Portfolio Optimization in Practice

These results suggest that, over the time period studied, international diversification into foreign bonds has offered some benefits. These benefits are best measured, however, by comparing the performance of a passive world index with that of a US. index. An ex post mean-variance analysis systematically overstates the possible gains from going international. The concept of mean-variance optimization, developed by Markowitz, is the cornerstone of modern finance theory and a powerful tool for efficiently allocating wealth to different investment alternatives.' The technique incorporates investor preferences and expectations of return and risk for all assets considered, as well as diversification effects, which reduce overall portfolio risk.