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Portfolio Optimization – Comparison with Default Portfolios in MarketXLS

Comparison Template


Portfolio Optimization is the technique of choosing the best portfolio from a set of standard portfolios based on their investment objective and investment style. The main difference in these portfolios is the risk-return ratio. The financial risk offered by each portfolio is different. Also, as we know, that, higher the risk, the higher is the reward. Hence, the majority of the investors have the following primary objectives of investing:
• Maximizing the returns given the portfolio
• Minimizing the risks assumed while holding the portfolio
To achieve these general investing objectives, the investor needs to compare the distribution of the assets in his portfolio with the asset distribution of the standard portfolios.
Portfolio Optimization is a corollary of the Modern Portfolio Theory (MPT). This theory says that investors want the highest possible return while undertaking the lowest risk.

Example of Portfolio Optimization

Suppose an investor has $100,000. He needs to invest this money for five years and expects a 50% annual rate of return on it. Hence, according to his investment objectives, he decides to invest in a portfolio comprised of 70% stocks and 30% bonds. However, after three months of investing, he finds out that the portfolio’s value has gone down by 25%. He realizes that while deciding to maximize his returns, he missed the risk-taking aspect. He understood that if he wanted higher returns, he needed to take more risk, for which he was not ready. Hence, he decided to compare his portfolio with other standard portfolios and accordingly select the asset classes and select the assets within each class. This would help him diversify his portfolio in different assets and asset classes and earn returns based on the risk he is capable and willing to undertake.

Process of Portfolio Optimization

The process of Portfolio Optimization is as follows:
1. Identifying your investment objectives
2. Understand your risk taking ability and capacity
3. Comprehending your preferences while holding risky assets
4. Searching for Recommended Default Portfolios
5. Creating a template for facilitating the comparison
6. Comparing your Portfolio with the Default Portfolios
7. Selecting the Asset classes of your portfolio
8. Selecting the Assets within each class
Hence, you can see that the process of Portfolio Optimization is not an easy one, with the most challenging part being the search for recommended default portfolios and comparing your portfolio with them.

Portfolio Optimization in MarketXLS

MarketXLS provides ready-to-use templates for facilitating data collection and presentation in an effortless manner. In MarketXLS, there are several functions using which you will be able to compare two different kinds of portfolios using the “Portfolio Comparisons” template.
Investors often require gauging their investment styles and comparing their portfolios with the standard portfolios, representing certain risk-reward ratio. We have designed this template to help investor identify their investment style by assigning them a risk taking ability measure. There are recommended portfolios from which they can choose a Model portfolio to compare it with their own on various parameters.
This template consists of two sections:
• Investor (Active_File)
• Comparison Sheet

‘Active_File’ Sheet

Portfolio Optimization

Legend used for assigning the scoring

In this sheet, based on a sample of questions we gauge the Investor’s risk taking ability and score it.
You have to enter the following information.
Investor Profile Analysis:
• Age Group
• Required Rate of Return
• Time Horizon (Duration) of Investment
• Investment Experience
Behavioural Loss Tolerance
• Willingness to take Financial Risk
• Your preference when holding risky assets
• Your action in past when you faced losses in your portfolio
The template based on its analysis automatically gives the score. The score is given on the basis of the index, which is attached below.
The result of the analysis is given in the ‘Active_File’ Sheet itself. The total score which you can see on the right side is the average of all the seven scores. This score would determine your risk taking ability.

Risk Taking Ability

‘Comparison’ Sheet

Comparison Template

In this sheet, based on the risk taking ability of the investor, we have made a list of some default portfolios, which will suit the investor, and he/she can compare his portfolio with these portfolios on various parameters. The various parameters are Sortino Ratio, Value at Risk, Sharpe Ratio, Portfolio Beta, Portfolio Volatility and 1-Yr Return %.
The investor can choose a recommended portfolio of his choice from the drop-down list encircled in black.

Contents of this sheet

The first table contains the stocks of the Default portfolio, which is selected from the drop-down list. In the second table, you can enter stocks which are there in your portfolio.
Thus, this template would facilitate a comparison between your portfolio and some default portfolios suggested by the template based on your risk-taking ability. In this example, your risk taking ability is 3.00. Based on this score, the template automatically creates a drop-down list of a certain amount of Default Portfolios, which would match your risk taking abilities. There are different Default Portfolios for different scores of risk-taking abilities. If you had a risk taking ability of 2, the template would have given you different portfolios in the drop-down list to select from. In total, there are more than 500 Default Portfolios available in this template.

The Bottom Line

The lengthy and tedious process of Portfolio Optimization is converted into a simple 4-step process.
1. Entering the required input in Investor Profile Analysis section and Behavioral Loss Tolerance Sheet
2. Selecting a Recommended Default portfolio from the available list to facilitate comparison
3. Selecting the Asset classes of your portfolio
4. Selecting the Assets within each class
Investor can add more default portfolios in this directory which has been maintained on worksheet – ‘Default_Portfolios’ and change the excel formulae accordingly to incorporate the additional portfolios for comparison.
You can read about the Default Portfolios here: http://www.lazyportfolioetf.com/allocation/
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None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person.
The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein. The trademarks, if any, are the property of their owners, and no representations are made. All trademarks referenced are the property of their respective owners. Other trademarks and trade names may be used in this document to refer to either the entity claiming the marks and names or their products. MarketXLS disclaims any proprietary interest in trademarks and trade names other than its own or affiliation with the trademark owner.




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