Title: Asset allocation and downside risk

Authors: Joel R. Barber

Addresses: Department of Finance, College of Business, Florida International University, 11201 SW 8th Street, Miami, FL 33199, USA

Abstract: Economists have long recognised that investors care more about downside risk than total variation, which includes upside gains. This paper develops a new technique, along the lines of Sharpe's (1990, 1992) asset-class model, to measure the performance of an actively managed portfolio with respect to downside risk. The new technique involves choosing a multiple asset-class benchmark with the highest possible correlation with the active strategy return subject to the constraint that the risks are the same. The risk-matched portfolio can be used to measure the performance of an active portfolio with respect to downside risk. Because, by construction the risk of the benchmark is the same as the active portfolio, it is a simple matter to compare the performance of the active to the benchmark using the Sortino ratio. To illustrate the new technique, we compare the performance of exchange traded funds that track S&P equal-weighted and value weighed sector indexes.

Keywords: asset-class models; downside risk; performance measurement; Sharpe ratio; Sortino ratio.

DOI: 10.1504/IJPAM.2021.115662

International Journal of Portfolio Analysis and Management, 2021 Vol.2 No.3, pp.268 - 284

Received: 15 May 2020
Accepted: 24 Jan 2021

Published online: 04 Jun 2021 *

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