The Benefits of Diversification
Modern Portfolio Theory: Diversification Increases Risk-Adjusted Returns
Click here to watch Michael Azlen, Founder and Executive Chairman, speaking on this topic.
Markowitz’s Nobel Prize-winning theory proved that lower risk and higher risk-adjusted returns can be achieved through combining investments with varied correlations. The lower the correlation, the greater the diversification benefit derived.
Alternative asset classes, with their ability to generate attractive returns throughout the economic cycle, significantly increase portfolio efficiency. Leveraging or deleveraging this efficent portfolio is a superior method of changing the risk/return profile of a portfolio compared to the more common method of altering the asset allocation.
The Importance of Diversification: Expanding the Efficient Frontier
Markowitz's Modern Portfolio Theory defined the Efficient Frontier as a curve on a risk-reward payoff graph that represents the 'optimal' portfolios - those that have the highest expected return for a given level of risk. The Efficient Frontier can be moved up (increasing returns) and to the left (reducing risk) by diversifying across asset classes with varied correlations and by using indexing strategies to save cost.
As financial markets become more global in nature, combining foreign equities with domestic equities no longer porvides sufficient diversifcation benefits. The growth of alternative asset classes, such as commodities and hedge funds, with lower correlations to traditional equity and bond asset classes, has allowed investors to further diversify their portfolios and increase risk-adjusted returns. Frontier are leaders in multi-asset and alternative investing, and will continue to seek new ways of expanding the Efficient Frontier for investors.
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