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V
Empirical Observations:
Questionnaire for Retail Investor and
Expert Opinion
This chapter presents the summary results of the two questionnaires used in
the study.
Investors spend a lot of time in searching for the right equity for investment,
which should be of zero regret or giving returns higher than pre-determined
benchmarks. For selecting such equities, investment advisors are nowadays focussing
on “goal based investing”. In this an investor is asked about the various goals which
he/she seeks and then based on the aspirations of the investor, the right kind of portfolio
is advised by the wealth managers.
In traditional equity selection strategy, the first step is to find the right brokerage
house, followed by finding the security which has delivered high returns and
performance with minimum risk and finally comparing their investment with
benchmark indices. However, in this process of equity selection, an investor may end
up in creating a portfolio which may not satisfy his/her goals. The traditional route to
investment may result in “good investment” which may not be the “right investment”.
Existing studies have shown that investment goals tend to depend upon the
demographics like gender, marital status, age, qualifications, profession, occupation,
annual income and responsibility status. These demographic factors are responsible for
different investor profiles and preferences which in turn finally affects portfolio choice.
This chapter contributes to the area of behavioural finance by understanding the
psychology of individual investors. This understanding acts as a base for developing a
goal programming model. The first contribution relates to the development of a
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questionnaire and its percentage analysis, trying to understand which variable has
maximum effect on a particular construct. Mean-standard deviation analysis has been
undertaken to further explain the results obtained by percentage analysis. The second
contribution relates to the qualitative analysis of the responses to the questionnaire for
expert opinion.
To present the results of the questionnaire analysis, this chapter has been
divided into two major parts: V.2 presents the empirical observations on information
collected through the questionnaire for retail investors. V.3 presents the results of the
survey questionnaire that sought expert opinion on portfolio management issues.
V.1 Introduction of Investor’s Goals and Constraints
Goals may be basic, discretionary or surplus in nature. Basic goal based
investment may involve planning in such a manner that you have enough to fulfil your
particular basic needs like marriage expenses or purchasing a house or day to day
expenses post retirement. Discretionary goal based investing involves focussing on
equities/portfolio which can provide high capital gain, in order to fulfil wishes of
funding a family vacation or purchase of jewellery. Surplus goal based investment may
involve realising gains so as to fund purchase of a second house, second car or
expanding current business.
Goal based investing focuses on matching of financial liabilities with existing or
expected financial resources. This may result in an allocation which may be far from
efficient frontier but maximises investor’s utility. The combination of risky and riskless
assets hence depends upon an individual’s expected future cash outflow and not only on
standard risk-return formulations. Hence, in goal based investing, the first step is to
decide the points of time when one would be requiring a lot of money. The asset
allocation will hence depend upon the amount of money needed (including cost
increases due to inflation) on these occasions. The next step is to define the priority that
one is to assign to each of these goals. It is of-course very complex to prioritise, as what
is more important, child’s marriage or higher education? These are questions which
vary across individuals and differ with time. The last step involves rebalancing existing
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portfolio, in case a goal is not met or is met before time. One of the limitations of this
investment strategy is that it involves very careful planning which may not finally get
implemented. Also, planning without proper implementation and monitoring will not
yield desired results. However, this limitation is true for any kind of planning.
Risk profiling is a part of investor profiling which relates to finding the ability
of an individual investor to bear risk. Investors on the basis of their risk profile are
generally classified as conservative, moderate and aggressive investors. Self
administered psychometric questionnaire are often used to define the risk tolerance of
an investor. The questionnaire helps financial planners, wealth managers and portfolio
managers identify the way an investor will behave to changing market swings. Risk
profiling is an extremely difficult process as an individual may exhibit risk taking
ability during the bull-run and an extreme risk-averse behaviour during the bear phase.
It is on the basis of risk profiling, alternate portfolios are recommended to the investors
keeping in account their investment goals and constraints.
V.2 Questionnaire for Retail Investor: Analysis and Interpretation52
The following section depicts the different types of information regarding the
respondents that were filled up in the “Personal Data Section” of the Questionnaire for
Retail Investor (Section V of Annexure 1).
V.2.1 Profile of the Questionnaire Respondents
The survey was dominated by males (89.6%). There were only 10.4% females
who responded to the questionnaire. The responses were collected from individuals
working in companies. The working population in companies being still dominated by
males is also represented in the sample. It indicates that females were less interested in
investing in shares. In our survey, we observed that married individuals (63.3%) were
more interested in investing in stock market than unmarried individuals (36.7%).
Age classification and investment shows that middle aged ranging from 25-40
years (47.8%) are more interested in investing in stocks. As the people are crossing 40
years but below 60 years the proportion of people investing reduces to 26.4%. The
proportion of young people between the age group of 18-25 years being 18.8%
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indicates that young people are not sufficiently attracted towards stock markets. It is
surprising that only 7% older people above the age group of 60 years are found to be
investing in stock markets.
Table V.1 Demographic details of the Questionnaire Respondents
Demographic Category No. of
Respondents
(512)
Percentage
(100)
Gender
Male 459 89.6
Female 53 10.4
Marital
Status Married 324 63.3
Unmarried 188 36.7
Age (in
years)
18-25 96 18.8
25-40 245 47.8
40-60 135 26.4
60 or above 36 7
Qualification
Graduate 145 28.3
Post Graduate 222 43.4
Professional 139 27.1
Doctoral 6 1.2
Professional
Level
Top 54 10.55
Senior 105 20.51
Middle 219 42.77
Executive 134 26.17
Occupation
Employed with a Company 251 49
Employed with a Non Profit Inst. 16 3.1
Employed with a Govt Unit 81 15.8
Self Employed 115 22.5
Any Other 49 9.6
Annual
Income
Between Rs. 1 lac-Rs. 5 lacs 309 60.3
Between Rs. 5 lacs-Rs. 10 lacs 137 26.8
Between Rs. 10 lacs-Rs. 20 lacs 41 8
Between Rs. 20 lacs-Rs. 30 lacs 17 3.3
Above Rs. 30 lacs 8 1.6
No. of
Members in
Family
Two or less than 2 64 12.5
2-5 393 76.8
5-9 46 9
More than 9 9 1.7
123
As per the survey, people with different qualifications have shown interest in
investing in shares, topping the proportion are post graduates (43.4%), graduates
(28.3%) and professionals like Chartered Accountants (CAs), engineers, lawyers and
architects (27.1%). Individuals who are highly educated i.e. Ph.D. are not active
participants in stock markets (1.2%). In terms of managerial level study, the middle
level management were found to be most participative (42.77%); executive level
(26.17%) and senior level executives (20.51%). Top level management was found to be
least active (10.55%).
In terms of analysis of occupation, we found that the corporate employees are
most active participants (49%) as compared to the next best as self employed (22.5%)
and government employees (15.8%). The people employed with non profit institutions
are least participative (3.1%) while proportion of people with other types of
organisation is 9.6%. Analysis based on income level revealed that the people with
income level of Rs. 1 lac to Rs. 5 lacs per annum topped the list of participants (60.3%),
followed by people with earnings level of Rs. 5 lacs to Rs. 10 lacs (26.8%). People with
higher incomes i.e. Rs. 10 lacs to Rs. 20 lacs, Rs. 20 lacs to Rs. 30 lacs and above Rs.
30 lacs are least participative with 8%, 3.3% and 1.6% respectively. Most of the survey
respondents have two to five family members (76.8%). Very few respondents (1.7%)
have family size of more than nine members (Table V.1).
A. Introduction
An attempt has been made in section V.2.2 to V.2.6 to analyse and interpret
perceptions and attitude of investors towards portfolio selection. The analysis is based
on responses received in section I of the questionnaire. The frequency, mean-standard
deviation analysis and percentages have been used to elicit the desired information.
V.2.2 Concept of Equity Portfolio Selection for investors
The response to the first question clearly shows that the mean value is highest
for the high return showing that when one asked about equity portfolio selection, the
first impression or idea that comes to the mind of an investor is high returns. For most
of the other objectives the mean and standard deviation is same (around 0.5)
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representing possibility of different conclusions for different samples. Equity portfolio
selection in descending order of preference represents high return (64.8%),
diversification (55.3%), wealth creation (52.5%) and safety (50.6 %) to most of the
investors (Table V.2 and Figure V.1).
