PORTFOLIO MANAGEMENT AND ANALYSIS

Suvabrata Mandal
ICFAI Business School, Kolkata
(Nov 2019)

Premise

For the sake of simplicity, it is assumed that you have entered into a job where your monthly take home
pay is ₹70,000. Construct a portfolio for coming 10 years stating clearly your short term and long term
goals, assets and liabilities as well as objective of investment. Feel free to take the necessary assumption
to construct your portfolio. Portfolio should be constructed after taking into account consumption,
inflation rate, and increment in income over the period of time. You are advised to state your return
expectation and reason for choosing a particular instrument (if it is mutual fund or share of company
etc.).

I. Introduction

The key elements of portfolio management are:

1. Asset Allocation

The key to effective portfolio management is the long-term mix of assets. Asset allocation
is based on the understanding that different types of assets do not move in concert, and
some are more volatile than others. Asset allocation seeks to optimize the risk/return
profile of an investor by investing in a mix of assets that have low correlation to each other.
Investors with a more aggressive profile can weight their portfolio toward more volatile
investments. Investors with a more conservative profile can weight their portfolio toward
more stable investments.

2. Diversification

The only certainty in investing is it is impossible to consistently predict the winners and
losers, so the prudent approach is to create a basket of investments that provide broad
exposure within an asset class. Diversification is the spreading of risk and reward within an
asset class. Because it is difficult to know which particular subset of an asset class or
sector is likely to outperform another, diversification seeks to capture the returns of all of
the sectors over time but with less volatility at any one time.

3. Rebalancing

Rebalancing is a method used to return a portfolio to its original target allocation at annual
intervals. It is important for retaining the asset mix that best reflects an investor’s
risk/return profile. Otherwise, the movements of the markets could expose the portfolio to
greater risk or reduced return opportunities. For example, a portfolio that starts out with a
70% equity and 30% fixed-income allocation could, through an extended market rally, shift
to an 80/20 allocation that exposes the portfolio to more risk

II. Investment issues

Some of the investment issues pertaining to India and in general:

1. Inflation

According to IMF, inflation is projected to be averaging around 4.8%. Therefore any

investment must have a return of at least 4.8%. Whether it is saving money for future
needs or simply generating good returns from an investment, inflation rate must always be
taken into account. If the return from an investment is same as the inflation rate, investor
does not actually gain any return from the investment.

Figure 1 – Inflation rate in India from the year 2012 to 2022

2. Bank debt instruments

Recurring Deposit is a special kind of Term Deposit offered by banks in India which help
people with regular incomes to deposit a fixed amount every month into their Recurring
Deposit account and earn interest at the rate applicable to Fixed Deposit (@7.3-7.5%).
Recurring Deposit schemes allow customers with an opportunity to build up their savings
through regular monthly deposits of fixed sum over a fixed period of time. Minimum Period
of Recurring Deposit is 6 months and maximum is 10 years. However, tax or TDS is
applicable on Recurring Deposits, if interest earned on recurring deposits exceeds Rs.
10,000 a year. Same rates and TDS are also applicable for Fixed Deposits.

These debt instruments provide a risk-free rate of return slightly greater than the inflation
rate and help in liability crunch. Sometimes liabilities arise due to uncertainty and urgent
cash may be required. In such a case, liquidity is provided since one can take a loan
against their fixed deposits or withdraw the entire amount.

3. Non-banking investments

Year-wise returns from some asset classes have been quite volatile in the past 11 years.
The diversified portfolio was more stable but often times return has been lower than bank
debt instruments as well as the inflation rate. It is therefore better to go for a diversified
equity portfolio through mutual funds and SIP for a period of 3-5 years.

Figure 2 – Performance of various assets over the past 10 years in India

4. Risk diversification

Figure 3 – Risk diversification graph

Company specific risk can be reduced by diversification. These are risks specific to a
company or industry. For example, let's say an investor holds shares in 10 automotive
companies. Tomorrow, the sector underperforms due to low demand, so the entire portfolio
will be adversely affected. If, however, the investor held 1 automotive company and 9 other
diverse companies, the specific risk (i.e. underperforming industry) can be reduced.
Market risk cannot be completely reduced. An example of the market risk is the general
fluctuation of share prices. This is the risk of the market. This is another good reason to
invest in mutual funds and diversify equity investments.

