Equal vs. Value and Price-Weighted Portfolios: Who Wins?

Equal-weighted portfolio of stocks in the major US equity indices with monthly rebalancing outperforms value- and price-weighted portfolios, a new report claims.

(March 28, 2012) — “Why does an equal-weighted portfolio outperform value- and price-weighted portfolios?,” asks a newly released report.

According to the authors — Yuliya Plyakha and Grigory Vilkov of the Goethe University of Frankfurt and Raman Uppal from the EDHEC Business School — the higher systematic return of the equal-weighted portfolio comes from its higher exposure to the market, size, and value factors. The report continues: “The higher alpha of the equal-weighted portfolio arises from the monthly rebalancing required to maintain equal weights, which is a contrarian strategy that exploits reversal and idiosyncratic volatility of the stock returns; thus, alpha depends only on the monthly rebalancing and not on the choice of initial weights.”

The report compares the performance of equal-, value-, and price-weighted portfolios of stocks in the major US equity indices over the last four decades. While an equal-weighted portfolio has greater portfolio risk, the report asserts that equal-weighted portfolios with monthly rebalancing outperform value- and price-weighted portfolios in terms of total mean return, four factor alpha, Sharpe ratio, and certainty-equivalent return.

“The total return of the equal-weighted portfolio exceeds that of the value- and price-weighted because the equal-weighted portfolio has both a higher return for bearing systematic risk and a higher alpha measured,” the report says. However, the equal-weighted portfolio has a higher volatility (standard deviation) and kurtosis compared to the value- and price-weighted portfolios.

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The conclusion: “The results…imply that the source of the superior performance of the equal- weighted portfolio is its significantly higher mean return, along with its less-negatively skewed returns.”

To complete the analysis, the authors constructed equal-, value-, and price-weighted portfolios from 100 stocks randomly selected from the constituents of the S&P500 index over the last 40 years.

Click here to download the full report.

Rocaton Investment Advisors has launched discretionary consulting services to reap better margins and for the need to adapt as its clients' needs change, says Robin Pellish, the investment consulting firm's CEO.

(March 28, 2012) — Rocaton Investment Advisors has joined the outsourced CIO — also known as “discretionary consulting” — bandwagon.

The firm announced that it would begin offering the service, as it has OK’ed its first discretionary consulting client. The new service will allow Rocaton to oversee total portfolios for their clients.

“Rocaton is anything but an impulsive organization,” Robin Pellish, the investment consulting firm’s CEO, told aiCIO. “We’ve grown slowly and methodically, and we felt that getting into the outsourced business makes sense for us.”

According to Pellish, the firm’s decision to pursue the outsourced CIO business stems largely from its hiring of John Nawrocki — who joined in 2011 from Rogerscasey where he led the outsourcing arm. Nawrocki will oversee Rocaton’s discretionary consulting business.

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Rocaton was spurred to offer discretionary services, first reported by Pensions & Investments, when one of its clients, a non-public defined benefit plan, requested discretionary consulting on an implemented basis. “We already had resources in place with John and had been thinking about offering discretionary consulting for several years — we observed the trend of more and more consulting firms offering this service.”

The trend toward discretionary consulting is obvious.

In June, NEPC revealed that amid growing client demand, the consulting firm was making its way into the field of discretionary consulting. “We’ve been forced to look into this business for many years now,” NEPC’s Steve Charlton told aiCIO when asked about what spurred the decision to move into the space. “A lot of our clients are choosing to go the outsourcing route. For many years we felt it wasn’t that big of a deal,” he said. “But that started to change last year when we received more requests for proposals (RFPs) asking for discretionary services.”

During that same month, the $40 billion Alaska Permanent Fund CIO Jeffrey Scott announced that he would leave the sovereign wealth fund and join Wurts & Associates, heading the firm’s discretionary asset management division.

When asked about the reasons for the transition into outsourced services, Rocaton’s Pellish attributed it to better margins and the need to adapt. “While requests for outsourced CIO services started with smaller funds years ago within the defined benefit pension space and endowments in particular, those requests are now not confined to a particular sector. Funds want to outsource to a consultant whose sole competency is doing that,” Pellish said.

In terms of the explanation behind the resistance among some consultants to offer the service, Pellish cited infrastructure. “Discretionary consulting requires a certain amount of administrative capabilities that have to be in-house, which is different for non discretionary consulting. We were fortunate to have these resources in house.”

Few consulting firms are left that have not spread into the outsourced CIO space. Albourne Partners — the world’s largest dedicated alternative investment consulting firm, is one of them. The firm is adamant about offering a fixed fee model, while refusing to take discretion for the advice they offer on investing in a hedge fund manager. In other words, the firm feels strongly that there is a Chinese wall between discretionary and non-discretionary advice on managers.

Rocaton and increasingly other firms, in contrast, echo a similar sentiment about the need, perhaps the pressure, to get into the outsourced CIO business amid the generally low-margin consulting environment. “We need to be competitive. This is a comfortable extension of our capabilities,” Pellish explains.