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Portfolio turnover when IC is time-varying

Author

Listed:
  • Zhuanxin Ding

    (Analytic Investors)

  • R. Douglas Martin

    (University of Washington)

  • Chaojun Yang

    (Shanghai Jiao-Tong University)

Abstract

We develop new formulas for the turnover and leverage of mean–variance optimal long–short market neutral portfolios, where active weights are obtained using a factor model conditional mean forecast and a conditional forecast error covariance matrix that reflects strategy risk. We show that for eight commonly used quantitative factors, the turnovers and leverages derived using our long–short formulas are quite close to what the practitioners actually implement. We further carry out extensive simulations for long-only active portfolios and develop a highly accurate empirical formula that relates long-only turnover to long–short turnover, a transfer coefficient, portfolio target tracking error, strategy risk and a benchmark choice coefficient. Our result shows that when the proper risk model is used in factor investing, the optimal portfolio’s turnover and leverage are well within reasonable practically implementable ranges even if no additional constraints are imposed.

Suggested Citation

  • Zhuanxin Ding & R. Douglas Martin & Chaojun Yang, 2020. "Portfolio turnover when IC is time-varying," Journal of Asset Management, Palgrave Macmillan, vol. 21(7), pages 609-622, December.
    • Handle: RePEc:pal:assmgt:v:21:y:2020:i:7:d:10.1057_s41260-019-00145-1
    DOI: 10.1057/s41260-019-00145-1
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    References listed on IDEAS

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    1. David King, 2007. "Portfolio optimisation and diversification," Journal of Asset Management, Palgrave Macmillan, vol. 8(5), pages 296-307, December.
    2. Ding, Zhuanxin & Martin, R. Douglas, 2017. "The fundamental law of active management: Redux," Journal of Empirical Finance, Elsevier, vol. 43(C), pages 91-114.
    3. Treynor, Jack L & Black, Fischer, 1973. "How to Use Security Analysis to Improve Portfolio Selection," The Journal of Business, University of Chicago Press, vol. 46(1), pages 66-86, January.
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    Cited by:

    1. Lars Heinrich & Antoniya Shivarova & Martin Zurek, 2021. "Factor investing: alpha concentration versus diversification," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 464-487, October.
    2. Feng Zhang & Xi Wang & Honggao Cao, 2021. "Turnover-Adjusted Information Ratio," Papers 2105.10306, arXiv.org.

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