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Modern portfolio theory (MPT) can be applied to business portfolio decision-making

17 May 2017

  • Shareholders seek to maximise company profits while minimising risk
  • However, lower risk businesses are usually accompanied with lower returns and high risk businesses with higher returns
  • Comparisons between various risk and return profiles can be measured using the Sharpe ratio – return per unit of risk
  • Combinations (degree of balance sheet investment) in individual portfolios could realise higher returns per unit of risk than what is achievable in an individual business unit – some combinations are not always obvious
  • By exiting a higher risk-return portfolio BU J, ABC would be able to increase its return per unit of risk from 4,3 to 4,5
  • It is often psychologically difficult for businesses to exit high return portfolios
  • Emotional decision-making can be muted by applying the logic of modern portfolio theory in the board room

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