Optimized Portfolio
About the report
The report is commissioned to construct a 3-asset optimal portfolio. Important to note, optimal portfolio is the one that offers highest risk-adjusted return to the investors amongst all the other portfolios available. For the purpose of this report, we have selected three different stocks, namely. Apple Inc, Bio Tech Holdings and Novavax. It is considerable that these three stocks were not just random pics but were selected as part of the diversification strategy.
According to the diversification rule, ‘’When an investor diversifies his holding across assets that are less than perfectly correlated, the weighted average risk of the portfolio is less than that of the individual security, and the risk that is eliminated is the unsystematic risk, i.e. the non-priced risk’’. Therefore, I selected stocks from different industries that share less than perfect correlation. Highlighted below is the correlation between the three stocks:
As we can see that since these stocks share minimal correlation, we prepared our portfolio for the diversification benefit
Expected Return and Standard Deviation
Once I had selected suitable stocks for my portfolio, the next step was calculating the expected return and standard deviation for each of them. Accordingly, we used past 5-year monthly stock prices of the companies and calculated monthly average return and standard deviation. Thereafter, we annualized monthly returns and standard deviation using appropriate formulas. Highlighted below is return and risk information relating with each stock:
Optimal Portfolio and Sharpe Ratio
Even though I was supposed to construct the portfolio in the given software, however, I chose to check the results in excel too using the solver function. Therefore, I used the sharpe ratio to standardize the risk adjusted returns under equal weighted portfolio and then maximizing the sharpe ratio using solver function under the constraint of no short sales.Highlighted below is the portfolio return, risk and sharpe ratio before optimizing it:
Optimized Portfolio
Therefore, following the optimization method, the portfolio with 69.63% allocation in Apple, 15.60% in NOVM and 14.77% in BPTH will be the optimized portfolio.
