Rick Ferri wrote:
Give a monkey enough darts and they’ll beat the market. So says a draft article by Research Affiliates highlighting the simulated results of 100 monkeys throwing darts at the stock pages in a newspaper. The average monkey outperformed the index by an average of 1.7 percent per year since 1964. That’s a lot of bananas!Any Monkey Can Beat the Market
I think the Fama-French crowd will approve of this article.
Rick Ferri wrote:In their yet-to-be-published article, the company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year, from 1964 to 2010, and tracked the results
If they chose a stock universe of the 1,000 largest
stocks, how can the size effect explain the outperformance? I thought the size effect is concentrated among the smallest and most illiquid stocks.
If the size effect explains the outperformance, we should note that active or passive retail funds presumably cannot capture the (entire ?) size premium. E.g., active or passive micro-cap funds usually underperform their benchmark.
Rick Ferri wrote:It also helped that the 30 stocks in the monkey portfolio were equally weighted by Research Affiliates. This technique reduced the average market cap relative to the cap weighted index and helped boost the return. In addition, equal weighting “tilted” the portfolio toward value stocks, which earned a higher return than growth stocks over the 1964 to 2011 period.
Furthermore, other factors could play a role. Recent rearch (*) found that factor exposure explains roughly 58% of the outperformance of a monthly rebalanced equal-weighted portfolio of SP500 stocks. 42% stem from rebalancing (contrarian strategy) (**). If the portfolio was rebalanced annually, the outperformance became statistically insignificant, although is was still positive (***).
(*)Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios?
Yuliya Plyakha, Raman Uppal, Grigory Vilkov, October 16, 2012
(**)Financial Times - Award for contrarian strategists, By Sara Silver and Steve Johnson
You may try to google the title.
The trio’s analysis of a random selection of stocks from the S&P 500 over the past 40 years found an equal-weighted portfolio generated an annual return 271 basis points above that of a value-, or market capitalisation-weighted portfolio,..The paper concluded that 58 per cent of the outperformance vis a vis the value-weighted portfolio stemmed from an “excess systematic component” driven by the equally weighted portfolio’s greater exposure to smaller and value stocks, factors long shown to lead to outperformance over a cycle. The remaining 42 per cent stems from “alpha”, or excess returns generated by the monthly rebalancing required to maintain equal weights, which is a contrarian strategy involving buying the losers and selling the winners.
(***)Why Does an Equal-Weighted Portfolio Outperform Market Capitalization- and Price-Weighted Portfolios?