Only 27 respondents (5.3%) checked the option of any other whereby they said
that equity portfolio represents a long term investment, quick and high returns,
moderate returns, high risk, proper wealth management, governance, investing in a
good company, research and personal finance management.
Table V.2 Concept of Equity Portfolio Selection for investors
Descriptive Frequency Percentage
(100)
Mean Standard
Deviation (total N = 512)
Code/Symbol 0 1 0 1
High Returns 180 332 35.2 64.8 0.65 0.478
Diversification 229 283 44.7 55.3 0.55 0.498
Wealth Creation 243 269 47.5 52.5 0.53 0.5
Safety 253 259 49.4 50.6 0.51 0.5
Any Other 485 27 94.7 5.3 0.05 0.224
Figure V.1
Concept of Equity Portfolio Selection for investors
X
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V.2.3 Gains sought from Equity Portfolio
As expected, most of the investors expect capital gain on their investment in
equities. Capital gain had a mean of 0.81 with a standard deviation of only 0.395,
further supporting the conclusion. Gains sought from an equity portfolio in descending
order of preference include capital gain (80.7%), dividend gain (29.5%) and voting
right (9.4%). This shows the lack of knowledge on the part of individual investors about
the importance of voting rights in companies. The postal ballot system and lack of
electronic voting may also be a possible cause for such response by the sample
respondents. Only 4.3 respondents said that they expect some other gain from an equity
which includes explanation like both capital and dividend gains (Table V.3 and Figure
V.2).
Table V.3 Gains sought from Equity Portfolio
Descriptive Frequency
(total N = 512)
Percentage
(100)
Mean Standard
Deviation
Code/Symbol 0 1 0 1
Capital Gain 99 413 19.3 80.7 0.81 0.395
Dividend Gain 361 151 70.5 29.5 0.29 0.456
Voting Right 464 48 90.6 9.4 0.09 0.292
Any Other 490 22 95.7 4.3 0.05 0.265
Figure V.2
Gains sought from Equity Portfolio
X
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V.2.4 Opinion on performance of professional portfolio managers
Investors in general are naive enough to be lured by the high returns with almost
no risk offered by financial advisors. It is because of this reason that a Rs. 300 Crores
fraud was committed in December 2010 by a relationship manager at Citibank’s
Gurgaon branch. Securities and Exchange Board of India (SEBI) has hence almost
finalised regulations for investment advisors along the lines of mutual fund industry. A
proactive role of a self regulatory organisation (SRO) has also been perceived.
Certifications offered by this proposed SRO are also expected to become mandatory.
This certification will ensure minimum education standards of financial advisors. Also
a clear distinction between financial advisors and distributors of financial products is
possible. This regulation is a welcome initiative as it will protects large number of retail
investors and high net worth investors (HNIs). Main reason behind these expected
regulation is to ensure due diligence by financial advisors by first undertaking risk
profiling of their clients and then recommending suitable portfolios. This practise of
risk profiling is common internationally but because of the presence of seller’s market
in India it is seldom used here. The finalised rules are a significant improvement over
the draft regulations issued in 2007. However, for successful implementation of these
rules a joint effort among SEBI, Reserve Bank of India (RBI), Insurance Regulatory
Development Authority (IRDA) and Pension Fund Regulatory Development Authority
(PFRDA) will be required. Also, existing SROs like Indian Bank’s Association and
Association of Mutual Funds in India (AMFI) can contribute positively in successful
implementation of these rules.
From the survey, it was found that most of the individuals neither agreed nor
disagreed with the statement that “Professional portfolio managers manage risk more
effectively than others” as the mean of the above statement is 3.96 with the standard
deviation of only 0.855, for responses on a Likert scale of one to five. Investor’s
perception in descending order of preference is agreed (54.7%), strongly agreed
(24.6%), neither agreed nor disagreed (13.7%), disagreed (5.7%) and only a small
proportion of investors disagreed (1.3%) with the statement. The percentage analysis
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shows that a large number of individual investors depend upon the professional advice
of wealth managers for managing risk (Table V.4 and Figure V.3).
Table V.4 Opinion on the Risk Management capabilities of Professional
Portfolio Managers
Figure V.3
Opinion on the Risk Management capabilities of Professional Portfolio Managers
V.2.5 Comparison of current and previous Portfolio Allocation
The respondents were asked to compare their current portfolio allocation with
the previous one. Most of the investors felt that it was about the same (46.9%). Some of
the investors perceived their current allocation to be superior (32.3%) while some felt
that they were better off (15.4%). Very few investors felt that they are either worse off
Likert Scale Frequency Percentage Mean
Standard
Deviation
Strongly Agree 126 24.6
3.96
0.855
Agree 280 54.7
Neither Agree
Nor Disagree 70 13.7
Disagree 29 5.7
Strongly Disagree 7 1.3
Total 512 100
128
(2.5%) or have made inferior investments as compared to their previous allocations
(2.9%). This shows that investors tend to learn from their mistakes and this learning
helps them to make better portfolio allocations in future (Table V.5 and Figure V.4).
The high response rate for the option “about the same” may be because individual
investors tend to follow passive portfolio strategy with seldom rebalancing of their
existing portfolio.
Table V.5 Comparison of current and previous Portfolio Allocation
Descriptive Frequency Percentage Mean Standard
Deviation
Superior 165 32.3
2.28
1.045
Better Off 79 15.4
About the Same 240 46.9
Worse Off 13 2.5
Inferior 15 2.9
Total 512 100
Figure V.4
Comparison of current and previous Portfolio Allocation
129
V.2.6 Asset allocation of respondents
While there exists a large number of options for investment of saving, the
preference of sample respondents in descending order was equities (54.9%), mutual
funds (31.6%), real estate (21.5%), fixed deposits (19.9%), cash/saving bank balance
(18.9%), insurance plans (15.6%), unit linked insurance plans (11.9%), preference
shares (10.9%), asset classes like art, commodities, gold and silver (8.2%) and least
interest in corporate bonds/debentures (7.6%). The preference for equities has a mean
of 0.55 with as standard deviation of 0.498, showing a high variability in equities being
the most preferred asset class. This variance is expected because desire for equities
depends directly upon the market performance. Equal mean and standard deviation for
cash/saving bank balance and a fixed deposit represents their equal preference by the
respondents. A high preference for equity also justifies the current selection of the
respondents. Low preference for asset classes like gold and silver was unexpected.
However, it may be justified on the ground that there is an increasing shift in the
choices of individuals as regards asset allocation. This shift may be because of the
increasing prices of gold and silver and limited knowledge of gold exchange traded
funds (ETF) or e-gold. Although it was a close ended question, yet some respondents
mentioned an option of tax saving schemes (Table V.6 and Figure V.5).
Table V.6 Asset Allocation Preferences
Descriptive Frequency
(total N =512)
Percentage
(100)
Mean Standard
Deviation
Code/Symbol 0 1 0 1 X
Equities 231 281 45.1 54.9 0.55 0.498
Mutual Funds 350 162 68.4 31.6 0.32 0.466
Real Estate 402 110 78.5 21.5 0.21 0.411
Fixed Deposits 410 102 80.1 19.9 0.20 0.400
Cash/Saving Bank Balance 415 97 81.1 18.9 0.19 0.392
Insurance Plans 432 80 84.4 15.6 0.16 0.363
Unit Linked Insurance Plans (ULIP) 451 61 88.1 11.9 0.12 0.324
Preference Shares 456 56 89.1 10.9 0.11 0.312
Alternate Asset Classes (Art,
Commodities, Gold & Silver) 470 42 91.8 8.2 0.08 0.275
Corporate Bonds/Debentures 473 39 92.4 7.6 0.08 0.266
130
Figure V.5
Asset Allocation Preferences
B. Portfolio Goals and Constraints: Analysis and Interpretation
In section V.2.7 to V.2.10, an attempt has been made to analyse and interpret
responses related to section II of the questionnaire on portfolio goals and constraints.
The frequency, mean-standard deviation and percentages have been used to elicit
desired information.
