Pi Portfolio Management: Reaching Goals While Avoiding Drawdowns

Abstract

We propose an approach to portfolio selection that explicitly takes into account investors’ simultaneous investment objectives, such as achieving target return levels and avoiding specific drawdowns. Our approach is consistent with both standard and non-standard risk preferences, such as those of prospect theory. Instead of asking the investor to choose between lotteries, transforming this into an estimate of the risk preferences, and then selecting the portfolio accordingly, we propose to directly offer investors a choice between “portfolio lotteries'' with varying probabilities of experiencing target levels of profits and losses. Our approach enables investors to flexibly assess the effectiveness of portfolio choices under various conditions. We discuss implementation considerations and compare our approach to traditional mean-variance portfolio selection.