Theory and practice in money management have a rocky relationship. What looks good on paper often suffers a difficult and even a fatal transition to the real world for several reasons, including trading costs, human error, and the ever-present burden of an uncertain future. But some models do better than others as portfolio strategies. At or near the top of this short list is what’s known as the global minimum variance portfolio (GMVP), which by design is a mix of assets that minimizes volatility. The success of this strategy violates modern portfolio theory, which tells us to build “optimal” portfolios, i.e., holding a combination of assets that maximizes expected return at a given level of risk. But many empirical studies show that portfolios that focus on minimizing volatility generate superior out-of-sample results. As such, it’s useful to consider how your current portfolio compares if you were to reweight it to reflect a GMVP strategy.
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