Methods and Tools for Portfolio Selection

Strategic asset allocation leads to the identification of a number of efficient portfolios in the risk-return space. This common feature brings the topic of portfolio selection to the fore, since it is obvious that when presented with a variety of long-term investment options which cannot be ranked (being all optimal), we face a problem of choice and selection. This chapter illustrates the methods and instruments for portfolio selection available to institutional investors for a more aware identification of the “optimal portfolio”, taking into consideration management objectives and constraints. These tools and/or methodologies have been formulated in contributions mainly related to the areas of risk budgeting and financial planning that appeared after Markowitz’s Modern Portfolio Theory. A detailed analysis will clarify that the tools and/or methodologies being considered aim: to enhance our knowledge of the nature and intensity of the diversification offered by the portfolios in the opportunity set; to gain a more profound and/or alternative assessment of the risk of optimal portfolios; to verify, at least in probabilistic terms, the extent to which optimal portfolios satisfy the need to “protect” a financial result or defend against possible losses; to analyse possible future scenarios of cumulative wealth associated with investment in efficient portfolios.