During this project, I created a portfolio based on the U.S. market that was tailored for clients seeking an optimal risk-adjusted return on equities, balanced with lower risk in fixed-income and derivatives markets. This portfolio was constructed using the Fama-French three-factor model and utilised risk-adjusted measures such as the asset's Sharpe ratio, Treynor measure, and its alpha. Data was gathered from CRSP, sourced via the WRDS platform.
The three-factor regression decomposed each equity's excess return against market (Mkt-RF), size (SMB), and value (HML) factor loadings, isolating the portion of return attributable to systematic risk exposure versus manager-specific alpha. Beta coefficients from the regression were then used to size position weights, tilting the equity sleeve toward names with favourable risk-adjusted alpha after controlling for size and value tilts, rather than raw historical returns alone.
On the fixed-income side, bonds were selected and weighted using duration and convexity matching to manage interest-rate sensitivity, with yield-curve positioning informing which maturities offered the best carry relative to reinvestment risk. This kept the fixed-income sleeve's contribution to portfolio volatility low while still contributing positive expected return.
Portfolio Composition
- 80% Weighted in equities, with the goal of maximising Sharpe ratio
- 17% In corporate and government bonds, with the goal of minimising risk
- 3% In derivative hedging for the two equities with the largest weight
For hedging, I used a fully hedged strategy of put options for the two top-weighted equities, ROP & S&P 500, against potential price downturn. Option premiums were evaluated using Black-Scholes pricing to confirm the hedge cost was justified relative to the reduction in portfolio downside (delta), keeping the hedge cost-efficient rather than a blanket insurance overlay.
Portfolio-level risk was cross-checked using the correlation matrix across the equity, bond, and derivative sleeves to confirm genuine diversification benefit rather than concentrated, correlated exposure, a key check before finalising position sizing.
Reference Workflow
Example stock and bond valuation workings used to derive the portfolio's risk-adjusted metrics: