Updated on: June 3, 2021 ; Investments
Background:
We have already covered three stock portfolio investment strategies. Today we are going to cover the fourth strategy. This one would be part 2 of the equal weighted portfolio of stocks. Consider this to be a continuation of the previous article on equal weighted portfolio with a change in the stock selection process.
I request you to please read through the previous three articles on portfolio creation. Here are the links for the same: link1, link2, and link3. This will help you understand the general progression of the slight differences in the strategies and comprehend the nuances better.
Portfolio selection:
This is the section where this strategy differs from its last avatar. So if you are familiar with the rest of the process, you can directly go to the ‘comparative study’ section after reading this section. Just don’t forget to have a look at the shortlisted stocks in the next section, on your way to the ‘comparative study’ section.
Last time we had picked up the stocks that were part of the original Sensex (in 1986) and were still in the Sensex 18 years later (in 2003). This took care of choosing the companies that had stood the test of time and had shown some resilience. This implied that most of them have strong fundamentals and a better chance of surviving the next few decades.
But what we might have missed out on is the chance of tapping into new-age companies that did not exist during the initial days of Sensex and maybe have a better chance of compounded growth in the future. For instance, there were no technology companies or banks in the original Sensex.
So, in this article, we will shortlist our portfolio of stocks from the Sensex of 2003 only. We would be looking back at no other year for this. The 30 stocks in the Sensex of 2003 would be our sole bucket of stocks to choose from.
So, to keep the stock selection unbiased, we will use some very basic rule for the creation of our equal weighted portfolio. We simply choose the top stocks of Sensex by market capitalization, as of March 2003.
Following the same trend as earlier, we will be analysing two scenarios. In the first scenario (Scenario 4a), we choose the top 5 stocks, and in the second scenario (Scenario 4b), we choose the top 8 stocks. These are chosen based on the market capitalization of the stocks.
Methodology for equal weighted portfolio:
If you have read my previous articles, then after looking at the list of the shortlisted stocks you can directly go to the next section. Below is the list of the top eights stocks of Sensex as of March 2003.
- ONGC
- Reliance Industries
- Hindustan Unilever
- Wipro Limited
- Infosys Technologies
- Indian Oil Corporation
- ITC
- State Bank of India
The first 5 stocks will be part of the equal weighted portfolio in scenario 4a. And all 8 stocks will form the portfolio in scenario 4b.
Since this is an equal weighted portfolio, we invest an equal amount of money in each stock in our portfolio.
Other things to note is that we are looking at a one-time investment with no withdrawals and no balancing. We allocate an equal sum of our corpus to each stock in march 2003 and let it remain as such till march 2021.
There are no adjustments or fund re-allocations between these stocks anytime in between. This is what I meant by no balancing.
We do not add any more funds either. That is what we call a one-time investment or lumpsum investment.
Now, going into specifics. We assume that we had a corpus of 100,000 rupees to start in March 2003. So in ‘Scenario 4a’ where we picked 5 top stocks, we allocate 20,000 rupees to each stock. And in ‘Scenario 4b’ where there are 8 stocks, each stock gets 12,500 rupees as the initial investment.
We compare both these scenarios with the third case. This third case serves as the base case, where the entire 100,000 rupees is invested in the broad index, i.e. Sensex.
Now, it is time to go to the analysis.
Comparative study:
Take a look at the tables below. They summarize the final investment values of the Sensex and the two scenarios as of March 2021. I have also provided the stock-wise break-up for both scenarios.
What you can observe from above is that both the equal weighted portfolios have performed better than the Sensex. Although, not all stocks performed equally in the portfolio. Even if all started with an equal share within the portfolio, they all ended up very differently after 18 years.
One very interesting observation is that the biggest stock of 2003 performed the worst in these 18 years. This shows that merely being big is no guarantee to success. In fact, ONGC was majorly responsible for dragging down the performance of both the equal weighted portfolios.
The star performers were Reliance Industries, Infosys and Hidustan Unilever.
Now, this analysis would not be complete without comparing it with its predecessor. Please compare the tables from both the strategies side by side. Scenarios 1a and 1b have shown much better performance in this case. That is because the new stocks that replaced the old ones had lower CAGRs.
Now, that may not be the case always. Maybe some other start year would have shown more promising results. Maybe a mix of both strategies would have yielded better results. Who knows?
Now let’s move into the part, where we look at the chart that shows the monthly performance of the scenarios.
This is a very interesting chart. Scenario 4b has been the dominant portfolio for most of the time period. It is only in the last one and a half year that Scenario 4a overtakes Scenario 4b. Also, if you look carefully, you will notice that before 2017, Scenario 4a and Sensex were running neck to neck.
Things turned out to be better finally in the last few years but would have left many investors anxious for a good 13-14 years. But, I do feel that this is NOT the best equal weighted portfolio strategy. The one we explored in the first article (Scenarios 1a and 1b) seems to be a better bet than this one.
Final remarks:
We saw the performance of the portfolios outperform the Sensex. They definitely have an edge over the Index. But for a long period of time, Scenario 4a had no advantage over the Index. Although nothing can be said conclusively about this strategy until you explore more iteration with different start periods.
But if you plan to create an equal weighted portfolio of stocks, be very cautious with the stock selection. Do Not just rely on the current market leaders. Try to pick stocks that have been in the top position for some time and have a better future prospect.
This article tells you how NOT to create an equal weighted portfolio of stocks. We will look at the other two weighting strategies with the same stock selection and see how worse or better they perform compared to other strategies discussed so far.
It is equally important to know what may not work !!!