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INTRODUCTION

™ PORTFOLIO MANAGEMENT SERVICES

WHAT IS PORTFOLIO MANAGEMENT SERVICE?

A group of experts design and manage your equity portfolio suiting risk-return
• appetite
• Benefit of Diversification and an element of customization
• No Settlement hassles
• Separately held securities
• Greater Flexibility
• Efficient switch between cash and equity positions
• Portfolio designing is done as per market conditions and market considerations
• Customized Performance Reporting
• 100% Transparency, managed under SEBI license and regulations
• Competitive Fee Structure

So investments under portfolio management are risk diversified and research oriented.

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™ Discretionary Portfolio Management

The Portfolio Manager undertakes the entire management of portfolio. Starting from
buying and selling of securities to reshuffling and safe custody is undertaken. Investor’s
involvement will be minimum thereby allowing investor the flexibility to attend to their
personal matters, while the Portfolio Manager takes care of investor’s investments and
keeps it posted on a regular basis.

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DIFFERENCE BETWEEN PMS & MUTUAL FUND

PMS MUTUAL FUND


Liquidation of holdings Regulatory restrictions and large
Flexibility
possible. fund size do not allow flexibility
Customized Performance
Yes No
Reporting
Separately held securities Yes No
Relationship Management Personal Impersonal
STCG 10% 10%
LTCG NIL 10%-20%
Dividend Distribution Tax Not Applicable Applicable

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PORTFOLIO MANAGEMENT PROCESS

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Portfolio management is a complex activity, which may be broken down into the
following steps:

• Specification of investment objectives and constraints:


The typical objectives sought by an investor are current income, capital appreciation,
safety, fixed returns on principal investment.

• Choice of asset mix:


The most important decision in portfolio management is the asset mix decision. This is
concerned with the proportions of “Stock” or “
Units” of mutual fund or “Bond” in the portfolio. The appropriate mix of Stock and
Bonds will depend upon the risk tolerance and investment horizon of the investor.

• Formulation of portfolio strategy:


Once the certain asset mix has been chosen an appropriate portfolio strategy has to be
decided out. Two broad portfolio choices are available
An active portfolio management: it strive to earn superior risk adjusted returns by
resorting to market timing, or sector rotation or security selection or some combination of
these.
A passive portfolio management involves holding a broadly diversified portfolio and
maintaining a pre-determined level of risk exposure.

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MUTUAL FUND SCENARIO

First Phase – 1963-87(UTI)


MF industry started in India in 1963 with formation of UTI 1987-1988 UTI had
Rs.6, 700 crore of assets under management. The first scheme launched by UTI was Unit
Scheme 1964. Followed by ULIP in 1971, CGGA (1986), Masters hare (1987). UTI was
still only player in the market enjoying monopoly position and huge Mobilization of
funds.

Second Phase – 1987-1993 (Entry of Public Sector Funds)


1987 marked the entry of SBI MF – the first non- UTI MF. SBI Mutual Fund was
the first non- UTI Mutual Fund established in June 1987 followed by Can bank Mutual
Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund
(Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established
its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990.
Change in mindset of investors. UTI was still the undisputed leader of the market.
At the end of 1993, the mutual fund industry had assets under management of Rs.47, 004
crore.

Third Phase – 1993-2003 (Entry of Private Sector Funds)


With the entry of private sector funds in 1993, a new era started in the Indian
mutual fund industry 1993 was the year in which the first Mutual Fund Regulations came
into being, under which all mutual funds, except UTI were to be registered and governed.
The Kothari Pioneer (now merged with Franklin Templeton) was the first private sector
mutual fund registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations were
substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The
industry now functions under the SEBI (Mutual Fund) Regulations 1996. The number of
mutual fund houses went on increasing, with many foreign mutual funds setting up funds
in India and also the industry has witnessed several mergers and acquisitions. At the end

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of March 2006, there were 38 Asset Management Companies with total assets of Rs.
2,31,861 crore.

Fourth Phase – since February 2003


In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI
was bifurcated into two separate entities. One is the Specified Undertaking of the Unit
Trust of India with AUM of Rs.29, 835 crore as at the end of January 2003, representing
broadly, the assets of US 64 scheme, assured return and certain other schemes.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is
registered with SEBI and functions under the Mutual Fund Regulations. With the
bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76, 000 crores of
AUM and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual
Fund Regulations, and with recent mergers taking place among different private sector
funds, the mutual fund industry has entered its current phase of consolidation and growth.
As at the end of September 2004, there were 29 funds, which manage assets of
Rs.153108 crores under 421 schemes.

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TYPES OF MUTUAL FUNDS

Mutual Fund schemes may be classified on the basis of its structure and its investments.

™ BY STRUCTURE:

Open-End Funds:
Available for sale and repurchase at all times based on the net asset values. Unit
capital of the fund is not fixed. Fund size and its total investment go up if more new
subscriptions come in than redemptions and vice versa.

Close-End Funds:
One time sale of fixed number of units.
Investors are not allowed to buy or redeem the units directly from the funds. Some funds
offer repurchase after a fixed period.
Listed on stock exchange and investors can buy or sell units through exchange. May be
traded at a discount or premium to NAV based on investor’s perception about the funds
future performance and other market factors.
A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15
years. The fund is open for subscription only during a specified period. Investors can
invest in the scheme at the time of the initial public issue and thereafter they can buy or
sell the units of the scheme on the stock exchanges where they are listed. In order to
provide an exit route to the investors, some close-ended funds give an option of selling
back the units to the Mutual Fund through periodic repurchase at NAV related prices.
SEBI Regulations stipulate that at least one of the two exit routes is provided to the
investor.

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Interval Funds:
Interval funds combine the features of open-ended and close-ended schemes. They are
open for sale or redemption during pre-determined intervals at NAV related prices.

