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FEU Provides Appealing Exposure To Europe

Summary I’m taking a look at FEU as a candidate for inclusion in my ETF portfolio. The correlation with SPY isn’t bad, and the overall risk level for a portfolio seems respectable. The expense ratio is a little bit high and the diversification is weak. I’ll keep FEU on the list as a possibility. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the SPDR STOXX Europe 50 ETF (NYSEARCA: FEU ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. What does FEU do? FEU attempts to provide results which are comparable (before fees and expenses) to the total return of the STOXX Europe 50 Index. FEU falls under the category of “Europe Stock.” Does FEU provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is about 80%, which is great for Modern Portfolio Theory. The lower correlation makes it much easier to mix the ETF into a portfolio and take advantage of the benefits of diversification. My goal is risk adjusted returns, and my method is minimizing risk. Standard deviation of daily returns (dividend adjusted, measured since January 2012) The standard deviation is moderately high, but not terrible. For FEU it is 1.0080%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, and the low correlation with SPY makes the higher standard deviation acceptable. So far, the ETF is look fairly solid in my first pass. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and FEU, the standard deviation of daily returns across the entire portfolio is 0.8250%. If an investor wanted to use FEU as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in FEU would have been .7343%. In my opinion, the standard deviation across the portfolio looks fine with a moderate position in FEU. In my opinion, a reasonable exposure based on the deviation is probably in the 5 to 10% range. Anything over 20% gets too risky. Average Volume The average volume was recently around 65,000 shares per day. That isn’t high, but it is enough that I would be comfortable holding the shares and believe the liquidity was good enough for the statistical values for correlation to be reliable. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The distribution yield is 5.40%. The SEC yield is 2.64%. That’s a fairly strong yield, though I’d caution investors to research the source of the yields and the tax implications for their individual situation. I’m not a CPA or CFP, so I’m not assessing any tax impacts. Expense Ratio The ETF is posting .29% for an expense ratio. I want diversification, I want stability, and I don’t want to pay for them. The expense ratio on this fund is higher than I want to pay for an equity fund, but it isn’t enough to disqualify the ETF from consideration. Market to NAV The ETF is at a .81% premium to NAV currently. Premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. I wouldn’t want to pay a premium greater than .1% when investing in an ETF, unless I could find a solid accounting reason for the premium to exist. I certainly won’t be paying a .81% premium to buy into FEU without finding a solid reason for the premium. Largest Holdings The diversification is fairly weak. Given that the name included “Europe 50,” investors should expect the diversification to be weak. However, modern portfolio theory still says the overall level of risk introduced to the portfolio through a small to moderate position (5 to 10%) is acceptable. (click to enlarge) Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade FEU with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. I’ll keep FEU on my list as a possibility for exposure to Europe as part of my international diversification. If I entered into a position in FEU it would be with a limit order that refused to pay the premium to NAV. Since the NAV could change suddenly, I’d have to do single day limit orders to reduce my risk of paying more than NAV. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.

US Value Stocks: Rewriting The Market’s Playbook

