Page 97 - BFSI CHRONICLE 10 th Issue (2nd Annual Issue ) 23062 COPY.indd

BFSI Chronicle, 2 Annual Issue, 10 Edition July 2022
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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
a given level of risk is the most efficient and optimal because they have a higher level of
optimal. Every investor should strive to risk for the defined rate of return. Portfolios
along the efficient frontiers are the ones that
construct an Efficient Portfolio for themselves
for long- term superior investment outcomes. are efficient, and investors need to choose
portfolios along the efficient frontier curve to
The Efficient Frontier experience the optimal investment outcome.
Markowitz suggested it was important
for investors to determine the level of Choosing Your Asset Allocation
diversification that best suited them. This can Since each asset class has its own risk-return
be achieved through what he called Efficient characteristics, investors should consider their
Frontier - a graphical representation of the set Risk Tolerance, Financial Goals and investment
of efficient (optimal) portfolios that offer the Time Horizon as the key determinants for their
asset allocation. All of these are important
highest expected returns for a defined level
of risk, or the lowest risk for a given level of considerations as investors look to create
expected returns. By positioning along the efficient portfolios and stay positioned along
efficient frontier curve, investors could: the efficient frontier.
1. At every level of return, create a portfolio The current market volatility, consequent upon
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!

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