Asset value modelling and portfolio optimization for ETF markets

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An exchange-traded fund (ETF) is an investment fund traded on stock exchanges. ETFs are attractive investment instruments because of their low expense ratios, easy diversification, tax efficiency, transparency, and stock-like features, since ETFs can be bought or sold at any time during the trading day for their net asset values. Currently, there are more than 1,500 ETFs traded on US exchanges, and about 350 ETFs traded on Toronto Stock Exchange (TSX). Emerging Star Investment Group Inc. (ESIG) is a rapidly growing Waterloo-based firm that provides valuable service to individual and institutional investors, portfolio managers and financial advisors. The company's product has innovative features that allows its clients to diversify their investment over a broader range of funds. ESIG's speciality is investment in ETFs. The objective of this NSERC Engage project is to introduce recent achievements of Modern Portfolio Theory to ESIG and provide them with a toolbox of models and methods used for scenarios simulation and portfolio optimization. First, we compare the performance of different multi-factor stochastic models and identify key factors that are crucial for selection of a right model. Second, we solve static and dynamic portfolio optimization problems using verified models from the first stage. Project results will help company improve the quality of their service, attract new customers and grow their company by creating more jobs. Once fully commercialized, ESIG's software will be make a very important impact on performance of Canada's institutional investors, e.g. pension plans, that were recently hit by economic downturn. It will also improve wealth of individual investors by providing them sound, science-based advise. In the longer term, we hope that latest research achievements in quantitative finance will be adopted in practice and will become available to individual investors.