Executive Summary

Chapter 02: Introduction

A portfolio manager normally follows either Top-down Approach or Bottom-up Approach. In
top-down approach, a manager performs Economic Analysis, Industry or Sector Analysis and
Security Analysis. This report also follows Top-down Approach.
This report is considering the economy of Bangladesh which is not a developed economy. It has
an emerging financial market and the market is very sensitive and dispersion level of stock prices
is very high.
This report is also considering a portfolio which has included stocks from 10 sectors of
Bangladesh economy. We are going to evaluate the sectors in ‘Industry Analysis’ chapter.
This report is considering one asset class which is Stock. The securities of the portfolio are listed
in Dhaka Stock Exchange (DSE). This report considers DSEX Index as benchmark for required
comparison.
For calculating historical risk and return measures of individual stock, this report included the
closing price of last 62 months. The report has also included cash dividend, stock dividend and
right share offering.
The report has constructed portfolio based on expected risk and returns of the individual stocks.
For portfolio construction, this report considers four scenarios:
 Short sale allowed, risk free borrowing and lending allowed.
 Short sale not allowed, risk free borrowing and lending allowed.
 Short sale allowed, risk free borrowing and lending not allowed.
 Short sale not allowed, risk free borrowing and lending not allowed.
This report has also demonstrated the performance evaluation of the portfolio based on Sharp
Ratio, Treynor Ratio, MM Square, Jensen Alpha and Information Ratio.
In the final section, this report includes performance attribution in three segments.
1. Pure sector allocation
2. Within sector allocation
3. Allocation/Selection Interaction
Chapter 02: Theoretical Background
From portfolio perspective, investors should invest in different asset classes and particularly not
in a single security in order to minimize risks. We, on a rational basis, investors want to
maximize return for a particular level of risk and minimize risks for a particular level return. This
notion is the basis of modern portfolio theory introduced by Harry Max Markowitz, an American
economist.
But an investor must understand, from portfolio approach, also known as diversification, which
portion of the risk can be minimized. We know that total risk from an investment can be divided
in two sections: Idiosyncratic Risk and Systematic Risk. From a portfolio approach, we can
only reduce the idiosyncratic portion which we also define as Standard Deviation of an
investment. The systematic portion is known as Covariance which measures the joint variability
of returns of two particular investment products. Actually, if the number of investment products
is close to infinity, standard deviation of the investment is close to zero and in this particular
situation, risk is only the covariance portion.
An investor can’t reduce the covariance of two particular investment products. Rather he or she
needs to choose the investment products which have lower or negative correlation among them.
The benefit that an investor can generate from portfolio approach is known as Diversification
Ratio. This ratio measures the percentage of standard deviation reduced from portfolio approach.
So, the crucial point is diversification ratio is maximum when investor choose investment
products which have negative correlation among them.
The investment products can be classified in two categories: Traditional and Alternative.
Tradition products are Stocks, Bonds, Cash and Real Estate. Alternative products are Mutual
Funds, Exchange-Traded Funds, Hedge Funds, Private Equity and Venture Capital. Before
starting investments, an investor needs to know the investment products which are available.
From portfolio approach, the risk of the investment depends on the investment products chosen
and the co-movements between those investment products. This is not a simple approach because
economic, financial, statistics and mathematical aptitude are required to make a portfolio and this
is why investors hire a portfolio manager, maybe a management team of economist, financial
analysist, statistician and mathematician.
A portfolio manager can be either active or passive. Active managers attempt to beat the market.
A manager can beat the market by generating more return from portfolio compared to the
benchmark return and by recurring less loss from portfolio compared to the benchmark loss.
Normally, active managers have two approach: Leveraging and Short Sale. In Leveraging
approach, the manager takes loan and buys security which are undervalued and in Short Sale
approach, the manager sells the overvalued share short and by them back when the price falls.
Here the number of transaction is also high and active manager demands both management fees
and performance fees and also active managers have to research. So active managers are costly.
Passive managers just adopt buy and hold strategy so that they can follow a benchmark or a
market index. Well, in a practical sense, passive managers can beat the market by choosing the
sector or the securities which are performing better compared to the other sectors which are
available in the market.
In order to develop a portfolio, an investor must understand the terms and tools related to the
portfolio approach. So, this section will cover the theoretical background related to the portfolio
approach.
Efficient Portfolio is basically a collection of investment products that provides maximum
return for a given level of risk or minimum risk for a particular level of return. For a given
collection of investment products, an investor may find some set of efficient portfolio. The
investor will choose the efficient portfolio based on his or her own risk-return objectives. For
example, a young investor may need more return and have more risk tolerance, so he should take
the efficient portfolio with more return and trade-of is more risk.
Efficient Frontier is basically a set of efficient portfolio generated from collection of investment
products based on different level of risk and return.