™ BY INVESTMENT OBJECTIVE:

Money/Cash Market Funds:


Instruments having less then one year maturity;
Treasury bills issued by government
Certificates of deposit issued by governments
Commercial paper issued by companies
Inter bank call money
Aim to provide easy liquidity, preservation of capital and moderate income.

Gilt Funds:
Securities maturity over a year;
Invested in government securities are called dated securities
Virtually zero risk of default it is backed by the government
It is more sensitive to market interest rates

Debt/Income Funds:
Investment in debt instruments issued not only by Government but also by private
companies, banks and financial institution and other entities such as infrastructure
companies. Target low risk and stable income for investors. Have higher price fluctuation
as compared to money market funds due to interest rate fluctuation.
Have higher risk of default by borrowers as compared to Gilt funds. Debt funds can be
categorized further based on their risk profiles. Carry both credit risk and interest rate
risk.

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Equity Funds:
Invest a major portion of their surplus in equity shares issued by cos, acquired directly in
initial public offering or through secondary market and keep a part in cash to take care of
redemption.
Risk is very high than debt funds but offer very high growth potential for the capital.
It can be further categorized based on investment strategy.
It must have along term objectives.

Balanced Funds:
Has a portfolio of debt instrument, convertible securities, and preference and equity
shares.
Consists of almost equal proportion of debt/money market securities and equities.
Normally funds maintain a ratio of 55:45 or 60:40 some funds allocate a flexible
proportion based on market conditions.
Aim is to gain income, capital appreciation and preservation of capital.
Ideal for investors for a conservative and long term orientation.

Load Funds:

A Load Fund is one that charges a commission for entry or exit. That is, each time you
buy or sell units in the fund, a commission will be payable. Typically entry and exit loads
range from 1% to 2%. It could be worth paying the load, if the fund has a good
performance history.

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No-Load Funds:

A no-Load Fund is one that does not charge a commission for entry or exit. That is, no
commission is payable on purchase or sale of units in the fund. The advantage of a no
load fund is that the entire corpus is put to work.

™ OTHER SCHEMES:

Tax saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Indian
Income Tax laws as the Government offers tax incentives for investment in specified
avenues. Investments made in Equity Linked Savings Schemes (ELSS) and pension
Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also
provides opportunities to investors to save capital gains u/s 54EA by investing in Mutual
Funds, provided the capital asset has been sold prior to April 1, 2000 and the amount is
invested before September 30, 2000.

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™ SPECIAL SCHEMES:

Industry Specific Schemes


Industry Specific Schemes invest only in the industries specified in the offer document.
The investment of these funds is limited to specific industries like InfoTech, FMCG and
Pharmaceuticals etc.

Index Schemes

Index Funds attempt to replicate the performance of a particular index such as the BSE
Sense or the NSE 50

Sector Schemes
Sector Funds are those, which invest exclusively in a specified industry or a group of
industries or various segments such as 'A' Group shares or initial public offerings.

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STRUCTURE OF MUTUAL FUNDS

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What is Index Funds?

Index funds are aligned to a particular benchmark index like the Standard & Poor, CNX,
Nifty or the BSE Sensex. The endeavor of these funds is to mirror the performance of the
designated benchmark index, by investing only in the stocks of the index with the
corresponding allocation or weightage.

What is Actively Managed Funds?

Actively managed funds are the ones wherein the fund manager uses his skills and
expertise to select invest-worthy stocks from across sectors and market segments. The
sole intention of actively managed funds is to identify various investment opportunities in
the market in order to clock superior returns, and in the process outperform the
designated benchmark index.

What people think of active fund managers?

Active fund managers enjoy a strong marketing edge over passive managers. Many
attain celebrity status and their opinions on what the market is doing are highly sought
after by the media. Great faith is often placed in their abilities, and what they do is often
portrayed as glamorous. Some fund managers are paid seven figure salaries and bonuses
and are often aggressively head hunted by rival firms. Above all, active fund managers
are usually perceived to be “interesting”.

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What people think of passive fund managers?

In contrast to their more colorful active counterparts, passive fund managers are seen as
the “nerds” of the investment business. Their performance objective is only to match an
index. Is this deliberate mediocrity bordering on negligence? You probably wouldn’t
want to be stuck next to a passive fund manager on a long flight, because all they ever
talk about is tax efficiency, cost minimization, diversification, asset allocation and buy
and hold investing. Where is the fun in that? Passive fund managers claim to have no
special insights into what the market is going to do, and have no clever strategy that they
intend to employ to “beat the market” by a large margin, often recommending investors
“stay the course” and hold a diversified portfolio through thick and thin. Above all,
passive fund managers are usually perceived to be “boring”.

Is index tracking more risky?

Investor would think that with diligent professionals at the wheel, even if they can’t
outperform indexes after costs at least they can manage risk properly by prudently
avoiding risky companies. Are active funds less volatile?

Actually, active funds on average are more volatile than index


funds because they are less diversified.

Index funds are also actively managed funds since they


represents continuous shifts in their structure by experts
according to change in markets.

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CHARACTERISTICS OF INDEX FUNDS

• Adopt a passive approach. Main focus is on achieving maximum diversification at


a minimum expense by holding a fixed percentage of every security in the market,
or a representative basket. Performance is determined by the asset class, index
funds make little attempt to do better.

• If the asset class does poorly, index funds do poorly. If the asset class does well,
index funds do well.

• These funds are quite boring because they offer no potential to beat the market,
most investors aren’t even aware they exist. Many “sophisticated” investors (and
those that aspire to be) flatly refuse to even consider indexing because it is just
too mediocre and too dull.

CHARACTERISTICS OF ACTIVE FUNDS

• When an investor buys an active fund, he is making a bet on a team of


professional investors, and their ability to generate high returns.

