Generative AI-enhanced Sector-based Investment Portfolio Construction

TL;DR

This study evaluates the use of Large Language Models from various providers in constructing sector-based investment portfolios, revealing their strengths and limitations across different market conditions and emphasizing the benefits of hybrid AI-quantitative approaches.

Contribution

It provides one of the first comprehensive multi-model, cross-provider assessments of generative AI in investment management, highlighting their market-dependent performance and potential when combined with traditional methods.

Findings

LLMs outperform sector indices during stable markets.

LLMs underperform in volatile markets, indicating sensitivity to regime shifts.

Hybrid approaches improve portfolio performance and robustness.

Abstract

This paper investigates how Large Language Models (LLMs) from leading providers (OpenAI, Google, Anthropic, DeepSeek, and xAI) can be applied to quantitative sector-based portfolio construction. We use LLMs to identify investable universes of stocks within S&P 500 sector indices and evaluate how their selections perform when combined with classical portfolio optimization methods. Each model was prompted to select and weight 20 stocks per sector, and the resulting portfolios were compared with their respective sector indices across two distinct out-of-sample periods: a stable market phase (January-March 2025) and a volatile phase (April-June 2025). Our results reveal a strong temporal dependence in LLM portfolio performance. During stable market conditions, LLM-weighted portfolios frequently outperformed sector indices on both cumulative return and risk-adjusted (Sharpe ratio) measures. However, during the volatile period, many LLM portfolios underperformed, suggesting that current models may struggle to adapt to regime shifts or high-volatility environments underrepresented in their training data. Importantly, when LLM-based stock selection is combined with traditional optimization techniques, portfolio outcomes improve in both performance and consistency. This study contributes one of the first multi-model, cross-provider evaluations of generative AI algorithms in investment management. It highlights that while LLMs can effectively complement quantitative finance by enhancing stock selection and interpretability, their reliability remains market-dependent. The findings underscore the potential of hybrid AI-quantitative frameworks, integrating LLM reasoning with established optimization techniques, to produce more robust and adaptive investment strategies.