Portfolio Analysis

How do you define portfolio?

A portfolio is a collection of financial investments like stocks, bonds, commodities, cash, and cash equivalents.

What is portfolio analysis?

Portfolio analysis is a quantitative method for selecting an optimal portfolio that can strike a balance between maximizing the return and minimizing the risk in various uncertain environments.

It also evaluates the probability of meeting the goals and objectives of a given investment mandate, particularly on a risk-adjusted basis and in light of historical asset class performance, inflation, and other factors. In this mini-project we'll only talk in terms of equity.

One of the key concepts in portfolio management is diversification—which simply means not to put all your eggs in one basket. Diversification tries to reduce risk by allocating investments among various financial instruments, industries, and other categories. It aims to maximize returns by investing in different areas that would each react differently to the same event.

What are the stocks covered in our portfolio

I have tried to cover and track blue-chip stocks in different industries in our portfolio like software (TCS & HCL tech), banking (HDFC), Paints (Asian Paints), FMCG (Britannia) and multinational conglomerates like Reliance and Hindustan Unilever.

What is covered in this mini-project?

We consider the initial investment to be ₹10,00,000 and we'll see how does our portfolio perform over the course of time. I have randomly allocated weightage to each stock in our portfolio and we there is a provision where you can see how does your money flow on a daily basis, the daily returns we obtain from our portfolio and the cummulative return we get on the initial investment. I have also represented this graphically for better visualisation.

In the end of analysis we calculate the Sharpe ratio of our portfolio.

What is Sharpe ratio?

Sharpe ratio is used to help investors understand the return of an investment compared to its risk. The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk.

It adjusts a portfolio’s past performance—or expected future performance—for the excess risk that was taken by the investor.

A high Sharpe ratio is good when compared to similar portfolios or funds with lower return.

where:

• Rp = Return of Portfolio

• Rf = Risk Free Rate

• σp = Standard deviation of the portfolio's excess return​

The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time

The standard deviation is a measure of volatility in the portfolio. Higher the standard deviation more is the risk associated due to high variance in the prices.

What is the ideal Sharpe ratio

A ratio of 1 is decent, ratio of 2 is better than average and ratio of 3 is excellent and you'll likely outperform the market.

Bonus

We'll calculate the Alpha and Beta values for our portfolio.

Alpha and beta are two of the key measurements used to evaluate the performance of a stock, a fund, or an investment portfolio.

Alpha measures the amount that the investment has returned in comparison to the market index or other broad benchmark that it is compared against.

Beta measures the volatility of an investment. It is an indication of its relative risk. They both are historical measures.

Takeaways :

• Alpha shows how well (or badly) a stock has performed in comparison to a benchmark index.

• Beta indicates how volatile a stock's price has been in comparison to the market as a whole.

• A high alpha is always good.

• A high beta may be preferred by an investor in growth stocks but shunned by investors who seek steady returns and lower risk.

An alpha of 1.0 means the investment outperformed its benchmark index by 1%. An alpha of -1.0 means the investment underperformed its benchmark index by 1%. If the alpha is zero, its return matched the benchmark.

If a stock's beta is 1.5, it is considered to be 50% more volatile than the overall market.

What is the perfect alpha and beta value for me?

The ideal alpha and beta value has a lot to do with your attitude and age. If you're a conservative investor you might want to avoid stocks with high beta value

On the other hand if you have a risk taking personality and have the courage to deal with volatility you can choose stocks with high beta values since they have a fast growth potential.

What does it have to do with my age?

If you're young then you can afford to take the risk of a high beta stock and even if you blow a lot of money you would have time to regain it back.

If you're old and if you've invested most of your savings then it could be risky to invest in volatile stocks. You don't want your retirement savings taken away from you in a flash.

Disclaimer : A lot of definitions were taken from Investopedia.com