Modern Portfolio Theory

4312 Monterey Court, Discovery Bay, California 94505, United States

(925)266-6578

John B. Douglas Receiverships, Estate Management and Fiduciary Services

Portfolio risk is best managed through careful diversification

The portfolio as a whole should be far more stable than it's individual investments.
Diversification is a technical term mathematically based on correlation analysis.

Non-Correlation

Portfolio risk is best managed through careful diversification

Non-correlated assets are not the same as negatively-correlated assets. Non-correlated assets are assets driven by differing, unrelated market or economic forces. Their price movements relative to one another tend to be arbitrary. One asset may be moving up when another is moving down at a given point in time. Yet at another time, those same assets may move up or down together. Such assets are non-correlated.

Negative Correlation

Portfolio risk is best managed through careful diversification

Negative Correlation

Though the market cycles of many assets coincide, others do not. Negative correlation occurs when the value of two investments regularly move in opposite directions. Equities and bonds are often examples of negatively correlated sectors.

Correlation

Asset Correlation and Non-Correlation

Negative Correlation

Market events influence the economy. However, the various sectors of our market react independently.
If a portfolio is made up of investments that share market sectors, these investments and their performance, are likely to be closely correlated: rising and falling together.If a portfolio is made up of investments that do not share market sectors, these investments and their performance, are impacted in varying ways and are not correlated: they are diversified.

Asset Correlation and Non-Correlation

The range of possible correlation coefficients is from 1.00 to -1.00. The prices of two assets sharing a correlation of 1.00 (100% correlation) historically move in the same direction at all times (rising and falling simultaneously). At the other extreme, the prices of two assets with a coefficient of -1.00 (negative one) are also perfectly correlated, but inversely, so one is always gaining when the other is losing.

(UPIA) - Was adopted in 1992. It reflects a "modern portfolio theory" and "total return" approach to the exercise of fiduciary investment discretion. Guardians and conservators are subject to laws of trust established in Probate Code Sec 2101, however, they are also limited in Probate Code Sec 2574 as to what investments can be made without Court approval. Trustees are subject to the laws of trust established in Probate Code Sec 2101, without the limitation of Sec 2574.

A trust's, or estate's entire portfolio is considered in evaluating the prudence of individual investments. The fiduciary is not liable for individual investment losses, so long as the investment, at the time it was made, was consistent with the overall portfolio objectives.
Diversification is required to avoid risk of market sector failure. No category or type of investment is, of it's self, imprudent. However the key is the fit of that investment to overall investment strategy. The fit to the trust's (or estate's) purposes and beneficiaries' needs is considered the key. The fiduciary is now permitted greater flexibility in portfolio management. However, because speculation and outright risk taking is not sanctioned by the rule, the fiduciary remain subject to criticism and liability if he goes too far.
The fiduciary is permitted to delegate investment management to third parties.

Correlation Tables

Asset Correlation and Non-Correlation

Correlation tables are displayed as a matrix of correlation coefficients exhibiting the correlation of each asset to every other asset in the portfolio. Correlation tables will enable the advisor, the fiduciary, attorney, or judge to determine if a portfolio is diversified.