Strategic Beta and Style Investing: Implication of a (In)dependent Sorting

We examine the performance of Strategic Beta on investment style portfolios instead of individual stocks. This method simplifies the allocation and reduces the errors in the covariance matrix of returns. We group stocks in categories on size, value and momentum characteristics according to either a traditional independent sort as in Fama and French (1993) or a dependent sort (Lambert and Hübner 2013). Because a dependent sort controls for correlated variables and better stratifies the stock universe in investment style portfolios, Strategic Beta on dependent portfolios delivers significant higher Sharpe ratios. We explain this outperformance with a decomposition of the diversification return from Booth and Fama (1992).