Step Optimization and Portfolio Design

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• Portfolio optimization is a theoretically appealing solution to the portfolio construction problem. In practice, optimized solutions often have several shortcomings
• One solution Jacobi has developed to help its users overcome these shortcomings is a process of incremental Step Optimizations starting from the client’s current or strategic asset allocation. The results of the Step Optimization process are returned as interactive charts depicting the incremental and aggregate change in positions as well as forecast portfolio outcomes.
• The current asset allocation is a useful starting point for the process because, assuming it has been thoughtfully constructed, it represents a good first approximation of the optimal portfolio for the investor’s true objective function. Visualizing how the optimizer would then improve upon that portfolio in small step-changes provides additional insight into potential changes that could be made, and on the signals that are being provided from the asset class assumptions.
• This paper explores how multi-asset investors can use Jacobi’s Step Optimization process to identify potential asset allocation trades, communicate changes to investment strategy with clients, and gain insight into the practical implications of their asset class assumptions.