Portfolio performance under tracking error and benchmark volatility constraints

Abstract

Purpose Using a portfolio comprising liquid global stocks and bonds, this study aims to limit absolute risk to that of a standardised benchmark and determine whether this has a significant impact on expected return in both high volatility period (HV) and low volatility period (LV). Design/methodology/approach Using a traditional benchmark comprising 40% equity and 60% bonds, a constant tracking error (TE) frontier was constructed and implemented. Portfolio performance for different TE constraints and different economic periods (expansion and contraction) was explored. Findings Results indicate that during HV, replicating benchmark portfolio risk produces portfolios that outperform both the maximum return (MR) portfolio and the benchmark. MR portfolios outperform those with the same risk as that of the benchmark in LV. The MR portfolio weights assets to obtain the highest return on the TE frontier. During HV, the benchmark replicated risk portfolio obtained a higher absolute risk value than that of the MR portfolio because of an inefficient benchmark. In HV, the benchmark replicated risk portfolio favoured intermediate maturity treasury bills. Originality/value There is a dearth of literature exploring the performance of active portfolios subject to TE constraints. This work addresses this gap and demonstrates, for the first time, the relative portfolio performance of several standard portfolio choices on the frontier.

Risk-managed time-series momentum: an emerging economy experience

“…This procedure starts with the computation of the last 12 months' cumulative return for all the securities. After computing the cumulative returns, the study formulates the long-short absolute momentum portfolios based on the signs of the cumulative returns (Hausner and van Vuuren, 2021). The present research takes a long position in the stocks having positive cumulative and vice-versa (as shown in Figure 1).…”