Well while writing this probably I am wasting my time but then there aint much to do on a Saturday morning.
Why Returns Alone Shouldn't Be Considered While Making A Portfolio
First things first.
The return of any security is determined by the risk being taken. We calculate this by using Sharpe ratio which basically tells us the return/risk beyond the risk-free rate.
Now the second important part. In modern portfolio theory the risk of a portfolio is judged by the summation of the standard deviation of the individual securities. For eg if there are two securities then:
S.D (portfolio) = (w1^2*S.D ^2(1) + w2^2*S.D^2 (2) + 2.S.D(1)*S.D(2))^1/2
Where w1 and w2 are weights of individual securities and S.D is standard deviation.
IF the correlation between two securities is less than 1 then the overall portfolio risk is reduced ( though the combining securities had more risk , can be deduced mathematically from the above equation)
The portfolio diversification can only reduce the unsystematic risk though the systematic risk(think of the whole economy as a perpetual motion machine) remains.
So what does this diversification depend on.
If we look at various sectors in our economy then their returns are related to business cycles. Some are positively correlated and some are negatively. This gives rise to securities which are not perfectly correlated and can be used to diversify a portfolio.
With this minor information (which is largely inadequate to understand portfolio theory) lets move on to the question why returns alone shouldnt be considered while investing money or why even if KSE offered superior returns , people are more likely to invest in India.
In top-down approach to security valuation the first thing to be considered is the economic environment of the country or region where one wants to invest. This largely depends upon govt. ( dictatorships being treated as unfavourable) and general economic regulations of a country. Now dont make me devalue Pakistan is economic sense because that is a well known truth.
The second primary reason is the lack of negatively or lowly correlated securities needed for portfolio diversification. BSE provides a more favourable mix of securities.
Lastly, High returns and low risks are not possible and against the law of effective market .KSE might have outperformed various indexes but that doesnt matter an inch because the reward/risk ratio is too less for investors as compared to a BSE or NYSE.
Got it? Else take some lessons from me on Modern Portfolio Theory for FREE.
P.S : Do me a favor and please dont blabber your false economic theories here. They disgust me no ends.
P.P.S : Reward/Risk and not just rewards speaks much louder then any of your bluster.
