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Optimized minimum-variance strategies tend to have low liquidity; high turnover; high tracking error; and concentrated stock, sector, and country positions. Minimum-variance index providers typically mitigate these implementation problems by imposing constraints. The authors construct minimum-variance portfolios for the United States, global developed markets, and emerging markets and apply commonly used constraints to determine their effect on simulated portfolio characteristics, performance, and trading costs. The constraints they test succeed in improving investability but shift portfolio characteristics toward those of the capitalization-weighted benchmark. In particular, each additional constraint increases volatility. Nonetheless, minimum-variance strategies are a valid choice for risk-averse investors.

About the Author(s)

Tzee-Man Chow

Tzee-Man Chow is senior vice president and head of smart beta at Research Affiliates, LLC, Newport Beach, California.

Engin Kose
Engin Kose

Engin Kose is a senior analyst with the systematic team at Allianz Global Investors. His expertise in alpha research and dynamic multi-factor strategies complements the team’s behavioral finance-focused investment process. Dr. Kose has more than 10 years of investment industry experience. Previously, he worked at Research Affiliates. Dr. Kose has authored many published articles and submissions on optimal portfolio construction, including diversification, component weighting, and asset quality and strategy constraints. He earned a BA in economics and mathematics at McGill University and a PhD in finance from Washington University in St. Louis.

Feifei Li

Feifei Li is director of investment strategy at Research Affiliates, LLC, Newport Beach, California.