There are four commonly used classes of portfolio construction techniques. These include,

• Screens: which involves simple ranking of the assets and composing an equal-weighted or capitalization-weighted portfolio.
• Stratification: builds on the screens method by ensuring that each category of assets is present in the portfolio.
• Linear programming: is used to choose a portfolio that closes resembles the benchmark portfolio using stratification based on industry characteristics.
• Quadratic programming: this technique models alpha, risk and transaction costs and can also incorporate constraints.

Things to Remember

• Alpha: A measure of the active return on an investment, the return in excess of a benchmark index.
• Portfolio Construction: The process of selecting the appropriate mix of assets to achieve the investment objectives within the constraints of risk tolerance, time horizon, and investment goals.
• Equal Weighting: A portfolio construction technique where each asset in the portfolio is given the same weight or allocation.
• Capitalization Weighting: A portfolio construction technique where the weights of assets are based on their market capitalization.
• Benchmark Portfolio: A portfolio that represents a standard against which the performance of an investment portfolio can be measured.