Comparison Between EF & CAL

0.035
0.03
0.025
0.02
Return

0.015
0.01
0.005
0
0 0.01 0.02 0.03 0.04 0.05 0.06 0.07
Risk
Efficient Frontier Capital Allocation Line

[Figure:2.1]
The [Figure:2.1] has a blue line, curved shape efficient frontier. The area under the efficient
frontier is sub-optimal or inefficient. The area above efficient frontier is attractive but not
attainable. All the points of the efficient frontier are optimal portfolio.
There are two lines related to efficient frontier and they are Capital Allocation Line (CAL) and
Capital Market Line (CML). Capital Allocation Line (CAL) shows all the possible
combinations of investment in risk-free asset and risky assets available for particular portfolio. If
an investor invests in the point where capital allocation line and efficient frontier is tangent, he is
basically investing only in risky assets. Again, if an investor invests in a point before the tangent
point, he is basically lending at risk-free rate and the investment point is after the tangent point,
he or she is basically borrowing at risk-free rate. Capital Market Line (CML) and Capital
Allocation Line (CAL) are the same in case of market portfolio.
Security Market Line (SML) and Capital Market Line (CML) are not the same though they
show relationship between risk and return. The differences are:
 The slope of (CML) is the Sharp Ratio of the market portfolio, whereas the slope of
(SML) is the Risk Premium of market portfolio.
 The (CML) shows return of the market portfolio in terms of Standard Deviation of the
market portfolio. The (SML) shows return in terms of Beta of the market portfolio.

