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UBC Theses and Dissertations

Diversification of portfolios in Canadian investment funds. Rosen, Calman

Abstract

Diversification is a desirable characteristic of a well balanced investment portfolio. By diversifying investments over -a number of assets, one has a better chance of maintaining overall stability of capital and earning power. Prior to the development of the Markowitz theory, diversification had always been an intuitive process for most investment analysts. Using the Markowitz criteria of efficient diversification, the analyst now has a means of evaluating diversification in an investment portfolio. In his theory of diversification, Markowitz showed that the selection of securities could be made in a scientific manner so as to give a minimum of variation in an investment portfolio. His theory was based on the fact that all securities were not closely correlated in their price fluctuations, and each security had its own characteristics of expected return and variations in expected return. Using a mathematical procedure called quadratic programming, Markowitz suggested that a series of portfolios which had a minimum of variation for a given return could be selected from any list of investment alternatives. The only information needed on each investment alternative was its return based on price fluctuations and dividends, its statistical variance of return, and the amount of correlation between it and the other investment alternatives. The purpose of this thesis is to investigate the diversification in Canadian investment funds. In order to do this, it was necessary to divide the Canadian securities market into a workable number of investment alternatives, and to generate a series of optimum portfolios for each given rate of return. The optimum portfolios, based on the Markowitz criteria for diversification, could then be compared with the actual portfolios of Canadian investment funds. As a further basis of comparison, a series of random portfolios were also generated. The results of the comparisons revealed that Canadian investment funds did not exhibit properties of diversification as defined by the Markowitz criteria. The results also revealed that the investment funds were not significantly better than a random selector. These results could possibly be attributed to the size and structure of the Canadian securities market. A large investment fund, for example, could not concentrate on the few issues needed for proper diversification without affecting prices in the securities market. Another reason for lack of diversification is that the Canadian market is possibly not independent enough to present sufficient variety to the investor who wishes to properly diversify. Finally, there is reason to suspect that the basic philosophy behind the Markowitz approach, may not apply to many of the Canadian investment funds.

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