How to manage portfolio risk and return
Portfolio management aims to pick and size positions in financial instruments that achieve the desired risk-return trade-off regarding a benchmark. As a portfolio manager, in each period, you select positions that optimize diversification to reduce risks while achieving a target return. Across periods, these positions may require rebalancing to account for changes in weights resulting from price movements to achieve or maintain a target risk profile.
The evolution of modern portfolio management
Diversification permits us to reduce risks for a given expected return by exploiting how imperfect correlation allows for one asset's gains to make up for another asset's losses. Harry Markowitz invented modern portfolio theory (MPT) in 1952 and provided the mathematical tools to optimize diversification by choosing appropriate portfolio weights.
Markowitz showed how portfolio risk, measured as the standard deviation of portfolio...