Portfolio Construction
The systematic process of selecting and weighting assets to meet an investor's objectives within defined risk constraints.
What is Portfolio Construction?
Portfolio construction is the systematic process of selecting and weighting individual securities, asset classes, and investment strategies to build a portfolio that achieves an investor's financial objectives within defined risk constraints. The process typically follows the framework established by Modern Portfolio Theory (MPT): define objectives and constraints, determine strategic asset allocation, select securities within each asset class, and implement and rebalance the portfolio over time. Effective portfolio construction balances expected return, risk (standard deviation and correlation), liquidity needs, tax efficiency, and cost, using tools such as mean-variance optimization, factor models, and risk budgeting.
Example
A pension fund uses mean-variance optimization to construct an 8-asset-class portfolio targeting 7% expected return with less than 12% annualized volatility. The optimizer allocates 45% to global equities, 25% to investment-grade bonds, 10% to real estate, 10% to private equity, and 10% to inflation-linked bonds—constrained so no single asset class exceeds 50% of the portfolio.