APPLICATION OF SINGLE SHARPE INDEX ON THE OPTIMUM PORTFOLIO CONSTRUCTION IN INDIAN CAPITAL MARKET

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1 Internatonal Journal of Physcal and Socal Scence Vol. 7 Issue 7, July 017 ISSN: Impact Factor: Journal Homepage: Emal: edtorjme@gmal.com Double-Blnd Peer Revewed Refereed Open Access Internatonal Journal - Included n the Internatonal Seral Drectores Indexed & Lsted at: Ulrch's Perodcals Drectory, U.S.A., Open J-Gage as well as n Cabell s Drectores of Publshng Opportuntes, U.S.A APPLICATION OF SINGLE SHARPE INDEX ON THE OPTIMUM PORTFOLIO CONSTRUCTION IN INDIAN CAPITAL MARKET Mohth. S * Pavthra. S* Bharadwaj R* Dr. A. Ananth ** ABSTRACT In today s concept, Indan securtes market s a hghly volatle and senstve market. The best way to analyss the market for gettng good returns s through portfolo constructon. Thus, the man focus of ths research s to construct an optmal equty portfolo usngthe sharpe ndex model (SIM) Method. In ths research, the sectors of energy and FMCGhas been taken nto consderaton for constructng the optmum portfolo. Nneteen companes were taken nto studed out of whch the energy companes were BPCL, CAIRN INDIA, HPCL, IOC, NTPC, RIL, TATA POWER, ONGC, GAIL and FMCG companes are HUL, TATA GLOBAL, BRITTANIA, ITC, DABUR, GODREJ, MARICCO, EMAMI, MCDOWELL S, JUBLIANT FOODWORKS have been selected and excess to beta rato has been calculated and ranked the companes based on that rato. The cut-off pont was calculated based on the hghest value and cut-off pont should be used to calculate the proporton of money to be nvested n each stock. Ths research fndngs and suggestons would be helpful to nvestors for nvestng n meda and entertanment sector. Keywords: Rsk, Return, Portfolo, Resdual Varance, Sharpe. * Student, Master of Busness Admnstraton, Gnanam School of Busness, Thanjavur, Taml ** Assocate Professor, Gnanam School of Busness, Thanjavur, Taml Nadu, Inda. 60 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

2 1. INTRODUCTION The hstory of Indan stock Markets s recognsed as one of the oldest n Asa. The evolutons of Indan Stock Market Indan Stock Markets s traced back nearly 00 years ago. Its exstence n the market s consdered as a most predomnant market due to the globalzaton and lberalzaton whch happened n the year of 1990 s. Though t happened only less than % of total populaton nvests n stocks. Prmarly t has been dvded nto two parts, Prmary market and secondary market. IPO happens n prmary market and tradng of ssued shares wll happen n secondary market. Securty analyss and portfolo management wll help to construct the optmum portfolo for the equtes market and helps to make the rght decson for nvestment FUNDAMENTALS A company s growth outlook s lnked to ts busness prospects and how well ts management s captalzng on the exstng opportuntes. The qualty of a company s management s crucal so pay attenton to the management practces of a company and ts level of corporate governance.. REVIEW OF LITERATURE Debassh Dutt (1998) explored that an approprate selecton of securtes can ensure good returns to nvestors and can also help to reduce the losses. An attempt s made to construct optmal portfolo by applyng share sngle ndex model of captal asset prcng. Nne stocks were selected for constructng an optmal portfolo from BSE 100 ndex. It was found that, all the stocks selected turned out to be stocks of banks. The portfolo s constructed usng Sharpe optmal ndex to obtan the optmal and effectve portfolo returns. P. Varadharajan (01) says the constructon of equty portfolo of large caps companes of selected sectors n Inda wth reference to the sharpe ndex model.n ths research 18 stocks from three dfferent large caps sectors are the rsk and return of all the stocks are studed ndvdually. Based on the study top fve stocks are selected for formng optmum portfolo. The fnal step n the process s to determne the number of shares of eac h stock to be purchased. The portfolo s constructed usng sharpe optmal ndex to obtan the optmal and effectve portfolo returns. 61 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