Chapter 03: Top-down Approach

3.1 Macroeconomic Analysis
Bangladesh is one of the fastest growing economy in the world. The growing economy has some
prospects and challenges coming forward. This growing economy has resulted growth in income,
consumption, savings and investment. These increases will definitely favor the growth of
business activities in the economy. Already we have seen that the number of company listed in
the capital market particularly in DSE is increasing, total market capitalization has also
increased. The number of banks and financial institution is also increasing. So, as the capital
flow is increasing in the financial system and the economy is experiencing growth, we can
predict that every sector of the economy will perform better but yes each sector will not perform
the same.
Year GDP Growth Real Interest Inflation Inflation Credit
Interest rate Rate growth growth
Rate growth
2013 6% 5.99%   7.54%   4%
2014 6.10% 6.89% 15.03% 7.01% -7.03% 12.13%
2015 6.60% 5.51% -20.03% 6.61% -5.71% 8.40%
2016 7.10% 3.45% -37.39% 5.68% -14.07% 10.53%
2017 7.30% 3.07% -11.01% 5.61% -1.23% 16.94%
2018 7.90% 3.84% 25.08% 5.63% 0.36% 11.20%
2019 8.30% 4.88% 27.08% 5.69% 1.07% 12.24%
[Table:3.1]
The table above shows the performance of the economy over the last seven years. From every
aspect, the economy is growing. In 2020, the GDP is predicted to fall by 2%. But in upcoming
years the economy is going to experience boom.
From investment perspective, Bangladesh is not the best but one of the growing and emerging
market. This economy should perform better at least in the long run. We can be optimistic
regarding investment in the Bangladesh economy.
3.2 Industry Analysis
Industry Analysis is the second perhaps the most crucial part of the top-down approach. In this
section, we are going to analyze how the sectors are going to perform. As we have seen in our
macroeconomic analysis, the economy is growing. So, apparently, the industries of the economy
should also be growing. So, let’s have e look at the sectors and evaluate the sectors in terms of
position in business cycle, structural changes, industry life-cycle and competitive environment.
Sectors Business Structural Life-Cycle Competitive
Cycle Change Environment
Banks Favorable No Mature Growth High
Pharmaceutical Favorable No Stabilization High
Telecommunication Favorable No Mature Growth Medium
Financial Institution Favorable No Stabilization High
Fuel and Power Favorable No Mature Growth High
Engineering Favorable No Mature Growth High
Real Estate Favorable No Mature Growth Medium
Cement Favorable No Mature Growth Medium
Textile Favorable No Stabilization High
Food and Allied Favorable No Stabilization High
[Table:3.2]
The above table shows the prospects of sectors which are included in portfolio. These ten sectors
are going to perform better according to industry analysis.
As the business cycle is going to move upward, these sectors are in favorable conditions in terms
of operating and generating revenue and experiencing growth.
There will be no structural changes or alternative sectors in these industries. So, as expected,
these sectors are going to perform for a long period of time.
Although, mature growth sectors are ideal for the investors who want to accumulate capital. But
mature sectors also play rule in terms generating return for the current period. So, it is
satisfactory to diversify in growth and stabilized sectors.
The competitive environment in these sectors is very high. So, an investor should be very careful
regarding the security selection of these sectors.
3.3 Company Analysis and Security Selection
Name Code Sector P/E P/BV DY Cat. Cap Beta
Bank Asia Ltd. BANKASIA Bank 10.65 0.84 5.52% Value Mid 0.62
Eastern Bank Ltd. EBL Bank 7.92 1.18 3.86% Value Mid 0.94
Islami Bank ISLAMIBANK Bank 8.47 0.80 3.37% Value Mid 1.62
Bangladesh Ltd
Square SQURPHARMA Pharmaceutical 12.86 2.52 2.21% Growt Large 0.89
Pharmaceuticals h
Ltd
The IBN SINA IBNSINA Pharmaceutical 14.91 4.34 1.67% Growt Small 0.64
Pharma Ltd. h
Jamuna Oil Ltd JAMUNAOIL Fuel and Power 10.04 0.96 7.34% Value Mid 0.55
United Power UPGDCL Fuel and Power 12.35 4.85 4.85% Growt Large 0.82
Generation Ltd h
Linde Bangladesh LINDEBD Fuel and Power 15.93 3.82 3.88% Growt Mid 0.28
Limited h
Padma Oil Limited PADMAOIL Fuel and Power 7.77 1.40 6.04% Value Mid 0.7
Singer Bangladesh SINGERBD Engineering 16.43 5.31 4.31% Growt Mid 0.67
Ltd h
National Polymer NPOLYMAR Engineering 13.74 1.57 1.60% Growt Small 1.14
Ltd. h
GPH Ispat Ltd. GPHISPAT Engineering 10.62 1.82 1.49% Growt Mid 1.01
h
BBS Cables Ltd. BBSCABLES Engineering 8.81 1.69 1.59% Growt Mid 0.92
h
Confidence CONFIDCEM Cement 19.67 1.69 1.16% Growt Small 1.16
Cement Ltd h
Premier Cement PREMIERCEM Cement 11.66 1.22 1.64% Growt Small 0.44
Ltd h
Grameenphone GP Telecommunication 13.86 13.12 4.59% Growt Large 1.02
Ltd. h
Olympic Industries OLYMPIC Food and Allied 17.93 4.48 2.78% Growt Mid 0.77
Ltd. h
Eastern Housing EHL Real State 13.75 0.68 3.70% Value Small 1.04
Ltd.
IDLC Finance Ltd. IDLC Financial 14.92 2.15 4.41% Growt Mid 1.34
Institution h
Paramount Textile PTL Textile 8.25 2.08 2.62% Growt Small 0.72
Ltd h
[Table:3.3]

The above shows the name of the companies selected to develop portfolio. We can see that there
are twenty companies selected from 10 sectors which are discussed in the ‘Industry Analysis’
section. The security selection involves considering six factors which will be discussed in this
section.
The selected companies have price to earnings (P/E) ratio less than 20, considering the fact that
the individual security should cover up the money invested by its earnings in less than 20 years.
The selected companies have dividend yield (DY) more than 1%. Along with this, we are also
considering price to book value (P/BV) ratio so that we can categorize the stocks as growth or
value. Normally, growth stock has lower dividend yield and higher P/BV ratio compared to the
value stock. So we make sure that the portfolio has both value and growth stock to generate
diversification.
We can also see that there are small, middle and large cap companies available in the portfolio.
Large cap companies generally have greater market share and small cap companies have lower
management and operation cost and growth scope. So we make sure that the portfolio is
diversified and we have large, small and middle cap companies selected.
The [Table:3.3] also shows the beta of the individual companies. We can see that there are both
less sensitive and more sensitive stocks related to the market. If we develop portfolio, we will get
a beta of 0.88 which is less than 1. This means that the portfolio will be relatively less sensitive
to the market and the good side is loss will be lower compared to the benchmark.
After economic analysis, industry analysis and security analysis, we have selected the stocks
which will be included in the portfolio.