V.2.7 Multiple goals pursued by investors
From empirical observations, it has been observed that investors pursue multiple
goals. It was also observed that some of the important portfolio goals in descending
order are minimisation of risk (35.7%), stability in return (29.5%), safety first and then
gain (28.1%), high long term return (27.1%) and tax saving (25%). Some of the other
important goals not pursued so aggressively include high average return (24%),
minimization of loss (22.3%), liquidity (21.1%), opportunities for superior gains
(16.6%), high short term return (14.5%), expected future performance (14.1%) and
future contingencies (10%). Least important goals included high past return (8.4%),
volatility (7.8%), consumption needs (6.4%), speculation (5.5%) and other goals (2%).
The standard deviation of all the objectives is higher than the mean, representing high
variability in the responses of the investors.
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The responses to this question when interpreted along with the responses of
question 1, shows the desire of the investor to make highest possible capital gain with
minimum risk. Also, safety of current capital along with the possibility of high capital
gains is an important objective of the sample investors. Tax saving, high average return,
loss minimisation and liquidity have similar priority for the investors. Opportunities for
superior gains, high short term return and expected future performance have similar
priority for investors. Very few respondents view equities as a measure that could
protect them in case of a future contingency. High past return and volatility have similar
priority for investors. Equities are not considered as a suitable measure to fund
consumption needs in India. Very few respondents said that they are involved in
speculation. While answering to any other option, some respondents remarked that they
look at expected future performance in case of growth funds only. Some respondents
shared the opinion that safety first and then gains has become more important after
recession while others had the opinion that the portfolio should give risk adjusted
returns higher than returns on fixed deposit (Table V.7 and Figure V.6).
Figure V.6
Multiple Goals pursued by investors
132
Table V.7 Multiple Goals pursued by investors
Descriptive Frequency Percentage Mean Std. Dev.
Code/Symbol 0 1 0 1 X
Most Important
Minimization of Risk 329 183 64.3 35.7 0.36 0.480
Stability in Return 361 151 70.5 29.5 0.29 0.456
Safety First and then Gain 368 144 71.9 28.1 0.28 0.450
High Long Term Return 373 139 72.9 27.1 0.27 0.445
Tax Savings 384 128 75 25 0.25 0.433
Somewhat Important
High Average Return 389 123 76 24 0.24 0.428
Minimization of Loss 398 114 77.7 22.3 0.22 0.416
Liquidity 404 108 78.9 21.1 0.21 0.408
Opportunities for Superior Gains 427 85 83.4 16.6 0.17 0.372
High Short Term Return 438 74 85.5 14.5 0.14 0.352
Expected Future Performance 440 72 85.9 14.1 0.14 0.348
Future Contingencies 461 51 90 10 0.10 0.300
Least Important
High Past Return 469 43 91.6 8.4 0.08 0.278
Volatility 472 40 92.2 7.8 0.08 0.269
Consumption Needs 479 33 93.6 6.4 0.06 0.246
Speculation 484 28 94.5 5.5 0.05 0.228
Any Other 502 10 98 2 0.02 0.139
V.2.8 Multiple constraints faced by investors
From the empirical survey it may be observed that investors pursue not only
multiple goals but also face multiple constraints. From the twelve constraints identified
in this questionnaire, main constraint faced by investors is of investment/budget
constraint, whereby only a given sum is available for investment in equities. Review of
literature of some of the early works by Markowitz, Sharpe and Samuelson has also
given focus to this constraint.
It was also observed that some of the important portfolio constraints identified
by investors in descending order include budget (43.2%), price (21.5%), profit booking
(18.6%), inflation (17.8%), income (16.4%) and brokerage fees (16%). Other less
important constraints include stop loss (12.9%), volume traded (11.9%), transaction tax
133
(10.4%), minimum number of equities to be purchased by an investor (10%), range
(10%) and turnover (9%). Only 2.9 percent respondents ticked the option of any other.
Like the portfolio goals, the variance is higher than the mean value for all the
constraints. Invariably all the constraints are faced by the investors. However the two
main constraints are available budget and price. A relatively small number of
respondents have checked any other option. While answering to the any other option,
respondents shared that they face the constraint of high level of entry load on unit
linked insurance plans (ULIPs), volatility in stock market and doubts related to the
credibility of the companies. Some made remarks that most of the Indian investors are
risk averse and in case of equities they are extra cautious. Some said that transaction tax
and brokerage fees are a relevant constraint only if turnover is higher. Other constraints
also included uncertain events in the global markets, monetary policy, liquidity of
stocks, dependability of promoter of the company, selection of right equities and the
software which is installed by the operator which may make it impossible to gain
(Table V.8 and Figure V.7).
Table V.8 Multiple Portfolio Constraints faced by investors
Descriptive Frequency Percentage Mean Standard
Deviation
Code/Symbol 0 1 0 1 X
Most Important
Investment/Budget 291 221 56.8 43.2 0.43 0.496
Price 402 110 78.5 21.5 0.21 0.411
Book Profit 417 95 81.4 18.6 0.19 0.389
Inflation 421 91 82.2 17.8 0.18 0.383
Income 428 84 83.6 16.4 0.16 0.371
Brokerage Fees 430 82 84.0 16.0 0.16 0.367
Somewhat Important
Stop Loss 446 66 87.1 12.9 0.13 0.335
Volume Traded (in Number) 451 61 88.1 11.9 0.12 0.324
Transaction Tax 459 53 89.6 10.4 0.10 0.305
Lot Size 461 51 90.0 10.0 0.10 0.300
Range 461 51 90.0 10.0 0.10 0.300
Turnover (in Rs. Lac) 466 46 91.0 9.0 0.09 0.286
Any Other 497 15 97.1 2.9 0.03 0.169
134
Figure V.7
Multiple Portfolio Constraints faced by investors
V.2.9 Preference among Equity based Mutual Funds53
For achieving portfolio goals, maximum preference was observed for equity
diversified mutual funds (51.6%). Some of investors preferred to invest in equity tax
planning mutual funds (23.4%) and industry specific mutual funds (15.8%). Very few
investors have showed interest in Index based mutual funds (11.3%). Responses show
capital protection attitude of investors as they attempt to reduce risk through
diversification. Responses also shows that Index based mutual funds have yet not
become popular among retail investors. Some respondents remarked that they do not
invest in mutual funds at all (Table V.9 and Fig.V.8).
Table V.9 Preference among Equity based Mutual Funds
Descriptive Frequency Percentage Mean Standard
Deviation
Code/Symbol 0 1 0 1 X
Equity Diversified 248 264 48.4 51.6 0.52 0.500
Equity Tax Planning 392 120 76.6 23.4 0.23 0.424
Industry Specific 431 81 84.2 15.8 0.16 0.365
Index Based 454 58 88.7 11.3 0.11 0.317
135
Figure V.8
Preference among Equity based Mutual Funds
V.2.10 Effect of Demographic factors on Portfolio Objectives
Investor's psychology has a direct effect on the portfolio choices made by the
investors. Demographic factors are often taken as a proxy to understand the emotional
and mental framework of an investor. The understanding of the relationship between
demographic factors and portfolio goals contributes to the existing literature on
individual investor's decision making. Here, an attempt is made to understand the
perception of investors as regards the effect of demographic factors on portfolio
objectives. From the survey, it was observed that a large number of investors perceive
that it is their risk bearing capability, that affects their portfolio selection most. Other
important factors in descending order of their ability to affect portfolio objectives are
family responsibility, liquidity needs, age, education, security of present job, time
horizon and years to retirement. The mean for most of the variables is around 3
representing that most of the respondents preferred to neither agree nor disagree with
the statements. Factor analysis has been further undertaken in the next chapter for this
question to group the variables which may be overlapping in their concept (Table V.10
and Figure V.9).
136
Table V.10 Effect of Demographic factors on Portfolio Objectives
Descriptive Frequency Percentage Mean Std.
Dev.
