Minimizing Shortfall

TL;DR

This empirical study compares shortfall optimization with Barra Style Factors to variance minimization across US, UK, and Japanese markets, showing shortfall's superior performance especially during downturns from 1985-2010.

Contribution

It provides the first comprehensive empirical comparison of shortfall and variance optimization using Barra Style Factors across multiple international markets.

Findings

Shortfall optimization outperforms variance minimization during market downturns.

Minimizing shortfall leads to tilts towards protective factors like Value.

Performance improvement is most notable when measuring overall asymmetry.

Abstract

This paper describes an empirical study of shortfall optimization with Barra Extreme Risk. We compare minimum shortfall to minimum variance portfolios in the US, UK, and Japanese equity markets using Barra Style Factors (Value, Growth, Momentum, etc.). We show that minimizing shortfall generally improves performance over minimizing variance, especially during down-markets, over the period 1985-2010. The outperformance of shortfall is due to intuitive tilts towards protective factors like Value, and away from aggressive factors like Growth and Momentum. The outperformance is largest for the shortfall that measures overall asymmetry rather than the extreme losses.