Journal of Investment Strategies

Ali Hirsa
Managing Partner, Sauma Capital LLC & Professor, Columbia University

Welcome to the second issue of the tenth volume of The Journal of Investment Strategies. In this issue you will find three papers: “Correlation diversified passive portfolio strategy based on permutation of assets”, “Strong-hand conjecture: agent-based numerical simulation” and “Cryptocurrency versus other financial instruments: how a small market affects a large market”.

In our first paper, “Correlation diversified passive portfolio strategy based on permutation of assets”, Yutaka Sakurai, Yusuke Yuki, Ryota Katsuki, Takashi Yazane and Fumio Ishizaki propose a new approach to diversifying the risk of a portfolio. They have developed a passive strategy to improve the inverse volatility weighting method by taking into account the correlation between different assets. They call this the correlation diversified portfolio strategy. Their proposed method adjusts the weight vector of the original index based on the permutation of the assets belonging to the original index. They seek a permutation of those assets such that the assets that have a strong correlation with many other assets are placed in the center of the permutation. By reducing the weights of these central assets, we can construct portfolios that are more diversified and have better risk-return characteristics than the original index. Sakurai et al solve this asset-permutation problem by adopting a quantum-inspired approach. Concretely, they convert this permutation problem into a quadratic unconstrained binary optimization problem, and they use simulated annealing to find a near-optimal solution in a reasonable time.

To assess the computational feasibility and effectiveness of the proposed method, they apply their approach to three major US and Japanese indexes, and they provide numerical experiments that show that portfolios constructed according to their method can achieve a higher Sharpe ratio than the original indexes while continuing to have behavior similar to that of the original indexes. They conclude that the correlation diversified portfolio strategy is useful as a passive portfolio strategy that improves index investing.

In the issue’s second paper, “Strong-hand conjecture: agent-based numerical simulation”, Marek Karaś and Anna Serwatka present research on the investment strategies of small and large investors in terms of the strong-hand hypothesis: that is, whether so-called small investors with the same strategy and knowledge about the market as large investors are in an inferior position as a group, even if we assume that both groups of investors have the same portfolio value to start with. They introduce a rebalancing strategy based on the Kim–Markowitz model and add a chaotic investor strategy. They do this by adopting the formula for calculating the estimated price by Kim and Markowitz and check the ratio of the value of the total portfolio of a group of large investors to the value of the total portfolio of a group of small investors (a ratio that was 1 to begin with) and find that at the end of the simulation this ratio was greater than 1. This suggests that large investors have an advantage over small investors, in line with the strong-hand conjecture.

The idea of virtual-world money has been implemented in recent years, and due to its convenience as a way of transferring funds, cryptocurrency has become a substitute for traditional money as a modern electronic means of payment that can potentially change the financial system. In this context, the digital currency market can be assessed as an emerging economic sector that competes with traditional financial markets. The discussion paper in the Investment Strategy Forum of this issue, “Cryptocurrency versus other financial instruments: how a small market affects a large market” by Anna Szczepańska-Przekota, analyzes the impact of cryptocurrencies on the functioning and position of financial markets. Szczepańska-Przekota’s work provides an introduction to cryptocurrencies and follows this with a historical analysis comparing Bitcoin prices against a handful of equities, commodities and currency markets, primarily through the correlation coefficient. Given the very early stage of development that crypto markets are in (especially as an investment asset class), it is not clear that a historical analysis would, by itself, provide significant insight into the trajectory that the markets are likely to take should crypto assets achieve more widespread adoption among investors.

Szczepańska-Przekota’s study covers the economic situation on the cryptocurrency market, the capital market (the S&P 500 index), the commodity market (gold and oil) and the (USD/EUR) currency market. These markets were characterized by descriptive statistics, and linkage studies were based on correlation. The data used for the analysis is weekly data for the period January 2017–March 2021. The author states that, despite the fact that cryptocurrencies arouse great interest, the market is still small compared with traditional financial markets. Until now, stock markets have been considered the riskiest ones in which to invest, but cryptocurrency markets can now be considered as such: they can offer considerable income, but they are very unstable.

On behalf of the editorial board, we hope you are doing well during the Covid-19 pandemic. We thank our readers for their continued support and keen interest in our journal and look forward to sharing with you the growing list of practical papers on a wide variety of topics on modern investment strategies that we continue to receive from both academics and practitioners.