Symbol/Code 1 2 3 4 5 1 2 3 4 5 X
Risk Bearing
Capacity 37 63 88 146 178 7 12 17 29 35 3.70 1.287
Time Span 38 62 140 187 85 7 12 27 37 17 3.40 1.165
Family
Responsibility 38 80 132 156 106 7 16 26 30 21 3.39 1.227
Liquidity
Needs 56 60 118 179 99 11 12 23 35 19 3.38 1.269
Security to
Present Job 44 78 149 149 92 9 15 29 29 18 3.30 1.22
Education 53 86 132 147 94 10 17 26 29 18 3.26 1.269
Years to
Retirement 45 89 151 147 80 9 17 29 29 16 3.23 1.208
Age 95 68 134 119 96 19 13 26 23 19 3.08 1.387
Figure V.9
Effect of Demographic factors on Portfolio Objective
137
C. Macroeconomic Factors: Analysis and Interpretation
An attempt has been made in this section (i.e. V.2.11 and V.2.12) to analyse and
interpret macroeconomic factors. The analysis is based on responses received in section
III of the questionnaire. The frequency, mean-standard deviation analysis and
percentages have been used to elicit the desired information.
V.2.11 Macroeconomic factors affecting Portfolio Selection
We identified ten macroeconomic factors which are most often discussed by
analysts while discussing the future outlook of equities market. As expected, not many
retail investors track macroeconomic factors and hence the response rate was low (7.8%
to 38.7%). Important macroeconomic factors in descending order of choice are growth
potential of the industry (38.7%), political stability (32.6%), buy and sell activity of the
foreign institutional investors (31.8%), monetary policy (29.7%), budget announcement
(27%) and state of the economy (26%). Other factors which are somewhat important
include exchange rates (13.9%), bulk deal (11.3%) and crude oil prices (11.1%).
It was found that bullion rates and its impact on equities market was least
tracked by the respondents (7.8%). Most of the responses for this question have high
standard deviation, showing that different investors prefer different macroeconomic
indicators for their analysis. Research analysts tend to focus a lot of attention on factors
like exchange rates, bulk deals, crude oil prices and bullion rates. However, these
factors do not attract the attention of retail investors. This indicates that the investor
awareness programs being organised by the stock exchanges, brokerage houses and
many non-profit organisations needs to be revised. These programs should enable an
investor to interpret effect of macroeconomic factors on equities market (Table V.11
and Figure V.10).
Lowering of sovereign rating of USA from AAA to AA+ by Standard and
Poor’s and later of Japan to Aa3 by Moody’s and financial crisis in some countries of
Europe (like Greece and Iceland) has created an atmosphere of political and financial
instability in the world resulting in large unexplained volatility in stock market indices
across the globe. The rising tensions in the Middle East and North Africa in 2011 after
138
the Jasmine revolution in Tunisia, followed by similar uprising in Egypt and Libya, the
movements for large number of stock market indices have been erratic on account of
fears of fluctuation in the supply of crude oil output and supply. The important question
is how should an investor interpret the rising crude oil prices and its impact on the stock
markets? The rise in crude oil prices results in increasing inflation and fiscal deficit.
Crude oil is also a source of raw material in a large number of industries.
For managing increasing costs, companies are either decreasing their profits or
increasing prices. This results in inflation. The increase in inflation directly result in
increasing of the long term interest rates so as to provide some real returns to attract
investment in fixed income securities. This makes investing in equities unattractive.
Also, with the increase in price of crude oil, the subsidy bill for the governments
dependent on oil imports, also increases which can be sponsored by either imposing
more taxes or by issuing government securities or by printing more money.
Increase of taxes makes the government unpopular, hence seldom done. Issuing
government securities offering high interest rates makes equities more unattractive. The
printing of currency results in devaluation of currency and loss of purchasing power
further fuelling inflation. Also higher interest rates offered by banks on deposits, results
in increasing the rate at which loans are offered to companies, further increasing the
costs for the companies, fuelling inflation. Higher interest rates in deposits may also
shift investors form stock markets to bank deposits. Hence, before an investor decides
to select a security for his portfolio a careful analysis of finding interest rate sensitivity
of various sectors is recommended. The right strategy for isolating the effect of
increasing crude oil prices is to find companies insulated from the effect of high interest
rate. Ronald Reagan (former president of United States of America) once said “Inflation
is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man”.
This raises an important issue of How to create an inflation proof portfolio?
In 2010-11, itself the Reserve Bank of India has increased the repo rate and
reverse repo rate about twelve times to tackle inflation by tightening the money supply.
Kashelkar (2011) recommended eight ways to rebalance a portfolio for insulating it
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from inflation by investing in companies: (1) belonging to extractive industries i.e.
companies that produce natural resources like oil, mineral and ores, or farm and forest
produce; (2) offering cheap alternatives to costly raw materials; (3) engaged in
recycling; (4) enjoying monopolistic position; (5) enjoying state patronage; (6) having
high brand value; (7) heavily focussed on innovation and technology and (8) engaged in
providing raw material for agriculture like seed, pesticides, fertilisers and irrigation etc.
Another school of wealth managers propound the idea that with increasing
inflation, the valuation of equities also rise as their revenue or asset value tends to
increase with inflation. However, this is only possible in countries like India and
specific commodities where there is a seller's market and increase in costs can be
transferred to the consumers. A causal nexus and co-integration between stock prices
and macroeconomic indicators was confirmed by Pradhan (2011).
Table V.11 Macroeconomic factors affecting Portfolio Selection
Descriptive Frequency Percentage Mean Std. Dev.
Symbol/Code 0 1 0 1 X
Maximum Focus
Growth Potential of the
Industry 314 198 61.3 38.7 0.39 0.487
Political Stability 345 167 67.4 32.6 0.33 0.469
Buy and sell activity of the
Foreign Institutional Investors
(FIIs) 349 163 68.2 31.8 0.32 0.466
Monetary Policy 360 152 70.3 29.7 0.30 0.457
Budget Announcement 374 138 73.0 27 0.27 0.444
State of the Economy (GDP,
GNP etc.) 379 133 74.0 26 0.26 0.439
Less Focus
Exchange Rates 441 71 86.1 13.9 0.14 0.346
Bulk Deal 454 58 88.7 11.3 0.11 0.317
Crude Oil Prices 455 57 88.9 11.1 0.11 0.315
Ignored
Bullion Rates 472 40 92.2 7.8 0.08 0.269
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Figure V.10
Macroeconomic factors affecting Portfolio Selection
V.2.12 Portfolio Benchmarks
It is generally believed that investors regularly track the return on their portfolio
with that of market indices like Sensex or Nifty. This belief is supported by as many as
74.4% respondents while 34.4% track the correlation between security returns and 32%
track the performance of world market indices. Some respondents shared their opinion
that they neither look at the correlation among security returns nor compare returns on
their portfolio with performance of world market indices (Table V.12 and Figure V.11).
Table V.12 Portfolio Benchmarks
Descriptive Frequency
Percentage
Mean Standard
Deviation
Symbol/Code 1 2 1 2 X
Return on Portfolio with the general
Index e.g. Sensex/Nifty 381 131 74.4 25.6 1.66 0.500
Correlation among Security Returns 176 336 34.4 65.6 1.64 0.501
Return on the Portfolio with the
World Market Indices Performance 164 348 32 68 1.25 0.439
Note: 1 represents regularly and 2 represent sometimes
141
Figure V.11
Portfolio Benchmarks
D. Equity Selection: Analysis and Interpretation
An attempt has been made in this section to analyse and interpret equity
selection process. The analysis is based on responses received in section IV of the
questionnaire. The frequency, mean-standard deviation analysis and percentages have
been used to elicit the requisite information.
V.2.13 Company factors affecting Equity Selection
A large number of stock market participants like the existing and potential
shareholders, equity funds, venture capitalists, investment bankers, credit analysts,
equity analysts and others regularly track the company factors to evaluate the financial
health of a company. These company factors include both quantitative (like discounted
cash flow valuation, price-to-earnings ratio, earnings per share etc.) and qualitative
factors (like stock familiarity, management team etc.). Some of the company factors
regularly tracked by analysts are mentioned in Table V.13 and Figure V.12.
From the survey, it was found that some of the important company factors in
descending order are fundamental valuation of a company (43.9%), price-to-earnings
ratio (41.4%), sales/net profit and earnings per share (40%), share price (32.8%), book
value/market value ratio (30.7%), technical analysis (29.7%), broker’s advice (29.3%),
promoter’s stake (26.4%) and return on net worth (25.8%).
