MPT Efficient Frontier

VT
Efficient Frontier: The Tool for Creating a "Superb" Portfolio
The Efficient Frontier is a vital concept in the world of investment that helps investors build a Portfolio—a collection of investment assets—that provides the best possible return for a given level of acceptable risk. This concept stems from the Modern Portfolio Theory (MPT), developed by Nobel laureate in Economics, Harry Markowitz.

What is the Efficient Frontier?
Imagine all the possible investment combinations you can put together. Each portfolio combination has a different level of risk (measured by volatility or Standard Deviation) and a different expected return.

When you plot all these possible portfolios on a graph, with the horizontal axis representing Risk and the vertical axis representing Return, you get a cloud of points (portfolios).

The Efficient Frontier is the curve that sits on the upper-most and left-most boundary of this cloud of points.

"Upper-most" means that the portfolios on this line provide the maximum return for that specific level of risk.

"Left-most" means that the portfolios on this line have the lowest risk for a given return.

Simply put, a portfolio lying on the Efficient Frontier is considered "Efficient" because no other portfolio exists that can offer a higher return at the same level of risk, or lower risk at the same level of return.

How to Use the Efficient Frontier
Investors use the Efficient Frontier to help them decide on the optimal portfolio for their needs. The key steps are:

1. Data Collection and Generating Possible Portfolios
Collect Data: Use historical data (or future projections) for the assets you are interested in (e.g., stocks, bonds, funds) to calculate their Expected Return, Risk (Standard Deviation), and, most importantly, the Correlation between the different assets.

Simulate Portfolios: Use computers or mathematical programs to simulate thousands or tens of thousands of different asset mix proportions to find all possible portfolio points.

2. Finding the "Minimum Variance Portfolio" (MVP)
The Minimum Variance Portfolio (MVP) is the point on the frontier with the absolute lowest risk (the far-left point on the curve). Investors with a very low risk tolerance might focus on this portfolio.

3. Finding the "Optimal Portfolio" for You
Once the Efficient Frontier is established, investors must select the point on the line that aligns with their personal Risk Tolerance.

Risk-Averse Investors: Will choose points on the left side of the curve (low risk and moderate return).

Risk-Tolerant Investors: Will choose points on the right side of the curve (high risk and high return).

Visualization Elements:
🔴 Red/Orange/Yellow/Green Dots => Each dot represents 1 portfolio combination. Plotted according to Risk (X-axis) and Return (Y-axis).
Color Coding by Sharpe Ratio => 🟢 Green: Sharpe > 2
🟡 Yellow: Sharpe 1-2
🟠 Orange: Sharpe 0-1
🔴 Red: Sharpe < 0
⬤ Large Yellow DotRepresents the MAX SHARPE RATIO—the Optimal Portfolio! Lying on the Efficient Frontier curve. Labeled with " Efficient Frontier".
❶❷❸❹ Colored Circles => Represents the Individual Assets (e.g., Blue, Red, Green, Purple).
■ Blue Square => Represents the Current Portfolio location.

Four Data Tables
1. Optimal Weights Table => Compares Current vs. Optimal weights for each asset. Weights Comparison: Green = Should increase weight. Red = Should decrease weight.
Max Sharpe (Current and Optimal).
2.Performance Comparison => Return, Risk, Sharpe for Current vs. Optimal portfolios.Improvement Metrics: Return (percent increase), Risk (percent decrease), Sharpe (percent improvement).Recommendation: 🚀 REBALANCE! (Score > 20); Consider (5-20); Maintain (< 5).
3.Correlation Matrix => Displays the Correlation between all assets. Helps assess Diversification.
4.Asset Statistics => Provides detailed statistics for Each Individual Asset.