The Efficient Frontier Concept

Typically people select investments by focusing on past or expected returns. This is a 1-Dimensional investment approach, prone to disappointments.(see Trading psychology)

Sophisticated investors use Portfolio Management, which is equivalent to 3-D investment analysis. The key concept is the Efficient Frontier, originally proposed by Harry Markowitz in the 1950s.

The Efficient Frontier brings in two more dimensions of an investment's quality - the volatility and correlation of returns with other investments.

This ensures that when a portfolio is formed, the expected returns are maximised for a person's tolerance of volatility (commonly known as ‘Risk Profile’).

The chart illustrates that there is a limited zone (just underneath the efficient frontier) where efficient portfolios are placed.

Inefficient portfolios generate unnecessarily low returns, given their volatility.

Click here to see independent validation of our approach. Chart shows result of the medium-volatility "Balanced" risk portfolio as a proxy for all portfolios. 

The process for optimising a portfolio performance is a complex mathematical procedure, aiming to reward those who employ it.

Above-median returns can be targeted, at the expense of the less sophisticated investors whose portfolios lie below the Efficient Frontier. (Note we are not believers in the Efficient Market Hypothesis).

Our approach is based on the integration of the best techniques of the petroleum industry (eg probability distribution of possible outcomes; determine lowside, median and highside; EMV; etc) and financial industry (using correlation cofficients).

While nothing can be guaranteed in life, there is no more rigorous strategy than the Efficient Frontier approach. Investing with the over-arching Efficient Frontier strategy reduces unnecessary risks to your hard earned $$.

Think you know what's the most important factor affecting investment returns?? No, it's not the quality of the company/investment!

To get a basic sketch of the basis of our approach, read the following paper ‘Does Asset Allocation explain 40, 90 or 100% of Performance’ by Ibbotson & Kaplan. This is only the tip of the iceberg - much more rigorous analysis can and should be applied to financial planning…

• We specialise in designing investment portfolios that seek to maximise portfolio return, given a person's risk profile.
• When placing investments, we can choose from many ‘asset sectors’ (eg property, shares, bonds). What are the average returns and volatilities of each sector? How does residental property compare?
• Of the many investment vehicles (e.g. direct shares, managed funds, superannuation, etc) that can be considered, what are the average returns and volatilities?
• Comparing direct shares with managed funds, how wide is the range of possible returns? Which one is less volatile?
• What effect does currency have on international investments?
• When stockmarkets are correcting, there is a tendency to sell and move into cash. This chart shows that even the professionals cannot pick the turning points of markets. Why would the average investor think they can do better?
• Many do-it-yourself Australian investors have Click here to read how smart this isn't…