Summary The traditional playbook that investors have used to navigate market cycles has become outdated. Certain sectors usually become inexpensive after the type of market run that we’ve experienced during the past few years. But investors are chasing yield, which has kept certain stocks expensive. Invesco’s US Value complex includes three broad strategies, each with a distinct approach to evaluating companies. Looking into 2015, we highlight where each approach is seeing the most attractive opportunities. By Kevin Holt The traditional playbook that investors have used to navigate market cycles has become outdated. Certain sectors usually become inexpensive after the type of market run that we’ve experienced during the past few years. But, because interest rates are so low, investors are chasing yield. That has kept certain stocks expensive when you wouldn’t normally expect them to be, based on past cycles. At the same time, other sectors look attractive when they would normally be out of favor. For example, when you look at market history, value investors would not typically want to own financials at this point in the cycle. However, as we enter 2015, I believe financials have very attractive valuations, along with a surplus of capital that I expect to be returned back to shareholders in the form of increased dividends and/or stock buybacks. Overall, I believe the quality of the financials sector is the best we’ve seen in at least a decade, and see this story playing out over the course of the next four or five years. On the other hand, I believe that broadly, the consumer staples and telecommunications sectors are either fairly valued or expensive, as investors have driven up valuations in their search for yield. However, as bottom-up stock pickers, all of our value managers are focused on finding value opportunities wherever they may be – even within sectors that may be overvalued as a whole. Invesco’s US Value complex includes three broad strategies. There are many ways to be successful and intellectual independence is a core value across our teams. Each strategy has a distinct approach to evaluating companies. Looking into 2015, here is where each approach is seeing the most attractive opportunities: Our relative value strategies look for companies that are inexpensive relative to their own history. In this space, we have a particular interest in energy stocks as we enter the new year. Often, market volatility can lead to value opportunities, as quality companies get swept up in the sell-off. The oil markets experienced significant volatility toward the end of 2014 that may result in such opportunities. Our deep value strategies look for companies that are trading at a discount to their intrinsic value. In this space, our managers are also emphasizing energy stocks as well as financials, for the reasons stated above. Our dividend value strategies closely evaluate companies’ total return profile, emphasizing appreciation, income and preservation over a full market cycle. Through this lens, they are finding stock-specific opportunities within the consumer area. Our dividend managers have a high confidence in the durability of margins and of free cash flow generation for their holdings over the next two to three years, and believe that expectations for top-line recovery embedded in street estimates are conservative. So, while 2015 may feel like a very different year for the markets, our approach is the same as ever – across all three value sleeves, and across large-, mid- and small-cap stocks, we’re looking for opportunities that fit our philosophy, no matter what the typical market playbook says. Important information A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets. Common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer’s board of directors and the amount of any dividend may vary over time. Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2014 Invesco Ltd. All rights reserved. blog.invesco.us.com

What To Find Before Seeking Alpha: Domestic Equity Allocation

Summary Contrary to Buffett’s advice, you should not use the S&P 500 as the sole proxy for the domestic market. Some ETF domestic allocations do seem better than others. Static domestic equity allocations limit alpha. There is a lot of advice on the strategy within the equity allocation space, but little in the way of practical comparisons. Many analyses focus on the characteristics of the ETFs themselves rather than how they fit together within a portfolio. This article looks at how they might play together in some of the standard configurations. Why a Static Allocation Approach? The U.S. stock market is by far the most efficient financial market on the planet. Its common language (ever tried to read a corporate report in Norwegian via Google Translate?), legal framework, financial depth, lack of transaction taxes, and common (reserve) currency conspire to make it much more efficient than even Europe’s developed markets. These, along with the fact, that its home to some of the world’s biggest companies, followed by both hordes of equity analysts