Maximising an Equity Portfolio Excess Growth Rate: A New Form of Smart Beta Strategy?

Summary:

It has been argued that the simple act of resetting portfolio weights back to the original weights can be a source of additional performance. This additional performance is known as the rebalancing premium and a detailed analysis (see for example Fernholz (2002)) suggests that the portfolio excess growth rate, defined as the difference between the portfolio expected growth rate and the weighted-average expected growth rate of the assets in the portfolio, is an important component of the rebalancing premium. In this context, one might wonder whether maximising a portfolio excess growth rate in the presence or in the absence of a risk-free asset would lead to an improvement in the portfolio performance or risk-adjusted performance. This paper provides a thorough empirical analysis of the maximisation of an equity portfolio excess growth rate in a portfolio construction context both for individual stocks and factor-tilted equity portfolios. In out-of-sample empirical tests conducted on individual stocks from 4 different regions (US, UK, Eurozone and Japan), we find that portfolios that maximise the excess growth rate are characterised by a strong negative exposure to the low volatility factor and a higher than 1 exposure to the market factor, implying that such portfolios are attractive alternatives to competing smart portfolios in markets where the low volatility anomaly does not hold (e.g., in the UK, or in rising interest rate scenarios) or in bull market environments. In parallel, our empirical analysis of US factor-tilted universes shows an outperformance in terms of mean return, growth rate and Sharpe ratio for portfolios that maximise the excess growth rate with respect to equally-weighted portfolios for 4 stock selections, namely past winners, past losers, high vol and high investment stocks. These results suggest in particular that maximising a portfolio excess growth rate is a welfare-improving approach for momentum portfolios.