Resampled efficient frontier is a technique ininvestment portfolio construction undermodern portfolio theory to use a set of portfolios and then average them to create an effective portfolio. This will not necessarily be the optimal portfolio, but a portfolio that is more balanced between risk and the rate of return. It is used when an investor or analyst is faced with determining whichasset classes, such as domesticfixed income, domesticequity, foreign fixed income, and foreign equity, to invest in and what proportion of the total portfolio should be of each asset class.[1]
In 1959,Harry Markowitz first described a method for constructing a portfolio with optimalrisk/return characteristics. His portfolio optimization method finds the minimum risk portfolio with a given expected return.[2] Because the Markowitz orMean-Variance Efficient Portfolio is calculated from thesample mean and covariance, which are likely different from the populationmean andcovariance, the resultinginvestment portfolio may allocate too much weight to assets with better estimated than true risk/return characteristics.
To account for theuncertainty of the sample estimates, a financial analyst can create many alternativeefficient frontiers based onresampled versions of the data. Each resampled dataset will result in a different set of Markowitz efficient portfolios. These efficient frontiers of portfolios can then be averaged to create a resampled efficient frontier.[3]
The appropriate compromise between the investor'sRisk aversion and desired return will then guide the financial analyst to choose a portfolio from the set of resampled efficient frontier portfolios. Since such a portfolio is different from the Markowitz efficient portfolio it will have suboptimal risk/return characteristics with respect to the sample mean and covariance, but optimal characteristics when averaged over the many possible values of the unknown true mean and covariance.[4] Resampled Efficiency is covered by U. S.patent #6,003,018, patent pending worldwide. New Frontier Advisors, LLC, has exclusive worldwide licensing rights.