Risk optimizations on basis portfolios: The role of sorting

This paper investigates the mean-variance and diversification properties of risk-based strategies ex-ecuted on style or basis portfolios. We show that the performance of these risk strategies is highlysensitive to the sorting procedure used to form the basis assets. Whereas the extant literatureprovides mixed support for the outperformance of smart beta strategies based on scientific diver-sification, our designed strategies outperform both the market model and multifactor model. Ourtesting framework is based on bootstrapped mean-variance spanning tests and shows valid conclu-sions when controlling for multiple testing, transaction costs, and luck from random basis portfolioconstruction rules. Economically, our results are supported by diversification-based properties.