Why do you minimize risk for a given return as opposed to maximize return for a given risk?

CFA Level III Portfolio Management
#1

I’m looking at [EXAMPLE 9 A Strategic Asset Allocation for Ian Thomas] on page 221 of Reading 17: Asset Allocation

Question 1 asks: Determine the strategic asset allocation that is most appropriate for Thomas.

We are given:

Objectives

  • Return objective. The return objective is to earn an average 8.5 percent annual return.69
  • Risk objectives. Given his substantial assets and the length of the first stage of his time horizon, Thomas has above-average willingness and ability to take risk, quantified as a capacity to accept a standard deviation of return of 18 percent or less.

How come instead of maximizing the return for a given level of risk, which is something that is stated over and over and over again in the text, we instead minimize risk for a given level of return. I thought that the best allocation for Ian Thomas lies between corner portfolio 1 and 2 as his risk tolerance is 18% SD, which lies in between those 2 portfolios. But instead, the optimal portfolio for Ian Thomas lies between corner portfolio 3 and 4 because his return target of 8.5% is in between those 2.

When do we maximize return given a level of risk taking ability vs minimizing risk given a level of desired return?

#2

If a client’s return objective can be met by taking a lower risk level, then why would he/she not do that. Doing otherwise would be risk seeking (return maximizing) behavior. Remember that a rational economic man is risk averse and a selfish utility maximizer (an input in that utility maximization function is clients risk aversion )

#3

ok thanks, that makes sense. if expected outcome were all the same, individual would choose one with the least risk

#4

glad I can help :slight_smile: