees and tend to underperform their benchmark. Index funds such as exchange traded funds still charge appreciable fees, and only deliver the performance of the benchmark. The authors find that MVO portfolios are relatively easy to manage by a retail investor, and that they tend to outperform their benchmark or, at worst, equal its performance, even after adjusting for risk. Moreover, they show that the performance of these funds is not particularly sensitive to the frequency at which they are rebalanced so that, in the limit, an investor might have to rebalance his/her portfolio only once a year. This last finding translates into very low trading costs, even for retail investors. Thus, the authors conclude that MVOs offer an easy, cheap alternative to invest in the world’s equity markets.
Highlights
Since its introduction in 1952 by Harry Markowitz, the mean-variance criteria have become the most widely known form of portfolio selection
In order to demonstrate the value of mean-variance optimization (MVO), we apply this methodology in its simplest form in various markets around the world and find that, at worst, the resulting portfolios obtain the same level of performance as their respective index benchmark and, at best, beat these benchmarks with long-term results that are statistically, as well as economically significant[1]
We set out to test the viability of the venerable mean-variance portfolio methodology introduced in Markowitz (1952) as a tool that modern retail investors could use to improve the performance of their investments, over and above that offered by the average actively managed or index equity fund
Summary
Since its introduction in 1952 by Harry Markowitz, the mean-variance criteria have become the most widely known form of portfolio selection. We explore a third possibility that a retail investor might be able to construct his/her own meanvariance portfolio using simple analytic tools and publicly available information, and maintain that portfolio by rebalancing at a frequency that maximizes risk-adjusted performance, while reducing trading costs To test this premise, we obtain stock price data from 22 markets (3 U.S indexes and 19 foreign ones), and conduct a back-test of MVO portfolio optimization over a period of 10 years. While we do not claim that simple MVO portfolios are a ‘silver bullet’ and the best solution available to retail investors, we do show that their performance (in terms of the Sharpe ratio) is higher and costs lower than other accessible alternatives, such as indexing and EW portfolio, tested in most markets.
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