Mike, our portfolio manager, has over 10,000 hours of very hard labor using just about every type of portfolio optimizer ever sold (up until mid-2003). But guess what? Also, asset allocation in general "didn't work" in 2011 either, as you can read about If the optimizer thinks adding a particular asset provides a diversification benefit, which could potentially lead to lower overall portfolio risk, without lowering the return significantly, the program will choose to use this asset at the exclusion of others. Two investments that have moved in opposite directions over the last ten years, could have moved in sync with each other over the last five years, or just one-year. Once an investment is sold, and the money spent, the loss cannot be made up again (in contrast to reinvesting the sale proceeds into another investment). Estimate Efficient Frontiers for Portfolio Object Given any portfolio, the functions estimatePortReturn , estimatePortRisk , … analysis, Estimate specified number of optimal portfolios on the efficient frontier, Estimate optimal portfolios with targeted portfolio returns, Estimate optimal portfolios with targeted portfolio risks, Estimate optimal portfolios at endpoints of efficient frontier, Estimate efficient portfolio to maximize Sharpe ratio for Portfolio Having to tell a client the portfolio's return when it's down is the #1 reason why advisers get fired. Portfolio Optimizer Pro uses the HoadleyEfficientFrontier function … Here are the differences in the results: • Optimizing using asset classes overstates diversification. So in a nutshell, all portfolio optimization does is refine and quantify the risk and return characteristics of a certain mix of investment assets (or asset classes) over a past time frame. To obtain efficient portfolios that have targeted In other words, a good professional advisor can sometimes pick better investments to work with than generic asset classes or indices. portfolio optimization problem using the problem-based approach. 2) A suntan lotion / sunglasses / surf shop that returns 7% ±10% during the summer, and 5% ± 2% during the winter. The problem with that is that you can only find index funds for a little more than half of the asset classes in the Real World (and using ETFs offer little-to-no help here, because they behave more like mutual funds than index funds, plus they have much too little history for the results to be statistically significant). • Mutual funds can be selected that have a long-term history of outperforming their appropriate benchmark index or asset class. Predicting rates of return on non-fixed / variable investments just can't be done, and anyone who says it can is, as they say, "either a liar or a fool.". This would then be the asset allocation you would get in portfolios. Efficient_Frontier_Portfolios (Excel 2010) (Version 3 corrects the volatility estimate for FrontierPort4.) (Correlation is the mathematical representation where covariance is scaled between 1 and -1 so computers can understand work with it.) In every asset class, there is a wide range of investments to choose from. Obtaining Endpoints of the Efficient Frontier. Investment vehicle returns, and the resulting correlation coefficients, are event driven - so they change daily based on millions of people making investment trades based on how they react to the daily news. But in the summer it returns -5% ± 10%. Portfolio optimization is the heart of what's called "Modern Portfolio Theory," or MPT. That's way too much, and is an example of how you can get into big trouble by letting an optimizer run unconstrained. See the image below). The line represents multiple portfolio possibilities providing the maximum portfolio return with the least risk possible. Project Portfolio Selection: the Efficient Frontier Approach Efficient Frontier Analysis traces its origins to Nobel Prize winner Harry Markowitz and his work related to modern portfolio theory. object, Estimate moments of portfolio returns for Portfolio object, Estimate portfolio risk according to risk proxy associated with corresponding This reduces risk because at any point in time, some asset classes will be performing badly, while others are doing well. VisualMvo is an implementation of the Markowitz critical line algorithm. object, Choose main solver and specify associated solver options for portfolio Computes the efficient frontier For multi-period optimization see the companion program MvoPlus; Free MCRetire with VisualMvo purchase Features Runs on all Windows versions, from Windows 95 through Windows 10, including 64-bit versions Easy to use Windows interface to obtain points over the entire range of the efficient frontier. You can download the image by right clicking on it. It's also called negative correlation, but the differences are minor. That more generic methodology does provide some value, but in order to do this work correctly, you'll need to use the actual assets and not asset classes. Here's an image of correlations between the two elephants in the room - the S&P 500 and 10-year Treasuries. actual results are in the returns, which is the overall goal of investment management in a nutshell, and speak for itself. For example, in most of 2001, the most efficient investment portfolio, given no constraints and the whole universe to work with, was 50% cash and 50% Microsoft stock. A new potential asset class did emerge! The point, and all one can do, is to know (from tinkering with a portfolio optimizer for many years) out of which of the dozens of asset classes that are available to invest in, which have correlation coefficients that are stable enough to use to manage client's money in the Real World.

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