Generative AI-enhanced Sector-based Investment Portfolio Construction

ArXiv ID: 2512.24526 “View on arXiv”

Authors: Alina Voronina, Oleksandr Romanko, Ruiwen Cao, Roy H. Kwon, Rafael Mendoza-Arriaga

Abstract

This paper investigates how Large Language Models (LLMs) from leading providers (OpenAI, Google, Anthropic, DeepSeek, and xAI) can be applied to quantitative sector-based portfolio construction. We use LLMs to identify investable universes of stocks within S&P 500 sector indices and evaluate how their selections perform when combined with classical portfolio optimization methods. Each model was prompted to select and weight 20 stocks per sector, and the resulting portfolios were compared with their respective sector indices across two distinct out-of-sample periods: a stable market phase (January-March 2025) and a volatile phase (April-June 2025). Our results reveal a strong temporal dependence in LLM portfolio performance. During stable market conditions, LLM-weighted portfolios frequently outperformed sector indices on both cumulative return and risk-adjusted (Sharpe ratio) measures. However, during the volatile period, many LLM portfolios underperformed, suggesting that current models may struggle to adapt to regime shifts or high-volatility environments underrepresented in their training data. Importantly, when LLM-based stock selection is combined with traditional optimization techniques, portfolio outcomes improve in both performance and consistency. This study contributes one of the first multi-model, cross-provider evaluations of generative AI algorithms in investment management. It highlights that while LLMs can effectively complement quantitative finance by enhancing stock selection and interpretability, their reliability remains market-dependent. The findings underscore the potential of hybrid AI-quantitative frameworks, integrating LLM reasoning with established optimization techniques, to produce more robust and adaptive investment strategies.

Keywords: Large Language Models (LLMs), Portfolio Construction, Quantitative Finance, Sector Indices, Hybrid AI-Quantitative Frameworks, Equities

Complexity vs Empirical Score

  • Math Complexity: 2.5/10
  • Empirical Rigor: 7.0/10
  • Quadrant: Street Traders
  • Why: The paper focuses on applying existing LLMs and classical portfolio optimization (like mean-variance) with minimal novel mathematical derivations, but employs rigorous out-of-sample backtesting across multiple models and market regimes with performance metrics like Sharpe ratios.
  flowchart TD
    A["<b>Research Goal</b><br/>How do LLMs enhance sector-based portfolio construction?"] --> B["<b>Methodology</b><br/>Prompt 5 LLM providers for<br/>stock selection & weighting (20/sector)"] --> C["<b>Hybrid Processing</b><br/>Combine LLM selections with<br/>Classical Portfolio Optimization"] --> D["<b>Out-of-Sample Testing</b><br/>Compare vs Sector Indices<br/>in 2 market regimes:"] --> E["<b>Key Findings</b><br/>1. Stable Market: LLM portfolios outperform<br/>2. Volatile Market: LLM portfolios struggle<br/>3. Hybrid Frameworks improve robustness"]

    D --> D1["Stable Phase<br/>Jan-Mar 2025"]
    D --> D2["Volatile Phase<br/>Apr-Jun 2025"]