• Active funds may perform quite differently to the asset class as the manager
adjusts the portfolio based on their research.

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Nature of active fund managers?

• Active fund managers enjoy a strong marketing edge over passive managers.
Many attain celebrity status and their opinions on what the market is doing are
highly sought after by the media.
• Great faith is often placed in their abilities, and what they do is often portrayed as
glamorous.
• Some fund managers are paid seven figure salaries and bonuses and are often
aggressively head hunted by rival firms.

• Above all, active fund managers are usually perceived to


be “interesting”.

Nature of passive fund managers?

In contrast to their more colorful active counterparts, passive fund managers are seen as
the “nerds” of the investment business.
Their performance objective is only to match an index. Is this deliberate mediocrity
bordering on negligence?
Investor probably wouldn’t want to be stuck next to a passive fund manager on a long
flight, because all they ever talk about is tax efficiency, cost minimization,
diversification, asset allocation and buy and hold investing. Where is the fun in that?
Passive fund managers claim to have no special insights into what the market is going to
do, and have no clever strategy that they intend to employ to “beat the market” by a large
margin, often recommending investors “stay the course” and hold a diversified portfolio
through thick and thin.

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Above all, passive fund managers are usually perceived to be
“boring”.

Is index tracking more risky?

Investor would think that with diligent professionals at the wheel, even if they can’t
outperform indexes after costs at least they can manage risk properly by prudently
avoiding risky companies. Are active funds less volatile?

Actually, active funds on average are more volatile than index


funds because they are less diversified.

Risk v/s. Reward

Risk is the chance you take of making or losing money on your investment. Greater the
risk, the more you stand to gain or lose. There is no such thing as zero risk.
There are always factors you cannot control like recession or high inflation.
Your range of investment choices and their relative risk factors is often described as a
pyramid. The base of your investment pyramid consists of those investments only, which
are highly liquid and safe. The bulk of your portfolio should comprise limited and
moderate risk investments, and only small percentage of your total portfolio should be
invested in the highest risk category. Your expected returns will also increase accordingly
as you go up the pyramid.

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The arithmetic of active management

The average performance of all investors will be the same as the market. It is impossible
for everyone to be above average, mathematically it just can’t happen!! Half will fail
because somebody always gets stuck holding the bad stocks!
The aggregate return of all investors in the market will be the market return, (obviously),
because all the investors own all the stocks. The market return is the weighted average of
passive returns plus active returns.
If the index funds have the same pre-fee return as the market (which is what they set out
to do), then the other type of investor (active) will also have the same pre-fee return. If
index funds bought, say, 30% of every stock issued, the remaining 70% left to the active
investors would still have market index weightings.
This is a zero sum game, the average return of all active investors before costs is
necessarily going to equal the average return of the market.
Active investment is usually more expensive than passive investment so active funds, as a
group, will do worse than index funds after fees.
No amount of trading or research will change that. Some will outperform, but as a group
they will underperform. Like a poker game, money is redistributed but not created or
destroyed by active management.
Costs drag down the average performance of all investors. The average performance of
all investors will be the market average return, minus the average expenses. To ensure
that your net performance is above average, diversify extensively and keep expenses well
below average.

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Why to buy an index fund?

Chances of relatively high performance compared to active funds are very good.
Most index funds are extremely tax efficient (stocks anyway, not bonds of course!), so
their performance after tax compares even more favourably.
Index funds don’t change much. You can buy one and safely forget about it, no need to
change funds every year. Apart from anything else this saves you the time and costs of
having to closely monitor your investments, or pay an advisor to do it.
Index funds are usually less volatile than actively managed funds. Active funds usually
hold more concentrated portfolios, but index funds only hold a couple of percent in their
biggest investments. Exposure to individual stocks is minimal.
Indexing means never having to say you’re sorry.

Returns of Index funds

In the Indian context, index funds have never really caught the retail investor’s fancy.
This is in complete contrast to developed economies like the United States. Reasons for
the same are not very difficult to guess. In the United States, stock markets are more
efficient, so investment opportunities are at a premium and are relatively difficult to
identify. Consequently, a number of actively managed funds fail to outperform the
broader stock market. Also other factors like no loads and lower expenses further the
cause of index funds.

Investing in index funds is less difficult to handle as compared to investing in actively


managed funds. Broadly speaking, investors need to consider two important aspects.
The expense ratio & the tracking error (i.e. the difference between the returns clocked by
the designated index and index fund).

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Investing in actively managed funds demands a deeper review and understanding of the
fund house’s investment philosophy; also the investor needs to decide on the kind of
funds he wishes to invest in – a large cap/mid cap/small cap fund among others.
In the Indian context, the mutual fund industry is dominated by actively managed funds;
index funds occupy a smaller share of the market. Well-managed actively managed funds
have been successful in outperforming index funds by a huge margin. This could be
attributed to the fact that the Indian markets are still in an evolutionary phase and there
exist a number of inefficiencies. These inefficiencies are in turn utilized by competent
fund managers to outperform the index. This explains why many actively managed funds
manage to outperform the index over the long-term (3-5 years).
We conducted study on index funds as well as actively managed funds with diversified
equity funds, over varied time frames. We came to know the below mentioned facts.

Why to buy an actively managed fund?

There are a few reasons to use active funds instead of, or as well as index funds:
despite the odds, perhaps investor think a particular fund can outperform
there may not be an index fund available for an asset class investor wish to invest in, so
investor don’t have much choice
If the active fund is different enough to the index, maybe it will diversify the portfolio
and potentially reduce overall portfolio volatility.

