Morgan Stanley IM: When Is a Portfolio Efficient Enough? Evaluating Alternative Betas
Over the past 40 years, since 1980, interest rates have declined, meaning bond prices have generally increased.04.07.2023 | 06:30 Uhr
Now that this 40-year trend of declining interest rates has ended — and rather abruptly — investors are struggling to find ways to create an efficient portfolio with more stable returns. Why? Well, it appears that bonds may no longer provide the portfolio ballast that they have for the past decade and the traditional 60/40 portfolio1 might no longer work as expected.
So, where do we go to find a solution? Back to the 1950s and 60s, when this very issue was really first analyzed in depth. Before that, and ever since serious investing began (for reference, the first stock market was formed in Amsterdam in 1611; the NYSE started in 1792) investors understood there was a relationship between risk and return. But, investors lacked ways to both reliably measure and manage risk and incorporate this uncertainty into the valuation of an investment portfolio.
Enter Harry Markowitz in 1952, who had the insight to measure and manage portfolio risks by holding imperfectly correlated assets together in a portfolio. He illustrated that lower correlations between assets had the net effect of canceling some — but not all — of the associated risks within a portfolio. These lower correlations, where assets would not move together in lockstep, helped reduce the variance of returns over time.