What is a Zero-Investment Portfolio
A zero-investment portfolio is a collection of investments that has a net value of zero when the portfolio is assembled, and therefore requires an investor to take no equity stake in the portfolio. For instance, an investor may short sell $1,000 worth of stocks in one set of companies, and use the proceeds to purchase $1,000 in stock in another set of companies.
BREAKING DOWN Zero-Investment Portfolio
A zero-investment portfolio that requires no equity whatsoever doesn’t exist in the real world, though such portfolios are of interest to academics studying finance. A truly zero cost investment strategy is not achievable for several reasons: First, when an investor borrows stock from a broker in order to sell the stock and profit from its decline, they must use much of the proceeds as collateral for the loan. Second, in the United States, short selling is regulated by the Securities and Exchange Commission (SEC) such that it may not be possible for investors to maintain the right balance of short investments with long investments. Finally, buying and selling securities requires investors to pay commissions to brokers, which increases costs to an investor, such that an real-life attempt at a zero-investment portfolio would involve risking one’s own capital
Zero-Investment Portfolios and Portfolio Weight
The unique nature of a zero-investment portfolio leads it to not have a portfolio weight at all. A portfolio weight is usually calculated by dividing the dollar amount that a portfolio is long by the total value of all the investments in the portfolio. Because the net value of a zero-investment portfolio is zero, the denominator in the equation is zero, and therefore the equation cannot be solved.
Zero-Investment Portfolios and Portfolio Theory
Portfolio theory is one of the most important areas of study for students and practitioners of finance and investing. The fundamental contribution of portfolio theory to our understanding of investments is that a group of stocks can earn investors a better risk-adjusted return than individual investments can. In most real world markets, however, diversification of assets cannot eliminate risk completely. An investment portfolio that can guarantee a return without any risk is known as an arbitrage opportunity, and academic financial theory usually assumes that such scenarios are not possible in the real world. A true zero-investment portfolio would be considered an arbitrage opportunity, if the rate of return this portfolio earns equals or exceeds the riskless rate of return, usually assumed to be the rate one can earn from U.S. government bonds.