Anyone for scrabble?

The graph above shows the performance of a market cap-weighted index of US equities against that of a portfolio of US stocks where the weights were chosen by applying the rules of Scrabble.

Every stock has a ticker symbol, that is, a three or four letter code. For example, the ticker for the software group Apple is AAPL, for Exxon Mobil it is XOM. Cass Business School calculated each company’s Scrabble score based upon the points awarded for each letter in the game; AAPL has a Scrabble score of six, while XOM has a points score of 12. They then divided each stock’s Scrabble score by the total Scrabble score of all the stocks in the portfolio, meaning that Exxon Mobil would receive a portfolio weight twice as large as that for Apple. The team repeated this process at the end of each year in their sample, and rebalanced the Scrabble weights as companies entered or left the stock universe over time.
As Cass associate dean Andrew Clare says: “By the end of 2014, $100 invested at the end of December 1968 in the portfolio where weights were determined annually on the basis of market cap, would be worth $7,718. Not bad. But the same $100 invested in the Scrabble score-weighted portfolio would be worth $14,108, almost double the benchmark.”
The outperformance of the Scrabble-weighted portfolio was achieved with slightly more volatility, 16.32%, compared with that of the market cap benchmark, 15.0%, but the overall risk-adjusted performance of the Scrabble portfolio is better since it achieves a Sharpe ratio of 0.44 compared with 0.38 for the benchmark.
“It may be surprising that it is so easy to come up with a portfolio strategy that beats the standard US equity performance benchmark so comprehensively,” says Clare’s colleague Nicholas Motson.
“But this result and our research elsewhere suggests very clearly that the market cap-weighted approach to investing has been a very bad investment strategy over the last few decades.”