Abstract
It has been widely observed that capitalization-weighted indexes can be
beaten by surprisingly simple, systematic investment strategies. Indeed, in the
U.S. stock market, equal-weighted portfolios, random-weighted portfolios, and
other naive, non- optimized portfolios tend to outperform a
capitalization-weighted index over the long term. This outperformance is
generally attributed to beneficial factor exposures. Here, we provide a deeper,
more general explanation of this phenomenon by decomposing portfolio
log-returns into an average growth and an excess growth component. Using a
rank-based empirical study we argue that the excess growth component plays the
major role in explaining the outperformance of naive portfolios. In particular,
individual stock growth rates are not as critical as is traditionally assumed.
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