Beyond Portfolio Optimization

Abstract Methods to obtain optimal portfolios have been used extensively in the financial community for several decades. The first methods were published by Markowitz in the 50's and the literature has been vastly expanded since these days. Most discussions and publications to date have been centered on the methods to perform portfolio optimization. However, the greatest value added by portfolio optimization is not in the optimization itself, but on the use of the results as an aid to decision making. Unfortunately, little research has been done on this behalf. This paper proposes a new approach, and intends to bridge this gap showing concrete portfolio management applications. Portfolio optimization is not a single event, on the contrary, it is an iterative procedure where the results gathered from each iteration are used to feed the decision making process. After some decisions are made, or company policies established, the process must be repeated to observe the results of the simulation and to provide feedback to the decision making process. This paper describes three portfolio applications that aid corporate decision makers. The first application deals with the effect that production and capital constraints have on the portfolio optimization process. These constraints assist management in the setting of realistic company goals. The second application explains how acquisitions and divestures can be evaluated in the portfolio context, and the effect that those projects have on the company objectives. The third application explains the use of portfolio optimization to manage and drive the company strategy. Using these methods, management could manage acquisitions and divestures in a proactive way, set realistic goals and objectives. As a result, management gain more control and insight over the company future.