Other things to look for in an actively managed fund

The fund should be very different to an index fund. Active funds that try to minimise
“tracking error” inevitably fail to add value in the long term. To outperform the index
takes more than conservative tilts to 20% of your portfolio.
Top investors like Warren Buffett get beaten by the index 40% of the time. You may
remember the heady days of the tech boom of the late 1990s, pundits called Buffett an
obsolete dinosaur who had lost his touch, though in the end Buffett was proven right, as

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usual. If you want to outperform in the long term you’ll have to be prepared for periods
of underperformance, and learn to ignore the pundits.
Index funds are cheap. You can buy the SSGA Street tracks ASX200 index fund for an
annual fee of only 0.286%pa, so how do you value active management?
An active fund that is 80% index + 20% active will not add value. If the index hugging
“active” fund is charging 1.5%pa, then they are charging a small fortune for their little
tilts: 80% x 0.286%pa + 20% x 6.356%pa = 1.5%pa
It would be more cost effective to combine a cheap index fund with a fire breathing
active stock picking fund if you want performance, rather than buy an index hugging
active fund. Don’t pay active MERs to index your money.

Returns of Actively managed funds

Not all actively managed funds are investment worthy and capable of generating superior
returns vis-à-vis benchmark indices. There are many laggards in the category as well who
have failed to match the benchmark indices (in this case BSE Sensex).
We also looked at various schemes in equity based open ended mutual funds, managed
by Franklin Templeton. These funds were actively managed funds.

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OPEN-ENDED
NAV 1- INCEPTI
EQUITYSCHEME 1-MTH 6-MTH 1-YR 3-YR 5-YR
(Rs) WEEK ON
S
-0.41 -0.80 -10.80 -14.49 -0.56 15.30
FRANKLIN FMCG G 30.99 0.00 %
% % % % % %
FRANKLIN ASIAN -2.34 -7.40 -27.15 -29.75
6.24 0.00 % 0.00 % -0.06 %
EQUITY G % % % %
FRANKLIN -2.87 -8.12 -39.57 -36.93 -16.88
21.85 2.82 % 0.00 %
INFOTECH G % % % % %
FRANKLIN -2.94 -7.59 -25.01 -46.34 12.22
92.04 0.86 % 3.56 %
BLUECHIP G % % % % %
TEMPLETON INDIA -3.49 -7.46 -41.59 -43.51
8.04 0.00 % 0.00 % 5.26 %
EQUITY G % % % %
FRANKLIN -3.50 -4.64 -25.46 -15.40 -7.57
21.07 5.52 % 3.78 %
PHARMA G % % % % %
FRANKLIN PRIMA -3.60 -7.59 -26.59 -41.22 16.48
101.50 2.38 % 0.00 %
PLUS G % % % % %
FRANKLIN FLEXI -3.88 -9.59 -30.05 -45.76 -3.53
13.58 0.00 % 0.21 %
CAP G % % % % %
FT INDIA INDEX -4.02 -10.54 -36.25 -45.10 -2.47 16.63
21.09 0.33 %
NIFTY G % % % % % %
-4.20 -10.90 -36.50 -51.25 -3.55 12.07
FRANKLIN OPP G 15.27 0.33 %
% % % % % %
TEMPLETON -4.26 -8.77 -37.72 -43.00 -1.61 10.33
47.72 0.00 %
GROWTH G % % % % % %
FRANKLIN PRIMA -4.50 -9.39 -37.02 -55.93 -15.64
105.75 6.51 % 0.00 %
FUND G % % % % %
FRANKLIN HIGH -4.69 -11.68 -36.11 -53.69
5.23 0.00 % 0.00 % 0.00 %
GROWTH G % % % %
FT INDIA INDEX -5.40 -11.12 -37.32 -47.13 -2.69
24.53 0.00 % 4.35 %
BSE G % % % % %

(NAV Appreciation date: Jan 22, 2009, Returns over periods greater than 12

months are annualized.)

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Index Tracking Tricks

MACRO-ECONOMIC FACTORS

• External shocks

An unanticipated drop in export prices can impair the capacity of domestic firms to
service their debts. This can result in deterioration in the quality of banks' loan
portfolios.

Adverse shock to domestic income associated with a decline in the terms of trade may
slow output and raise default rates.

Capital outflows induced by an increase in world interest

Drop in deposits; may force banks to liquidate long-term assets to raise liquidity or
cut lending abruptly. May entail a recession and a rise in default rates.

• The Exchange Rate Regime

A credibly-fixed exchange rate provides an implicit guarantee (no foreign exchange


risk) which may lead to excessive (and unhedged) short-term foreign borrowing.
This increases the fragility of the banking system to adverse external shocks,
particularly if the degree of capital mobility is high under any pegged rate regime,
capital outflows affect the financial system through an expansion or contraction of
bank balance sheets; they can lead to instability in the banking sector.

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A flexible exchange rate may also create problems. An abrupt outflow of capital can
lead to a sharp depreciation of the nominal exchange rate. The depreciation may raise
the domestic-currency value of foreign-currency liabilities, for banks and their
customers. Large, unhedged foreign-currency positions increase risk of default on
existing loans and vulnerability to adverse (domestic or external) shocks.
The fall in borrowers’ net worth may also lead to a rise in the finance premium and to
increased default rates; higher incidence of nonperforming loans may lead to a
banking crisis.

• Financial Repression

Financial system in most developing countries is “repressed” by government


interventions. This keeps interest rates that domestic banks can offer to savers very
low. By keeping interest rates low, it creates an excess demand for credit. It then
requires the banking system to set a fixed fraction of the credit available to priority
sectors. Combination of low nominal deposit interest rates and moderate to high
inflation has resulted in negative rates of return on domestic financial assets.
Financial Repression Leads to Low Growth, Poor legal system, weak accounting
standards, financial institutions nationalized, inadequate government regulation.

• Domestic shocks

Increase in domestic interest rates (to reduce inflation or defend the currency) slows
output growth and may weaken the ability of borrowers to service their loans. It may
lead to an increase in non-performing assets.

