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Strategies & Market Trends : The Covered Calls for Dummies Thread -- Ignore unavailable to you. Want to Upgrade?

To: Dan Duchardt who wrote (2136)	8/20/2001 12:04:37 PM
From: Wyätt Gwyön	Read Replies (1) \| Respond to of 5205

hi Dan Duchardt, if you want to achieve a certain level of return with the least volatility you are better off holding several representative assets than to be focused on a small number of them it may or may not be worth debating what is or is not obvious, but i think there is indeed something counterintuitive in the idea of mixing SDs of different covariances and thereby achieving a lower SD for the targeted return. for example, this means a very conservative government bond investor might add, say, a 5% weighting in equities and actually reduce portfolio volatility vs. a 100% bond weighting (this type of combination, and its resulting lower SD vis-a-vis the 100% bond portfolio, is discussed in detail in "The Intelligent Asset Allocator"). that sort of thing is not at all obvious to most people IMO. the key factor is that the asset classes being combined have a degree of noncorrelation. if you want your return to be the same as the S&P 500, the way to do that with minimum variance, or standard deviation, or volatility is to own everything in the S&P 500 rather than just a basket of 25 random stocks, or just all the tech stocks, or just all the financials, or just all the drugs. There is nothing really new here. If the return on the S&P is good enough, then by all means go this route. If you want to do better, then you must be selective and attempt to avoid the elements of the universe that are below average, keeping the elements that are above average. In other words, you must try to deliberately skew your sample toward the better performing stocks or sectors i think you are really bringing up a different line of argument here. first you are talking about the SD of the entire universe of assets being smaller than that of its component classes, then you talk about trying to invest with minimum SD from the S&P. the first SD is not the same as the second. SD from the S&P is benchmark tracking error, which may matter if you are a mutual fund investor in US large caps, but if you are just an individual trying to get the most return for the least risk, then (in my case at least), the concerns are the absolute return and the absolute SD of my own portfolio, not how it tracks the S&P. the idea of asset class mixing to achieve an efficient frontier is very different from the idea of simply "beating the S&P" by selecting the better performers within the S&P. the resulting portfolio is unlikely to be efficient, because the S&P consists primarily of US large caps and is skewed heavily toward growth. really the only asset-class variance one can achieve there is a distinction between large cap growth and large cap value, which is a much smaller range of parameters than that afforded by a broader asset class mix.