How Uncorrelated Strategies Can Improve Portfolio Sharpe
Summary
This tutorial illustrates how combining assets or strategies can smooth portfolio returns and raise the portfolio Sharpe ratio, even when individual components have weak risk-adjusted performance. It generates synthetic return series, builds equal-weight combinations of increasing size, and compares their equity curves and Sharpe ratios. A second set of examples introduces correlations among returns to show that diversification benefits diminish as components move more closely together.
The examples are explanatory simulations, not evidence from live markets or a historical backtest. Their conclusions depend on the chosen return distribution, equal weighting, and assumed correlation structure; real strategies may share changing exposures, incur costs, and behave differently in stress periods. The useful principle is that portfolio risk depends on relationships among component returns as well as each component’s standalone performance, so adding strategies helps most when their returns are not highly correlated.
Key ideas
- Combining multiple return streams can reduce portfolio volatility and improve risk-adjusted performance.
- The examples use synthetic returns to compare portfolios with different numbers of components.
- Higher correlation among component returns reduces the diversification benefit.
- The illustrations assume equal weighting and a specified return and correlation model.
- Live performance may differ because correlations, costs, and market behavior can change.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.