and legions of small investors active in the small-cap space also contribute to its prime position. This exceptional efficiency has also given rise to a fixed allocation model for domestic equities, typically consisting of 1-10 ETFs. But both the number and type of passive fund is open for discussion. The number of assets varies from one to perhaps fifteen with a sector-based strategy or individual stock strategy à la Peter Lynch & Jim Cramer. Which Fund? When it comes to which fund, opinions also vary. Warren Buffett advocates a cheap S&P 500 fund. Seeking Alpha contributor Joe Springer advocates a mid-cap fund rather than the S&P 500 fund to capture the gains as stocks transition from small to large but avoids buying more at inflated prices. Academia tells us to hold the market portfolio. Using an equal-weighted portfolio exploits the random nature of returns. To minimize risk, theory tells us to use the minimum variance portfolio. Jim Cramer advocates 5-15 individual stocks in different sectors. More advanced portfolios rely on a sector-based allocation strategy. So which is right for a domestic equity allocation? It Depends on Your Objectives Part of this conflicting advice comes from the fact that not all participants have the same investing objectives; this is why it is important for you to clarify your own. Many investors, overwhelmed by financial markets, might want a single vehicle with which to save. There is evidence that people just want the most “juice” possible out of their equity portion by picking a strategy that maximizes returns, such as with an equal-weighted or high beta portfolio, but cannot or do not want to use margin to get those returns. Retirees, who may simply want some equity exposure to hedge against inflation, might seek only to minimize downside risk at the expense of capping gains. Others, who want the chance at generating alpha or enjoy trading, might deploy both more numerous and more narrow ETFs or even individual stocks within the domestic equity allocation. I personally am interested in the most risk-efficient returns while taking the general amount of equity risk. In short, there is no single right answer to both the number and type of equity asset to hold. Nevertheless, it is worth investigating the properties of common domestic equity allocations so that one may make an informed decision. To that end, the next section introduces several common equity allocation and portfolio strategies. Meet the U.S. Equity Portfolios The main portfolios were implemented using ETFs rather than individual stocks. This is more realistic for the typical small investor, who cannot compute and rebalance portfolios cost effectively. The intent of this exercise is to examine a plausible portfolio strategy, which covers the entire investible market, comparable to the market portfolio, rather than examine the performance of individual funds or stocks. In selecting the ETFs, I tried to choose the biggest one by assets under management according to ETFdb.com rather than by using any performance or cost characteristics. The “Jim Cramer” stock portfolio was arbitrarily assembled based on his recommendations, charitable trust picks, and the CEO appearances on his ” Mad Money ” show, whilst respecting his tenet of sector diversification. With the exception of Apple (NASDAQ: AAPL ), which I have held, I did not look at the individual stocks’ performance when choosing, but I believe my choices of his choices generally represent the types of large-cap stocks he and his callers tend to favor. The sector-based portfolio was implemented using Vanguard’s funds rather than the more popular “XL sector” SPDRs from State Street because they cover all capitalizations, rather than just S&P 500 stocks. This is theoretically more congruent with holding the market portfolio. For the risk-efficient portfolio, I had to fudge a bit in that, to my knowledge, there is no ETF for minimum variance portfolio consisting solely of U.S. stocks, which includes small-cap stocks. Instead, the risk-efficient portfolio comprises a variance-optimized slice based on the large and mid-cap stocks, and a low-volatility slice for the small caps. While the individual variance of the stocks plays a role in variance minimization, this is not quite the same as optimizing across all stocks, which exploits the covariance structure amongst the assets. Where there was a deep enough ETF pool, I computed a few variants, but report only the main ones to focus on the most common (If there’s enough interest, I might report the others