A Quantitative Analysis of Multi-Asset Portfolio Selection Using Risk-Return and Efficient Frontier(2020-2022)

Abstract

Diversification remains a fundamental principle and a critical task for portfolio managers to mitigate investment risk. Modern Portfolio Theory (MPT), developed by Harry Markowitz, provides a robust framework for constructing feasible sets of portfolios and identifying the optimal portfolio among them. A key result in the context of theory is the construction of the Efficient Frontier and identifying the optimum portfolio among the different sets of portfolios. Efficient Frontier is a graphical representation of the ideal trade-off between the risk of the portfolio and the expected return of the portfolio.

However, the practical effectiveness of the Efficient Frontier depends largely on the careful selection of securities, appropriate assignment of weightage, and the inclusion of assets with low or negative correlations. This study aims to bridge the gap between theoretical portfolio principles and practical construction by emphasizing correlation-driven security selection within the Indian financial market.

In this study, the researcher focuses on constructing an efficient frontier for various portfolio combinations and identifying an optimal portfolio comprising securities with low or negative correlations, based on their historical return patterns. This approach is consistent with the core principle of diversification, illustrating how the strategic combination of such assets can enhance diversification benefits and reduce overall portfolio risk without materially affecting expected returns.

To evaluate the effectiveness of diversification in line with Markowitz's theory, the researcher has selected a set of five diversified securities representing various sectors of the Indian financial system, including private and public sector banks, the IT sector, the bond market, and the commodity market. It comprises HDFC Bank, SBI Bank, HCL Technologies Ltd., SBI Gold ETF, and Bharat Bond ETF. These securities were chosen to ensure broad sectoral representation, as they include large-cap stocks from the banking, IT, and FMCG sectors, along with commodity-based and fixed-income exchange-traded funds (ETFs). To assess the effectiveness of the Markowitz model, 104 weeks of data have been utilized. Return series, correlation coefficients, and mean-variance optimization calculations have been employed to construct various portfolio combinations.

The resulting Efficient Frontier is analyzed to identify the Minimum Variance Portfolio and the Optimal Portfolio. The findings demonstrate that deliberate, correlation-conscious asset selection significantly enhances diversification opportunities and efficiency of the portfolio. The study reinforces the practical relevance of MPT by highlighting the effect of risk-return trade-off between various portfolios and how incorporating negatively or weakly correlated securities effectively reduces overall portfolio risk and increases diversification opportunities.

These insights hold practical significance for investors and portfolio managers, particularly in emerging markets like India, where asset correlations can vary considerably across sectors. By strengthening the connection between correlation analysis and portfolio efficiency, this research contributes to both academic literature and practical investment strategies, offering a foundation for constructing more resilient and efficient portfolios.