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.