Performance and Hedge portfolios

A portfolio optimised purely for return tends to carry more risk than is comfortable in a downturn. To balance this, a portfolio can be built from two parts. The Performance Portfolio is a set of assets designed for high returns. The Hedge Portfolio is a second set designed to reduce risk. Combining the two aims for a balanced portfolio with a better return-to-risk ratio than either could reach alone. The hedge is your choice—the Hedge Portfolio switch is on by default, and all of pfolio's pre-built portfolios use both parts.

The Performance Portfolio holds the assets meant to drive returns. Its Risk Level setting is typically high—a recommendation of 80% to 100%—so it leans towards the maximum-Sharpe end of the trade-off between risk and return.

The Hedge Portfolio holds assets chosen to reduce overall risk, typically at a low Risk Level setting—a recommendation of 0% to 10%—so it leans towards minimum volatility. It is designed to hold up when the Performance Portfolio struggles.

The key to this is the Correlation goal metric, selected in one of the Hedge Portfolio's goals by default. In the Hedge Portfolio, correlation is measured against the Performance Portfolio's returns, and lower values rank better—so the goal selects assets with a low or negative correlation to the Performance Portfolio. That is what achieves the hedging: assets that move independently of the Performance Portfolio, or against it, cushion the overall portfolio when the Performance Portfolio falls.

At each rebalance the two are optimised in turn: the Performance Portfolio first, then the Hedge Portfolio. The split between them is set inside the Hedge Portfolio's optimisation, not by a separate step—the finished Performance Portfolio enters it as a single combined holding, and the optimiser assigns that holding its share of the whole, leaving the rest for the hedge. That share is bounded by the Performance Portfolio Allocation constraint—for example, 50% to 80% to the Performance Portfolio leaves 20% to 50% for the Hedge Portfolio. An individual asset can belong to both at once.

Each portfolio has its own goals, optimisation method, and constraints, configured independently. The Performance and Hedge portfolios can therefore pursue different objectives over different assets.

The Hedge Portfolio is optional. Turn off the Hedge Portfolio switch to build from the Performance Portfolio alone; the whole portfolio is then optimised for returns, without the risk-reducing second part.