Professional Investment Services Noll

Moriarty

THE “EFFICIENT FRONTIER”

The financial industry assesses investments in terms of the amount of the expected return versus the
“risk”, which is defined as the volatility of the series of returns. This volatility is quantified by the
statistical measure of standard deviation.
For reference, the annualised return and volatility for the last 10 years of the various asset sectors 1 are
graphed below:

Asset Sector Performance (1991 - June 2002)

15%
Efficient
Annualised Return

Frontier
10%

5%

Annualised Volatility
0%
0% 5% 10% 15%
CPI Aust Cash Aust Bonds
International Bonds Listed Property Aust Shares
International Shares Sydney Residential Brisbane Residential
Perth Residential Melbourne Residential Adelaide Residential

It is apparent that higher returns are usually associated with higher risk. The major exception is
residential property, which over the last 10 years has had low returns, yet is medium-to-high risk.
Note the improving return as asset sectors move from the income sectors (cash, bonds) to growth
sectors (listed property and shares). International shares are the highest return and volatility sector.
Note that listed property display similar volatility to residential property, but had higher returns.
An investor’s risk profile sets the maximum amount of volatility for a portfolio. The financial planner’s
challenge is to maximise the return, after an investor’s risk level has been determined. The major point
to note is that the portfolio components selected should be the best available in a given asset sector.
For given volatility, returns are as high as possible – such a portfolio is close to the “Efficient Frontier.”

1
Source - Assirt Journal, May/June 2002:
 Residential housing from Rothschild/ASSIRT All Housing Accumulation Indices (weighted average of capital city
house and unit prices. Takes into account net rental income on houses and units).
 Cash – UBS Warburg Bank Bills Index; Australian bonds - UBS Warburg Composite Bond – all maturities
 Listed property – ASX Property Trust Accumulation; International bonds – JPM Global Traded in AUD
 Australian shares – S&P/ASX 300 melded accumulation
 International shares – MSCI World Accumulation in AUD.
Professional Investment Services Noll
Moriarty
When constructing an investment portfolio, the efficiency should be a demonstrably addressed by the
financial planner.