A model for the optimisation of an individual investor's portfolio of exchange traded funds
Thesis (MBA)--Stellenbosch University, 2015.
ENGLISH ABSTRACT: Facilities are available to individual investors to enable them to invest directly in a multitude of investments without making use of investment brokers or financial advisors. Although this facility offers the benefit of reduced administration and management fees, it also puts the investor in a position where he is responsible for making his own investment decisions. Since Markowitz’s publication fifty years ago, it has been known that diversification is necessary in order to reduce the investor’s exposure to any unsystematic investment risk while still obtaining an acceptable return. Studies have shown that human behaviour has an impact on investment decisions and that human nature skews the individual’s perception of diversification and risk and the reality thereof. For this reason, the individual investor is better off making use of quantitative methods in order to ensure a properly diversified portfolio. Exchange traded products are passive, index tracking investments that trade on stock exchanges and pose benefits to individual investors owing to their low administrative costs and inherent levels of diversification. Individual investors are able to purchase exchange traded products such as exchange traded funds (ETFs), exchange traded notes (ETNs) and index tracking unit trusts through various means, including brokerage firms and online trading platforms. These platforms offer little advice to the individual investor on how to select the most suitable investment products and how each product will affect the risk profile of an investor’s portfolio. The purpose of this research assignment was to develop a portfolio optimisation tool that would help the investor obtain the optimal return for his desired level of risk, thereby ensuring efficient diversification. An optimisation model was developed by using performance data from 2009 to 2013 and the resultant optimised portfolio’s performance was evaluated for 2014. It was found that optimisation rendered acceptable results, provided that the covariances between the various ETFs showed equivalence year on year. This requirement limited the number of ETFs that could be included in the model. Improvements to the model were recommended, based on the results of similar research in the field of portfolio optimisation. Further research is proposed that would utilise other optimisation methods, other sources of data and comparisons that are more detailed.