The Weighting Is the Hardest Part: Superiority of Equal Weighting Countries in Emerging and Frontier Markets
Diversification is commonly considered to be the “free lunch” of portfolio management, in that higher expected returns with lower volatility are achievable simply by diversifying. However, how should this diversification be achieved? The answer depends on investors’ predictions of volatility, correlation, and the expected growth rates of the portfolio constituents. While it is already a challenge to get “good” estimates for these metrics in most asset classes, it is especially true in emerging markets, where countrylevel macro-economic shocks are frequent and unpredictable, and stock-level information is often not reliable. Under these conditions, we would contend that the naïve equal-weighted portfolio is the rational choice for achieving diversification.