Portfolio Management

ARUN G DSOUZA
JKSHIM NITTE
Investment Portfolio
• A portfolio investment is ownership of a stock, bond, or other
financial asset with the expectation that it will earn a return or grow
in value over time, or both. It entails passive or hands-off ownership
of assets as opposed to direct investment, which would involve an
active management role.
• Portfolio investment may be divided into two main categories:
• Strategic investment involves buying financial assets for their long-
term growth potential or their income yield, or both, with the
intention of holding onto those assets for a long time.
• The tactical approach requires active buying and selling activity in
hopes of achieving short-term gains.
Portfolio Construction
• The composition of investments in a portfolio depends on a number of factors.
The most important are the investor’s tolerance for risk and investment horizon.
• Is the investor a young professional with children, a mature person looking
forward to retirement, or a retiree looking for a reliable income supplement?
• Those with a greater risk tolerance may favor investments in growth stocks, real
estate, international securities, and options, while more conservative investors
may opt for government bonds and blue-chip stocks.
• On a larger scale, mutual funds and institutional investors are in the business of
making portfolio investments. For the largest institutional investors such as
pension funds and sovereign funds, this may include infrastructure assets like
bridges and toll roads.
• Portfolio investments by institutional investors generally are held for the long
term and are relatively conservative. Pension funds and college endowment
funds are not invested in speculative stocks.
Portfolio Construction Process
Traditional Approach of Portfolio Management
•  It basically deals with two major decisions viz., determining the objectives of the
portfolio and selection of securities.
• The need of a rational investor is concerned all about income generation and capital
appreciation.
• The traditional approach describes the appropriate level of which is to be selected to
meet the investors’ needs.
• The traditional approach is carried out in the following steps:

a) Analysis of constraints

b)      Determination of objectives

c)      Selection of portfolio

d)      Assessment of risk and return

e)      Diversification
Example
• Mr. A is assertive investors whose annual saving is Rs.2,00,000. He wants to invest his saving in different financial
instruments, his main investment motive is regular income i.e. dividend as well as capital appreciation in the
medium to long term. Mr. A set some objectives before the investment these are capital appreciation in the
medium term, earning dividend i.e. regular income. He also set the objective of safety at a given level of risk,
liquidity of the investors is one of the another objective of Mr. A because many investors fail to take into account
or understand the liquidity factor and as a result, their financial plans fail

 Mr. A invests his saving in such a way that all objectives he set should be fulfilled. His portfolio consists of equity
shares, short term money market instruments, bonds, foreign investment, and property. He invests 50% of his
saving in equity shares i.e. 1,00,000 of his total saving. 30% investment in the money market this is commercial
paper, certificate of deposit, etc. 30% of his saving in bonds, 30% in foreign capital, and 10% in property
consisting gold.

He invests half of his saving in equity because its return is not constant it gives higher return as well as also the
risk of getting loss of money generally equity shares gives higher rate of return as compared to fixed interest-
bearing securities. The money market and bonds give him a fixed rate of return that helps him to maintain
liquidity. Foreign investment helps in tax incentives but it is also carries high risk and property helps in capital
appreciation because its price goes higher with time.

If Mr. A faces any loss from equity then fixed interest bearing securities and property helps him recover those
losses and if equity gives a higher rate of return then Mr. A gets a good amount of return. And also equity and
property helped him in getting capital appreciation.
• Mr. A should never be static and sit cool after investing. He should consider shares of different companies
belonging to a different sectors. Similarly, the same diversification applies to all categories of investment. If his
present portfolio does not seem to combat his set objective, diversification is the only answer to meet his dream.
Modern Portfolio Approach
Introduction
• Finance in its present form dates only from 1950s
• In the last seven decades there has been many revolutionary ideas
being generated in this area
• Most of it coming from USA (most from Jewish scholars)
• The first in the series of modern portfolio theory (MPT) was the
problem of ‘Portfolio Selection’ by Harry Markowitz in 1952 published
by JoF
• This articles gave the origin to risk return
Markowitz Portfolio Theory
• In the early 1960s, the investment community talked about risk, but there was
no specific measure for the term
• To build a portfolio model, however, investors had to quantify their risk variable.
• The basic portfolio model was developed by Harry Markowitz (1952, 1959), who
derived the expected rate of return for a portfolio of assets and an expected risk
measure.
• Markowitz showed that the variance of the rate of return was a meaningful
measure of portfolio risk under a reasonable set of assumptions.
• More important, he derived the formula for computing the variance of a
portfolio.
• This portfolio variance formula not only indicated the importance of diversifying
investments to reduce the total risk of a portfolio but also showed how to
effectively diversify.
MPT Assumptions
• The Markowitz model is based on several assumptions regarding investor behaviour:
• Investors consider each investment alternative as being represented by a
probability distribution of expected returns over some holding period.
• Investors estimate the risk of the portfolio on the basis of the variability of
expected returns.
• Investors base decisions solely on expected return and risk, so their utility curves
are a function of expected return and the expected variance (or standard
deviation) of returns only.
• For a given risk level, investors prefer higher returns to lower returns. Similarly, for
a given level of expected return, investors prefer less risk to more risk.
• Under these assumptions, a single asset or portfolio of assets is considered to be
efficient if no other asset or portfolio of assets offers higher expected return with
the same (or lower) risk or lower risk with the same (or higher) expected return.
Such a portfolio is called OPTIMAL PORTFOLIO
Feasible set of portfolio
• Portfolio means combination of securities.
• With a limited no. of securities, an investor can create a very large no.
of portfolios by combining these securities in different proportions.
• These constitute feasible set/opportunity set in which investor can
invest.
Efficient Portfolio
• Each portfolio has its own expected return and risk
• So the investor is not interested in every portfolio but interested in only
efficient portfolio.
• A portfolio is efficient if and only if, there is no other alternative with
• Same expected return E(R) and lower risk- σp
• Same risk ( σp) but higher expected return E(R)
• Higher return and lower risk (σp)
• Other portfolio are called inefficient portfolios in which the investor is
not interested
Example
• Let us assume you want to invest ₹100,000. You have two stocks A
and B. You can buy each stock individually or 50% in each stock. The
forecasted returns are given in the table:
State of the Probability Return on Stock A Return on Stock B Portfolio Return
Economy
1 0.20 15% -5% 5

2 0.20 -5% 15% 5

3 0.20 5% 25% 15

4 0.20 35% 5% 20

5 0.20 25% 35% 30

 Returns on Individual Stock and the Portf olio
40%

35%

30%

25%

20%

15%

10%

5%

0%
1 2 3 4 5

-5%

-10%

Return on Stock A Return on Stock B Portfolio Return

Relationship between Diversification and
Risk
Market Risk Vs Unique Risk
• Unique risk of a stock represents that portion of its total risk which
stems from firm-specific factors like the development of a new product,
a labor strike, or the emergence of a new competitor.
• Unique risk is also referred as diversifiable risk or unsystematic risk.
• Market risk of a stock represents that portion of its risk which is
attributable to economy – wide factors like the growth rate of GNP, the
level of government spending, money supply, interest rate structure,
and inflation rate.
• Market risk is also referred as Systematic Risk or Non-diversifiable risk.
Portfolio Return and Risk
• Portfolio expected return: The expected return on a portfolio is
simply the weighted average of the expected returns on the individual
securities in the portfolio.
• Weight refers to proportion of portfolio value invested in the security.
Example
• A portfolio consists of 4 securities A, B, C and D with expected returns
of 12%, 15%, 18% and 20%. The proportions of portfolio value
invested in these securities are 0.20, 0.30, 0.30, 0.20. What would be
expected return on the portfolio?
• Consider the below portfolio:
Security Qty Price Expected Return
ACC 1000 950 12
ABB 1500 562 18
Wipro 2000 358 12
ITC 500 212 8
TCS 500 2458 18
Measurement of co-movements in security
returns (Towards Portfolio Risk)
• Co-movements between the returns of securities are measured by
covariance (An absolute measure) and Correlation (Relative)
• Covariance reflects the degree to which the returns of the two
securities vary or change together.
• A positive covariance means that the returns of the two securities
move in the same direction whereas negative covariance implies that
the two securities move in an opposite direction.
• Correlation reflects the relationship between the movement of stock
prices. Correlation can vary between -1.0 to +1.0.
• Covariance (Ri, Rj) = p1[Ri1-E(Ri)][Rj1-E(Rj)]+p2 [Ri2-E(Ri)][Rj2-E(Rj)]+
……………… [Rin-E(Ri)][Rjn-E(Rj)]
Illustration
• Calculate the Covariance and Correlation from below data:
State of nature Probability Return on Security 1 Return on Security 2
1 0.10 -10 5
2 0.20 12 12
3 0.30 18 22
4 0.10 25 19
5 0.30 23 18
Illustration
• Calculate the Covariance and Correlation from below data:
State of nature Probability Return on Security 1 Return on Security 2
1 0.20 18 08
2 0.20 16 13
3 0.20 12 19
4 0.20 08 21
5 0.20 06 13
Calculation of Portfolio Risk
• 2 Security Case:

