Why Track Inefficiency?

Abstract

Benchmarks play an important role in assessing performance as a part of the investment process. Modern portfolio theory suggests that the benchmark of the true market portfolio on the efficient frontier is unknown. However, the S&P 500 Index is often used as a proxy for the U.S. domestic equity market portfolio. In this study, the authors examine the efficiency of the S&P 500.The results imply that more efficient subsets of the S&P 500 are easily constructed by randomly selecting stocks across industry sectors within the S&P 500. The implications of the study suggest portfolios consisting of fewer stocks equally weighted across industries are more efficient than the S&P 500 Index.

TOPICS: Portfolio theory, equity portfolio management, portfolio construction