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Some of the other company factors which are considered somewhat less
important by respondents are institutional holding (22.5%), debt equity ratio (21.5%),
management team (19.9%), yield (18.9%), bonus shares issued (18.2%), stock holding
pattern (18%), stock familiarity (17.4%), right share issued (16%), size (15.8%), equity
capitalization (13.5%), number of mutual funds that have invested in that particular
company and classification as A/B1/S group (12.9%), interest obligation of the
company and percentage of pledged shares (12.1%), public announcements (11.5%).
Very few respondents track other company related factors (9.2%) and the application of
circuit filters to a particular security (4.9%).
The data shows the relevance of valuations carried out by research analysts as
this is identified to be the most important factor for stock selection in any portfolio.
Contrary to our expectations, public announcements are tracked by very few investors.
This may be because they perceive that the information is known to all and hence may
not be having any potential for making superior gains. After the Satyam crisis, company
factors like percentage of promoter’s stake, interest obligation of the company and
pledged shares are gaining importance among investors.
Valuation and technical analysis tend to dominate other company factors in
terms of their ability to affect the decision of an investor, for selecting a particular script
to be a part of their portfolio. However, company valuation was considered to be a more
important factor than company’s performance in terms of technical charts. One possible
explanation for this observation could be that most of the respondents to the survey
were investors and not daily traders. The standard deviation for all the company factors
was also higher than the mean cautioning the readers about the validity of the
interpretations.
Some respondents shared that they also track the volatility of the equity with
respect to the index, range of equity price movements over last 6 months to 1 year,
return on capital employed (ROCE), trading pattern of the equity, changes in
promoter’s holding pattern, future business potential, some rely on sixth sense and
some felt shareholding pattern and promoter’s stake should be clubbed together to form
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one option. One of the respondents remarked that the answers which are mentioned in
the question are definitely the basis for stock selection but these factors are changing
from last two years due to worldwide recession. If there is fall in Dow Jones, then it
means NIKKEI, CAC 40, will also go down and also may be the Nifty, which may not
be depending on what the company financials are saying. The respondent gave
examples of the stock price movements of different companies for explaining his
statement. However, still it may be said that the factors outlined in this question may be
used to find the companies with “unbreachable moats”. On the basis of the factors
mentioned in this question, one can create a goal programming portfolio selection
model in which the goals may be defined in terms of each of the company factors.
The term “Economic moat” was coined by Warren Buffet which involves
investing in a company which has a competitive advantage which no one can easily
catch up to. He said “In business, I look for economic castles protected by unbreachable
moats”. It involves selecting such companies which have access to unmatched
intellectual property rights, patents, low cost technology, high brand value, long term
licences or land/natural resource reserves. For this both quantitative and qualitative
analysis is recommended. However, over focussing on all the company factors is not
recommended.
Investors focussing on all the factors may be suffering from “Surplus Attention
Syndrome”. It refers to excessive thinking and worrying about the investment in
equities despite low proportion of asset allocation in equities and equity based mutual
funds. A large number of Indian retail investors suffer from this syndrome whereby
most of their asset allocation tends to be in fixed deposits, real estate or gold, yet their
main cause of worry tends to be the small proportion of their total assets invested in
equities. A possible reason could be the large amount of information available through
newspaper, television, internet and brokerage house research reports. This motivates
individuals to undertake more trades in search for better gains. However, for such trades
to be gainful, proportion of equity in the net worth has to be substantial. What would
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amount to substantial investment, will differ across individuals depending upon their
risk tolerance level.
Table V.13 Company factors affecting Equity Selection
Descriptive Frequency
Percentage
Mean Standard
Deviation
Symbol/Code 0 1 0 1 X
Important
Valuation 287 225 56.1 43.9 0.44 0.497
Price-to-earnings ratio (P/E) 300 212 58.6 41.4 0.41 0.493
Sales/Net Profit and
Earning Per Share 307 205 60.0 40.0 0.40 0.490
Price 344 168 67.2 32.8 0.33 0.470
Book Value/ Market Value
Ratio (B/M) 355 157 69.3 30.7 0.31 0.462
Technical Analysis Chart 360 152 70.3 29.7 0.30 0.457
Broker's Advice 362 150 70.7 29.3 0.29 0.456
Promoter's Stake 377 135 73.6 26.4 0.26 0.441
Return on Net Worth (%) 380 132 74.2 25.8 0.26 0.438
Somewhat Important
Institutional Holding 397 115 77.5 22.5 0.22 0.417
Debt Equity Ratio 402 110 78.5 21.5 0.21 0.411
Management Team 410 102 80.1 19.9 0.20 0.400
Yield 415 97 81.1 18.9 0.19 0.392
Bonus Share Issued 419 93 81.8 18.2 0.18 0.386
Stock holding Pattern 420 92 82.0 18.0 0.18 0.384
Stock Familiarity 423 89 82.6 17.4 0.17 0.379
Right Share Issued 430 82 84.0 16.0 0.16 0.367
Size 431 81 84.2 15.8 0.16 0.365
Equity Capitalization 443 69 86.5 13.5 0.13 0.342
Number of Mutual Funds
Invested in a Particular Coy. 446 66 87.1 12.9 0.13 0.334
Certification as A/B1/S
Group and Other 446 66 87.1 12.9 0.13 0.335
Interest Obligation of the
Company 450 62 87.9 12.1 0.12 0.327
% of Pledged Share 450 62 87.9 12.1 0.12 0.327
Public Announcement 453 59 88.5 11.5 0.12 0.320
Ignored
Any Other 465 47 90.8 9.2 0.09 0.289
Circuit Filters Application 487 25 95.1 4.9 0.05 0.216
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Figure V.12
Company factors affecting Equity Selection
V.2.14 Time horizon for tracking Portfolio Returns
Most of the respondents tracked returns on their portfolio either on monthly
basis (47.3%) or on yearly basis (46.7%). Very few respondents tracked the returns on
their portfolio on a daily basis (12.3%). These respondents may be active traders who
track returns on hourly and daily basis. Some respondents shared that they track weekly
returns. Hence, empirical analysis focussing on portfolio optimisation models should
use monthly and/or yearly data for return optimisation (Table V.14 and Figure V.13).
Table V.14 Time horizon for tracking Portfolio Returns
Description Frequency
Percentage
Mean Standard
Deviation
Symbol/Code 0 1 0 1 X
Monthly 270 242 52.7 47.3 0.47 0.500
Yearly 273 239 53.3 46.7 0.47 0.499
Daily 449 63 87.7 12.3 0.12 0.329
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Figure V.13
Time horizon for tracking Portfolio Returns
V.2.15 Market Capitalisation
Investors preferred to invest in mid cap companies (56.2%) and large cap
companies (56.1%). Investor’s second preference is for initial public offers (21.9%) and
small cap companies (15%). Very few respondents made the choice of any other (3.5%)
whereby they said that they invest in penny stocks or a mix of all. Some respondents
shared that they do not focus on the market capitalization but on Nifty index (put and
call), potential industries (like biotech, food companies, etc.). Respondents felt that
after recession most of mid-cap companies are now in small cap segment, so they
consider upper small cap companies, mid cap equities and blue chip stocks for stability
in their portfolio. Some respondents select equities based on new opportunities which
may be from small/mid/large cap segment depending on situation and market
conditions (Table V.15 and Figure V.14).
Table V.15 Market Capitalisation
Description Frequency
Percentage
Mean Standard
Deviation
Symbol/Code 0 1 0 1 X
Mid Cap Companies 224 288 43.8 56.2 0.56 0.497
Large Cap Companies 225 287 43.9 56.1 0.56 0.497
Initial Public Offers 400 112 78.1 21.9 0.22 0.414
Small Cap Companies 435 77 85.0 15 0.15 0.358
Any Other 494 18 96.5 3.5 0.04 0.184
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Figure V.14
Market Capitalisation
V.2.16 Social Investing
According to Milton Friedman “There is one and only one social responsibility
of business, to use it resources and engage in activities designed to increase its profits
so long as it stays within the rules of the game, which is to say, engages in open and
free competition without deception or fraud”. However, Peter F. Drucker contended
that an enterprise is an organ of society and its actions have a decisive impact on it.
