Betas, Benchmarks and Beating the Market

TL;DR

This paper presents a straightforward algorithm and source code for constructing long-only benchmark portfolios using a multifactor risk model, enabling market outperformance strategies without complex computations.

Contribution

It introduces a novel explicit formulaic method for building positive-weight long-only benchmarks using a tailored multifactor risk model, avoiding principal components and iterative procedures.

Findings

Provides an explicit, non-iterative algorithm for benchmark construction

Uses a multifactor risk model with industry classification for weights

Enables long-only market outperformance strategies

Abstract

We give an explicit formulaic algorithm and source code for building long-only benchmark portfolios and then using these benchmarks in long-only market outperformance strategies. The benchmarks (or the corresponding betas) do not involve any principal components, nor do they require iterations. Instead, we use a multifactor risk model (which utilizes multilevel industry classification or clustering) specifically tailored to long-only benchmark portfolios to compute their weights, which are explicitly positive in our construction.