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Presented by
Pranav Bhagat(03)
Darshit Desai(08)
Ratul Ghosh(12)
Sagar Ghutkude(13)
Aanchal Narula(30)
Madhur Sawant(43)
Khushbu Shah(46)
Flow of Presentation
Introduction
Traditional Investments
- Security Analysis
- Portfolio Management
Security Analysis involves estimating the merits of individual
investments
Portfolio Management deals with the construction and maintenance
of collection of investments
Aims at reducing risks rather than increasing returns
Portfolio construction is a part of portfolio management
Portfolio Construction is a disciplined personalized process
In constructing a portfolio, the individual risk & return characteristic
of underlying investment must be considered along with clients
unique needs, goals and risk considered
Brief History
1952
1964
1980
1986
-Publication of
Harry
Markowitz
thesis, Portfolio
Selectiion
- William
Sharpe came
out with
CAPM model
-Introduced
Alpha and Beta
- AG Becker
introduced
concept of
Investment
Style
- Gary
Brinson
introduced
Determinants
of Portfolio
Performance
Asset Allocation
Performance Monitoring
Portfolio Construction
Evaluation of Investment Structure
Manager Selection
Measure Performance
Important Terms
Important Terms
Value
Investing
Cumulative
Returns
Deep Value
Rolling
Period Return
Relative
Value
Standard
Deviation
Growth
Interest
Beta
GARP
Alpha
Analogy
Imagine a cricket series just got over and we are
analyzing the score of Sehwag, Dhoni and Sreesanth
1.Sehwag (0, 0, 120, 160) Average- 70, Standard
Deviation- 71.41
2.Dhoni (60, 60, 70, 70) Average- 65, Standard
Deviation- 10
3.Sreeasnth (0, 0, 5, 20) Average- 6.25, Standard
Deviation- 8.19
Here Sharpe Ratio will be
Sehwag - 70-6.25/71.41= 0.9
Dhoni - 65-6.25/10 = 5.8
Market Sentiments
Market sentiment is the general prevailing attitude
of investors as to anticipated price development in a
market.
This attitude is the accumulation of a variety
of fundamental and technical factors, including price
history, economic reports, seasonal factors, and
national and world events.
Accounting scandals
Accounting scandals are political and/or business
scandals which arise with the disclosure of financial
misdeeds by trusted executives of corporations or
governments.
Such misdeeds typically involve complex methods for
misusing or misdirecting funds, overstating revenues,
understating expenses, overstating the value of corporate
assets or underreporting the existence of liabilities,
sometimes with the cooperation of officials in other
corporations or affiliates.
In public companies, this type of creative accounting" can
amount to fraud, and investigations are typically launched by
government oversight agencies, such as the Securities and
Exchange Board of India (SEBI).
Satyam scandal
The Satyam Computer Services scandal was a corporate
scandal that occurred in India in 2009 where chairman Ramalinga
Raju confessed that the company's accounts had been falsified.
The Global corporate community was shocked and scandalized
when the chairman of Satyam, Ramalinga Raju resigned on 7
January 2009 and confessed that he had manipulated the accounts
by US$1.47-Billion.
The Indian arm of PwC was fined $6 million by the SEC (US
Securities and Exchange Commission) for not following the code of
conduct and auditing standards in the performance of its duties
related to the auditing of the accounts of Satyam Computer
Services.
Satyam's shares fell to 11.50 rupees on 10 January 2009, their
lowest level since March 1998, compared to a high of 544 rupees in
2008
Systematic Risk
The risk inherent to the entire market or an entire market segment.
This type of risk is both unpredictable and impossible to completely
avoid.
Putting some assets in bonds and other assets in STOCKS can
mitigate systematic risk because an interest rate shift that makes
bonds less valuable will tend to make stocks more valuable, and vice
versa, thus limiting the overall change in the portfolios value from
systematic changes.
Systematic risk underlies all other investment risks.
The Great Recession provides a prime example of systematic risk.
Anyone who was invested in the market in 2008 saw the values of
their investments change because of this market-wide economic
event, regardless of what types of securities they held.
