Gold As A Portfolio Diversifier Harvard Case Solution & Analysis



Investors usually analyze their returns of different asset classes through mean of returns, standard deviation, coefficient of variation and other measures, however, returns are available in many different time intervals. This could include the returns being available weekly, quarterly, monthly or annually. Investors therefore, need to decide which interval gives the most realistic results and reveals the true picture of the performance of different asset classes. In this case, the mean, standard deviations and the correlations of different asset classes has been calculated based on the monthly return data.

However, the calculation that has been performed in the spreadsheet calculates the mean, standard deviation and the correlation by using the annual returns data. The results under both the calculation are completely different. The reason for this is due to the fact that the timing and the magnitude of the investments held is different and this also has effect on the fluctuations of the returns of the three asset classes. Therefore, in order to see the true picture regarding the performance of each asset class, annual returns should be used because most of the factors are incorporated within it. This reveals the true performance for each of the asset classes. Also the data that is to be used in the optimization problems should be based on annual data so that the problem is realistically optimized.



The three asset optimization model has been made on the basis of three asset classes comprising of US Large capital stocks, bonds and Gold. In the first 3 Asset Optimizer model, the standard deviation of the entire portfolio has been restricted at 10 % and the investment weightage in Gold has been restricted to 0%. Based on this, the total portfolio weight has been calculated. The total return of the portfolio under these conditions is found to be around 7.99%. In the second model of 3 asset optimization the restriction for investment in Gold has been removed and the inclusion of Gold in the portfolio is also considered. Based on the investment in the three asset classes along with Gold shows that at the restricted standard deviation of 10% the total return for the portfolio is around 8.56 % and this shows that the total return has increased after the inclusion of Gold in the portfolio.



In the second scenario, again the three asset optimization model has been used to optimize the total returns and find out the optimized weights of each of the three asset classes. Here the restriction on the standard deviation has been removed and two optimization solutions are produced, one without the inclusion of Gold and the second with the inclusion of Gold. In the first optimization solution which is without the investment in Gold, the total return of the portfolio is 8.13 %, while after the inclusion of Gold in the portfolio the total return of the portfolio has increased to 8.68%. Both of the above scenarios show that due to Gold’s negative correlation with the other types of asset classes and based on the total portfolio returns an investor should include gold in his portfolio to maximize the returns and minimize the overall volatility of the returns of the portfolio.



Using the 11 asset optimization model, the total return of the portfolio has been found once again by optimizing the weights of some of the realistic asset classes that investors usually come across in practical life. The asset classes in the 11 asset model consist of large cap stocks, small cap stocks, US T-bills, US bonds, Global bonds, developed market equities, emerging market equities, hedge funds, commodities, US REIT’s and Gold. The target standard deviation for the portfolio is again set at a maximum level of 10%. Based on these assumptions, the total return of the portfolio is found to be around 8.2%.


Looking at the past history of Gold and the role that Gold has played in times of social turmoil and euro crisis and market collapses, Gold is long symbolized as a sign of guaranteed wealth. Based on the calculations that have been performed above regarding the mean, standard deviation, correlations and the 3 asset optimizer and the 11 asset optimizer it is recommended that Gold should be made one of the investment choices within a portfolio. The arguments in favor of this recommendation are the correlations of Gold with other major and also minor classes of asset are negatively correlated. This means that as the returns of all other asset classes decrease, the returns of Gold are increased simultaneously.............................................

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