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The first method gives you the return of a a price-weighted average, like the Dow Jones average. So I suppose it is OK to use. The second method gives you a rebalanced EW (equal weighted) average: you initially invest the same amount (say 1000 dollars) in each stock and then you rebalance to equal weights at each point where you do the calculation. ...


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I think the only valid answer is you can't. The techniques you describe would work of the signal was much stronger than the noise but it seems that with your fund returns this is not the case. You could try to get more data or look at other risk measures like max drawdown to get some idea of the risks involved.


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Here is a simple way of solving the above: Take future returns (use the daily return matrix of all the assets for the future investment horizon), calculate covariance matrix. Calculate weights using future perfect data. Repeat for all time periods. Pick whichever method of estimating the covariance matrix you prefer the most and plug it into 1), likewise ...



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