• N Security Case:
Illustrations
• A portfolio consists of two securities A and B in the proportion of 0.5 and 0.5.
The SD (A) is 10 and SD (B) is 16. The correlation is 0.5 what is the Portfolio SD?
• A portfolio consists of two securities A and B and Mr. JOHN is invested 2 lacs in
A and 3 lacs in B. The SD (A) is 18 and SD (B) is 12. The correlation is 0.75 what
is the Portfolio SD?
• A portfolio consists of 3 securities A, B and C. The proportion is 1/3. The SD (A)
is 12 SD (B) is 19 and SD (C) is 22. The correlation between A and B is 0.6, B&C
is 0.5 and A&C is 0.8. What is the portfolio SD?
• A portfolio consists of 3 securities A, B and C. The proportion is 0.5, 0.3 and
0.2. The SD (A) is 15 SD (B) is 09 and SD (C) is 12. The correlation between A
and B is 0.5, B&C is 0.8 and A&C is 0.2. What is the portfolio SD?
Efficient Frontier
• Suppose an investor is evaluating two securities, A and B:

A B
Expected Return 12% 20%
SD 20% 40%
Correlation 0.20

• The investor can combine securities A and B in a portfolio in a number

of ways by simply changing the proportions of funds allocated to
them. Some of the options are shown next:
 Minimum Variance
Portfolio Option Portfolio

Portfolio Proportion of A Proportion of B Expected SD

Return

1 1.00 0.00 12% 20%

2 0.90 0.10 12.80% 17.64%
3 0.759 0.241 13.93% 16.27%
4 0.50 0.50 16% 20.49%
5 0.25 0.75 18% 29.41%
6 0.00 1.00 20% 40%
Important Points
• The benefit of diversification arises when the correlation between the
two securities is less than 1
• Picking MVP or MSDP is important
• There would be a curved line represent the opportunity set and the
investor can pick any point with an asset mix.
• No investor would like to invest in a portfolio whose expected return
is less than that of MVP.
Feasible region
Efficient Frontier
• So portfolio laying in the northwest boundary of the shaded area is
called efficient frontier
• It contains all efficient portfolios. ABC is efficient frontier
• All the rational investors would like to move as for as possible in the
northwest direction to maximize returns and minimize the risk
Selection of Optimal Portfolio
• After determining the efficient portfolio, the investor must select the
best portfolio which suits him/her (risk appetite).
• Risk taker would like to stay in the upper part of efficient frontier.
• Risk avoider would like to stay in the bottom part of the efficient
frontier
• Risk preference of an investor can be represented with help of
indifference curves.
Indifference curves
• Indifferences curves represent different combinations of risk and
return which are equally satisfactory to the investor
• So the investor is indifferent between them. Each successive IC gives
higher and higher satisfaction
• So investor would like to reach the topmost indifference curve for
getting maximum satisfaction
• So optimum portfolio for the investor lies at the point of tangency of
efficient frontier with IC
Indifference Curves(ICs) - Utility
• IC represents different combination of 2 things (risk and return) that gives equal satisfaction to
the investor
Illustrations 1
• The stock of Box Limited performs well relative to other stocks during recessionary
periods. The stock of Cox Ltd on the other hand does well during growth period. Both the
stocks are currently selling at ₹100. You assess the rupee return of these stocks for the
next year as below:
• Economic Condition
High Growth Low Growth Stagnation Recession
Probability 0.3 0.4 0.2 0.1
Return on BOX 100 110 120 140
Return on COX 150 130 90 60

• Calculate expected return and SD if:

• ₹1000 in the equity stock of Box Ltd
• ₹1000 in the equity stock of Cox Ltd
• ₹500 each in the two stocks
Illustrations 1
• The stock of Sirca Paints Limited performs well relative to other stocks during recessionary
periods. The stock of Berger Ltd on the other hand does well during growth period. Both
the stocks are currently selling at ₹500. You assess the rupee return of these stocks for the
next year as below:
• Economic Condition
High Growth Low Growth Stagnation Recession
Probability 0.4 0.4 0.1 0.1
Return on SIRCA 520 560 650 800
Return on Berger 850 700 520 350

• Calculate expected return and SD if:

• ₹10000 in the equity stock of SIRCA Paints Ltd.
• ₹5000 each in the two stocks
Single Index Model
• The single-index model (SIM) is a simple asset pricing model to measure both
the risk and the return of a stock.
• The model has been developed by William Sharpe in 1963 and is commonly
used in the finance industry.
• To simplify analysis, the single-index model assumes that there is only 1
macroeconomic factor that causes the systematic risk affecting all stock
returns and this factor can be represented by the rate of return on a market
index, such as the S&P 500.
• According to this model, the return of any stock can be decomposed into the
expected excess return of the individual stock due to firm-specific factors,
commonly denoted by its alpha coefficient (α), the return due to
macroeconomic events that affect the market, and the unexpected
microeconomic events that affect only the firm.
Single Index Model
• Unlike Markowitz portfolio model the Single index model will not
consider correlation between different securities while
calculating the risk.
• Portfolio risk is defined as aggregate of systematic risk and
unsystematic risk.
• These risks would be computed independently.
Example 1
Capital Asset Pricing Model
• CAPM is an improved version of Portfolio Theory.
• Several questions related to Modern Portfolio Theory were raised by
economist which were focused on understanding the relationship
between risk and return.
• The important ones are:
• What is the relationship between risk and return for an efficient
portfolio?
• What is the relationship between risk and return for an individual
security?
Capital Asset Pricing Model
• CAPM predicts the relationship between the risk of an asset and its
expected return.
• The relationship produces a benchmark for evaluating various
investments.
• It helps us to make an informed guess about the return that can be
expected from an asset that has not been traded. (Ex. IPO Pricing)
• CAPM is widely used due to its valuable insights and accuracy of
application.
Assumptions
• Individuals are risk averse.
• Individuals seek to maximize the expected utility of their portfolio over a
single period planning horizon.
• Individuals have homogeneous expectations – they have identical
subjective estimates of the means, variances, and covariances among
returns.
• Individuals can borrow and lend freely at a riskless rate of interest.
• The market is perfect: There are no taxes: There are no transaction costs;
securities are completely divisible; the market is competitive.
• The quantity of risky securities in the market is given.
Capital Market Line
• The capital market line (CML) represents portfolios that optimally
combine risk and return.
• CML is a special case of the capital allocation line (CAL) where the
risk portfolio is the market portfolio. Thus, the slope of the CML is
the Sharpe ratio of the market portfolio.
• When the expected return is related to absolute risk of the stock i.e
standard deviation.
• CML will be presented graphically
• It will result in a straight line slopping upwards.
`
Sharpe Ratio
• It 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. Volatility is a measure of the price
fluctuations of an asset or portfolio.
• The Sharpe ratio 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 returns.
• The Sharpe ratio is denoted as Lamda
Formula and Calculation of Sharpe Ratio
Analyzing the Sharpe Ratio
• The greater a portfolio's Sharpe ratio, the better its risk-adjusted
performance.
• If the analysis results in a negative Sharpe ratio, it either means
the risk-free rate is greater than the portfolio’s return, or the
portfolio's return is expected to be negative.
• In either case, a negative Sharpe ratio does not convey any
useful meaning.
• The Sharpe ratio is often used to compare the change in overall
risk-return characteristics when a new asset or asset class is
added to a portfolio.
Security Market Line (SML)
• shows different levels of systematic, or market risk, of various marketable securities,
plotted against the expected return of the entire market at any given time.
• It is also known as the "characteristic line,“.
• The SML is a visualization of the CAPM, where the x-axis of the chart represents risk
(in terms of beta), and the y-axis of the chart represents expected return.
• The market risk premium of a given security is determined by where it is plotted on
the chart relative to the SML.
• The SML can help to determine whether an investment product would offer a
favorable expected return compared to its level of risk.
• The formula for plotting the SML is:
Required return = risk-free rate of return + beta (market return - risk-free rate of
return).
Important inputs for CAPM
• Risk Free Rate:
• It is the return on a security that is free from default risk and is
uncorrelated with returns from anything else in the economy.
• Best alternatives that are commonly used in India are:
1. The rate on a short term government security like the 364 days
Treasury bill.
2. The rate on a long term government bond that has a maturity of 15
to 20 years.
Important inputs for CAPM
• Market Risk Premium:
• The market risk premium is the difference between the expected
return on a market portfolio and the risk-free rate.
• It provides a quantitative measure of the extra return demanded by
market participants for the increased risk.
• The market risk premium can be calculated by subtracting the risk-
free rate from the expected equity market return, providing a
quantitative measure of the extra return demanded by market
participants for the increased risk.
Important inputs for CAPM
• Beta:
• Beta, primarily used in the capital asset pricing model (CAPM), is a
measure of the volatility–or systematic risk–of a security or portfolio
compared to the market as a whole.
• Beta data about an individual stock can only provide an investor
with an approximation of how much risk the stock will add to a
(presumably) diversified portfolio.
• For beta to be meaningful, the stock should be related to the
benchmark that is used in the calculation.
• A beta coefficient can measure the volatility of an individual stock
compared to the systematic risk of the entire market.
Jensen’s Alpha
• Jensen’s measure, or Jensen’s alpha, developed by Michael Jensen in
1968, is used to calculate the return on a portfolio in excess of its
theoretical expected return.
• The idea behind this ratio is that any investment that performs better
than its projected or expected risk-adjusted return shows that the
manager is able to extract more mileage from his investments.
• In other words, Jensen’s Alpha is the difference between actual returns
of a fund and those that could have been earned on a benchmark
portfolio with the same amount of market risk (e.g. the same Beta).
• Jensen’s Alpha measures the return earned by a portfolio above or
below that demanded by the market for its risk class.
Alpha Vs Beta
• Both alpha and beta are historical measures of past performances.
• 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.
Illustrations 1
• The rates of return on stock A and Market portfolio for 8 periods are
given below:
Period Return on stock A Market portfolio return
1 22 12
2 13 14
3 17 13
4 15 10
5 14 9
6 18 13
7 16 14
8 6 7