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TECHNICAL ANALYSIS

• TRENDLINE ANALYSIS

Trend line is technique that adds a line to a chart to represent the trend in the market or a
stock. Drawing a trendline is as simple as drawing a straight line that follows a general
trend. These lines are used to clearly show the trend and are also used in the identification
of trend reversals. As shown in Figure 5, an upward trendline is drawn at the lows of an
upward trend. This line represents the support the stock has every time it moves from a
high to a low. Notice how the price is propped up by this support. This type of trendline
helps traders to anticipate the point at which a stock's price will begin moving upwards
again. Similarly, a downward trendline is drawn at the highs of the downward trend. This
line represents the resistance level that a stock faces every time the price moves from a
low to a high.

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• Channels

A channel, or channel lines, is the addition of two parallel trendlines that act as strong
areas of support and resistance. The upper trendline connects a series of highs, while the
lower trendline connects a series of lows. A channel can slope upward, downward or
sideways but, regardless of the direction, the interpretation remains the same. Traders
will expect a given security to trade between the two levels of support and resistance until
it breaks beyond one of the levels, in which case traders can expect a sharp move in the
direction of the break. Along with clearly displaying the trend, channels are mainly used
to illustrate important areas of support and resistance. Figure 6 illustrates a descending
channel on a stock chart; the upper trendline has been placed on the highs and the lower
trendline is on the lows. The price has bounced off of these lines several times, and has
remained range-bound for several months. As long as the price does not fall below the
lower line or move beyond the upper resistance, the range-bound downtrend is expected
to continue.

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• Support and Resistance

Support and resistance levels are the levels at which a lot of traders are willing to buy the
stock (in the case of a support) or sell it (in the case of resistance). When these trendlines
are broken, the supply and demand and the psychology behind the stock's movement sis
thought to have shifted, in which case new levels of support and resistance will likely be
established.

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• The Importance of Support and Resistance

Support and resistance analysis is an important part of trends because it can be used to
make trading decisions and identify when a trend is reversing. For example, if a trader
identifies an important level of resistance that has been tested several times but never
broken, he or she may decide to take profits as the security moves toward this point
because it is unlikely that it will move past this level. Support and resistance levels both
test and confirm trends and need to be monitored by anyone who uses technical analysis.
As long as the price of the share remains between these levels of support and resistance,
the trend is likely to continue. It is important to note, however, that a break beyond a
level of support or resistance does not always have to be a reversal. For example, if prices
moved above the resistance levels of an upward trending channel, the trend has
accelerated, not reversed. This means that the price appreciation is expected to be faster
than it was in the channel. Being aware of these important support and resistance points
should affect the way that you trade a stock. Traders should avoid placing orders at these
major points, as the area around them is usually marked by a lot of volatility. If you feel
confident about making a trade near a support or resistance level, it is important that you
follow this simple rule: do not place orders directly at the support or resistance level. This
is because in many cases, the price never actually reaches the whole number, but flirts
with it instead. So if you're bullish on a stock that is moving toward an important support
level, do not place the trade at the support level. Instead, place it above the support level,
but within a few points. On the other hand, if you are placing stops or short selling, set up
your trade price at or below the level of support.

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• Head and Shoulders

This is one of the most popular and reliable chart patterns in technical analysis. Head and
shoulders is a reversal chart pattern that when formed, signals that the security is likely to
move against the previous trend. As you can see in Figure 20, there are two versions of
the head and shoulders chart pattern. Head and shoulders top (shown on the left) is a
chart pattern that is formed at the high of an upward movement and signals that the
upward trend is about to end. Head and shoulders bottom, also known as inverse head
and shoulders (shown on the right) is the lesser known of the two, but is used to signal a
reversal in a downtrend.

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• Rounding Bottom

A rounding bottom, also referred to as a saucer bottom, is a long-term reversal pattern


that signals a shift from a downward trend to an upward trend. This pattern is
traditionally thought to last anywhere from several months to several years.

A rounding bottom chart pattern looks similar to a cup and handle pattern but without the
handle. The long-term nature of this pattern and the lack of a confirmation trigger, such
as the handle in the cup and handle, make it a difficult pattern to trade.
We have finished our look at some of the more popular chart patterns. You should now
be able to recognize each chart pattern as well the signal it can form for chartists.
We will now move on to other technical techniques and examine how they are used
by technical traders to gauge price movements.

33
• Moving Average Analysis

Among the most popular technical indicators, moving averages are used to gauge the
direction of the current trend. Every type of moving average is a mathematical result that
is calculated by averaging a number of past data points. Once determined, the resulting
average is then plotted onto a chart in order to allow traders to look at smoothed data
rather than focusing on the day-to-day price fluctuations that are inherent in all financial
markets.
The simplest form of a moving average, appropriately known as a simple moving average
(SMA), is calculated by taking the arithmetic mean of a given set of values. For example,
to calculate a basic 10-day moving average you would add up the closing prices from the
past 10 days and then divide the result by 10. In Figure 1, the sum of the prices for the
past 10 days (110) is divided by the number of days (10) to arrive at the 10-day average.
If a trader wishes to see a 50-day average instead, the same type of calculation would be
made, but it would include the prices over the past 50 days. The resulting average below
(11) takes into account the past 10 data points in order to give traders an idea of how an
asset is priced relative to the past 10 days. Perhaps you're wondering why technical
traders call this tool a "moving" average and not just a regular mean? The answer is that
as new values become available, the oldest data points must be dropped from the set and
new data points must come in to replace them. Thus, the data set is constantly "moving"
to account for new data as it becomes available. This method of calculation ensures that
only the current information is being accounted for. In Figure 2, once the new value of 5
is added to the set, the red box (representing the past 10 data points) moves to the right
and the last value of 15 is dropped from the calculation. Because the relatively small
value of 5 replaces the high value of 15, you would expect to see the average of the data
set decrease, which it does, in this case from 11 to 10.