III. Personality profile & Asset allocation

Due to high market volatility in India, it is better to proceed with a cautious optimism on
markets. Therefore a significant portion on investment has to be done through SIP on
large cap funds. Though the returns on large cap stocks is not as high as small and mid
cap funds, they score high on consistence and risk-reward mix. Bank debt instruments are
7% to 9% of the investment only. This is to ensure liquidity and availability of funds during
an emergency. The rest is invested in equity shares, mutual funds and insurance.
The proportion of SIP investment according to the risk profile can be visualized as follows

Figure 4 – SIP investment breakup

According to industry experts, investment in a SIP portfolio with such a profile can be
considered as follows for an investment of ₹10000

Fund name Category SIP amount (₹) 3 year 5 year

Aditya Birla SL Frontline Equity Large cap 2000 15.47 18.09
Franklin India Flexi Cap Large cap 2000 14.26 18.92
Kotak Select Focus Large cap 2000 19.43 27.07
MoST Focused Multicap 35 Multi cap 2000 23.73 -
Tata India Tax Savings Tax savings 2000 22.67 -
Figure 5 – Cautiously aggressive SIP portfolio with large-cap orientation

Average returns for a 3 year investment from this SIP portfolio is about 20%
 IV. Portfolio design and implementation

Goal:

To purchase a four wheeler at a cost of ₹7,50,000 after 3 years. Payment will be done
through EMI over 2 years. Amount to be paid per month will amount to ₹31,250 and
investment is done accordingly. Therefore planning period horizon is for 3 years only.

Assumptions:

• Inflation for income, consumption as well as the price of vehicle is taken into
account over the years. Only investment inflation is considered.
• EMI payment is at 0% interest
• The average inflation, as projected by IMF is taken as 4.8% each year
• Payment of ₹10,000 to Mediclaim gives a coverage of ₹1,50,000 for 3 years
• Zero base budgeting, i.e.; no wealth acquired from previous years before start of
investment

Year 0 investments

Salary = ₹70,000 / month

Consumption (Rent, Electricity, Food, Misc) = ₹25,000 / month
Investment = ₹45,000 / month

Figure 6 – Year 0 investment breakup

1. SIP
Investment amount in SIP = ₹30,000 / month
Return after 3 years (without accounting for inflation) = 20%
Return amount after 3 years (without accounting for inflation) = ₹36,000 / month
Inflation after 3 years (4.8 * 3) = 14.4%
Return after 3 years = 5.6 %
Actual return amount after 3 years = ₹31,680 / month
Actual return amount at the end on 3rd year = ₹3,80,160

2. Recurring deposit
Investment amount in RD = ₹5,000 / month
Return after 1 year (without accounting for inflation) = 7.5%
Inflation and tax after 1 year (7.5 – 4.8) = 2.7%
Actual return after 1 year = ₹61,620
Note: The proceeds from the recurring deposit is invested in a fixed deposit in the next year. Since we don’t
want to to compromise our SIP investments to open a fixed deposit account initially. We invest and get the
benefits of the fixed deposit from next year onwards

3. Mediclaim
Investment amount = ₹10,000 / month

Year 1 investments

Salary = ₹80,000 / month

Consumption (Rent, Electricity, Food, Misc) = ₹25,000 / month
Recurring deposit from previous year = ₹61,620
Investment = ₹55,000 / month

Figure 7 – Year 1 investment breakup

1. SIP
Investment amount in SIP = ₹35,000 / month
Return after 3 years (without accounting for inflation) = 20%
Return amount after 3 years (without accounting for inflation) = ₹42,000 / month
Inflation after 3 years (4.8 * 3) = 14.4%
Return after 3 years = 5.6 %
Actual return amount after 3 years = ₹36,960 / month
Actual return amount at the end on 4th year = ₹4,43,520

2. Equity shares (long term holding)

Investment amount in shares = ₹10,000 / month

3. Fixed deposits
Investment amount in FD = ₹61,620
Return after 1 year (without accounting for inflation) = 7.5%
Inflation and tax(@ 10%) after 1 year [7.5(1 – 0.1) – 4.8] = 1.95%
Actual return amount after 1 year = ₹62,821.59

4. Mediclaim
Investment amount = ₹10,000 / month

Year 2 investments

Salary = ₹90,000 / month

Consumption (Rent, Electricity, Food, Misc) = ₹30,000 / month
Fixed deposit from previous year= ₹62,821.59
Investment = ₹60,000 / month