• What is the beta for stock A?

Illustrations 2
• The rates of return on SBI Cards and Market portfolio for 8 periods are
given below:
Period Return on SBI Cards Market portfolio return
1 10 13
2 08 18
3 06 09
4 08 12
5 09 08
6 12 08
7 11 12
8 09 09
• What is the beta for SBI Cards?
Illustration 5
• The rates of return on stock A and market portfolio for 15 periods are given below:

Period Return on A Portfolio Return Period Return on Stock A Portfolio Return

1 22 12 8 6 7
2 13 14 9 -8 1
3 17 13 10 13 12
4 15 10 11 14 -11
5 14 9 12 -15 16
6 18 13 13 25 8
7 16 14 14 9 7
15 -9 10

• Calculate BETA and Alpha

Illustration 6
• The rates of return on stock A and market portfolio for 15 periods are given below:

Period Return on ACC NIFTY Period Return on ACC NIFTY

1 3 2 8 6 7
2 2 4 9 3 1
3 7 3 10 1 1
4 5 2 11 5 -1
5 4 2 12 -1 -3
6 5 3 13 -5 -2
7 6 4 14 3 2

• Calculate BETA and Alpha for stock ACC.

Illustration 3
• The following table gives an analyst’s expected return on two stocks
for particular market returns:

Market Returns Aggressive Stock Defensive Stock

8% 3% 9%
22% 25% 17%

• What are the betas of two stocks?

• What is the expected return on each stock if the market return is
equally likely to be 6% and 20%?
• What are the alphas of the two stocks? Assume 7% as risk free rate.
Illustration 3
• The following table gives an analyst’s expected return on two stocks
for particular market returns:

Market Returns Aggressive Stock Defensive Stock

5% -5% 8%
25% 40% 18%

• What are the betas of two stocks?

