Virginia Investment Partners Optimal Portfolio Allocation

10 Pages Posted: 5 Apr 2010

See all articles by Richard B. Evans

Richard B. Evans

University of Virginia - Darden School of Business

Abstract

This technical note provides a simple, yet powerful, optimization exercise to demonstrate the benefits of diversification in a portfolio and the importance of asset allocation. While the note is targeted for MBA students in an investments or portfolio management course, it is also appropriate for an advanced undergraduate course.

Excerpt

UVA-F-1598

August 25, 2009

Virginia investment partners Optimal Portfolio Allocation

Gazing out your office window at the Blue Ridge Mountains, you ponder how to proceed with your first client. You have recently joined Virginia Investment Partners (VIP) in Charlottesville, VA, and your first assignment is to suggest an investment plan for a prospective client. The client is an IBM executive whose portfolio consists entirely of his company's stock. VIP typically suggests an overall investment plan that allocates the client's assets across three broad classes: U.S. domestic equity as proxied by the S&P 500 Index, U.S. fixed income as proxied by the Lehman Brothers Aggregate Bond Index, and foreign equity as proxied by the MSCI World Index (excluding the United States). To prepare the investment plan, you have access to 10 years of monthly return data for three asset classes and IBM (Exhibit 1) as well as the company's proprietary mean-variance optimizer (Exhibit 2).

1. Using the return data for IBM in Exhibit 1, calculate the mean and standard deviation for the stock.

2. Assume a portfolio with three equally weighted asset classes. Using the return data in Exhibit 1, calculate the monthly return for this portfolio from January 1997 to December 2006. The formula for this return will simply be the weighted average return (i.e., RPortfolio = WeightSP500*RSP500 + WeightMSCI*RMSCI + WeightLehmanAgg*RLehmanAgg). From these returns, calculate the mean and standard deviation of the portfolio. What arguments could be made for the client to sell IBM and diversify into such a portfolio? What arguments could be made against it?

. . .

Keywords: Portfolio optimization, diversification, asset allocation, the risk and return tradeoff.

Suggested Citation

Evans, Richard B., Virginia Investment Partners Optimal Portfolio Allocation. Darden Case No. UVA-F-1598. Available at SSRN: https://ssrn.com/abstract=1583749

Richard B. Evans (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4030 (Phone)
434-243-7680 (Fax)

HOME PAGE: http://faculty.darden.virginia.edu/evansr/

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