An alternative strategy for balancing profit maximization and risk reduction.

Abstract

Portfolio diversification is a central theme in modern investment theory. We revisit the classic return-risk trade-off and propose an alternative objective [Formula: see text] that balances higher expected returns with a direct penalty on portfolio volatility via the inverse standard deviation. This objective belongs to the axiomatic class of mean-variance preferences (as formalised by [1] for additively separable forms) and admits tractable solutions, including a closed-form characterisation in the two-asset case. In rolling out-of-sample backtests on standard Fama-French equity portfolios with realistic trading costs and long-only constraints, [Formula: see text] delivers statistically significantly lower realised volatility (paired t-test p < 0.01) and shallower maximum drawdowns than the Sharpe-maximising benchmark, while maintaining average performance comparable to Markowitz, equal-weight, and risk-parity strategies. These advantages persist across major stress episodes (GFC, COVID-19, 2022 rate shock) and are robust over a wide range of the trade-off parameter [Formula: see text]. The results position [Formula: see text] as a pragmatic alternative for investors who value smoother wealth paths and robust downside protection.