Page 97 - BFSI CHRONICLE 10 th Issue (2nd Annual Issue ) .indd

BFSI Chronicle, 2 Annual Issue, 10 Edition July 2022
th
nd

correlated) assets is a form of Risk Reduction, Figure 1. Efficient Frontier
and enables long-term superior portfolio According to Markowitz, any portfolio that
performance. For example, Stocks and Bonds, falls outside the efficient frontier is considered
normally, tend to move in opposite directions sub-optimal because it carries too much risk
(i.e. inversely correlated) under different relative to its return, or too little return relative
interest rate cycles. And, blending these two is to risk undertaken. Portfolios that lie below the
a classical diversification strategy for portfolio efficient frontier don’t provide optimum return
risk reduction. compared to the risk level. Portfolios that lie to
the right of the efficient frontier are also sub-
The portfolio giving the highest return for
optimal because they have a higher level of
a given level of risk is the most efficient and risk for the defined rate of return. Portfolios
optimal. Every investor should strive to along the efficient frontiers are the ones that
construct an Efficient Portfolio for themselves are efficient, and investors need to choose
for long- term superior investment outcomes.
portfolios along the efficient frontier curve to
The Efficient Frontier experience the optimal investment outcome.
Markowitz suggested it was important Choosing Your Asset Allocation
for investors to determine the level of
Since each asset class has its own risk-return
diversification that best suited them. This can characteristics, investors should consider their
be achieved through what he called Efficient Risk Tolerance, Financial Goals and investment
Frontier - a graphical representation of the set Time Horizon as the key determinants for their
of efficient (optimal) portfolios that offer the asset allocation. All of these are important
highest expected returns for a defined level
considerations as investors look to create
of risk, or the lowest risk for a given level of efficient portfolios and stay positioned along
expected returns. By positioning along the the efficient frontier.
efficient frontier curve, investors could:
The current market volatility, consequent upon
1. At every level of return, create a portfolio surging macro risks like global inflation, rising
that offers the lowest possible risk.
interest rates, looming fear of recession and geo
2. For every level of risk, create a portfolio political tensions call for far greater emphasis
that offers the highest return. on asset allocation. The need for efficient
portfolio construction is beyond exaggeration!

The Institute Of Cost Accountants Of India

97