or entertain requests, but it seemed overkill for the purpose at hand). Table 1: Portfolios for U.S. Equity Allocation Portfolio Rationale Implementation Benchmark The market portfolio is the most efficient portfolio possible. Market-cap weighting also does a decent job of approximating the opportunities available. The Vanguard Total Stock Market ETF (NYSEARCA: VTI ) Mid-Cap Mid-cap companies strike a good balance between stability and returns while the index avoids the bubble upside and bankruptcy downside extrema of the upper and lowermost equity slices. The iShares Core S&P MidCap ETF (NYSEARCA: IJH ) S&P 500 Both the depth of coverage and liquidity of biggest stocks with global business provide the most efficient returns. The SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) Market Cap Traditional 3-slice large cap/mid/small seen in many brokerage models. It is a way of capturing the entire market, and accessing the superior expected returns of the small and mid-cap companies without relying on a single fund. SPY, IJH, the iShares Russell 2000 ETF (NYSEARCA: IWM ) Value Moment Both value and momentum exhibit excess returns over the market portfolio, but both are inversely correlated, ergo a portfolio of these ought to exhibit superior risk-adjusted returns. The iShares Russell 1000 Value ETF (NYSEARCA: IWD ), the SPDR S&P 1500 Momentum Tilt ETF (NYSEARCA: MMTM ) Equal Weight Cap-weighted indices tend to buy high and sell low; moreover, they have a bias towards “safer” stocks, which lowers expected returns. Equal-weighted indices militate against these tendencies, sacrificing short-term momentum for long-term appreciation. The Guggenheim S&P Equal Weight ETF (NYSEARCA: RSP ), the Guggenheim Russell Midcap Equal Weight ETF (NYSEARCA: EWRM ), the Guggenheim Russell 2000 Equal Weight ETF (NYSEARCA: EWRS ) Factor Equity portfolio returns are dictated by: beta, value, size, and momentum. A portfolio comprising these components should perform better than holding the diluted market portfolio. The PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ), IWW, MMTM, IWM Dividend Aside from revealing value, dividends act as signal on cash-flow stability, mitigate downside risk by returning some principal, and exert some spending discipline over management. The WisdomTree LargeCap Dividend ETF (NYSEARCA: DLN ), the WisdomTree MidCap Dividend ETF (NYSEARCA: DON ), the WisdomTree SmallCap Dividend ETF (NYSEARCA: DES ) Personal Conceptually, the large-mid cap minimum variance portfolio is a reasonable choice for what I believe to be an overvalued U.S. equity market. Small value stocks exhibit excess returns over time, and are risk-efficient. The iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), DES Sector Sectors have cycles that are phase shifted, and thus not completely correlated, a portfolio of sector-based funds should exhibit superior risk-adjusted returns. The number of funds allows for some alpha potential. The Vanguard Consumer Discretionary ETF (NYSEARCA: VCR ), the Vanguard Consumer Staples ETF (NYSEARCA: VDC ), the Vanguard Energy ETF (NYSEARCA: VDE ), the Vanguard Financials ETF (NYSEARCA: VFH ), the Vanguard Health Care ETF (NYSEARCA: VHT ), the Vanguard Industrials ETF (NYSEARCA: VIS ), the Vanguard Information Technology ETF (NYSEARCA: VGT ), the Vanguard Materials ETF (NYSEARCA: VAW ), the Vanguard REIT Index ETF (NYSEARCA: VNQ ), the Vanguard Telecom Services ETF (NYSEARCA: VOX ), the Vanguard Utilities ETF (NYSEARCA: VPU ) Cramer You can do better than the market by holding 5-15 individual solid stocks in various sectors. Popeyes Louisiana Kitchen (NASDAQ: PLKI ), Clorox (NYSE: CLX ), Royal Dutch Shell (NYSE: RDS.A ) (NYSE: RDS.B ), AIG (NYSE: AIG ), Bristol-Myers Squibb (NYSE: BMY ), Flextronics International (NASDAQ: FLEX ), Apple, Weyerhaeuser (NYSE: WY ), Ventas (NYSE: VTR ), Verizon (NYSE: VZ ), American Electric Power Company (NYSE: AEP ) Random Random choice of 11 stocks listed at least 5 years on the NYSE or NASDAQ (i.e. no penny stocks). Allegheny Technologies (NYSE: ATI ), Oritani Financial (NASDAQ: ORIT ), National Fuel Gas (NYSE: NFG ), RCM Technologies (NASDAQ: RCMT ), j2 Global (NASDAQ: JCOM ), Heartland Express (NASDAQ: HTLD ), SandRidge Energy (NYSE: SD ), Regency Centers (NYSE: REG ), Dawson Geophysical (NASDAQ: DWSN ), LaSalle Hotel Properties (NYSE: LHO ), Unifi (NYSE: UFI ) Risk Efficient The minimum variance portfolio reduces volatility and drawdown. The XSLMV is a risk-efficient small-cap fund, which complements the mid/large cap fund. USMV, the