Say I have a portfolio of expected return $10\%$ and volatility $20\%$. If I have another asset that is either one of:
- Negatively correlated
- Positively correlated
With negative expected return $\mu < 0$ and volatility $\sigma$. From intuition, I think that if we are allowed to use leverage, we should be adding this to portfolio under scenarios 1 and 3 to reduce risk (and apply leverage to achieve desire rate of return). Is this true? How would I size this position if I want to target $10\%$?
Is this scenario similar to the case of shorting one asset and buying another that are positively correlated to each other? In both instances (long/short positively correlated or long/long negatively.. or zero correlated), they should be risk reducing. And if we're allowed to use leverage we should be ale to achieve target return at lower risk? Though this also depends on the bounds of expected return and correlation?
Basically, is it ever smart to add something with negative expected value to a portfolio depending on its correlation to the portfolio?