Unleveraged Portfolios and Pure Allocation Return

Barbara Alemanni,Pierpaolo Uberti,Mario Maggi

doi:10.3390/jrfm14110550

Barbara Alemanni, Pierpaolo Uberti + Show 1 more

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https://doi.org/10.3390/jrfm14110550

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Abstract

In asset management, the portfolio leverage affects performance, and can be subject to constraints and operational limitations. Due to the possible leverage aversion of the investors, the comparison between portfolio performances can be incomplete or misleading. We propose a procedure to unleverage the mean-variance efficient portfolios to satisfy a leverage requirement. We obtain a class of unleveraged portfolios that are homogeneous in terms of leverage, so therefore properly comparable. The proposed unleverage procedure permits isolating the pure allocation return, i.e., the return component, due to the qualitative choice of portfolio allocation, from the return component due to the portfolio leverage. Theoretical analysis and empirical evidence on actual data show that efficient mean-variance portfolios, once unleveraged, uncover mean-variance dominance relations hidden by the leverage contribution to portfolio return. Our approach may be useful to practitioners proposing to take long positions on “short assets” (e.g. inverse ETF), thereby considering short positions as active investment choices, in contrast with the usual interpretation where are used to overweight long positions.

Highlights

Our approach may be useful to practitioners proposing to take long positions on “short assets”, thereby considering short positions as active investment choices, in contrast with the usual interpretation where are used to overweight long positions
This paper proposes a novel approach to take into account the portfolio leverage in order to assure feasibility and to highlight mean-variance dominance relations that remain hidden under the bias introduced by the leverage
Any type of investors can benefit from the optimal mean-variance portfolios resulting from an unconstrained optimization approach, in spite of regulatory limits or lack of suitable candidates to short sales

Summary

Introduction

Publisher’s Note: MDPI stays neutral with regard to jurisdictional claims in published maps and institutional affiliations. A key assumption underlying classical portfolio theory (Markowitz 1952) is that portfolio optimal composition is obtained from a mean-variance optimization computed starting from the expected returns, variances and covariance of the selected assets. The optimal solution of this problem could imply that the portfolios have negative holdings that require the shorting of assets and implicitly assume a leveraged position. The implementation of these unconstrained portfolios may pose both practical and theoretical issues

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