Separation property (Finance)
Encyclopedia
A separation property is a crucial element of modern portfolio theory
that gives a portfolio
manager the ability to separate the process of satisfying investing clients' assets into two separate parts.
The first part is the determination of the "optimum risky portfolio". This portfolio is the same for all clients. In one version, it has the highest Sharpe ratio
. See mutual fund separation theorem
for a discussion of other possibilities. It is the construction of a universal portfolio that is kept separate from the individual needs of each client.
The second part is tailoring the use of that portfolio to the risk-aversive needs of each individual client. This is achieved through simulation of a given risk-return
range by allocating the client's total investments partly to that universal portfolio and partly to the risk-free asset.
Modern portfolio theory
Modern portfolio theory is a theory of investment which attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets...
that gives a portfolio
Portfolio (finance)
Portfolio is a financial term denoting a collection of investments held by an investment company, hedge fund, financial institution or individual.-Definition:The term portfolio refers to any collection of financial assets such as stocks, bonds and cash...
manager the ability to separate the process of satisfying investing clients' assets into two separate parts.
The first part is the determination of the "optimum risky portfolio". This portfolio is the same for all clients. In one version, it has the highest Sharpe ratio
Sharpe ratio
The Sharpe ratio or Sharpe index or Sharpe measure or reward-to-variability ratio is a measure of the excess return per unit of deviation in an investment asset or a trading strategy, typically referred to as risk , named after William Forsyth Sharpe...
. See mutual fund separation theorem
Mutual fund separation theorem
In portfolio theory, a mutual fund separation theorem, mutual fund theorem, or separation theorem is a theorem stating that, under certain conditions, any investor's optimal portfolio can be constructed by holding each of certain mutual funds in appropriate ratios, where the number of mutual funds...
for a discussion of other possibilities. It is the construction of a universal portfolio that is kept separate from the individual needs of each client.
The second part is tailoring the use of that portfolio to the risk-aversive needs of each individual client. This is achieved through simulation of a given risk-return
Risk-return spectrum
The risk-return spectrum is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken.-The progression:...
range by allocating the client's total investments partly to that universal portfolio and partly to the risk-free asset.