Hence, every business policy must be viewed from the perspective of its impact upon
the society. Recently, investment houses are subscribing to the view of Drucker and
recommending investment in companies which not only perform well in the economic
sense but also act responsibly towards shareholders, employees, consumers,
government, community and the society.
“Impact investing” or social investing involves equity investment by investors
in companies focusing on not only on financial goals but pursuing corporate social
responsibility as well. This is also known as “triple bottom line investing or blended
value”. The main idea behind this investment strategy is that to qualify for investment a
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firm should not only be evaluated on financial parameters but also on parameters like
contribution to environment protection, valuing customers, human rights, social justice,
employee welfare and corporate governance. To qualify for impact investing, it does
not mean that a firm should not earn profit or should not be self sustainable. It only
represents the ideology of management and company of contributing towards society of
which it is a part. Internationally, the Global Impact Investing Network (GIIN) has been
conceived by the Rockefeller Foundation (US) to promote the idea of impact investing
to investors internationally. Impact investing represents a more structured way of
making an investment and prevents undertaking investments based on emotions.
For finding out if impact investing or socially responsible investing is catching
up in India, question number 15 in section IV was asked to respondents whereby they
were asked to rank from 1 to 9 with highest preference represented by 9 followed by 8
and the least by 1 for nine socially responsible measures adopted by companies and its
effect on the inclusion of a security in the portfolio. Only 294 respondents replied to
this question. Data analysis of the mean and standard deviation data clearly points out
that the aid offered in national distress is the most important social factor. Other
important social investing factors given preference by investors in descending order are
product innovation and safety, education efforts, donation for special causes, worker’s
participation in management, employee welfare, pollution control efforts, family
planning and health and lastly employment of minorities. Also, the mean value is higher
than the standard deviation lending support to the analysis (Table V.16 and Figure
V.15).
If one analyses the responses to this question and the branding efforts of large
cap companies, then one can observe that large cap companies tend to lay a lot of
emphasis on contributing in case of a national calamity, product innovation and safety
and in promoting education. Some companies have also started performing social
accounting and social audit whereby they disclose their socially responsible actions in
their annual report. Indirectly, these actions have the impact of increasing shareholder’s
wealth by increasing the demand for the script on stock exchanges.
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Table V.16 Social Investing
Description Percentage Mean
Std.
Dev.
1 2 3 4 5 6 7 8 9 X
Aid in National
Distress 8.8 13.4 15.6 14.3 15.6 10.5 9.2 7.8 4.8 5.77 3.091
Product
Innovation and
Safety 15.0 9.9 5.8 6.1 6.1 6.1 6.5 12.9 31.6 5.64 2.482
Spreading
Education 6.8 7.8 15.4 13.9 13.3 12.9 16.3 7.5 6.1 5.52 2.567
Donation for
Special Causes 5.1 10.2 14.3 13.3 15.3 18.7 10.9 7.1 5.1 5.23 2.670
Worker’s
Participation in
Management 4.8 13.9 9.9 10.9 6.1 8.2 15.6 18.4 12.2 4.97 2.235
Employee
Welfare 7.1 7.8 6.1 12.9 11.2 12.6 12.4 15.3 14.6 4.89 2.127
Pollution Control 12.9 7.8 11.3 8.2 9.9 8.8 13.9 16.3 10.9 4.51 2.256
Family Planning
and Health 11.2 19.0 11.6 12.6 12.6 10.5 7.5 7.5 7.5 4.40 2.457
Employment of
Minorities 28.2 10.2 10.3 7.8 9.9 11.6 7.8 7.1 7.1 4.05 2.696
Figure V.15
Social Investing
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V.2.17 Futures and Options (F&O) Market Analysis
On being asked, if the respondents continuously reviewed the movement in the
Futures and Options (F&O) market, only 251 respondents replied to this question
positively, while 261 respondents did not analyse the derivative segment before making
their investment in spot market.
As many as 31.9% of these 251 respondents track the open, high, low and close
on future prices; 29.5% tracked the percentage difference between spot price and future
price; 28.3% reviewed percentage change in open interest in futures and options; 26.7%
analysed the market wide position and position limits in futures and options, 25.5%
reviewed the option type and expiry; 24.7% tracked the active calls and puts in futures
and options; 19.9% tracked the open, high, low and close on option premiums and
15.5% tracked the number of contracts in futures and options.
The variance is higher than the mean value for all the eight choices representing
the changing choices of individuals depending upon their understanding of the
derivative market (Table V.17 and Figure V.16).
Table V.17 Futures and Options (F&O) Market Analysis
Descriptive Frequency Percentage Mean Standard
Deviation
Symbol/Code 0 1 0 1 X
Open, High, Low and Close on Future Prices 171 80 68.1 31.9 0.32 0.47
Percentage Difference between Spot Price and
Future Price 177 74 70.5 29.5 0.29 0.46
Percentage Change in Open Interest in Futures and
Options 180 71 71.7 28.3 0.28 0.45
Market wide Position and Position Limits in
Futures and Options 184 67 73.3 26.7 0.27 0.44
Option Type and Expiry 187 64 74.5 25.5 0.25 0.44
Active Calls and Puts in Futures and Options 189 62 75.3 24.7 0.25 0.43
Open, High, Low and Close on Option Premiums 201 50 80.1 19.9 0.20 0.40
Number of Contracts in Futures and Options 212 39 84.5 15.5 0.16 0.36
151
Figure V.16
Futures and Options (F&O) Market Analysis
V.3 Questionnaire for Expert Opinion: Analysis and Interpretation
The questionnaire for expert opinion attempted to seek personal reflections of
the practitioners, on how this research endeavour on multi-objective portfolio selection
be made more relevant. Their suggestions were helpful in framing the research
hypotheses in a manner that resolve non only practitioner concerns but handle
theoretical issues as well. Analysis of the questionnaire for expert opinion enables a
reader to understand the practical implications and relevance of this monograph. The
comments made by experts serve as an important cognitive resource. According to an
often quoted dictum by Jacob Viner “Economics is what economists do”. Similarly, the
field of investment management has evolved by carefully analysing and recording the
actions of practitioners to changes in capital markets.
152
Responses to the questionnaire for expert opinion (Annexure 2) have been
tabulated in Table V.18. Most of the experts agree to our proposition of perusal of
multiple goals by investors. These multiple objectives include capital protection,
absolute return generation, liquidity and volatility. However, one of the experts was of
the opinion that there is only one objective function of maximisation of overall utility
and all other variables can be included as constraints.
Industry experts advised to undertake a balanced approach while resolving the
issue of multiple goals which are contradictory in nature. Some of the experts advised
to create a matrix and undertake portfolio allocation based on priority of the clients.
Academic experts recommended to either use multi-objective optimisation algorithm or
linear programming.
Goals pursued by an investor are identified by practitioners by undertaking
investor profiling. Investor profile is interpreted from age, time span for investment,
location, family background, tax consideration, liquidity requirements, preferences,
income level, asset position and ethical beliefs. For example, with the help of age one
can decide the number of working years and this affects the duration of the portfolio.
Number of dependents affects the liquidity requirements from the portfolio. Most of the
experts believed that mathematical model can help to optimise across multiple goals
and constraints. However, experts cautioned that the model should be applied properly.
Time horizon for investment, return expectations, risk appetite, frequency for
investment, risk-reward parameter and tick size were the commonly faced portfolio
constraints. These multiple constraints are managed by appraising the investor of the
trade-offs between risk-return and return-liquidity. One can also use optimiser tools for
striking balance across different constraints. Academic experts recommended use of a
combination of quantitative methods and qualitative heuristics based on economic
sense. Alternatively, one may use Markowitz type of analysis for desired results.
