The Application of the Principal Component Analysis for Portfolio Investment Selection with Global ETF
Keywords:
portfolio selection, sector diversification, portfolio diversification, modern portfolio theory, principal components analysisAbstract
This study examines the application of Principal Component Analysis (PCA) in portfolio investment selection with Global ETFs. Using the weekly price data from 216 Global ETFs in the U.S. stock market during 2012–2022, the findings reveal that the Technology sector achieved the highest returns, while the Energy sector had the lowest returns and the highest risk. Consumer Staples exhibited the lowest risk. PCA enabled the selection of representative ETFs for each sector, resulting in an average portfolio correlation of 0.45. Incorporating PCA with Modern Portfolio Theory under the objective of maximizing the Sharpe Ratio of the portfolio, with the constraint of prohibiting short selling, it was found that increasing the investment weightings with an upper limit approach in two ETF sectors can lead to improved returns. Particularly, with an increase in allocation ranging from 10% to 50%, Consumer Staples Equities and Technology Equities in the Semiconductor industry, with an increase in allocation ranging from 3% to 17% can improve rate of return of the portfolio.
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