Portfolio Optimization and Rebalancing

Portfolio Optimization and RebalancingDetermining the best portfolio for a financial institution is difficult given the constant changes in the values of investments.  Once an ideal portfolio is specified, how should one go about selling and buying assets in order to obtain that ideal portfolio?

Typical users include portfolio managers within mutual fund companies, hedge funds, and investment banks.  Some users may be interested in both the portfolio optimization and rebalancing, while others may just be interested in optimal rebalancing.

Problem: Given uncertain market returns and the need to maximize the overall value of a portfolio, what investments should an institution make?  Different assets historically co-vary in price, and the historical returns of different assets over time create infinite possibilities for the future.   Once an ideal portfolio is identified, what is the most effective way to change a portfolio?  Any time a security is bought or sold, there are taxes to pay.  If too much of the portfolio is invested too conservatively, there is a possibility of underperforming the target return.  At the same time, if the composition of the portfolio is too aggressive, the overall portfolio risks sudden drops due to volatility.  Finally, with large portfolios, unloading large amounts of any security is likely to change the value of the security.  This adds a time element to strategy, which increases the costs of volatility and tracking error.

Solution: Optimized Portfolio Selection and Rebalancing help portfolio managers devise a best strategy for both asset allocation and asset rebalancing.  It provides the ability to determine what the likely effect of increasing or decreasing the quantity of a security will be to a portfolio.

Resources on Portfolio Optimization and Rebalancing:
Multi-stage stochastic linear programs for portfolio optimization