Riding the 1/N Premium

Abstract

This article proposes a simple and effective rotation strategy. The strategy rotates between the value-weighted market portfolio (VW) and the equal-weighted counterpart (EW) based on an implicit market signal—the lagged one-month market return. The authors report a statistically significant relation between the lagged one-month market return and the future 1/N premium, which is the return difference between the EW and VW portfolios. Building on the predictive quality and exploiting the time-varying nature of the 1/N premium, they introduce a transparent and robust investment strategy that yields superior absolute and risk-adjusted returns.

TOPICS: Portfolio construction, statistical methods, security analysis and valuation, performance measurement

Key Findings

• ▪ The authors propose a simple market-based signal to rotate between value- and equal-weighted portfolios.

• ▪ The signal quality is statistically significant and robust across the world.

• ▪ The strategy generates significant alpha after accounting for transaction costs.