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notjustinfo.com |
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Knowledge centre for MBA students. |
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Portfolio Choice in the Indian Environment Dr N.Balakumar The term 'efficiency', in a broader sense, means
organisational or administrative efficiency of the stock market. However, it is
used in this work with reference to information efficiency, that is, how
prudent and successful the market is in articulating stock prices by
incorporating all new information in a fast and unbiased manner, such that
abnormal profits are impossible. Three types or forms of efficiency - weak, semi-strong and
strong - are found in the literature, each level pertaining to specific set
of information, which is more comprehensive than the earlier. The market is efficient in the weak sense if share prices
fully reflect the information implied by all prior price movements. Price
movements in effect are, totally, independent of previous movements, implying
the absence of any price patterns with prophetic significance. Thus, at this
level, it is unlikely to reap huge abnormal returns by the investors by
employing past price data, ruling out the validity of trading rules. On the
other hand, in the conventional view, if the market is inefficient in the
weak form, it implies that by using technical analysis - on the assumption of
'history tends to repeat itself' - the chartists attempt to predict future
price movements by interpreting past patterns. The market is efficient in the semi-strong sense, if share
prices respond instantaneously and without bias to newly published
information. Since stock prices adjust so rapidly to new information, it
would be impossible for investors to gain above-average returns by analysing
published information. The market is efficient in the strong sense if share
prices fully reflect not only published information but also all relevant
information including data not yet publicly available. Thus, if the market is
efficient in its strong form, even the inside trader cannot crown his profits
with his privileged information. Most of the research works before 1980s supported the
existence of weak form of efficient market hypothesis (EMH) in India, Rao,
K.N. and Mukherjee, K. (1971) and Sharma, J.L. and Kennedy, E.R. (1977), to
name a few. Mixed results were found during early 1980s. However, many
studies employing data pertaining to late 1980s rejected the EMH in its weak
form, Ramachandran, G. (1989), for example. Contrast to this, again, the most
recent works like Mittal, R.K. (1994) and Belgaumi, M.S. (1995) using early
1990s data accepted the weak form of EMH, under Indian conditions. Thus, Indian stock market data yielded, in general,
different results during different time periods. This point has been clearly
vindicated by the poor performance of the FIIs and foreign (as well as
Indian) mutual funds, in spite of their proclaimed expertise in research and
fund management. One of the reasons for this varying results may be due to
the fact that the Indian share market witnessed a phenomenal growth during the
decade of 1980s bringing more number of players into the market, which, in
turn, would have led to informational inefficiencies linked with
organisational inefficiencies, such as inadequate number of brokers. The net
result of these deficiencies led to the multi-crore scam. During early 1990s,
many players leaving the market or remaining idle after the scam coupled with
many new regulations introduced by regulatory agencies such as SEBI would
have made the Indian stock market somewhat efficient. In short, Indian stock markets cannot be equated with that
of the well-developed markets abroad. Thus, the analytical tools applied in
well-developed markets, if imported, may not yield the same results. Portfolio selection is an art as well as a science. To
obtain maximum returns while minimising risks, a fusion between theory and
practice has to be brought out. Thus, in a market like India where there is
no concrete research evidence regarding the usage of tools of portfolio
choice, a methodology which involves scientific reasoning coupled with
practical skills may yield higher returns with minimal risks. Presented below is a strategy for portfolio managers under
Indian conditions where the efficiency of the market keeps changing from time
to time: Stage - I: Company Analysis Individual company analysis comprises (a) technical
analysis and (b) fundamental analysis. Technically a scrip can be Weak,
clearly depicting a downward movement, or, Strong, indicating a confirmed
upward movement. Similarly, a stock can be fundamentally Weak or Strong. Thus, four outcomes are possible at the first stage: (1)
WW - Both fundamentally as well as technically weak; (2) WS - Fundamentally
weak but technically strong; (3) SW - Fundamentally strong but technically
weak; and (4) SS - Both fundamentally and technically strong. Those scrips, which are both technically as well, as
fundamentally strong only are considered for further analysis. However, few more outcomes are also possible other than
the above-mentioned ones, a company's price movement depicting an uncertain
pattern (band), for example. This kind of outcomes can be comfortably ignored
till certainty is found in the graph - an upward or downward outbreak. Stage - II: Industry Analysis A company may have good prospects. But, its industry
prospects may be weak. However, while looking at industry prospects, one can
consider time factor too. That is, the industry prospects may not be good in
the near future. But, it may be attractive in the long run. Thus, someone
building a portfolio with long-term growth as investment objective, may
consider time and portfolio objective and act accordingly. In the Second Stage, it is advisable to select only those
companies whose individual as well as industry prospects are good, after
giving weight age to investment objectives. As an alternative, mainly to save time, industry analysis
can precede company analysis. That is, the growth industries can be
identified first, after which through company analysis, scrip’s may be narrowed
down. Thus, stages I and II can be interchangeably executed. In sum, at the end of the first two stages, we have done
nothing but combining technical and fundamental analysis, by which a sincere
attempt has been made to reduce the portfolio risk element while providing adequate weight age
to the returns. Stage III: Market Opinion Now, we will be having a list of companies, which are
technically and fundamentally strong; and whose industry prospects are good.
These scrip’s, though worth investing theoretically, may not be a sound
investment decision, since market may have a different opinion. After all,
the stock prices too depend on future expectations of the market. Thus, the
list may be further short listed after taking the market realities into
consideration. Stage - IV: Final Selection Now, the final list can be classified according to
industry-wise and an appropriate portfolio may be selected, taking industry
diversification into account, so that the risk of the portfolio is minimised,
as suggested by Markowitz. However, practice demands certain other things
too. Thus, a portfolio may be constructed in such a way that: (a) Not more
than 10 per cent of the funds are blocked in a solo scrip; (b) Not more than
20 per cent of the funds are invested in a single industry; (c) In a rising
market, it is advisable to choose volatile scrips to maximise returns and in
a declining market non-volatile shares may be picked-up to minimise losses;
and (d) In order to monitor the portfolio in an efficient manner, the size of
the portfolio [that is, the number of scrips in a portfolio] may be decided
according to the amount invested. In practice, a portfolio can be comfortably
managed if the number of scrips in that portfolio are between 10 to 20.
However, in the case of fund managers who manage huge funds [mutual funds,
for example] may sub-divide their portfolios in any specialised manner (for
example: Portfolio A = Primary Market Investments; Portfolio B = Sensex
Investments; Portfolio C = Basic Goods Industry Investments; etc.]. Finally, all these can be efficiently done only with a
strong-authentic database and a team of dedicated research personnel. Hence, a well-carved portfolio - based on scientific
reasoning blended with common sense - which is altered from time to time
depending upon changing market realities will yield superior portfolio
returns, with minimum risk-factor involvement. |
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