index funds investment
2009
Portfolio optimization under universe of hedge funds?
Emerging markets are booming these days, tons of money has been exported by institutional investor to pocket handsome return.
A investment company runs 1000 of different funds some of which are exposed completely to emerging markets & other are 10% to 20%. World’s know that these market are highly volatile and extremely risky but had performed well than other caps fund and indexes funds.
As an investment company, they had to manage the risk associated with these markets, so they invest millions of money in hedge funds and derivative markets. The significant question arise here is,how the fund manager of the company can optimize their portfolio under a large universe of hedge funds.
This is very similar to the portfolio selection problem. The way this is done is to weigh in different stocks with different weights in your portfolio. The historic returns of each individual stock is also known. The expected return can be formulated as E(r) = sum(w_i*r_i). The expected risk, which is usually denoted by the variance of the portfolio, is modelled as V = sum sum [w_i*w_j Cov(r_i,r_j)]. The fund managers need to generate whats known as an “efficient frontier” of portfolios which minimize risk for a given return or maximize return for a given risk.
This process is fairly well documented and researched. You could look up the book “Quantitative Finance” by Brealy and Myers or search online for “portfolio optimization”.
Hope this helps.
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