Financial Education

Assets should be considered for portfolio addition if their inclusion would improve the portfolio’s mean-variance efficient frontier. This occurs when the asset class’s Sharpe ratio is higher than the product of the existing portfolio’s Sharpe ratio and the correlation between the asset class return and the portfolio return.

For example, a manager may be considering whether to add an asset class with a Sharpe ratio of 0.18 to a portfolio with a Sharpe ratio of 0.20. The correlation between the asset class and the portfolio is 0.5. Since 0.18 > 0.20 * 0.5 = 0.10, the asset class should be added.

For more information, see all articles on: Asset Allocation, FInancial Planning, Investment Returns, Portfolio Management

See also:

What Makes an Asset Class?

Mean-Variance Optimizers in Asset Allocation

Asset Allocation Optimization Using Resampled Efficient Frontiers

Macro Performance Attribution

Tactical Asset Allocation in Portfolio Management