Portfolio Construction and Management (Equity and Debt) using Efficient Frontier Hypothesis


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Portfolio Construction and Management (Equity and Debt) using Efficient Frontier Hypothesis

  1. 1. Portfolio Construction and Management Investment Management Project Himanshu Gupta – 12P138 Ishpreet Singh – 12P139 Karan Jaidka – 12P141 Shivendra – 12P169 Vikas Jain – 12P178 Investment Management (IM) – B – Group 7 PGPM 2012-2014
  2. 2. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 1 Name of our Investment Management Fund Greenback Capital Advisors Private Limited (Greenback Capital) About the Fund Greenback Capital Advisors Private Limited (Greenback Capital) was established in July, 2005 to address the growing need of the different types of investors in the Indian capital markets. We manage our investors’ capital with three fundamental ethos: expertise, accountability and transparency. Greenback Capital’s portfolio managers (belonging to IM-B Group 7, PGPM 2012-14, MDI Gurgaon) have a lot of experience in the capital markets and this expertise has been developed over multiple business cycles. While past performance is no guarantee of future success, the funds managed by us have generally outperformed or, during times of recession, performed at par with the markets. Accountability to us means a deep commitment to do what is right for our investors. We also believe that transparency leads to trust which will create a long lasting fiduciary relationship between us and our investors. We proactively invest in securities to further propagate the three ethos. Greenback Capital aims to achieve a high absolute rate of return over a business cycle while minimizing risk of capital loss. We practice the established investment principles espoused by the likes of Graham, and Warren Buffett.
  3. 3. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 2 Investment Strategy followed at Greenback Capital The primary focus is to invest in undervalued companies from the large-cap universe primarily of the publicly traded Indian securities. The potential for aggressive expansion in large-cap companies is small, but these stocks are relatively more stable. They are much more likely to pay dividends and possess greater free cash flows. Historically, large-cap companies are known to ride the storm and are relatively more stable when the market is undergoing a sustained bear run. They are also more suited for long term investing, and since most of our investors stay invested in our fund for many years, it aligns with our strategy of focusing on large-cap stocks. These companies have businesses in multiple geographical locations and hence, diversify the risk associated with domestic problems. Also, the fundamentals and business models of large- cap companies are believed to be better for investments in the long run. Apart from investing in securities, we also invest in riskless assets, which we keep changing from time to time. This riskless asset, combined with the risky asset portfolio, makes up our complete portfolio. The weights assigned to the risky assets are fixed at a given point of time. These weights are assigned in such a way that we offer the maximum return at the minimum possible variance at that level of return, i.e. the highest possible Sharpe Ratio in our portfolio at a given point of time. Our investors are not given an option of changing the composition and/or weights of our risky assets. This composition is evaluated from time to time by our competent asset managers and the best possible combination at that point of time is determined and frozen. After this step is complete, different weights are assigned to the riskless asset and the combined risky assets and are offered to our investors based on their requirements risk appetite, expected returns, etc.
  4. 4. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 3 Current Composition of the Portfolio The current offerings of Greenback Capital include a combination of risky assets (equity) and riskless asset (bonds issued by Government of India enterprises) as described below:- Risky Assets 10 Large-cap stocks (blue-chip companies) listed on the S&P BSE Sensex make-up Greenback Capital’s risky asset portfolio. These stocks have been selected from various sectors and they have historically been good performers in their respective businesses and in the stock market. Their fundamentals remain strong and our asset managers expect them to continue offering good levels of returns in future as well. The securities have been chosen from different sectors in order to mitigate the industry-specific risks which a particular industry may face from time to time. Details of the stocks comprising our risky-asset portfolio are:- Company Name Sector Rationale for including in the portfolio Mahindra and Mahindra Ltd. Auto and Auto Ancillaries Market leadership in SUV segment, Fastest growing in Vehicle industry ITC Ltd. FMCG and Retail Strong presence in rural market (Fast growing) Godrej Consumer Products Ltd. FMCG and Retail Revitalizing company with Focus on global market HCL Technologies Information Technology Core strengths in engineering and R&D services and infrastructure management Reliance Industries Limited Oil and Gas Continuity of positive results from Cauvery basin adding to long term profitability of the company Axis Bank Banking and Financial Services Best Bank (CNBC-TV18), Profitability Dr. Reddy’s Laboratories Pharmaceuticals and Healthcare Focus on new markets, Developing new products through partnership route Container Corporation of India Limited Logistics and Transportation Market share of more than 75%
