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1.
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Definition
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Every possible asset combination can be plotted in risk-return
space, and the collection of all such possible portfolios defines a
region in this space. The line along the upper edge of this region
is known as the efficient frontier (sometimes “the Markowitz
frontier”). Combinations along this line represent portfolios
(explicitly excluding the risk-free alternative) for which there is
lowest risk for a given level of return. Conversely, for a given
amount of risk, the portfolio lying on the efficient frontier
represents the combination offering the best possible return.
Other Resources:
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Absolute Return Partners,
LLP:
A set of portfolio allocations that delivers the highest
possible return for a given amount of standard deviation (risk).
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Kayne Anderson Rudnick:
In
mean/variance analysis, the curve where the set of efficient
portfolios lie. That is, those portfolios of risky assets which
have the highest level of expected return for their level of
risk.
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CDM Trading:
Feasible combinations of expected profit and risk which,
for each level of risk, have maximum profit.
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Massachusetts Association of
Contributory Retirement Systems:
A general term for the set of optimal portfolios at differing
levels of reward and risk. Each portfolio on the frontier offers
the highest possible expected reward at its level of risk.
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2.
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Examples, Types, or
Variations
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Other Resources:
The
CAPM assumes that the risk-return profile of a portfolio can be
optimized - an optimal portfolio displays the lowest possible level
of risk for its level of return. Additionally, since each additional
asset introduced into a portfolio further diversifies the portfolio,
the optimal portfolio must comprise every asset, (assuming no
trading costs) with each asset value-weighted to achieve the above
(assuming that any asset is
infinitely
divisible). All such optimal portfolios, i.e., one for
each level of return, comprise the efficient (Markowitz) frontier.
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3.
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Formula
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Mathematically the Efficient Frontier is the intersection of the Set
of Portfolios with Minimum Variance and the Set of Portfolios with
Maximum Return.
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4.
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Related Terms
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5.
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As
Used in the Hedge Fund World
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Other Resources:
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Duke University:
In recent
years, there has been much research conducted which demonstrates
the benefits of including hedge funds in the traditional
portfolio. Jaeger’s [2001] study has shown that hedge funds
dramatically improve the efficient frontier of the traditional
portfolio, producing significantly higher returns with
substantially lower risk.
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MoneyManagement.com.au:
Hatfield says if it were left up to efficient frontier theory to
create an asset allocation, it would identify hedge funds as the
investment class that should have the heaviest weighting due to
their ability to respond to market movements proactively rather
than reactively.
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6.
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Applications
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Other Resources:
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Guided Choice:
Staying on the Efficient Frontier — A Rebalancing Act.
Once
you have found a portfolio along the Efficient Frontier that
satisfactorily offers an expected rate of return for your
assumed degree of risk, there remains the act of ensuring that
your portfolio remains efficient throughout the swings in the
economy. This task is known as rebalancing.
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7.
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Misused
& Abused
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Other Resources:
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Max Wideman:
Inability to Find the Efficient Frontier. Most
organizations fail to find the best project portfolios and,
therefore, do not create all of the value available. Inability
to find the efficient frontier is the fifth reason organizations
choose the wrong projects.
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
| HEDGE FUND RISK AND OTHER
DISCLOSURES |
Hedge funds, including fund of funds (“Hedge
Funds”), are unregistered private investment partnerships, funds or
pools that may invest and trade in many different markets,
strategies and instruments (including securities, non-securities and
derivatives) and are NOT subject to the same regulatory requirements
as mutual funds, including mutual fund requirements to provide
certain periodic and standardized pricing and valuation information
to investors. There are substantial risks in investing in Hedge
Funds. Persons interested in investing in Hedge Funds should
carefully note the following:
- Hedge Funds represent speculative investments and involve a
high degree of risk. An investor could lose all or a substantial
portion of his/her investment. Investors must have the financial
ability, sophistication/experience and willingness to bear the
risks of an investment in a Hedge Fund.
- An investment in a Hedge Fund should be discretionary capital
set aside strictly for speculative purposes.
- An investment in a Hedge Fund is not suitable or desirable for
all investors. Only qualified eligible investors may invest in
Hedge Funds.
- Hedge Fund offering documents are not reviewed or approved by
federal or state regulators
- Hedge Funds may be leveraged (including highly leveraged) and
a Hedge Fund’s performance may be volatile
- An investment in a Hedge Fund may be illiquid and there may be
significant restrictions on transferring interests in a Hedge
Fund. There is no secondary market for an investor’s investment in
a Hedge Fund and none is expected to develop.
- A Hedge Fund may have little or no operating history or
performance and may use hypothetical or pro forma performance
which may not reflect actual trading done by the manager or
advisor and should be reviewed carefully. Investors should not
place undue reliance on hypothetical or pro forma performance.
- A Hedge Fund’s manager or advisor has total trading authority
over the Hedge Fund.
- A Hedge Fund may use a single advisor or employ a single
strategy, which could mean a lack of diversification and higher
risk.
- A Hedge Fund (for example, a fund of funds) and its managers
or advisors may rely on the trading expertise and experience of
third-party managers or advisors, the identity of which may not be
disclosed to investors
- A Hedge Fund may involve a complex tax structure, which should
be reviewed carefully.
- A Hedge Fund may involve structures or strategies that may
cause delays in important tax information being sent to investors.
- A Hedge Fund may provide no transparency regarding its
underlying investments (including sub-funds in a fund of funds
structure) to investors. If this is the case, there will be no way
for an investor to monitor the specific investments made by the
Hedge Fund or, in a fund of funds structure, to know whether the
sub-fund investments are consistent with the Hedge Fund’s
investment strategy or risk levels.
- A Hedge Fund may execute a substantial portion of trades on
foreign exchanges or over-the-counter markets, which could mean
higher risk.
- A Hedge Fund’s fees and expenses-which may be substantial
regardless of any positive return- will offset the Hedge Fund’s
trading profits. In a fund of funds or similar structure, fees are
generally charged at the fund as well as the sub-fund levels;
therefore fees charged investors will be higher that those charged
if the investor invested directly in the sub-fund(s).
- Hedge Funds are not required to provide periodic pricing or
valuation information to investors.
- Hedge Funds and their managers/advisors may be subject to
various conflicts of interest.
The above general
summary is not a complete list of the risks and other important
disclosures involved in investing in Hedge Funds and, with respect
to any particular Hedge Fund, is subject to the more complete and
specific disclosures contained in such Hedge Fund’s respective
offering documents. Before making any investment, an investor should
thoroughly review a Hedge Fund’s offering documents with the
investor’s financial, legal and tax advisor to determine whether an
investment in the Hedge Fund is suitable for the investor in light
of the investor’s investment objectives, financial circumstances and
tax situation.
All performance information is believed
to be net of applicable fees unless otherwise specifically noted. No
representation is made that any fund will or is likely to achieve
its objectives or that any investor will or is likely to achieve
results comparable to those shown or will make any profit at all or
will be able to avoid incurring substantial losses. Past performance
is not necessarily indicative, and is no guarantee, of future
results.
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Before making any investment, you should thoroughly review the
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Any indices and other financial benchmarks
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volatility and other material characteristics that may differ from a
particular hedge fund. For example, a hedge fund may typically hold
substantially fewer securities than are contained in an index.
Indices also may contain securities or types of securities that are
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fund’s performance may differ substantially from the performance of
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