In: Finance
Which is the optimal return combination for both the US/UK and US Spain?
US | UK | SPAIN | CH13 | INTERNATIONAL PORTFOLIO DIVERSIFICATION ANALYSIS | |||||||||
ER | 15% | 12% | 5% | DEVELOPED VS EMERGING MARKET DIVERSIFICATION | |||||||||
STD | 10% | 9% | 4% | CAN-β= | CAN$ rose by | COL Peso fell by | |||||||
CORR | 1 | 0.33 | 0.06 | COL-β= | US&CAN* $Ret= | US&COL* $Ret | |||||||
CV | 1.5 | 1.3333 | 1.25 | ||||||||||
Weights | W1 | 100% | 90% | 80% | 70% | 60% | 50% | 40% | 30% | 20% | 10% | 0% | |
W2 | 0% | 10% | 20% | 30% | 40% | 50% | 60% | 70% | 80% | 90% | 100% | ||
US&UK | ER | 15.00% | 14.70% | 14.40% | 14.10% | 13.80% | 13.50% | 13.20% | 12.90% | 12.60% | 12.30% | 12.00% | |
STD | 10.0% | 9.34% | 8.76% | 8.29% | 7.95% | 7.75% | 7.71% | 7.82% | 8.08% | 8.48% | 9.00% | ||
US&SPAIN | ER | 15.00% | 14.00% | 13.00% | 12.00% | 11.00% | 10.00% | 9.00% | 8.00% | 7.00% | 6.00% | 5.00% | |
STD | 10.00% | 9.03% | 8.09% | 7.17% | 6.30% | 5.50% | 4.79% | 4.22% | 3.87% | 3.79% | 4.00% |
An optimal-risk portfolio is typically somewhere in the middle of the curve of returns and volatility, owing to the fact that the higher you go up the curve, the greater the proportion of risk you take on to the potential of return. On the other end, low risk/ low return portfolios have generally been considered a waste of time, as one can achieve a similar return by simply investing in risk-free securities and assets, like government bonds or sovereign treasuries.
An individual investor can determine how much volatility he or she is willing to maintain in his other portfolio by picking another point which lies along the so-called efficient frontier. An investor looks out for maximum returns for the amount of risk that he can handle.
In case the expected returns are given then we can compute the return per risk unit using Sharpe & Treynor Ratio and take a decision.
However, in the above scenario, US & UK at 40% & 60% as well as US & Spain at 10% and 90% should not be blindly taken to since it minimizes risk. We should consider the return per risk unit and take a decision.
For computing Return per risk unit we will divide the return in each scenario by the Standard Deviation
Weights | W1 | 100% | 90.0% | 80.0% | 70.0% | 60.0% | 50.0% | 40.0% | 30.0% | 20.0% | 10.0% | 0.0% |
W2 | 0% | 10.0% | 20.0% | 30.0% | 40.0% | 50.0% | 60.0% | 70.0% | 80.0% | 90.0% | 100.0% | |
US & UK | ER | 15.00% | 14.70% | 14.40% | 14.10% | 13.80% | 13.50% | 13.20% | 12.90% | 12.60% | 12.30% | 12.00% |
STD | 10.00% | 9.34% | 8.76% | 8.29% | 7.95% | 7.75% | 7.71% | 7.82% | 8.08% | 8.48% | 9.00% | |
1.50 | 1.57 | 1.64 | 1.70 | 1.74 | 1.74 | 1.71 | 1.65 | 1.56 | 1.45 | 1.33 | ||
US & Spain | ER | 15.00% | 14.00% | 13.00% | 12.00% | 11.00% | 10.00% | 9.00% | 8.00% | 7.00% | 6.00% | 5.00% |
STD | 10.00% | 9.03% | 8.09% | 7.17% | 6.30% | 5.50% | 4.79% | 4.22% | 3.87% | 3.79% | 4.00% | |
1.50 | 1.55 | 1.61 | 1.67 | 1.75 | 1.82 | 1.88 | 1.90 | 1.81 | 1.58 | 1.25 |
Hence, We should choose 50% - 50% distribution for US & UK and 30% - 70% for US & Spain portfolio, since it maximises return per risk unit.