Chapter 4: Portfolio Construction

In this chapter, we are going to focus on three sections which are expected risk-return, optimal
portfolio and efficient frontier.

4.1 Expected Risk-Return

We can imply scenario analysis tool in order to estimate the expected return. First of all, we have
to find out the historical return on a monthly basis for at least 60 months. Then we can develop a
scenario analysis model which is shown below.
Scenario Monthly Return Weight
Optimistic Historical Average*(1+Standard Deviation) 20%
Normal Historical Average 70%
Pessimistic Historical Average*(1-Standard Deviation) 10%
[Table:4.1.1]
Here, we are assuming that the historical returns follow a normal distribution. So, close to 70%
return should fall under the average plus standard deviation point. We are more optimistic
because of our future predictions from macroeconomic, industry and company analysis.
In terms of variance and covariance, we are assuming that historical and expected are the same
as the companies are in mature position and there will be no structural changes in the sectors.
Now let’s have a look at the monthly expected return and standard deviation of the selected
companies.

Security Expected Risk-free Excess Return Standard

Return Rate Deviation
BANKASIA 1.86% 0.49% 1.37% 7.03%
EBL 2.21% 0.49% 1.72% 6.47%
ISLAMIBANK 1.98% 0.49% 1.49% 11.00%
SQURPHARMA 1.21% 0.49% 0.72% 5.73%
CONFIDCEM 3.08% 0.49% 2.59% 9.86%
GP 1.82% 0.49% 1.33% 7.06%
IDLC 2.03% 0.49% 1.54% 7.86%
BBSCABLES 1.82% 0.49% 1.33% 11.89%
OLYMPIC 1.24% 0.49% 0.75% 6.78%
JAMUNAOIL 1.30% 0.49% 0.81% 6.50%
UPGDCL 3.14% 0.49% 2.65% 10.31%
LINDEBD 0.75% 0.49% 0.26% 4.41%
PTL 3.30% 0.49% 2.81% 9.71%
SINGERBD 1.42% 0.49% 0.94% 6.49%
NPOLYMAR 1.86% 0.49% 1.37% 9.40%
PADMAOIL 1.36% 0.49% 0.87% 6.50%
PREMIERCEM 1.00% 0.49% 0.51% 8.63%
EHL 1.84% 0.49% 1.35% 7.56%
GPHISPAT 2.11% 0.49% 1.62% 7.40%
IBNSINA 3.07% 0.49% 2.59% 9.43%
[Table:4.1.2]
The table shows expected return and standard deviation of the individual securities which are the
basic inputs of portfolio construction model. Another important input is the covariance.

4.2 Optimal Portfolio

Optimal Portfolio is basically a collection of investment products that provides maximum return
for a given level of risk or minimum risk for a particular level of return. For portfolio
construction, this report considers four scenarios:
Scenario Required Conditions
1 Short sale allowed, risk free borrowing and lending allowed.
2 Short sale not allowed, risk free borrowing and lending allowed.
3 Short sale allowed, risk free borrowing and lending not allowed.
4 Short sale not allowed, risk free borrowing and lending not allowed
Scenario 1:
Security Expected Return Weight Weighted
Return
BANKASIA 1.86% -0.05 -0.10%
EBL 2.21% 1.03 2.27%
ISLAMIBANK 1.98% -0.35 -0.70%
SQURPHARMA 1.21% -0.32 -0.39%
CONFIDCEM 3.08% 0.46 1.41%
GP 1.82% 0.47 0.85%
IDLC 2.03% 0.33 0.67%
BBSCABLES 1.82% -0.42 -0.76%
OLYMPIC 1.24% -0.41 -0.50%
JAMUNAOIL 1.30% 0.14 0.18%
UPGDCL 3.14% 0.48 1.52%
LINDEBD 0.75% -0.54 -0.41%
PTL 3.30% 0.61 2.03%
SINGERBD 1.42% -0.21 -0.30%
NPOLYMAR 1.86% -0.17 -0.32%
PADMAOIL 1.36% -0.83 -1.13%
PREMIERCEM 1.00% -0.06 -0.05%
EHL 1.84% -0.12 -0.23%
GPHISPAT 2.11% 0.30 0.63%
IBNSINA 3.07% 0.66 2.04%
Total 1 6.72%

