Modern Portfolio Theory (MPT) Allocation – How It Works in Fincanva

What It Is

Modern Portfolio Theory (MPT) is a quantitative framework for constructing a portfolio that offers the maximum expected return for a given level of risk—or the minimum risk for a given level of return. It uses historical returns, volatility, and correlations among assets to place the portfolio on the "efficient frontier."

What It Does in Fincanva

• Logic: MPT determines optimal weights using mathematical optimization to achieve the best possible risk-return tradeoff

• Simulation Behavior: During each rebalance, capital is allocated based on updated return and risk statistics from historical data

• Variants Supported in Fincanva:

  • Markowitz Optimal Portfolio – Maximizes expected return for a given level of risk

  • Minimum Variance Portfolio – Minimizes volatility regardless of return

  • Maximum Return Portfolio – Focuses solely on maximizing return, without considering volatility

• Constraints (optional):

  • Positive Weights Only (models only)

  • Constrained Weights – Limits max difference between asset weights

  • Diversified Constraint – Caps annualized standard deviation

Pros

• Optimizes risk-return profile using well-established financial theory

• Adapts to correlations, not just asset risk or return

• Offers multiple configurations to fit different goals (e.g., max return, min risk)

• Suitable for advanced users seeking mathematically optimal portfolios

Cons

• Relies heavily on historical data, which may not predict future returns

• Sensitive to input changes, especially in small or highly correlated asset sets

• Computationally intensive, especially with constraints enabled

• May result in concentrated portfolios if constraints are not applied

Where You Can Use It

• Portfolios: Yes - Positive weights only

• Models: Yes

When to Use It

• Best when aiming to maximize performance with managed risk

• Ideal for academic, institutional, or research-backed strategies

• Suitable for optimizing model compositions with diverse return/risk characteristics

• Recommended when working with asset classes that exhibit varied correlation and volatility

Example
Suppose Asset A and Asset B are negatively correlated. MPT will allocate more capital to both assets to reduce overall portfolio volatility, even if their individual volatilities are high—thus increasing diversification benefits.

• Portfolios: Available on Ultimate and Professional plans

• Models: Available on Ultimate and Professional plans