34
35
RETURNS

Income Funds Since Return Size(crore) Rank


Sahara Classic Fund – Growth 2008 16.4641 0.13 1
HSBC Flexi Debt Fund - Ret – Growth 2007 11.5144 344.09 2
DWS Money Plus Advantage Fund - Reg –
Growth 2007 10.9532 8.59 3
Birla Sun Life Income Plus – Growth 1995 10.8305 2788.06 4
Birla Sun Life Income Fund – Growth 1997 10.2867 928.82 5
Birla Sun Life Income Fund - 54EA – Growth 1997 10.2804 39.74 6
Birla Sun Life Income Fund - 54EB – Growth 1997 10.2226 39.74 7
Kotak Bond Regular Plan – Growth 1999 10.1498 673.12 8
ICICI Prudential Income Fund –Growth 1998 10.0312 3965.5 9
Reliance Income Fund - Retail - G P – Growth 1997 10.0268 2395.39 10
Escorts Income Plan- Growth 1998 9.6108 5.51 11
Canara Robeco Income Scheme – Growth 2002 9.6081 462.23 12
DSP BlackRock Bond Fund - Retail Plan –
Growth 1997 9.4645 939.24 13
HDFC HIF – Growth 1997 9.4203 789.74 14
LIC Bond Fund – Growth 1999 9.4011 91.22 15
Kotak Bond Deposit – Growth 1999 9.3111 673.12 16
ICICI Prudential L T P – Cumulative 2002 9.2359 8.23 17
IDFC SSIF - Invt. Plan - Plan A – Growth 2000 9.1386 647.82 18
Sundaram BNP Paribas Bond Saver – Growth 1997 8.9505 98.39 19
PRINCIPAL Income Fund – Growth 2000 8.9122 197.03 20
UTI Bond Fund – Growth 1998 8.8611 609.83 21
ING Income Fund - Regular Plan – Growth 1999 8.7969 70.04 22
IDFC D B F- Plan A – Growth 2002 8.7059 615.07 23

36
Fortis Flexi Debt Fund – Growth 2004 8.6851 94.18 24
HDFC Income Fund – Growth 2000 8.4939 1486.4 25
Birla Sun Life DBF - Retail – Growth 2004 8.2868 1713.45 26
Sahara Income Fund – Growth 2002 7.3519 2.35 27
Reliance Medium Term Fund – Growth 2000 7.2364 15966.74 28
HSBC Income Fund - Invst Plan - Reg - Growth 2002 6.6091 105.62 29
DWS Premier Bond Fund - Regular Plan –
Growth 2003 6.1577 315.3 30
IDFC SSIF - MTP - Plan A – Growth 2003 5.8619 57 31
Tata Income Plus Fund - Plan A – Growth 2002 5.793 3.19 32
ING Dynamic Duration Fund – Growth 2004 5.6331 1.58 33
Franklin India International Fund 2002 3.5923 1.29 34

37
Index funds Since Return Size(crore) Rank
HDFC Index Fund - Sensex Plus Plan 2002 19.2251 27.21 1
Tata Index Fund - Nifty Plan - Option A 2003 18.1197 5.71 2
Birla Sun Life Index Fund – Growth 2002 17.2292 27.46 3
Tata Index Fund - Sensex Plan - Option A 2003 16.8287 4.16 4
ICICI Prudential Index Fund 2002 14.4655 36.32 5
HDFC Index Fund - Nifty Plan 2002 14.3733 25.23 6
HDFC Index Fund - Sensex Plan 2002 13.9161 37.85 7
SBI Magnum Index Fund – Growth 2002 13.5472 14.81 8
LIC MF Index Fund - Sensex Plan – Growth 2002 10.8045 20.98 9
Franklin India Index Fund - NSE Nifty Plan –
Growth 2000 10.8026 66.93 10
LIC MF Index Fund - Sensex Advantage
Plan – Growth 2002 10.3235 2.84 11
UTI Master Index Fund – Growth 1998 9.9076 35.71 12
Franklin India Index Fund - BSE Sensex
Plan – Growth 2001 9.6463 25.41 13
Canara Robeco Nifty Index – Growth 2004 9.5083 4.29 14
LIC MF Index Fund - Nifty Plan – Growth 2002 9.4008 100.12 15
ING Nifty Plus Fund – Growth 2004 7.2147 6.92 16
PRINCIPAL Index Fund – Growth 1999 7.1378 45.14 17
UTI Nifty Fund – Growth 2000 6.4704 179.04 18
JM Nifty Plus Fund – Growth 2009 0.586 8.82 19
Benchmark S&P CNX 500 Fund – Growth 2008 -4.874 1.29 20

38
RATIO MEASUREMENT

TREYNOR RATIO:

The Treynor ratio is a measurement of the returns earned in excess of that which could
have been earned on a riskless investment
The Treynor ratio relates excess return over the risk-free rate to the additional risk taken;
however systematic risk instead of total risk is used. The higher the Treynor ratio, the
better the performance under analysis.

Explanation of Treynor’s Ratio

In other words, the Treynor ratio is a risk-adjusted measure of return based on systematic
risk. It is similar to the Sharpe ratio, with the difference being that the Treynor ratio uses
beta as the measurement of volatility.

Also known as the "reward-to-volatility ratio".