  5. 5. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 4 ACC Limited Metals and Cement Super brand status, nationwide presence Coal India Limited Metals and Cement Largest coal producer in world, Majority owned by Govt. Riskless Asset In order to mitigate the overall market and systematic risk and to cater to the varying risk appetites of our investors, we have currently included the tax-free secured bond issued by Rural Electrification Corporation Limited (a Government of India enterprise). Some important details of the bond are as follows:- Issue Size ` 1,000 crore with an option to retain oversubscription up to the shelf limit of ` 4,500 crore Instrument Tax Free Secured Redeemable Non-Convertible Bonds of face value of ` 1,000 each in the nature of Debentures having tax benefits under the Section 10(15)(iv)(h) of the Income Tax Act, 1961 Credit Rating ‘CRISIL AAA/Stable’ by CRISIL, ‘CARE AAA’ by CARE, ‘IND AAA’ by IRRPL & ‘*ICRA+ AAA’ by ICRA Face Value ` 1,000/- per bond Minimum Subscription Minimum Subscription - 5 Bonds (` 5,000) across both the series Coupon Rate 7.22% p.a for Category I, II and III Applicants Weights assigned to Stocks in the Risky Portfolio As mentioned above, the weights assigned to individual stocks were determined by our asset managers based on historical data. The current weights assigned are as follows:- ACC Axis Bank Coal India CONCOR Dr. Reddy's GCPL 0.0934 0.0000 0.0000 0.0000 0.1438 0.0000 HCL Tech. ITC M&M RIL Mean Variance Standard Deviation Sharpe Ratio 0.0797 0.6667 0.0162 0.0000 0.0520 0.0019 0.0443 1.1713
  6. 6. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 5 Investor Profile Client Name– Mr. Ajay Chauhan Age – 36 years Place of Residence – Mumbai Investment Start Date – 1st July, 2011 The client’s family consists of four members – his wife who is working as an event manager in a company and two children of ages 5 and 7. The client works as a project manager in Microsoft. His annual compensation is INR 32 Lakhs. Financial Goals The client has planned to have a family trip to Europe once his children attain an age of around 10 years. He has some savings whose value he does not want to erode in the meantime. So, he was looking out for a good investment opportunity which could give him good returns over and above market risk. His aim is to have at least annual inflation adjusted, after-tax cash flow of around INR 14-15 lakh Investment Objective To get at least 10% inflation adjusted returns on a highly diversified portfolio so that the risk can be minimized. He wants to invest money both in risk-free assets and risky assets since his risk appetite does not allow him to have full exposure to equity market. The client wants to invest 20% of his portfolio in risk free assets. Volatility Tolerance The client’s financial position is quite sound. He also has a good knowledge about securities and he understands the risks associated with them. Due to his financial capacity and future prospects, he is quite tolerant towards interim fluctuations in portfolio market value and rates of returns.
  7. 7. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 6 Investment Time Horizon Investment horizon is 5 years. Afterwards, it would depend on the client if he wants to continue or not. The client does not have short term need for liquidity. Portfolio Performance in 2 Years (1st July, 2013 – 16th August, 2013) The point at which the Sharpe Ratio is maximum is mentioned in the graph above. By investing 20% of the total investment in riskless assets, our investor has slid slightly lower along the Capital Allocation Line (CAL) to the point mentioned in the graph. He has effectively lowered his risk, but at the same time, his expected return has also reduced from 5.2% quarterly to 4.521% quarterly.
  8. 8. Portfolio Construction and Management IM Section B – Group 7 – Project Report Page 7 Expected Quarterly Returns Standard Deviation Weight of risk-less asset 0.2 0.01805 0.0 Weight of risky asset 0.8 0.05200 0.044 Total Return 0.04521 0.0352 Expected quarterly return of portfolio 4.521 (in % terms) Total Standard Deviation of portfolio 0.03520 Hence, by investing 20% of the total invested amount in the riskless REC Bond and 80% in the risky equity portfolio our investor’s portfolio has provided him with 4.521% quarterly returns and with a risk of 0.0352. He expects the same return-risk relationship in future as well. In the 2 years (approximately 8 quarters) which the investor has remained invested, he has unrealized gains of INR 4,24,388 (without inflation) (assuming the gains are re-invested). If we take inflation into account, the gain reduces to INR 2,21,827 (CPI in 2011 = 6.4% and CPI in 2012 = 11.17%). Effective Annual Rate (EAR) for quarterly returns of 4.521% = 19.347% Year CPI (in %) EAR – CPI (in %) Investment at the end of period 2011 6.4 12.947 1129470 2012 11.17 8.177 1221827 Total inflation adjusted value of portfolio at the end of two years = INR 12,21,827 Total inflation adjusted return at the end of two years = 10.53% Conclusion When the client viewed his portfolio over the past 2 years and observed that he is getting returns of 10.53% after adjusting for inflation, he was quite happy with the performance and decided to remain invested.