Experts recommended various quantitative factors that should be kept in mind
before selecting a stock for inclusion in a portfolio. These factors include beta,
price/book value, dividend yield, ratios concerning profitability, liquidity, valuations,
153
cash flows, operating and financial leverage, asset utilization and operational efficiency,
expected return, uncertainty of returns and covariance with other assets. Qualitative
factors affecting stock selection include quality and prior record of senior management,
corporate governance, timely disclosures, level and extent of competition in the sector,
government policies affecting the company and its sector, product/service nature and
industry characteristics and life cycle and sensitivity to the business cycle. One of the
industry experts said performance in terms of 4Ps i.e. Profit, Promoter, Product and
Price should be analysed for the purpose of equity selection.
Some experts felt that there exists pricing inefficiencies between the spot and
the Futures & Options (F&O) markets, which may be gainfully exploited. However,
with the advent of automated software and algorithm based trading, complex arbitrage
strategies (like pair trading) and event based trading such opportunities are available
occasionally. Doubts were also expressed as regards the presence of these opportunities
to be large enough to accommodate the transactions costs for a typical investor.
All of the factors outlined in question number ten (Annexure 2) were found to
be affecting the functioning of the stock exchanges. More important factors included
pledging of shares, listing of stock exchanges, illiquidity of listed shares, responsibility
of financial advisors and financial media, role of IPO grading by credit rating agencies
and role of merchant bankers in pricing IPOs. International academic experts were not
familiar with these India specific systematic factors and could not answer this question.
Intelligent regulation was articulated as the most important factor for improving
the functioning of equities markets. Rules and regulations need to be regularly updated
and strengthened for keeping up to date with global standards. Regulations must aim at
increasing competition and participation. Regulations should be fine tuned for
controlling information leakages, window dressing by corporate, stock price
manipulation, transparency and governance, technological advancements and increasing
participation of retail investors. Securities and Exchange Board of India (SEBI) is
aware of the regulatory gaps and is constantly working at improving the regulatory
framework, governing the equities market in India.
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Table V.18 Practitioner’s Solution to Portfolio Selection Issues
Responses from Industry Experts
Jagannadham Thunuguntla Vikash Raj Arun Gupta
Q1 Yes, there are indeed multiple objectives while
making a portfolio selection decision. Some of these
are Capital/Principal protection, Absolute Returns,
Risk-adjusted Returns, Liquidity for mid-way exit
and final exit, etc
Yes. In the selection of securities in the debt side, we consider the
factors like duration we have a proprietary model called 3D factor
model and credit risk which are measured using the credit risk
monitor. The 3D factor model considers attributes like economic
fundamentals, market psychology and market valuations before
choosing the securities.
On the equity side, to identify a great business we do research at 3
levels.
• The dynamics of the industry the company is operating in, such
as the industry’s growth rate and sensitivity to business cycles.
• Company specific data to evaluate position in the growth cycle,
ROI in the business, underutilized capacity and ability of the
company to raise resources to expand capacity.
• Management track record
Yes. Maximisation of
wealth, liquidity, safety,
etc
Q2 Most of the times the goals are contradictory in
nature, however, while constructing the portfolio a
realistic view of the future is taken and a balance is
struck which is suitable for the risk-profile of the
investor. For example, compromising high liquidity in
favour of high returns for an investor willing to take
higher risk
The multiple goals given multiple constraints are resolved by
forming a matrix which denotes the priority of the investor and
eliminating the products which do not score high on the list
Resolve by seeing priority
of client
Q3 There are many factors while deciding on different
goals. The most important of them is the investor
profile. The age group of the investor, the duration for
which the investor wishes to invest, the various goals
that an investor expects to achieve from the said
portfolio, etc
The different factors are age, location, family background, tax
consideration, liquidity requirements, etc
Safety, liquidity, return
(SLR), etc.
155
Q4 It is quite possible that a mathematical model may
help achieve the same goal and shall improve
standardization across products. This shall improve
both tracking of portfolio and reduce tracking costs
Yes Yes
Q5 These are most critical factors that decide portfolio
goals of an investor
Yes Yes
Q6 There are multiple constraints while creating a
portfolio. Some of these are investor-related like time
horizon for investment, returns expectations, risk
appetite, frequency of investment (single or spread
out over a time period like SIP), etc. Apart from that
there are other external factors like current state of
economy, risk-reward parameter for various available
asset classes, tick size for different asset classes (low
for equities but very high for real estate), etc.
By analyzing the investor goals and his/her
investment parameters, it is possible to create a
portfolio that suits the various requirements of the
investor. Of course, there needs to be trade-offs
between various parameters like Risk-Return,
Returns-Liquidity, etc. The investor is appraised of
the said trade-offs before finalization of the portfolio
Yes, there are multiple goals and constraints while selecting a
portfolio. The multiple goals given multiple constraints are resolved
by forming a matrix which denotes the priority of the investor and
his constraints. We try to strike balance using an optimizer tool
Resolve by priority
Q7 The demographic variables too affect the portfolio
allocation considerably. The age, income levels,
expenses, number of dependents, etc. are some of
these variables that decide the final portfolio goals.
For example, the age decides the number of working
years before the investor is to retire and thus decides
the duration of the portfolio. The number of
dependents decides both the corpus and the liquidity
of the portfolio (Early exit for emergency/planned
expenditures for dependent parents/children)
The differently demographic variables definitely affect the portfolio
goals and constraints. E.g. As a person gets older, his or her needs
and wants change as well. As for gender, the best examples include
clothing, hairdressing, toiletries, cosmetics and reading materials.
On the other hand, businesses have different marketing strategies
for affluent and low income consumers
Yes
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Q8 Various quantitative factors that should be kept in
mind while selecting a stock for inclusion in a
portfolio are: Beta, Price/Earnings multiple,
Price/Book value, Dividend yield, etc. Whereas the
qualitative factors that need to be considered are:
Background of senior management, Level and extent
of competition in the sector, Government policies
affecting the company and its sector, etc
The qualitative variables include the Management quality, corporate
governance, timely disclosures, etc. whereas the quantitative factors
include the ratios concerning profitability, liquidity, valuations,
cash flows, etc
4P theory, It means to
earn Profit (1st P). Please
see three `P’ i.e.
Promoter, Product and
Price
Q9 Theoretically there are arbitrage opportunities
between the Futures & Options (F&O) market and the
spot market. However, with the advent of automated
software and algorithm based trading, such
opportunities are rare these days in the practical world
The market provides several opportunities for traders to take
advantage of pricing inefficiencies between spot and futures prices
of the same stock. However, the returns are uncorrelated with the
market returns making the fund ideal for low risk appetite investors
with guaranteed returns irrespective of the direction of the markets.
As markets mature and with advent of things like algorithm trading
and other complex arbitrage strategies like pair trading, event based
trading etc. pricing inefficiencies are reducing to a great extent
Yes
Q10 All of the above stated points do affect the
functioning of the Stock exchanges like NSE and
BSE in India
Pledging of shares, Listing of stock exchanges, Illiquidity of listed
shares, Responsibility of financial advisors and financial media,
Role of IPO grading by credit rating agencies and Role of merchant
bankers in pricing IPOs affect the functioning and returns on BSE
and NSE
Yes
Q11 Market regulator and stock exchanges have been very
proactive in regularly strengthening the Indian
markets by keeping their rules and regulations up to
date with global standards
Active participation from retail investors and effective control on
information leakages
Avoid
manipulation/window
dressing; Jugglery in
Accounts where there is
no growth. Transparency
and governance
Q12 Yes Yes Yes
Q13 Not Answered Not Answered Weightage for quality of
Management
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Responses from Academic Experts
Robert Savickas Rick Mendenhall
Q1 Yes. Expected return, volatility, downside risk,
liquidity, etc
I do not think of it this way. I think of one objective function and
several constraints. The real objective is to maximize utility, but in
reality, we may maximize expected return for a given level of risk. But
I do think it is useful to think in terms of maximizing one objective
with multiple constraints, e.g., not investing in stocks of companies
whose products are not morally repugnant to the investor
Q2 Have not had this issue, but would use a multi-
objective optimization algorithm
This is why it is useful to have one objective with multiple constraints.