39
SHARPE RATIO

A ratio developed by Nobel laureate William F. Sharpe to measure risk-adjusted


performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that
of the 10-year U.S. Treasury bond - from the rate of return for a portfolio and dividing
the result by the standard deviation of the portfolio returns. The Sharpe ratio formula is:

Explanation of Sharpe Ratio

The Sharpe ratio tells us whether a portfolio's returns are due to smart investment
decisions or a result of excess risk. This measurement is very useful because although
one portfolio or fund can reap higher returns than its peers, it is only a good investment if
those higher returns do not come with too much additional risk. The greater a portfolio's
Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio
indicates that a risk-less asset would perform better than the security being analyzed.

A variation of the Sharpe ratio is the Sortino ratio, which removes the effects of upward
price movements on standard deviation to measure only return against downward price
volatility.

40
JENSON MEASURE

Explanation of Jenson’s Measure

A risk-adjusted performance measure that represents the average return on a portfolio


over and above that predicted by the capital asset pricing model (CAPM), given the
portfolio's beta and the average market return. This is the portfolio's alpha. In fact, the
concept is sometimes referred to as "Jensen's alpha."

The basic idea is that to analyze the performance of an investment manager you must
look not only at the overall return of a portfolio, but also at the risk of that portfolio. For
example, if there are two mutual funds that both have a 12% return, a rational investor
will want the fund that is less risky. Jensen's measure is one of the ways to help
determine if a portfolio is earning the proper return for its level of risk. If the value is
positive, then the portfolio is earning excess returns. In other words, a positive value for
Jensen's alpha means a fund manager has "beat the market" with his or her stock picking
skills.

41
Return of Index (SENSEX)

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Sensex 5209 3990 3262 3383 5872 6626 9422 13827 20325 9340

Return

A = P [1+r] ^ n

9720 = 5209 X [1+r] ^ 8.16

R = 7.412 % p.a.

42
Index Funds

Index Sharpe Sharpe treynor treynor jenson RETURN


Funds ratio rank ratio rank measure %
HDFC 26.49454 1 11.29286 1 0.067351 19.2251

TATA 23.24113 2 10.23225 2 0.111317 18.1197

BIRLA 22.10862 3 9.275578 3 0.046146 17.2292

TATA 21.46854 4 9.008878 4 0.176574 16.8287

ICICI 16.73868 5 6.952151 5 0.452585 14.4655

HDFC 14.44416 6 6.463793 6 0.089226 14.3733

HDFC 14.1663 7 6.253805 7 0.319469 13.9161

SBI 11.93218 8 5.470611 8 -0.07766 13.5472

LIC 7.41239 9 3.161781 9 0.316909 10.8045

FRANK 4.925985 11 2.805405 10 0.002803 10.8026

LIC 6.425306 10 2.717544 11 0.336908 10.3235

UTI 4.309831 12 1.898109 12 -0.00954 9.9076

FRANK 3.504287 14 1.676477 13 0.029633 9.6463

CANARA 3.216273 15 1.554948 15 0.045249 9.5083

LIC 3.64728 13 1.579256 14 0.15829 9.4008

ING -1.70436 16 -0.81973 16 -0.03298 7.2147

PRINCI -2.00343 17 -0.88704 17 -0.02414 7.1378

UTI -3.46574 18 -1.5342 18 -0.00459 6.4704

43
FINDINGS

INDEX FUNDS

Rank Sharpe Return % Treynor’s Return %


rank rank
1 HDFC 19.2251 HDFC 19.2251
2 TATA(N) 18.1197 TATA(N) 18.1197
3 BIRLA 17.2292 BIRLA 17.2292
4 TATA(S) 16.8287 TATA(S) 16.8287
5 ICICI 14.4655 ICICI 14.4655

¾ The top five index funds hold the same ranking according to Sharpe’s and
Treynor’s ratio.
¾ This indicates that the total risk as well as the volatility is well managed and
tracked by the best five index funds.
¾ Thus index funds actively manage the total risk and are efficient at diversifying
the risk over excess returns.

44
INCOME FUNDS
Income sharpe sharpe treynor trynor jenson
funds ratio rank ratio rank measure RETURN%
HSBC ************* ****** 1.389091 16 -5.37703 11.5144

BIRLA 0.340258 3 6.180131 1 1.534131 10.8305

KOTAK 0.31586 4 4.673478 2 1.160892 10.1498

ICICI 0.238235 8 4.523831 3 1.119191 10.0312

RIL 0.307276 5 4.415686 4 1.096499 10.0268

ESCORT 0.48937 2 3.29407 6 0.823119 9.6108

CANARA 0.158383 11 3.739767 5 0.916617 9.6081

DSP 0.287079 7 3.15625 7 0.784972 9.4645

HDFC 0.215528 9 3.114693 8 0.772643 9.4203

LIC 0.300422 6 2.98742 9 0.743984 9.4011

KOTAK 0.195618 10 2.875219 10 0.713238 9.3111

ICICI 1.078591 1 2.501822 12 0.625365 9.2359

IDFC 0.123574 13 2.564414 11 0.633062 9.1386

UTI 0.135654 12 1.843897 13 0.458966 8.8611

ING 0.098561 14 1.807029 14 0.445467 8.7969

IDFC 0.074022 17 1.589865 15 0.39248 8.7059

FORTIS 0.077994 16 1.353953 17 0.338439 8.6851

HDFC 0.088519 15 1.059871 18 0.263743 8.4939

BIRLA 0.068448 18 0.542155 19 0.135083 8.2868

SAHARA -0.08143 19 -1.44989 20 -0.3584 7.3519

HSBC -0.22614 20 -2.97837 21 -0.74135 6.6091

FRANK -0.41787 21 -9.49935 22 -2.36253 3.5923

45
INCOME FUNDS

Rank Sharpe Return Treynor’s rank Return


rank % %
1 ICICI PRU 9.2359 BIRLA INCOME 10.8305
LTP PLUS
2 ESCORT 9.6108 KOTAK 10.1498
3 BIRLA 10.8305 ICICI PRU 10.0312
4 KOTAK 10.1498 RIL INCOME 10.0268
5 RIL 10.0268 CANARA ROBECO 9.6081

46
FINDINGS

• ICIC holds first rank according to Sharpe’s ratio and stands 3rd according to
Treynor’s ratio. It suggests that ICICI fund gives good returns given the total risk
but it is unable to manage or diversify the risk among the various securities. So its
returns fall due to inability to diversify the risk properly.