PowerShares S&P SmallCap Low Volatility Portfolio ETF (NYSEARCA: XSLV ) Data and Methods The data come from the data facility of Yahoo! Finance, but are limited to about 8 years at the most. Some of the ETFs have had a very short life (i.e. less than 2 years) during a raging bull market, so their return distributions are likely heavily skewed. To combat this effect and render comparisons more realistic, the market benchmark portfolio was recalculated for the same period. For simplicity and to remove skill effects, the portfolios are strictly equally weighted in the initial review. We shall relax this assumption somewhat by assuming some trading ability further on. The continuous logged total returns for the portfolios are computed from their split and volume-adjusted prices using the quantmod package for R . The dividends are accrued daily over the observed period. The daily return and standard deviation statistics are then annualized using 252 trading days; in this sense, the results in Table 2 below reflect the underlying generative process rather than the realized gains. For simplicity, the real risk-free rate is assumed to be 0% (depending on the benchmark, it’s currently about +0.5% or -1.75%). Portfolios are evaluated using: annualized returns, Sharpe ratio (return efficiency), Calmar ratio (drawdown efficiency), and inverse beta (systemic risk). These statistics capture the main portfolio attributes of interest for an equity investor, and are highly correlated with other measures (Fling & Schumacher 2006). These four statistics are then computed relative to the market portfolio, and their harmonic mean is taken to arrive at a general score (last column). Table 2 shows the results of this computation. Table 2: Strict Equal Weight Portfolios PORTFOLIO DATA (years) Portfolio Stats Comparable Period Benchmark Relative Stats (stat_portfolio/stat_benchmark) R SD Sharpe Calmar Beta R SD Sharpe Calmar R Sharpe Calmar Beta^-1 Score Risk Efficient 1.9 20.1% 10% 2.011 3.721 0.795 20.7% 11.6% 1.79 2.83 0.97 1.12 1.32 1.26 1.16 Value Moment 2.2 23.0% 9% 2.438 2.984 0.694 23.1% 11.6% 1.99 3.15 1.00 1.23 0.95 1.44 1.14 Personal 3.2 21.6% 12% 1.808 2.821 0.844 22.0% 13.4% 1.65 2.24 0.98 1.10 1.26 1.19 1.13 Mid-Cap 8.0 9.7% 25% 0.394 0.119 1.076 8.4% 22.2% 0.38 0.11 1.17 1.05 1.06 0.93 1.05 Factors 1.6 25.2% 12% 2.12 4.831 0.987 23.1% 11.6% 1.99 4.96 1.09 1.07 0.97 1.01 1.04 Market 8.0 8.4% 22% 0.376 0.113 1 8.4% 22.2% 0.38 0.11 1.00 1.00 1.00 1.00 1.00 S&P 500 8.0 7.9% 22% 0.358 0.106 0.989 8.4% 22.2% 0.38 0.11 0.95 0.95 0.95 1.01 0.96 Dividend 8.0 8.4% 24% 0.348 0.104 1.041 8.4% 22.2% 0.38 0.11 1.01 0.93 0.92 0.96 0.95 Sectors 8.0 8.1% 23% 0.353 0.104 1.014 8.4% 22.2% 0.38 0.11 0.96 0.94 0.92 0.99 0.95 Market Cap 8.0 8.4% 24% 0.345 0.099 1.079 8.4% 22.2% 0.38 0.11 1.01 0.92 0.88 0.93 0.93 Cramer 8.0 8.5% 26% 0.325 0.096 1.073 8.4% 22.2% 0.38 0.11 1.02 0.86 0.85 0.93 0.91 Equal Weight 4.1 15.2% 18% 0.86 0.523 1.059 17.0% 15.8% 1.08 0.80 0.90 0.80 0.66 0.94 0.82 Random* 7.2 1%* 32% 0.032 -0.036 1.25 8.2% 23.0% 0.36 0.11 0.13 0.09 -0.33* 0.8 NaN* *Due to the slight difference in how returns are calculated between the method outlined and the Calmar ratio in the performance analytics package for R, an imaginary solution is produced when the harmonic mean is taken. The results in Table 2 seem to support the notion that the market is efficient. Most portfolios do not do much better than the market portfolio when scored on all attributes. Nevertheless, some highlights worth discussing do stand out. The risk-efficient portfolio does very well vis-à-vis the benchmark. The observed period however is very short, wherein hordes of bond-market refugees have been forcibly evicted by the world’s central banks from their tranquil abode in fixed income into the turbulent equity market. They have found sanctuary in mostly low volatility utilities, staples, and healthcare stocks, which have been pumped to very pricey historical levels. (As an example, Clorox, a maker of bleach, has a PEG of 4.24, and trades at 22x FW earnings!). Whether this outperformance will persist in these “bond-market” equivalents is dubious. The value-momentum portfolio stands out in that its standard deviation is markèdly lower than the market portfolio. The excellent feature of this portfolio is that its beta is about 30% less than that of the market portfolio, implying that using about 44% leverage would bring the portfolio up to a beta of one, yielding 33% annualized return within the observed period, nice! Warren Buffett’s S&P 500-only suggestion