Returns Benchmarking
A benchmark is a feasible alternative to a portfolio against
which performance is measured.
Investors look to broad indexes as benchmarks to help
them gauge not only how well the markets are performing, but
also how well they, as investors, are performing.
For those who own stocks, they look to indexes like the S&P
500, the Dow Jones Industrial Average (DJIA) and the Nasdaq
100 to tell them "where the market is".
Most investors hope to meet or exceed the returns of these
indexes over time.
The problem with this expectation is that they immediately put
themselves at a disadvantage because they are not comparing
apples to apples.
How it works
Let's assume you compare the returns of
your stock portfolio, which is a broadly diversified
collection of small-cap stocks and is managed by
Company XYZ, with the Russell 2000 index, which
you feel is an accurate universe of feasible
alternative investments.
If Company XYZ's portfolio returns 5.5% in a year
but the Russell 2000 (the benchmark) returns 5.0%,
then we would say that your portfolio beat its
benchmark.
Portfolio Optimization
Definition
Portfolio optimization is the process of choosing the
proportions of various assets to be held in a portfolio,
in such a way as to the portfolio better than any other
according to some criterion.
Efficient portfolios
It is assumed that an investor wants to maximize a
portfolio's expected return contingent on any given
amount of risk.
All efficient portfolios are well-diversified.
Traditional measure
standard deviation
Sortino ratio
CVaR (Conditional Value at Risk)
Optimization constraints
Regulation and taxes
Transaction costs
Quadratic programming
Nonlinear programming
Mixed integer programming
Meta-Heuristic Methods
Top-down Approach:
In this approach, managers observe the market as a whole and decide
about the industries and sectors that are expected to perform well in
the ongoing economic cycle. After the decision is made on the
sectors, the specific stocks are selected on the basis of companies that
are expected to perform well in that particular sector.
Bottom-up:
In this approach, the market conditions and expected trends are
ignored and the evaluations of the companies are based on the
strength of their product pipeline, financial statements, or any other
criteria. It stresses the fact that strong companies perform well
irrespective of the prevailing market or economic conditions.
Fundamental Strategies
Tactical Asset Allocation
- Asset Class Rotation: Shifts funds between stocks, bonds and
other securities depending on market forecasts and estimated
returns.
Sector, Industry or Style Rotation Strategy
- Shifts funds between different equity sectors and industries
(financial stocks, technology stocks, consumer cyclicals,
durable goods) or among investment styles (e.g., large
capitalization, small capitalization, value growth)
Individual Stock Selection
- Buy low, Sell High
44
Technical Strategies
Contrarian investment strategy
- Best time to buy a stock is when the majority of other
investors are selling.
- Buy low, sell high. Hope asset prices are mean
reverting.
- Overreaction hypothesis.
Price momentum strategy
Earnings momentum strategy
45
In order to generate profits, the investors consider that some market segments are less
efficient than others.
Portfolio Manager may manage the volatility or risks of market by investing in less-risky
and high-quality companies instead of investing in market as a whole.
Investors may take additional risk for achieving higher-than-market returns.
Those investments which are not vastly correlated to the market function as portfolio
diversifier and decrease the portfolio volatility as a whole.
Investors may follow a strategy for avoiding certain industries in comparison to the market
as a whole.
Investors that follow actively-managed fund are more aligned for achieving their specific
investment goals.
Passive management is most common on the equity market, where index funds track
a stock market index
One of the largest equity mutual funds, the Vanguard 500, is a passive management
fund.
The two firms with the largest amounts of money under management, Barclays Global
Investors and State Street Corp., primarily engage in passive management strategies.
METHODS
Efficient market theory: This theory relies on the fact that the
information that affects the markets is immediately available and
processed by all investors. Thus, such information is always considered
in evaluation of the market prices. The portfolio managers who follows
this theory, firmly believes that market averages cannot be beaten
consistently.
Indexing: It is done by retail investors by buying one or more index
funds. An investment portfolio tracks an index and achieves low
turnover, very low management fees and good diversification.
