We are delighted to share with you our recent research piece: “Maximum Diversification vs Minimum Volatility”.

You can download the piece below.

After mounting evidence of the risks involved in investing in a concentrated, inefficient, biased, and poorly constructed market capitalization weighted index, investors are (yet again) increasingly turning towards the alternative weighting schemes also known as the “Smart Beta” strategies. These alternative weighting schemes are seen by investors as alternatives that are expected to offer better return, or risk adjusted return over the long term when compared to cap-weighted indices.

Investors who anticipate that markets are close to or have already reached an inflection point, tend to look for strategies that are well-known for their risk reducing properties. As such, we often hear the question asking to what extent – ‘Maximum Diversification’ and ‘Minimum Volatility’ are different.

Based on diversification metrics of the market, there never was a better time to change from a market-cap weighted portfolio to a truly diversified one. So, looking at different options, it might be worthwhile making the distinction between ‘Maximum Diversification’ and ‘Minimum Volatility’ the subject of this dashboard.

In what follows, we attempt to highlight the difference between ‘Maximum Diversification’ and ‘Minimum Volatility’ portfolio optimization approaches in terms of their construction methodology and the implications of these construction choices in their risk-return performance profiles. We notably highlight:

• how both portfolios achieve better diversification and risk-adjusted returns over the cap-weighted index in the long run
• how ‘Maximum Diversification’, with its pure focus on diversification, achieves better diversification and risk-adjusted returns over the cap-weighted index in an unbiased way
• how ‘Minimum Volatility’ takes on bets on ‘Low Volatility’ stocks in order to achieve risk reduction, and some not-so-obvious empirical consequences of these bets

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