Efficient Asset Allocation for Individual Investors in the ETF World

Abstract

ABSTRACT Research has shown that investment success is largely driven by asset allocation. With the dramatic growth in number of exchange-traded funds (ETFs), individual investors have gained access to a wicie variety of funds including funds representing non-traditional asset classes, This proliferation of ETFs allows investors to take advantage of high return alternatives while maintaining an asset allocation that is well diversified. This paper explores the potential for creating effcient portfolios using ETFs exclusively. We use price data from 2007 to 2017 for thirty-four ETFs to demonstrate that a portfolio of ETFs based on an average optimal weight allocation has a higher Sharpe ratio than 85 percent of the ETFs studied. Constructing effcient portfolios based on the average of optimized weights improves this portfolio’s returns by 370 basis points and increases the Sharpe ratio significantly as compared with ex ante mean-variance optimization. We conclude that investors can benefit from using average optimized weights in building portfolios made up primarily of ETFs.