What is Portfolio Optimization

Portfolio optimization has been an area of research that has attracted a lot of attention from researchers and financial analysts. Designing an optimum portfolio is a complex task since it not only involves accurate forecasting of future stock returns and risks but also needs to optimize them. This article presents a systematic approach to portfolio design using two risk optimization approaches, the hierarchical risk parity algorithm and the hierarchical equal risk contribution algorithm on seven critical sectors and the NIFTY 50 stocks listed in the National Stock Exchange of India of the Indian stock market. The portfolios are built following the two approaches on historical stock prices from Jan 1, 2016 to Dec 31, 2020. The portfolio performances are evaluated on the test data from Jan 1, 2021 to Nov 1, 2021. The backtesting results of the portfolios indicate that the performance of the HRP portfolio is superior to that of the HERC portfolio on both training and the test data for the majority of the sectors studied in this work.