Portfolio Construction
Small and Value Effects
Now that we’ve laid the foundation of Modern Portfolio Theory the next question is one of portfolio construction. What is an efficient composition of asset classes?
There are many factors to consider when trying to find what might be an optimal combination of asset classes. For the equity portion of a portfolio, there are two notable factors to point out. Simply put, it is that smaller companies and value companies tend to outperform large and growth oriented companies. This does not mean that large and growth companies should be excluded form a portfolio. It does mean that small and value stocks should be weighted more heavily.
Bonds
The traditional role of a bond is to provide safety and income. When analyzed in the context of Modern Portfolio Theory an allocation to bonds becomes the safety lever used to adjust an efficient portfolio’s level of risk. Once the other asset classes are organized efficiently, one can simply add or subtract bonds to appropriately adjust a portfolio to the desired level of risk.
Summary >>
Now that we’ve laid the foundation of Modern Portfolio Theory the next question is one of portfolio construction. What is an efficient composition of asset classes?
There are many factors to consider when trying to find what might be an optimal combination of asset classes. For the equity portion of a portfolio, there are two notable factors to point out. Simply put, it is that smaller companies and value companies tend to outperform large and growth oriented companies. This does not mean that large and growth companies should be excluded form a portfolio. It does mean that small and value stocks should be weighted more heavily.
Bonds
The traditional role of a bond is to provide safety and income. When analyzed in the context of Modern Portfolio Theory an allocation to bonds becomes the safety lever used to adjust an efficient portfolio’s level of risk. Once the other asset classes are organized efficiently, one can simply add or subtract bonds to appropriately adjust a portfolio to the desired level of risk.
Summary >>