Figure 8 – Year 2 investment breakup

1. SIP
Investment amount in SIP = ₹40,000 / month

2. Equity shares (long term holding)

Investment amount in shares = ₹10,000 / month

3. Fixed deposits
Investment amount in FD = ₹62,821.59
Return after 1 year (without accounting for inflation) = 7.5%
Inflation and tax(@ 10%) after 1 year [7.5(1 – 0.1) – 4.8] = 1.95%
Actual return amount after 1 year = ₹64,046.98

4. Mediclaim
Investment amount = ₹10,000 / month

V. Conclusion and analysis

Return after 3 years investment in SIP in Year 0 = ₹31,680 / month

Return after 3 years investment in SIP in Year 1 = ₹36,960 / month
Requires EMI = ₹31,250 / month

We are generating enough return from our SIP investments to cover our EMI in the first
year of EMI payment. If the SIP portfolio underperforms, we can balance the amount by
taking a loan from the Fixed deposit. We are generating slightly higher than required
returns in the second year of EMI payment, which can act as a cushion. We are also able
to cover insurance expenses as well as invest in stocks for long term

From the above portfolio, we can see that we have fulfilled our objective by generating
enough returns over the period of 2 years to cover the EMI. There are two distinct ways
investment in equity has been made. One is to choose stocks and buy and sell them
yourself and the other is to invest through equity funds. The final goal is the same, to
benefit from the superior returns that equity investing offers.

However, to become an expert investor in the stock market, one has to be willing to put in
considerable amount of time and effort required to become one. We have allocated a
greater proportion of of our investment towards mutual funds. Moreover, projection of
equity growth are difficult to predict over a long period due to market index, sector
performance etc. There are other complex factors such as arbitrage opportunities that can
affect returns as well. According to industry experts, investment in the following stocks is
advisable for long term investments for atleast 10 years.

Figure 9 – Analyst recommendations and 1-year target prices according to Bloomberg as on 7 th Aug 2018
A portfolio design greater than 3 years in not considered due to a larger spread of
variables over time such as inflation, salary hike, stock market performance, RBI
regulations etc. It is therefore not possible to make assumptions that reflect market
condition within acceptable limits for the future. However, over time as individuals wealth
increases, the focus shifts from maximizing returns to protection of investments. Investor
prefers to have reasonable growth without too much risk and depending less on the stock
market. Having a SIP portfolio consisting of balanced funds divide their corpus between
debt and equity, giving investors the best of both worlds. The equity portion generates
returns when markets are doing well, and the debt portion acts as a cushion when equities
are headed southwards. Such a portfolio will mostly consist of Hybrid instruments.
Proportion of investment will be about the same as the portfolio design above.
 VI. Annexture

List of tables and illustrations

Figure 1 – Inflation rate in India from the year 2012 to 2022

Figure 2 – Performance of various assets over the past 10 years in India
Figure 3 – Risk diversification graph
Figure 4 – SIP investment breakup
Figure 5 – Cautiously aggressive SIP portfolio with large-cap orientation
Figure 6 – Year 0 investment breakup
Figure 7 – Year 1 investment breakup
Figure 8 – Year 2 investment breakup
Figure 9 – Analyst recommendations and 1-year target prices according to Bloomberg as on 7th Aug 2018
 VII. References

Narendra Nathan (Jul 09, 2018), How to diversify your investment portfolio, Economic Times [Online],
Available at: https://economictimes.indiatimes.com/wealth/invest/how-to-diversify-your-investment-
portfolio/articleshow/64895229.cms

Babar Zaidi (Dec 11, 2017), 5 model mutual fund portfolios for different investor types, Economic Times
[Online], Available at: https://economictimes.indiatimes.com/wealth/invest/5-model-mutual-fund-
portfolios-for-different-investor-types/articleshow/61995095.cms

ET contributors (Apr 30, 2018), Investing in equity mutual funds versus investing in shares: Which is
better?, Economic Times [Online], Available at:
https://economictimes.indiatimes.com/wealth/invest/investing-in-equity-mutual-funds-versus-investing-
in-shares-which-is-better/articleshow/63949573.cms

Sameer Bhardwaj (Aug 14, 2018), 6 promising stocks for long term investment, Economic Times
[Online], Available at: https://economictimes.indiatimes.com/wealth/invest/6-promising-stocks-for-long-
term-investment/articleshow/65363418.cms

(2018), India: Inflation rate from 2012 to 2022 (compared to the previous year), Statista [Online],
Available at: https://www.statista.com/statistics/271322/inflation-rate-in-india/

Owen Raszkiewicz (Apr 21, 2017), What is diversification?, Raskfinance [Online], Available at:
https://www.raskfinance.com/2017/04/21/what-is-diversification/