If 2 investments both return 5%, can a portfolio made up of these 2 investments return more than 5%? In theory, it should not be possible, but in reality, it is possible to wring out some extra return from these 2 investments. How is this possible? Through portfolio rebalancing.

Modern Portfolio Theory states that if 2 investments are not perfectly correlated, a portfolio made up of these 2 investments should result in lower risk. However, it does not mention that extra returns might be obtained from this portfolio. To prove that this is possible, we consider the returns and standard deviations of 5 indices over the last 25 years since 1988, as follows:

Table 1: Risks and Returns of 5 Component (Read more...)