Designing Portfolios for Different Risk-Return

Clusters- Ayan Doss

Portfolio Designing – The Main Steps

Expectation Determinati

on

Stock Selection

Portfolio Allocation

Performance Evaluation

Assumptions and Constraints

• Stocks in the BSE-500 have been considered only.

• The portfolio is created as on 7th May 2010.

• Any company having negative earnings have been ignored.

• The portfolio has been backtested for 1 year only.

Expectation Determination• Average Return in the Indian markets is 12.16% with a risk of 35.12% over a 10

year period.

• Share Prices are log-normally distributed across indices and time horizon.

• Most of the financial Performance parameters are not normally distributed even within industries.

Expectation Determination

• Among all the parameters only the EPS growth rate within the banking industry is normally distributed.

• This shows that we can outperform the markets by investing in good and strong companies.

• We divided all the 500 stocks in the BSE-500 into three groups to find out the risk and return characteristics of the various classes of investors.

Expectation Determination – Cluster Analysis

• As expected risk and return go hand in hand. Excess return cannot be earned without taking some additional risk.

• Thus, in Indian context an aggressive investor would look to earn a return of 18% with 55.89% amount of risk

Risk – Return Scatter Plot

Expectation Determination – Cluster Analysis

Expectation Determination – Cluster Analysis

• Buying stocks is just like buying any other thing.

Stock Selection

• We look for two main characteristics

1. Quality of the offering, and2. Price.

3. Growth (Stock Specific factor).

Stock Selection

Quality

PriceGrowt

h

RONWEV /

EBITDA

SalesCash Flow

EPS

• Top 22 stocks on the basis of above criteria were selected for investment.

Portfolio Allocation – Base Portfolio

Weights as per BSE-500 Index

Portfolio Allocation – Efficient Frontier

• Top 8 stocks in BSE 500 taken in same proportion.

• Minimum Allocation to each stock is - 1%

• Maximum Allocation to each stock is - 25%

Portfolio Allocation – 3 portfolios

• Each of the three portfolios over a better risk-return characteristics compared to what the investors expects as per cluster analysis (given below)

Portfolio Stress Testing(Monte Carlo Simulation)

A Brownian motion simulation for the portfolio with 15 runs.

- Mean Return : 37.27%- Risk : 15.00%

As Per Efficient Frontier- Mean Return : 22.68%- Risk : 17.71%

Portfolio Stress Testing(Monte Carlo Simulation)

Portfolio Evaluation

Returns over a one year period

Portfolio Evaluation - Analytics

Value addition to Religare

• Help Religare move up the value chain.

• PMS is a high margin business compared to plain vanilla brokerage business.

• Attract HNI Clients.

• Can use this model in their MF schemes also.