scores considerably worse than what academia advocates by holding the market portfolio, or what the Seeking Alpha’s contributor has pointed out about mid-cap companies having favorable attributes. Both the market, VTI, and mid-cap indices, VO, outperform even after adjusting for risk. We see the “Cramer” portfolio performing in line with the market, and doing considerably better than the random 11 stock portfolio. This stark contrast hints that Cramer does a decent job of avoiding some of the landmines that make the random portfolio the worst of the cohort examined here. It also might indicate that even a bit of stock-picking diligence in a concentrated portfolio goes a long-way toward approaching the market return (even if not beating it). Portfolios with Slack We now make the exercise a bit more realistic in the sense that we allow the equal weight allocations to increase by 10%, which is an amount by that Vanguard found to be a good for a rebalancing policy in this paper . Aside from a rebalancing strategy, this 10% slack also allows the investor some room to “play” with the same assets within the allocation to demonstrate mythical alpha . Using quadratic programming, the ex-post mean-variance efficient allocation was computed with no margin, and a zero-bound no short-selling constraint with 10% slack to overweight. This optimizes the allocation amongst assets for the period. The solution represents a reasonable amount of alpha an investor might hope to attain with a long-only portfolio containing only a few assets. (In the real world, investors can shift money in and out of the market to generate even more alpha , but here we’re assuming they are placing informed risk-efficient bets for the entire observed period – drastically overstating their initial knowledge, but perhaps substantially understating their ability to react dynamically to new information). Table 3: Equal Weight Portfolios Mean-Variance Optimized ex post with +10% slack PORTFOLIO DATA (years) Portfolio Stats Benchmark Relative Stats (stat_portfolio/stat_benchmark) R SD Sharpe Calmar Beta R SD Sharpe Calmar R Sharpe Calmar Beta^-1 Score Cramer 8.0 13.6% 23.0% 0.59 0.219 0.986 8.4% 22.2% 0.38 0.11 1.63 1.57 1.94 1.01 1.50 Risk Efficient 1.9 20.1% 10.1% 1.99 3.752 0.798 20.7% 11.6% 1.79 2.83 0.97 1.11 1.33 1.25 1.16 Value Moment 2.2 23.0% 9.5% 2.431 2.991 0.713 23.1% 11.6% 1.99 3.15 1.00 1.22 0.95 1.40 1.13 Personal 3.2 21.8% 12.3% 1.778 2.735 0.866 22.0% 13.4% 1.65 2.24 0.99 1.08 1.22 1.16 1.11 Sectors 8.0 8.9% 22.0% 0.406 0.129 0.976 8.4% 22.2% 0.38 0.11 1.07 1.08 1.14 1.02 1.08 Factors 1.6 25.5% 11.7% 2.186 4.951 0.964 23.1% 11.6% 1.99 4.96 1.11 1.10 1.00 1.04 1.06 Mid-Cap 8.0 9.7% 24.7% 0.394 0.119 1.076 8.4% 22.2% 0.38 0.11 1.17 1.05 1.06 0.93 1.05 market 8.0 8.4% 22.2% 0.376 0.113 1 8.4% 22.2% 0.38 0.11 1.00 1.00 1.00 1.00 1.00 Dividend 8.0 8.5% 23.9% 0.355 0.106 1.028 8.4% 22.2% 0.38 0.11 1.01 0.94 0.94 0.97 0.97 S&P 500 8.0 7.9% 22.2% 0.358 0.106 0.989 8.4% 22.2% 0.38 0.11 0.95 0.95 0.95 1.01 0.96 Market Cap 8.0 8.5% 24.1% 0.352 0.102 1.069 8.4% 22.2% 0.38 0.11 1.02 0.94 0.91 0.94 0.95 Equal Weight 4.1 15.5% 17.4% 0.892 0.544 1.056 17.0% 15.8% 1.08 0.80 0.91 0.83 0.68 0.95 0.84 Random 7.2 5.3% 30.9% 0.172 0.026 1.199 8.2% 23.0% 0.36 0.11 0.65 0.49 0.24 0.83 0.50 As Table 2 & 3 reveal that a broad-based ETF allocation strategy is not conducive to generating alpha in that, even with some slack, the returns and risk properties do not change much . The results show that choosing these broad-based ETFs virtually eliminates the possibility for positive alpha in a fixed allocation model though the returns for the sector-based portfolio do improve by about 0.9% annually. But a bit to my own surprise, the “Cramer” concentrated sector and stock-based portfolio jumps to the top of the list, handily beating the market by 520 basis points annually over a fairly long period of 8 years. Even the random portfolio shows that a good cook might be able to make something decent out of an awkward hash of a portfolio, with just a minimal amount of slack, the returns improve by about 430 basis points. I think the large relative gains in the stock-based portfolios illustrate why some investors continue to hold portfolios of individual stocks rather than simply index the equity portion even in the face of evidence that most investors do not outperform. Capturing that last 4-5% of alpha would be economically substantial, and thus may be worth seeking… Disclosure: The author is long USMV, DES. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.