You could specify a minimum level of liquidity for investments
Q3 Different aspects of risk and return The preferences and situation of the investor. A young investor can
bear more risk than an older investor. Different investors have different
ethical beliefs. These types of things should drive the nature of the
problem to be solved
Q4 Sometimes, but not always Yes—if properly applied
Q5 Definitely Absolutely. These are the types of things to which I was referring
above
Q6 Yes, there are multiple constraints with multiple
objectives. I do it by a combination of quantitative
methods and qualitative heuristics/logic based on
economic sense
I do support this view. I think a Markowitz type analysis provides a
simple method of building in constraints. Please understand that I think
a Markowitz type analysis is one (important) tool. When someone does
an analysis of this type and gets an outcome that does not seem right,
they need to think about their assumptions
Q7 Yes. Different age, income level and asset positions of
investors affect their goals and constraints
I have not thought about this and do not have a good answer
Q8 Product/service nature and industry characteristics and
life cycle, sensitivity to the business cycle, quality and
prior record of the management team, efficiency of
operations, profitability, asset utilization, operating and
financial leverage
Expected return, uncertainty of return and covariance with other assets
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Q9 Occasionally I have not looked for these and so I cannot say. I doubt that these
opportunities are large compared to transactions costs for the typical
investor
Q10 I am not familiar with these exchanges I am not very familiar with these exchanges, so I cannot answer this
question
Q11 N/A Intelligent regulation. Regulation is good when it increases competition
and participation, e.g., like margin when it ensures investors can live
up to their promises. Regulation is bad when it reduces competition or
decreases participation such as a transaction tax. Also, improved
technology has greatly improved equity markets and will continue to
do so
Q12 Yes Yes
Q13 None No, I can’t think of any
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V.4 Summary and Conclusions
A questionnaire for retail investor (Annexure 1) was constructed for
understanding the investor’s perception. The questionnaire facilitated in
understanding the application of portfolio theories by investors, portfolio goals and
constraints and corresponding conflicts, perception and attitude towards investment
options, portfolio effectiveness and satisfaction, effect of systematic factors, investor
personality and values, social investing and managing changes in securities markets
like increasing lead-lag relationship between derivative and spot markets. A case has
been created for making empirical observations as regards multiple goals pursued and
multiple constraints being faced by investors.
The respondents to this questionnaire were mostly males, married, between the
age group of 25-40 years, post-graduates, middle level executives, employed with
private company and having 2-5 members in their family.
Analysis and interpretation section discusses the empirical observations from
the questionnaire for retail investor. However, the scientific validity of conclusions
made in this chapter is limited to the extent of presence of estimation error as
applicable to classical mean-variance approaches. Also, the survey has been
undertaken for representative investors; hence the analysis and implication for
individual investors in general may not be applicable. From the percentage analysis of
the questionnaire, it may be observed that
(a) Equity portfolio conveys the signal of being an investment option yielding
high returns.
(b) Capital gain is invariably the main motivating factor behind investment in
equities.
(c) Investors perceive that risk can be mitigated in consultation with the financial
advisors.
(d) Prior experiences in equity markets do educate some investors in making
superior portfolio allocations in future. However, majority of investors felt that
their current portfolio allocation is almost similar to their previous allocations.
(e) The sample respondents made maximum allocation in equities justifying their
selection for this research. Other popular investment options preferred by
investors included mutual funds, real estate and fixed deposit. Unexpectedly,
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low preference for gold and silver was observed. This may be indicative of
rising changes in asset allocation preference of investors.
(f) As regards investor’s goals, investors aim at maximising returns with
minimum possible risk. An increasing focus on safety of investment was also
observed. Goals related to tax saving, high average returns, loss minimisation
and liquidity have similar priority for the investors. Similarly, opportunities
for superior gains, high short term return and expected future performance
have similar but lesser priority for the investors. High past return and volatility
have similar but further lesser priority for the investors. Equities are not
considered to be a suitable hedge for any future contingency or as a means to
finance old age consumption. Invariably, multiple goals were pursued by most
of the investors.
(g) Budget constraint originally identified by Markowitz (1952) still continues to
be the most important constraint faced by investors. Share price is the second
most important constraint, followed by profit booking and inflation constraint
receiving similar and lesser priority, followed by income and brokerage fees
constraint receiving similar and further lesser priority, followed by stop loss
constraint, volume traded, transaction tax, minimum number of equities to be
purchased, range and turnover receiving similar and least priority. Volume
traded/Turnover are important constraints but were found to be given very less
priority by investors. This often results in individual investors selecting
illiquid equities.
(h) Maximum preference for diversified equity mutual funds shows the capital
protection attitude among investors. It was also found that index based mutual
funds have not gained popularity among small investors.
(i) Investors perceive risk bearing capacity to be the most important factor
affecting portfolio objectives.
(j) Growth potential of the industry was found to be the most important factor for
timing selection of equities for inclusion in the portfolio. Other important
factors included political stability, buy and sell activity of the Foreign
Institutional Investors (FIIs) and monetary policy. Factors like exchange rates,
bulk deals, crude oil prices and bullion rates often discussed and debated by
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stock analysts do not attract much attention of the retail investors. From the
responses to this question and experience of attending investor awareness
programs, a need to revamp the existing investor awareness programs, was
felt. Discussions on macroeconomic factors and their effect on spot markets
needs to be included. This will enable investors in perceiving a holistic view
of the economy and capital markets.
(k) Investors tend to often benchmark the returns on their portfolio with some
national market index like Sensex or Nifty. Not many investors focus on
correlation among security returns and world market indices.
(l) Most of the investors focus on valuation of the company and Price-to-earnings
ratio (P/E ratio) before selecting it to be a part of the portfolio. It may be
because of this reason, that most of the research reports published by
brokerage houses carry out Discounted Cash Flow (DCF) valuation and had
analysed the P/E ratios. Other important variables affecting equity selection
were price, Book value/Market value ratio (B/M ratio), technical analysis
reports, broker’s advice, promoter’s stake and return on net worth. Variables
not much affecting stock selection included public announcements by
companies and application of circuit filters to a particular security. A large
number of company specific variables are considered by investors before
selecting a security. This information is easily available to them through
research reports published online by brokerage houses or magazines like Dalal
Street and Capital Markets. Further research is recommended to find the
presence of “Surplus Attention Syndrome” amongst retail investors.
Researches in future may also want to use a mix of these factors to create a
model that can help identify companies with “unbreachable moats”.
(m) Most of the retail investors track returns on their portfolio on monthly or
yearly basis.
(n) Equal preference for investment in large cap and mid cap companies was
observed, followed by investment in Initial Public Offers (IPOs). Very few
respondents invest in small cap companies. Some respondents shared that they
create a portfolio having a mix of large cap and mid cap companies.
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(o) On being asked on the values investors follow while investing, it was found
that aid offered in national distress is the most important social factor,
followed by product innovation and safety and education efforts. Least focus
was given to employment of minorities. If one analyses the responses to this
question and the branding efforts of large cap companies, then one may
observe that large cap companies tend to lay a lot of emphasis on these social
factors. Indirectly, these actions have the impact of increasing shareholder’s
wealth by increasing the demand for its script. The question was asked to
analyse the practice of “Impact investing” or social investing undertaken by
investors.
(p) Around fifty percent of the respondents regularly tracked the derivative
segment for taking positions in the spot market. Mostly respondents tracked
the open, high, low and close on future prices, the percentage difference
between spot price and future price and percentage change in open interest in
futures and options.
Analysis and Interpretation of the questionnaire for expert opinion revealed
that while some experts optimise across multiple objectives, others attempt to
maximise the utility function with multiple constraints. For achieving multiple
objectives one may create a matrix with priority coefficients or use a multi-objective
optimisation algorithm. Investor goals are interpreted from investor’s age, time span
for investment, location, family background, tax consideration, liquidity requirements,
preferences, income level, asset position and ethical beliefs. Return expectations, risk
appetite, frequency for investment, risk-reward parameter and tick size were identified
as the commonly faced portfolio constraints. A combination of quantitative and
qualitative methods is recommended for managing constraints.
Quantitative and qualitative factors of companies often analysed by experts
have also been enumerated. The presence of arbitrage opportunities between the spot
and the Futures and Options (F&O) markets were found to declining on account of
algorithm based trading, arbitrage strategies and event based trading. Existing
inefficiencies in the equities markets could be weeded out through prudent regulation.
