Journal of Portfolio Management - Assignment Example

Annotated Bibliography Chua, D. B., Kritzman, M., &Page, S. (2009). The Myth of Diversification. Journal of Portfolio Management, 36(1), 26–35 Primarily, diversification seeks to elevate a non-performing asset on the issue of portfolio growth. However, in the case where an asset is doing well, diversification should move in tandem with it. The authors analyze the mathematical approach to conditional correlations. In the article, they assume that returns become regularly distributed (Ang, 2014). Using the aid of a broad range of assets, they illustrate that empirical correlations are asymmetric, unlike theoretical conditional correlations. They explain further about portfolio construction concerning upside and downside correlations. Unconditional correlations lead to less conservative portfolios than conditional correlations. Their focus was on strategic asset allocation while arguing that securities ought to be strong enough to withstand turbulence as it occurs. They further elaborate on full-scale optimization as an approach to portfolio construction. The authors aim at explaining correlation mathematics with the assumption of even distribution of returns. They further represent empirical results across a broad range of assets. The representations lead to a conclusion that empirical correlations are asymmetric. Eventually, the authors give a detailed explanation on full-scale optimization that is one of the approaches to portfolio construction. When measuring the theoretical bias expected from conditional correlations, the authors assume the proper distribution of returns. Unlike previous research, the authors make different assumptions about regime-switching models. The article seeks to prove that full-scale optimization better generates portfolios with lower downside correlation and higher upside correlation than mean-variance optimization. Diversification simplifies portfolio growth by incorporating assets that have low correlations with domestic equities. These assets seek to complement a portfolio’s growth by diversification. There is a difference in the use of a full sample of returns instead of a partial sample in correlation mathematics. Empirical relationships are asymmetrical, unlike theoretical correlations. Conventional approaches to portfolio growth ignore correlation asymmetry. Full-scale optimization, unlike other methods, generates collections with a more upside unification and the downside diversification. The difference results from improvements in correlation profiles by evaluating conditional correlation. The approach identifies portfolios that are strong and resilient enough to withstand turbulence in contrast with mean-variance analysis. Chhabra, A., Koneru, R., Zaharoff, L (2011). Modern Portfolio Theorys Third Rail: Achieving Wealth Mobility Through Idiosyncratic Risk. Naturally, people have a need to move up the economic ladder to outdo their current position and reach heights of wealth they have never achieved before regardless of how wealthy they are. The authors investigate how an investor can change their wealth position. They explain that diversification of portfolios has a very minimal contribution to wealth addition. The most efficient way of increasing wealth is through business ownership, reinvesting in companies marriage, inheritance, real estate, and personal finance. Investors should make a division of their assets into the safety net, the market portfolio and the aspirational portfolio for wealth mobility. The modern portfolio theory leverages well diversified market portfolios in a bid to attain outperformance. However, it is risky to leverage the whole market portfolio because investors in search of excess returns become aggressive during bull markets and have to deal with losses when the market turns. The journal article seeks to explain how the need for creating substantial wealth influences behavioral decisions concerning building of personal portfolios. It explores a broad range of investment strategies and determines the one that guarantees an increase in wealth. Consequently, they bring forth the question of whether to take up systematic risk or idiosyncratic risk to achieve upward wealth mobility using modeling returns based on previous norms or projected distributions, MPT, and real-world examples. They make assumptions that will have an almost insignificant effect on the results of the study. The conclusion derived from the study is that an aggressive portfolio plays no role in wealth creation. An efficient portfolio is one that does not eliminate idiosyncratic risk of its constituents. To preserve wealth, an investor needs a diversified portfolio of risks. Wealth generation calls for different investment strategy (Bensanko, 2010). The journal seeks to explain the impact of portfolio diversification on an investor to move up the wealth ladder. Modern portfolio theory eliminates idiosyncratic risk to make an optimal diversified portfolio, and upward mobility is rare with the assumption of idiosyncratic risk.  In the case where an investment portfolio becomes limited to well-diversified portfolios an investor will take up to centuries before moving up the wealth spectrum. Modern Portfolio Theory points out the weakness in idiosyncratic risk. Wealth creation is bidirectional, and investors should create a strong safety net to and a market portfolio with a risk tolerance in harmony with life goals. In reconciling modern portfolio theory with upward wealth mobility, a risk-based framework based on mental accounting is an essential requirement. Bansal, Y., Kumar, S., Verma, P. (2014). Commodity Futures in Portfolio Diversification: Impact on Investors Utility. The authors examine the role of Indian Commodity Futures as an asset class in a conventional portfolio compromising of equity and bond for investors. Investing in commodities enables investors to balance in their exposure to bonds and stocks. During periods of unexpected inflation, debt holdings tend to lose value when the prices of assets rise. Investing in commodities that grow with inflation counters loses that come with inflation. The paper provides information on Indian-Commodity futures market. The mean-variance optimization technique elaborates the diversification benefits of commodity futures in India. The paper also develops on the phenomenon of the effects of risk aversion on risk allocation. Introduction of commodity futures to a portfolio raises the returns without a corresponding increase in risk and with the rise in risk avoidance levels, allocation to commodity future tend to go up. To earn extra returns, investors tend to depend on more than the traditional asset distribution of bonds, treasury bills, stocks, and real estate. Their attention has shifted to alternative assets in a bid to earn extra returns. A portfolio consisting of several asset classes that have a low correlation between them guarantees substantial benefits to an investor. The authors use mean-variance optimization technique to determine the suitability of a portfolio consisting either commodity futures or stocks and bonds. The authors examine prior research that mainly concentrates on adding commodity futures to a portfolio of stocks and bonds. Adding commodity futures to a portfolio creates an inflation hedge. With the use of optimal portfolio strategy in a mean-variance framework, the paper examines the advantages of commodity future investments. The study supports the inclusion of commodity futures in a traditional portfolio to increase the utility of an investor. Introduction of commodity futures in India is a relatively new phenomenon in India, and hence little information is available concerning the subject. Compared to equity, commodity futures have higher returns and lower risk. Thereby it is the best investment tool for risk neutral investor. An allocation in commodity futures leads to an increase in the Sharpe ratio when risk aversion levels increase (Cochrane, 2008). The investor is at a better position holding a composite index in the portfolio of equity and bond. The findings in the research support diversifying properties of commodity futures once included in the conservative portfolio with the ability to increase an investor’s utility. The paper could also aid in studying the conduct of commodity futures as an asset class during inflation. References Ang, A. (2014). Asset management: A systematic approach to factor investing. Besanko, D. (2010). Economics of strategy. Hoboken, NJ: John Wiley & Sons. Cochrane, J. H. (2008). Asset Pricing: (Revised). Princeton: Princeton University Press. Read More