Updated on: June 8, 2021 ; Investments
Background:
We have already covered four stock portfolio investment strategies. Today we are going to cover the fifth strategy. This one would be part 2 of the marketcap weighted portfolio of stocks. Consider this to be a continuation of the previous article on market weighted portfolio with a change in the stock selection process.
I request you to please read through the previous four articles on portfolio creation. Here are the links for the same: link1, link2, link3, and link4. This will help you understand the general progression of the slight differences in the strategies and comprehend the nuances better. If you already read through part 2 of the equal-weighted portfolio, then you can skip the next section.
Portfolio selection:
This is the section where this strategy differs from the first three strategies. There 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 marketcap 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 5a), we choose the top 5 stocks, and in the second scenario (Scenario 5b), we choose the top 8 stocks. These are chosen based on the market capitalization of the stocks.
Methodology for marketcap 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 market weighted portfolio in scenario 5a. And all 8 stocks will form the portfolio in scenario 5b.
In a marketcap weighted portfolio, we invest in each stock, an amount proportional to the market capitalization of that 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 the amount proportional to market capitalization 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 5a’, this amount was distributed among the top 5 stocks. And in ‘Scenario 5b’, it was distributed among 8 stocks. The exact distributions are provided in the tables below.
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 marketcap weighted portfolios have performed better than the Sensex. Although, not all stocks performed equally in the portfolio.
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 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 2a and 2b have shown much better performance in this case. That is because the new stocks that replaced the old ones had lower CAGRs. In fact, it has performed poorly compared to scenarios 4a and 4b as well.
But, 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?
Moving on, we will look at the chart that shows the monthly performance of the scenarios.
This is again a very interesting chart. For most of the investment period scenario 5b was the dominant of the three strategies. It is only in the last one and a half year that scenario 5a overtakes scenario 5b. If you look closely, you will notice that for some time scenario 5a was very close to or below Sensex.
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 marketcap weighted portfolio strategy. The one we explored in the second article (Scenarios 2a and 2b) 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 at times, Scenario 5a underperformed the Index. We cannot say anything conclusively about this strategy until we explore more iteration with different start periods.
But if you plan to create a marketcap 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 marketcap weighted portfolio of stocks. We will look at the other strategies with the same stock selection and see how worse or better they perform compared to other strategies discussed so far.
Keep exploring !!!