Minimum Variance Portfolio and the Efficient Frontier

Minimum Variance Portfolio

The minimum variance portfolio theory was adopted from the Portfolio Theory where the variance level of a portfolio is adopted to indicate the risk level of the portfolio. The variance portfolio is defined as a portfolio of assets which has a low beta value when compared to the beta value of the individual financial assets included in the portfolio. Beta value indicates the volatility of the portfolio indicating the risk level attached to the portfolio as a whole. Usually investing individual financial assets is riskier than investing in the portfolio as a whole. Therefore, Minimum variance portfolio aims at creating a portfolio with lowest beta value to create low level of risk in the portfolio. Mode of diversification is used to create a portfolio of risk with minimum variance level and successful creation of portfolio with a minimum variance will result in a portfolio which has a lower beta value (risk level) than beta value (risk level) of individual financial assets included in the portfolio. When creating a minimum variance portfolio techniques such as offsetting riskier assets with low risky assets can be used depending on the risk apatite of the investor.

The Efficient Frontier

Efficient frontier indicates the relationship between the risk (volatility/beta) and the efficient frontier indicates the best possible return that can be obtained at a given level of risk or the lowest risk that has to be accepted in order to achieve a given level of returns. The efficient frontier can be graphically represented as follows.



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