Separation property (Finance)

Separation property, a crucial element of Modern portfolio theory, is the ability of a portfolio manager to separate the process of satisfying investing clients' needs into two separate parts [Bodie, Z, Kane, A, and Marcus, A, (1999), "Investments" 4^{th} Edition, McGraw Hill, ISBN 0-256-24626-2, p226-7] .

The first part is the determination of the "optimum risky portfolio". This portfolio is the same for all clients as it has the highest Sharpe ratio. It is this construction of a universal portfolio that is kept separate from the individual needs of each client.

The second part is tailoring the use of that portfolio to the risk-aversive needs of each individual client. This is achieved through simulation of a given risk-return range by dividing the client's total investment partly to that portfolio and partly to the risk-free asset.


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