The Importance of Portfolio Diversification
The Importance of Portfolio Diversification Large Cap
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Small Cap
Presented by Dimitrios Gravanis
Page 1
What is portfolio diversification and why is it good? Portfolio Diversification
Allocating investments in different asset classes attempting to reduce the overall risk of the portfolio.
• In other words, portfolio diversification attempts to avoid damaging a portfolio's performance by the poor performance of a single security, industry, country, etc. • Diversification helps benefit from changing market cycles, manage risks, reduce the volatility of an asset's price movements and supports the preservation of capital. o However, always remember:
“There's no such thing as a free lunch.” Milton Friedman Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Page 2
So how does it work? An Example Our new fund, “HC Growth Fund III” raised € 5.0 million in the 2016 capital raising cycle. The capital will be invested in the following investment vehicles: • Vanguard Total Bond Market Index Fund (ticker: VBTLX) - Income
• Vanguard 500 Index (ticker: VFIAX) Equity
VBTLX Statistics (Jan 12 - Dec 15) Individual Average Return 0.17% Standard Deviation - Risk 0.80% Variance 0.01% Minimum Return -1.70% Maximum Return 2.32%
VFIAX Statistics (Jan 12 - Dec 15) Individual Average Return 1.24% Standard Deviation - Risk 2.99% Variance 0.09% Minimum Return -6.04% Maximum Return 8.43%
Sharpe Ratio - Risk Adjusted Return
Sharpe Ratio - Risk Adjusted Return
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
0.21
0.41
Page 3
So how does it work? An Example If “HC Growth Fund III” was fully invested in those two assets, the "optimal risky portfolio" on the efficient frontier would consist of; • VBTLX – 67.85%
• VFIAX – 32.15% HC Growth Fund III Statistics (Jan 12 - Dec 15) VBTLX 67.85% $ 3,392,296 VFIAX 32.15% $ 1,607,705 100.00% $ 5,000,000 Portfolio Average Return Standard Deviation - Risk Variance Sharpe Ratio - Risk Adjusted Return
0.51% 1.07% 0.00011 0.4796 Efficient Frontier
*”optimal risky portfolio” being the portfolio asset allocation that has the maximum Sharpe Ratio
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Page 4
So how does it work? An Example
VBTLX vs. VFIAX vs. HC Growth Fund III
As illustrated opposite, “HC Growth Fund III” offers greater stability than returns on the individual VBTLX and VFIAX funds. VFIAX during the period from Jan 2016 to July 2016 appeared to be more volatile, with a large dip in January, followed by a large growth in March. The combination of VBTLX in the overall portfolio with a weighting of 67.85% offered more stability to the overall investment. Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Monthly Returns – VBTLX vs. VFIAX vs. HC Growth Fund III
Page 5
So how does it work? An Example
AAPL vs. HC Growth Fund III
Similarly, as illustrated opposite, “HC Growth Fund III” offers greater stability than the individual returns of AAPL.
AAPL during the same period appears to be more volatile, with large dips and peaks. “HC Growth Fund III” offers more stability in the long-term with stable returns and reduced overall risk of the investment. HC Growth Fund III vs. AAPL - Key Statistics (Jan 16 - Jul 16) Portfolio Average Return 0.51% 0.43% Standard Deviation - Risk 1.07% 8.97% Sharpe Ratio - Risk Adjusted Return 0.480 0.048 Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Monthly Returns – AAPL vs. HC Growth Fund
Page 6
Which of the two would you prefer? An Example
AAPL vs. HC Growth Fund III
As illustrated opposite, the diversified portfolio “HC Growth Fund III” outperformed AAPL. Although returns on both assets are “largely similar”, which one will let you have a calm sleep at night? In April 2016 your investment with APPL would have been c. $ -523k of your initial investment of $ 5 million. HC Growth Fund III vs. AAPL - Key Statistics (Jan 16 - Jul 16) Portfolio Average Return 0.51% 0.43% Standard Deviation - Risk 1.07% 8.97% Sharpe Ratio - Risk Adjusted Return 0.480 0.048 Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Monthly Total Investment Value – AAPL vs. HC Growth Fund
Page 7
Conclusions As we mentioned previously, there is no free lunch and Portfolio Diversification does NOT offer one. However, it can significantly reduce risk exposure of an investment by simply allocating the right proportion of investment in the right assets.
THANK YOU for your time For more information please contact Dimitrios Gravanis
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Page 8
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Small Cap
Presented by Dimitrios Gravanis
Page 1
What is portfolio diversification and why is it good? Portfolio Diversification
Allocating investments in different asset classes attempting to reduce the overall risk of the portfolio.
• In other words, portfolio diversification attempts to avoid damaging a portfolio's performance by the poor performance of a single security, industry, country, etc. • Diversification helps benefit from changing market cycles, manage risks, reduce the volatility of an asset's price movements and supports the preservation of capital. o However, always remember:
“There's no such thing as a free lunch.” Milton Friedman Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Page 2
So how does it work? An Example Our new fund, “HC Growth Fund III” raised € 5.0 million in the 2016 capital raising cycle. The capital will be invested in the following investment vehicles: • Vanguard Total Bond Market Index Fund (ticker: VBTLX) - Income
• Vanguard 500 Index (ticker: VFIAX) Equity
VBTLX Statistics (Jan 12 - Dec 15) Individual Average Return 0.17% Standard Deviation - Risk 0.80% Variance 0.01% Minimum Return -1.70% Maximum Return 2.32%
VFIAX Statistics (Jan 12 - Dec 15) Individual Average Return 1.24% Standard Deviation - Risk 2.99% Variance 0.09% Minimum Return -6.04% Maximum Return 8.43%
Sharpe Ratio - Risk Adjusted Return
Sharpe Ratio - Risk Adjusted Return
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
0.21
0.41
Page 3
So how does it work? An Example If “HC Growth Fund III” was fully invested in those two assets, the "optimal risky portfolio" on the efficient frontier would consist of; • VBTLX – 67.85%
• VFIAX – 32.15% HC Growth Fund III Statistics (Jan 12 - Dec 15) VBTLX 67.85% $ 3,392,296 VFIAX 32.15% $ 1,607,705 100.00% $ 5,000,000 Portfolio Average Return Standard Deviation - Risk Variance Sharpe Ratio - Risk Adjusted Return
0.51% 1.07% 0.00011 0.4796 Efficient Frontier
*”optimal risky portfolio” being the portfolio asset allocation that has the maximum Sharpe Ratio
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Page 4
So how does it work? An Example
VBTLX vs. VFIAX vs. HC Growth Fund III
As illustrated opposite, “HC Growth Fund III” offers greater stability than returns on the individual VBTLX and VFIAX funds. VFIAX during the period from Jan 2016 to July 2016 appeared to be more volatile, with a large dip in January, followed by a large growth in March. The combination of VBTLX in the overall portfolio with a weighting of 67.85% offered more stability to the overall investment. Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Monthly Returns – VBTLX vs. VFIAX vs. HC Growth Fund III
Page 5
So how does it work? An Example
AAPL vs. HC Growth Fund III
Similarly, as illustrated opposite, “HC Growth Fund III” offers greater stability than the individual returns of AAPL.
AAPL during the same period appears to be more volatile, with large dips and peaks. “HC Growth Fund III” offers more stability in the long-term with stable returns and reduced overall risk of the investment. HC Growth Fund III vs. AAPL - Key Statistics (Jan 16 - Jul 16) Portfolio Average Return 0.51% 0.43% Standard Deviation - Risk 1.07% 8.97% Sharpe Ratio - Risk Adjusted Return 0.480 0.048 Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Monthly Returns – AAPL vs. HC Growth Fund
Page 6
Which of the two would you prefer? An Example
AAPL vs. HC Growth Fund III
As illustrated opposite, the diversified portfolio “HC Growth Fund III” outperformed AAPL. Although returns on both assets are “largely similar”, which one will let you have a calm sleep at night? In April 2016 your investment with APPL would have been c. $ -523k of your initial investment of $ 5 million. HC Growth Fund III vs. AAPL - Key Statistics (Jan 16 - Jul 16) Portfolio Average Return 0.51% 0.43% Standard Deviation - Risk 1.07% 8.97% Sharpe Ratio - Risk Adjusted Return 0.480 0.048 Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Monthly Total Investment Value – AAPL vs. HC Growth Fund
Page 7
Conclusions As we mentioned previously, there is no free lunch and Portfolio Diversification does NOT offer one. However, it can significantly reduce risk exposure of an investment by simply allocating the right proportion of investment in the right assets.
THANK YOU for your time For more information please contact Dimitrios Gravanis
Wharton Business and Financial Modeling Capstone Business and Financial Modeling Online, University of Pennsylvania
Page 8