In this scenario, short sale is allowed, risk free borrowing and lending allowed. The above table
shows the optimal weights of the portfolio and we can see that some weights are negative. The
negative weights mean that these securities will be included in short sale. The optimal portfolio
return is 6.72%.
Scenario 2:
Security Expected Weight Weighted
Return Average
BANKASIA 1.86% 3% 0.06%
EBL 2.21% 22% 0.49%
ISLAMIBANK 1.98% 0% 0.00%
SQURPHARMA 1.21% 0% 0.00%
CONFIDCEM 3.08% 11% 0.33%
GP 1.82% 1% 0.01%
IDLC 2.03% 8% 0.17%
BBSCABLES 1.82% 0% 0.00%
OLYMPIC 1.24% 0% 0.00%
JAMUNAOIL 1.30% 0% 0.00%
UPGDCL 3.14% 15% 0.47%
LINDEBD 0.75% 0% 0.00%
PTL 3.30% 22% 0.72%
SINGERBD 1.42% 0% 0.00%
NPOLYMAR 1.86% 0% 0.00%
PADMAOIL 1.36% 0% 0.00%
PREMIERCEM 1.00% 0% 0.00%
EHL 1.84% 0% 0.00%
GPHISPAT 2.11% 0% 0.00%
IBNSINA 3.07% 19% 0.57%
Total 1.00 2.81%

In this scenario, Short sale not allowed, risk free borrowing and lending allowed. The above table
shows the optimal weights of the portfolio and we can see that all weights are positive but some
weights are zero. The zero weights mean that these securities will not be included in the optimal.
The optimal portfolio return is 2.81%.
Scenario 3:
Expected Rf = 0.25% Rf = 0.75%
Security Return Weight Weighted Weight Weighted Average
Average
BANKASIA 1.86% 0.04 0.00 -0.78 -0.01
EBL 2.21% 0.60 0.01 4.39 0.10
ISLAMIBANK 1.98% -0.25 -0.01 -1.12 -0.02
SQURPHARM 1.21% -0.20 0.00 -1.25 -0.02
A
CONFIDCEM 3.08% 0.26 0.01 2.02 0.06
GP 1.82% 0.29 0.01 1.84 0.03
IDLC 2.03% 0.19 0.00 1.39 0.03
BBSCABLES 1.82% -0.22 0.00 -1.92 -0.03
OLYMPIC 1.24% -0.20 0.00 -2.04 -0.03
JAMUNAOIL 1.30% 0.09 0.00 0.49 0.01
UPGDCL 3.14% 0.25 0.01 2.31 0.07
LINDEBD 0.75% -0.16 0.00 -3.58 -0.03
PTL 3.30% 0.38 0.01 2.47 0.08
SINGERBD 1.42% -0.03 0.00 -1.62 -0.02
NPOLYMAR 1.86% -0.12 0.00 -0.57 -0.01
PADMAOIL 1.36% -0.41 -0.01 -4.15 -0.06
PREMIERCEM 1.00% 0.02 0.00 -0.61 -0.01
EHL 1.84% -0.10 0.00 -0.31 -0.01
GPHISPAT 2.11% 0.18 0.00 1.22 0.03
IBNSINA 3.07% 0.39 0.01 2.81 0.09
Total 1.00 4.36% 1.00 25.26%