• Similarly kotak holds 2nd rank according to Treynor’s ratio and 4th according to
Sharpe’s ratio. This indicates that increase in total risk lowers the return of
portfolio but here Sharpe’s ratio fails to reap from market premium which is best
done by Treynor’s ratio by allocating funds between risky and non risky assets
and diversifying the risk.

• Thus it can be concluded that funds ranking first according to Sharpe’s ratio
perform best when overall risk is minimum. Such funds are best at managing
inherent risk. Whereas Treynor’s ratio gives the best result by manipulating
effectively between risky and non risky assets.

47
COMPARISON OF TOP FIVE FUNDS

Income funds Sharpe’s Sharpe’s Treynor’s Treynor’s Jenson’s


ratio rank ratio rank ratio RETURN%

BIRLA 0.340258 3 6.180131 1 1.534131 10.8305

KOTAK 0.31586 4 4.673478 2 1.160892 10.1498

ICICI 0.238235 8 4.523831 3 1.119191 10.0312

RIL 0.307276 5 4.415686 4 1.096499 10.0268

ESCORT 0.48937 2 3.29407 6 0.823119 9.6108


Index funds

HDFC 26.49454 1 11.29286 1 0.067351 19.2251

TATA 23.24113 2 10.23225 2 0.111317 18.1197

BIRLA 22.10862 3 9.275578 3 0.046146 17.2292

TATA 21.46854 4 9.008878 4 0.176574 16.8287

ICICI 16.73868 5 6.952151 5 0.452585 14.4655

48
FINDINGS

• From the above table it is clear that index funds perform relatively better than
income funds because they track the index and provides return in the
respective proportion. Whereas the income funds capital allocation depends
upon the fund manager’s perception of risk and return of assets.

• The funds that prove best in index funds are best at managing inherent risks.
But the same funds gives poor return on income funds because they are not
able to diversify risk among various assets or adjust the investments according
to non diversifiable risks.

• Moreover index funds just track the movements of index so its less risky and
provides more returns than income funds. Whereas income funds proportion
of capital investment varies widely from index and is based upon the
perception of fund managers. Thus risk is inherent in income funds than index
funds based on the managers ability to judge the risk inherent in particular
assets.

49
SENSEX
20

15

RETURNS % 10

0
5000
10000
15000
20000
25000
1
January 2000
3

February 2001 5
7
March 2002 9

FUNDS
11
April 2003
13
May 2004 15

SENSEX

TIME
17
June 2005
19
RETURN ON FUNDS

July 2006 21

August 2007

September
2008

S1
SENSEX
INDEX FUND

50
INCOME FUNDS
INVESTMENT CRIETERIA

Aggressive
Equity Stocks & investors with
High Risk 3 years plus
Funds Shares long term out
look.
Balanced ratio
Capital of equity and
Balanced Market Risk debt funds to Moderate &
2 years plus
Funds and Interest ensure higher Aggressive
Risk returns at
lower risk
Portfolio
NAV varies
Index indices like Aggressive
with index 3 years plus
Funds BSE, NIFTY investors.
performance
etc
Salaried &
Gilt Interest Government 12 months
conservative
Funds Rate Risk securities & more
investors
Bond Predominantly
Funds Debentures,
Credit Risk Salaried &
Government More than 9
& Interest conservative
(Floating securities, - 12 months
Rate Risk investors
- Long- Corporate
term) Bonds
Treasury Bills,
Those who park
Certificate of
their funds in
Money Deposits, 2 days - 3
Negligible current accounts
Market Commercial weeks
or short-term
Papers, Call
bank deposits
Money
Short- Call Money,
term Commercial
Funds Papers,
Little Those with
(Floating Treasury Bills, 3 weeks -
Interest surplus
- short- CDs, Short- 3 months
Rate short-term funds
term) term
Government
securities.
51
KEY INVESTMENT CONSIDERATION:

• Safety : you get your money back

The biggest risk is the losing the money investor has invested. Another equally important
risk is that investor’s investments will not provide enough growth or income to offset the
impact of inflation, which could lead to a gradual increase in the cost of living. There are
additional risks as well but the biggest risk of all is not investing at all.

• Liquidity : you get the money back when you want it

How easily an investment can be converted to cash, since part of your invested money
must be available to cover any financial emergencies

52
• Plus convenience: How easy is it to invest, disinvest and
adjust to your needs?

Investment risk means uncertainty of expected returns. All investments are exposed to
various sources of risk, due to which there is a potential for fluctuation in the value of an
investment, which could result in loss of principal.

• Post-tax Returns: How much is really left for you post tax?????

53
SUMMARY

¾ Active funds as a group do not beat index funds. If investor wants a low stress
high probability investment strategy, forget “beating the market” and buy and
hold index funds.

¾ There is also a slight performance premium for smaller companies, particularly


small value companies.
¾ Small “growth” companies, usually the favourites of speculators and stock
brokers are historically the most risky and worst performing class of stock. It can
give superb return for very short time, but for more than 4 to 6 months, they are
the worst stocks.
¾ Costs matter a lot. If investors want to improve performance they are more likely
to get better results by focusing on tax efficiency, brokerage, reducing turnover
and minimising fees. There simply is no more reliable way to increase returns.
¾ Fees will probably matter more in the next ten years than the last, because average
returns are probably not going to be as high. They can be stable in long run.

*******************************

54