Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation

Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation

Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation

Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation


In spite of theoretical benefits, Markowitz mean-variance (MV) optimized portfolios often fail to meet practical investment goals of marketability, usability, and performance, prompting many investors to seek simpler alternatives. Financial experts Richard and Robert Michaud demonstrate that the limitations of MV optimization are not the result of conceptual flaws in Markowitz theory but unrealistic representation of investment information. What is missing is a realistic treatment of estimation error in the optimization and rebalancing process.

The text provides a non-technical review of classical Markowitz optimization and traditional objections. The authors demonstrate that in practice the single most important limitation of MV optimization is oversensitivity to estimation error. Portfolio optimization requires a modern statistical perspective.Efficient Asset Management, Second Editionuses Monte Carlo resampling to address information uncertainty and define Resampled Efficiency (RE) technology. RE optimized portfolios represent a new definition of portfolio optimality that is more investment intuitive, robust, and provably investment effective. RE rebalancing provides the first rigorous portfolio trading, monitoring, and asset importance rules, avoiding widespread ad hoc methods in current practice.

The Second Edition resolves several open issues and misunderstandings that have emerged since the original edition. The new edition includes new proofs of effectiveness, substantial revisions of statistical estimation, extensive discussion of long-short optimization, and new tools for dealing with estimation error in applications and enhancing computational efficiency. RE optimization is shown to be a Bayesian-based generalization and enhancement of Markowitz's solution. RE technology corrects many current practices that may adversely impact the investment value of trillions of dollars under current asset management. RE optimization technology may also be useful in other financial optimizations and more generally in multivariate estimation contexts of information uncertainty with Bayesian linear constraints.

Michaud and Michaud's new book includes numerous additional proposals to enhance investment value including Stein and Bayesian methods for improved input estimation, the use of portfolio priors, and an economic perspective for asset-liability optimization. Applications include investment policy, asset allocation, and equity portfolio optimization. A simple global asset allocation problem illustrates portfolio optimization techniques. A final chapter includes practical advice for avoiding simple portfolio design errors.

With its important implications for investment practice,Efficient Asset Management's highly intuitive yet rigorous approach to defining optimal portfolios will appeal to investment management executives, consultants, brokers, and anyone seeking to stay abreast of current investment technology. Through practical examples and illustrations, Michaud and Michaud update the practice of optimization for modern investment management.

This edition includes a CD that contains a demo of the patented, internet-based optimization software created by the authors at their consulting firm, New Frontier Advisors, which has been chosen to cosponsor the new Harry M. Markowitz Award.


Effective asset management is not only a matter of identifying desirable investments: it also requires optimally structuring the assets within the portfolio. This is because the investment behavior of a portfolio is typically different from the assets in it. For example, the risk of a portfolio of U.S. equities is often half the average risk of the stocks in it.

Prudent investors concern themselves with portfolio risk and return. An understanding of efficient portfolio structure is essential for optimally managing the investment benefits of portfolios. Effective portfolio management reduces risk while enhancing return. For thoughtful investors, portfolio efficiency is no less important than estimating risk and return of assets.

Most institutional investors and financial economists acknowledge the investment benefits of efficient portfolio diversification. Optimally managing portfolio risk is an essential component of modern asset management. Markowitz (1959, 1987) gave the classic definition of portfolio optimality: a portfolio is efficient if it has the highest expected (mean or estimated) return for a given level of risk (variance) or, equivalently, least risk for a given level of expected return of all portfolios from a given universe of securities. Markowitz mean-variance (MV) efficiency is a practical and convenient framework for defining portfolio optimality and for constructing optimal stock portfolios and asset allocations. A number of commercial services provide optimizer software for computing MV efficient portfolios.

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