In this scenario, Short sale is allowed, risk free borrowing and lending are not allowed. So, the
problem is we don’t have a risk-free rate. In order to develop portfolio and see how sensitive
risk-free rate is, we assumed risk-free rate at two extreme levels which are 0.25% and 0.75%. We
can see that risk-free rate is very sensitive and the portfolio return is increased by a significant
amount.
Scenario 4:
Expected Rf = 0.75% Rf = 0.25%
Security Return Weight Weighted Weight Weighted
Return Return
BANKASIA 1.86% 0.00 0.00% 0.05 0.10%
EBL 2.21% 0.22 0.49% 0.21 0.46%
ISLAMIBANK 1.98% 0.00 0.00% 0.00 0.00%
SQURPHARMA 1.21% 0.00 0.00% 0.00 0.00%
CONFIDCEM 3.08% 0.12 0.36% 0.09 0.28%
GP 1.82% 0.00 0.00% 0.03 0.06%
IDLC 2.03% 0.07 0.14% 0.08 0.16%
BBSCABLES 1.82% 0.00 0.00% 0.00 0.00%
OLYMPIC 1.24% 0.00 0.00% 0.00 0.00%
JAMUNAOIL 1.30% 0.00 0.00% 0.00 0.00%
UPGDCL 3.14% 0.15 0.48% 0.14 0.44%
LINDEBD 0.75% 0.00 0.00% 0.00 0.00%
PTL 3.30% 0.24 0.78% 0.20 0.66%
SINGERBD 1.42% 0.00 0.00% 0.00 0.00%
NPOLYMAR 1.86% 0.00 0.00% 0.00 0.00%
PADMAOIL 1.36% 0.00 0.00% 0.00 0.00%
PREMIERCEM 1.00% 0.00 0.00% 0.00 0.00%
EHL 1.84% 0.00 0.00% 0.00 0.00%
GPHISPAT 2.11% 0.00 0.00% 0.02 0.04%
IBNSINA 3.07% 0.20 0.62% 0.17 0.53%
Total 1.000 2.87% 1.00 2.74%

In this scenario, Short sale is not allowed, risk free borrowing and lending are not allowed. So,
the problem is we don’t have a risk-free rate. In order to develop portfolio and see how sensitive
risk-free rate is, we assumed risk-free rate at two extreme levels which are 0.25% and 0.75%. We
can see that risk-free rate is not very sensitive and the portfolio return is increased by a little
amount.
4.3 Efficient Frontier
Efficient Frontier is basically a set of efficient portfolio generated from collection of investment
products based on different level of risk and return.
There are two lines related to efficient frontier and they are Capital Allocation Line (CAL) and
Capital Market Line (CML). Capital Allocation Line (CAL) shows all the possible
combinations of investment in risk-free asset and risky assets available for particular portfolio. If
an investor invests in the point where capital allocation line and efficient frontier is tangent, he is
basically investing only in risky assets. Again, if an investor invests in a point before the tangent
point, he is basically lending at risk-free rate and the investment point is after the tangent point,
he or she is basically borrowing at risk-free rate. For portfolio construction, this report considers
four scenarios:
Scenario Required Conditions
1 Short sale allowed, risk free borrowing and lending allowed.
2 Short sale not allowed, risk free borrowing and lending allowed.
3 Short sale allowed, risk free borrowing and lending not allowed.
4 Short sale not allowed, risk free borrowing and lending not allowed

Scenario 1:
 Short Sale allowed, Risk Free lending and bor-
rowing allowed.
0.080

0.070

0.060

0.050
Return

0.040

0.030

0.020

0.010

0.000
0.000 0.020 0.040 0.060 0.080 0.100 0.120 0.140
Risk

Efficient Frontier Capital Allocation Line

Scenario 2:

Short Sale not allowed, Risk Free lending and

borrowing allowed
0.035
0.03
0.025
0.02
Return

0.015
0.01
0.005

0
0 0.01 0.02 0.03 0.04 0.05 0.06 0.07
Risk
Efficient Frontier Capital Allocation Line
Scenario 3:

Short Sale allowed, Risk Free lending and

borrowing not allowed
7.00%

6.00%

5.00%

4.00%
Return

3.00%

2.00%

1.00%

0.00%
0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1 0.11
Risk
Efficient Frontier

Scenario 4:
 Short Sale not allowed, Risk Free borrowing and
lending not allowed
0.035
0.030
0.025
0.020
Return

0.015
0.010
0.005
0.000
0.03 0.035 0.04 0.045 0.05 0.055 0.06
Risk

Efficient Frontier