Some common mistakes you will no longer make after this course – Portfolio risk

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Portfolio and Risk Management

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University of Geneva

Portfolio and Risk Management

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Cours 3 sur 5 dans Specialization Investment Management

In this course, you will gain an understanding of the theory underlying optimal portfolio construction, the different ways portfolios are actually built in practice and how to measure and manage the risk of such portfolios. You will start by studying how imperfect correlation between assets leads to diversified and optimal portfolios as well as the consequences in terms of asset pricing. Then, you will learn how to shape an investor's profile and build an adequate portfolio by combining strategic and tactical asset allocations. Finally, you will have a more in-depth look at risk: its different facets and the appropriate tools and techniques to measure it, manage it and hedge it. Key speakers from UBS, our corporate partner, will regularly add a practical perspective on these different topics as you progress through the course.

À partir de la leçon

General Introduction and Key Concepts

In this introductory week, you will first be presented with a few mistakes you will no longer make after following this course. In order to avoid making these mistakes, you will start by gaining a foundation and understanding of the three main types of information we need in order to build optimal portfolios: expected returns, risk and dependence.

Why you should choose this course3:06

Some common mistakes you will no longer make after this course – Portfolio risk6:27

Some common mistakes you will no longer make after this course – Free lunch9:35

Rencontrer les enseignants

University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Ines Chaieb
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Philipp Krueger
SFI Assistant Professor of Finance
Geneva Finance Research Institute
University of Geneva- Kerstin Preuschoff
Associate Professor of Neurofinance and Neuroeconomics
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute

[MUSIC]

Hi everyone.

In this video, we're going to have a look at some common mistakes,

which are made when talking about strategic asset allocation and

risk and diversification.

So these are the main outcomes of this video,

some common mistakes you will no longer make after this video.

Let's start with mistake number one.

Mistake number one says,

is the risk of the average equal to the average of the risks?

Ooh, that sounds a bit mind boggling.

Let's take one example, do you remember if you've done,

which I hope, course number one?

And when we talked about and a long short strategy, I gave you

this illustration of a man working just outside a train station here in Geneva.

And he was selling ice creams and so I thought

maybe what he could do is the days when the weather is nice, he sells ice cream.

And when it rains, he sells umbrellas.

[LAUGH] And so, this inspired me the following simulations which I show here.

Let's imagine we have two firms, one which sells ice creams, and

the other one which sales umbrellas.

And you are an investor and we are at the beginning of the summer and

you need to make some weather forecasts to find out whether it's going to be the one

who sells ice creams wins, or the ones who sells umbrellas.

And so, this is how the two evolve and

you can see that there's a negative correlation.

When one goes up, clearly the other one goes down.

It's rare that you see people eating ice creams under an umbrella.

So here you have the returns of these two firms, and these two strategies.

So if you're long ice creams,

you will be generating a total return over summer of some 23%.

If you're long, so if you're buying the umbrella firm, you actually lose 26%.

So ice cream firm, umbrella firm.

Here are the results.

Performance, you see IC for ice cream, For umbrella.

Plus 23, -26.

And then, the second line underneath this, I've put downside volatility.

This is a measure on which we will return.

I will give you more details as to how we compute this.

But with downside deviation or downside volatility, what we focus on is the left,

the part of the distribution of returns which is to the left of the mean, i.e.,

subpar returns, for that is more interesting when you're an investor.

So question to you, and that's a quiz, let's assume,

you don't know whether it's going to be a hot summer or a rainy one.

So you don't know whether it's going to be the ice creams or the umbrella who wins.

So you decide to put half of your eggs in the ice cream firm and in the baskets and

the other half in the umbrella perhaps, and this gives you the 50/50 portfolio.

So the average performance as we may expect is

50% of 23 plus 50% -26 and

that's -1.5, pretty straightforward.

Now, now about the risk?

How about the downside deviation?

Is it the average, i.e., between 17.2 and 8.4, i.e., 12.8?

In other words, if we present this graphically, would you say that the,

we have the ice creams far on the right, we have the umbrellas down on the left.

Would you say that the 50:50 portfolio lies exactly in the middle or

straight line that goes between these 2 assets?

We can think of ice creams are being equities and umbrellas as being bonds?

Will the 50:50 portfolio be exactly there?

Quiz for you.

Think about this.

The risk of an average portfolio,

say 50 umbrellas and 50 ice creams is not equal to

the average of the risks of these 2 firms or two assets.

And you see from this table here.

We have performance.

We have downside volatility and you see the 50:50 portfolio.

That's very interesting actually.

Look at this, we have 50:50, -1.5 for the return and

5.2 for the downside risk, i.e.,

the 50:50 portfolio is actually less risky

than the least risky of these firms,

which are umbrellas, which is umbrellas, the umbrella firm.

So it's interesting.

If you think of this is being equities versus bonds, we could have that.

When you diversify, you end up with a portfolio which is less

risky than the least risky asset which is bonds.

So this is the magic impact of diversification on which we will return.

So graphically, this is what we have.

Ice cream, umbrellas, the 50:50 portfolio does

not lie in the middle but lies to see that far to the left and

this is due to the impacts of decorralation or lack of correlation.

Basically when ice creams go up, umbrellas go down and conversely so

here in this particular instance we have a negative correlation between the two,

i.e., you may reduce risk for a same level of return.

[MUSIC]

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