• What is the expected return on each stock if the market return is
equally likely to be 5% and 25%?
• What are the alphas of the two stocks? (Risk free rate is 5%)
Miscellaneous Illustrations
1. The risk-free return is 10 percent. The required return on a stock whose beta is
0.50 is 14 percent. What is the expected return on the market portfolio?
2. The risk-free return is 10 percent. The beta of the stock is 2. What is the
expected return on stock if the portfolio return is 12%?
3. The rate of return on the stock of Sigma Technologies and on the market
portfolio for 6 periods has been as follows. Calculate Alpha:
Perio Return on the stock Return on the
d of Sigma market
Technologies (%) portfolio (%)
1 16 14
2 12 10
3 -9 6
4 32 18
5 15 12
6 18 15
Arbitrage Pricing Theory
• Arbitrage pricing theory (APT) is a multi-factor asset pricing model based on
the idea that an asset's returns can be predicted using the linear relationship
between the asset’s expected return and a number of macroeconomic
variables that capture systematic risk.
• Unlike the CAPM, which assume markets are perfectly efficient, APT assumes
markets sometimes misprice securities, before the market eventually corrects
and securities move back to fair value.
• It is a useful tool for analyzing portfolios from a value investing perspective, in
order to identify securities that may be temporarily mispriced.
• Using APT, arbitrageurs hope to take advantage of any deviations from fair
market value.
• The theory was created in 1976 by American economist, Stephen Ross.
Efficient Market Hypothesis
• The efficient market hypothesis (EMH) or theory states that share
prices reflect all information.
• The EMH hypothesizes that stocks trade at their fair market value on
exchanges.
• Proponents of EMH posit that investors benefit from investing in a
low-cost, passive portfolio.
• Opponents of EMH believe that it is possible to beat the market and
that stocks can deviate from their fair market values.
• According to EMH the only way an investor can obtain higher returns
is by purchasing riskier investments.
EMH
• Market efficiency refers to how well prices reflect all available
information.
• The efficient markets hypothesis (EMH) argues that markets are
efficient, leaving no room to make excess profits by investing since
everything is already fairly and accurately priced.
• This implies that there is little hope of beating the market, although
you can match market returns through passive index investing.
• The idea of EMH was developed by Eugene Fama in the year 1968
who provided empirical evidences to the same in the following
years.
Validity of EMH
• The validity of the EMH has been questioned on both theoretical and
empirical grounds.
• There are investors who have beaten the market, such as Warren
Buffett, whose investment strategy focused on undervalued stocks
made billions and set an example for numerous followers.
• There are portfolio managers who have better track records than
others, and there are investment houses with more renowned
research analysis than others.
• EMH proponents, however, argue that those who outperform the
market do so not out of skill but out of luck, due to the laws of
probability: at any given time in a market with a large number of
actors, some will outperform the mean, while others will
underperform.
Can markets be inefficient?
• There are certainly some markets that are less efficient than others.
• An inefficient market is one in which an asset's prices do not accurately
reflect its true value, which may occur for several reasons.
• Market inefficiencies may exist due to information asymmetries, a lack of
buyers and sellers (i.e. low liquidity), high transaction costs or delays, market
psychology, and human emotion, among other reasons.
• Inefficiencies often lead to deadweight losses. In reality, most markets do
display some level of inefficiencies, and in the extreme case an inefficient
market can be an example of a market failure.
• Accepting the EMH in its purest (strong) form may be difficult as it states
that all information in a market, whether public or private, is accounted for
in a stock's price.
Forms of EMH
Random Walk Theory
• Random walk theory suggests that changes in stock prices have the same
distribution and are independent of each other.
• Random walk theory infers that the past movement or trend of a stock price
or market cannot be used to predict its future movement.
• Random walk theory believes it's impossible to outperform the market
without assuming additional risk.
• Random walk theory considers technical analysis undependable because it
results in chartists only buying or selling a security after a move has occurred.
• Random walk theory considers fundamental analysis undependable due to
the often-poor quality of information collected and its ability to be
misinterpreted.
• Random walk theory claims that investment advisors add little or no value to
an investor’s portfolio.
Market Anomalies
• Earning Surprise
• Small Firms Tend to Outperform
• January Effect
• Low book value
• Neglected Stocks
• Price Reversals
• Days of the week
• Dogs of the Dow
• Sell in May and Go Away
• Low Beta Anomaly
END OF PORTFOLIO THEORIES