The low management fees enable the investor to receive higher returns in
comparison to similar fund investments with higher management fees or
transaction costs. Passive management is widely used in the equity
market and involves tracking of stock market index by index funds.
Patient Portfolio: This type of portfolio involves making investments in wellknown stocks. The investors buy and hold stocks for longer periods. In this
portfolio, the majority of the stocks represent companies that have classic growth
and those expected to generate higher earnings on a regular basis irrespective of
financial conditions.
Aggressive Portfolio: This type of portfolio involves making investments in
expensive stocks that provide good returns and big rewards along with carrying
big risks. This portfolio is a collection of stocks of companies of different sizes
that are rapidly growing and expected to generate rapid annual earnings growth
over the next few years.
Conservative Portfolio: This type of portfolio involves the collection of stocks
after carefully observing the market returns, earnings growth and consistent
dividend history.
Advantages
Low cost: Provides meaningful and specific
incremental advantage.
Reduced uncertainty of decision errors: By making
investments, investors are exposed to market risks and
passive investment strategy reduces the uncertainty of
decision errors.
Style consistency: Indexing enables the investors to
control their overall allocation by selecting the
appropriate indexes.
Tax efficiency: Indexing is considered as more tax
efficient especially in cases of larger-cap indexes that
involve less trading and which are fairly stable.
Traditional
Performance Measures
Sharpe Measure
Treynor Measures
Jensen Measure
R Rf
R Rf
Jensen Measure
The Jensen measure is also based on CAPM.
Named after its creator, Michael C. Jensen.
The Jensen measure is 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.
Jensen Measure
Measuring Returns
How to measure returns generated by an investment
manager?
Measuring Returns
Dollar weighted rate of return is the internal rate of
return (IRR) of an investment
In investment management industry, time weighted
rate of return is preferred
Rate does not depend on when investment is
made (timing of cashflows)
Since different clients will invest at different
times, need a measure that is independent of
timing
PROBLEM
Four years ago, this investor put $200,000 in a
portfolio aligned with her long-term goals. This
portfolio then grew by 10% a year for 4 years. At the
start of the 5th year the investor received a large
inheritance, worth $1,000,000, and added it to the
account. During this same year the market happened
to decline, and the portfolio lost 10%. The portfolio
value historically would look like this:
SOLUTION
Because her account was so much larger during the
market decline of the 5th year, the investor has
actually lost money ($1,163,538 - $1,200,000 = $36,462) when compared to her total contributions.
However, the statement shows a positive timeweighted annualized rate of return. How can this be
correct?
FORMULA
TWRR = (1+10%) x (1+10%) x (1+10%) x (1+10%)
x (1+(-10%)) -1 = 32% cumulative return. Total
returns greater than 1 year are then annualized.
The annualized return is calculated as (1 + total
return)^(1/(Time/365))
= (1+ 32%) ^ ((1/1825/365)) -1 = 5.67%.
SOLUTION
The answer lies in the time-weighted rate of return calculation,
where each annual period counts equally. With this
performance measure, the portfolios positive performance
during the first 4 years would account for the 4/5s of the
return, with the last year being the last 1/5. The performance
will show a positive 5.67% annualized return; reflecting the
overall portfolio performance during the entire 5 year period
because each years return has an equal weight in the total
return calculation. Also, the timing of the cash inflow to the
portfolio, of which the portfolios money managers had no
control, does not influence the return.
SOLUTION
If you were to use dollar-weighted calculations, the 5th years
performance would overwhelm the return number, because the
value was so much higher during that one year. In this scenario
the portfolios previous 4 years of positive performance would
have less weight, and the focus would almost entirely be on
the 5th year, during which the market happened to decline. In
this scenario the DWRR would be (1.86%), since the
portfolios money managers performance is dominated by the
timing of the cash flow received.
FORMULA
DWRR = Initial cash flow + (CashFlow1) / (1 +
Return)^1 + (CashFlow2) / (1+Return)^2 +
(CashFlowN) / (1+Return)^N
In this scenario the DWRR would =
$-200,000 + ($-1,000,000) / (1+R)^4 + ($1,163,538) /
(1+R)^5, solving for return = (1.86%).
THANK YOU