3 Dr. S. Poornma, Aruna P Remesh (015) n ther research constructon of optmal portfolo usng sharpe s sngle ndex model- a study wth reference to bankng & t sector n ths research 10 companes from bankng sector and 10 companes from t sector lsted n the Bombay stock exchange (NSE) were selected. Share prces for the perod of January 011 to December 015. Dr. Sathya Swaroop, Debassh Jakk, Samr khan (01) n ther research used 14 selected stocks from the varous manufacturng sectors lke automobles, cements, pants, textles and ol & refneres sectors have been taken nto consderaton they were the stocks lsted n NSE Nfty. The portfolo s constructed usng sharpe optmal ndex to obtan the optmal and effectve portfolo returns. Dr. R. Naln (014) study have taken consderaton of about ffteen companes from the S&P BSE SENSEX ndex were selected for the study. Among the ffteen sample companes only four were selected for optmal portfolo usng SIM. The portfolo s constructed usng sharpe optmal ndex to obtan the optmal and effectve portfolo returns. Dr. K. V. Ramanathan, K. N. Jahnav (014) n the study have referred that meda and entertanment sector has been taken nto consderaton for constructng the optmum portfolo. Twenty companes lke PVR, Sun Network, Inox, Raj televson have been selected and the portfolo s constructed usng sharpe optmal ndex to obtan the optmal and effectve portfolo returns. Thangjam Ravchandra (014) endeavors to buld an deal portfolo by utlzng sharpe s sngle ndex model. For ths reason, NSE Nfty and all the 50 stocks where are a part of t have been utlzed as busness record for plannng portfolo for the perod of Aprl 008 to December 013. S. Devarajan and I. Francs Gnanasekar studed about the constructon of optmal portfolo usng sharpe's ndex model: a comparatve analyss of Indan prvate and publc-sector banks n post global fnancal crss perod the study helps to analyze the rsk and return of 34 selected prvate and publc sector bankng stocks whch are part of CNX 500 as market ndex. The portfolo s constructed usng sharpe optmal ndex to obtan the optmal and effectve portfolo returns. 6 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

4 Saugat Das and Ankt Agarwal (014) has researched on optmal portfolo constructon of pharmaceutcal companes-a study on CNX Pharma ndex whch conssts of 10 pharmaceutcal stocks and develops an approach to construct an optmal portfolo usng the sharpe ndex model. Chntan a. Shah bhagwan (015) n hs research constructon of optmal portfolo usng sharpe ndex model& camp for BSE top 15 securtes was conducted based on the performance of bse15 securtes through sharpe model. We have used the descrptve research desgn and used the secondary data collecton methods. P. Varadharajan (011) constructed an equty portfolo (Ol, IT, Steel and Bankng Stocks) wth reference to the sharpe ndex model.the study ncludes 5 stocks from fve dfferent sectors. Only the secondary data for the past fve years ( to ) are used n the study. The fnal portfolo thus constructed ncludes stocks from more than one sector. Ch. Naveen(014) from have done research on the ttle applcaton of sharpe sngle ndex model to BSE he has selected 30 blue chp companes of BSE wth 6 years data.e. from January 007 to December 01 have been consdered. Besdes ths, an attempt has been made to test the valdty of the sharpe model to construct the portfolo. 3. STATEMENT OF PROBLEM Indan Captal Markets s hghly volatle n the last two decades and there are huge number of ganers and losers n market. Even though lot of Economc ndcators and Busness affars are nfluencng the market trend, there are lots of technques avalable to predct the market to some extent. The present study consdered on Sharpe optmal sngle ndex model. The portfolo should not be constructed based on the brand dentty, current performance etc because that would not help nvestors n achevng the antcpated return. The man am of portfolo constructon s dversfcaton and to mantan perfect negatve correlaton between the securtes. Also, holdng two or three stocks s always better than holdng one. The optmum portfolo gves the nvestors a better clarty to nvest the rght proporton of money n the rght stock and t helps the nvestors to get maxmum returns wth mnmal rsk. 4. OBJECTIVE OF THE STUDY 1. To analyse the rsk-return relatonshpsof the sample stocks. 63 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

5 . To evaluate stock performance on the bass of excess return to beta. 3. To construct Effectve/Optmum portfolo for stocks after the determnaton of cut-off pont on the bass of rank. 4. To calculate the proporton of money to be nvested by nvestors out of ther nvestment 5. RESEARCH METHODOLY Ths present study used analytcal analyss and used secondary data collecton method n whch the companes lsted n NSE-NIFTY. 19 companes were selected for the study under energy and FMCG sector. Those companes who has been tradng contnuously for past 5 years from 1 st January 011 to 31 st December 015 n NSE-NIFTY has been taken as a sample. The data was collected from and Tools used for the study was rsk and return, beta and Sharpe optmal sngle ndex. The am s to mprove the practces of these companes n future TOOLS USED STOCK DESIRABILITY To compare dfferent stocks and dentfy the best stocks (stock whch offer hgh returns and have low rsk), the frst step s to determne that part of the stock return accrued over and above the return from rsk-free nvestments. By dvdng ths spread by beta (β), the coeffcent of the stock (systematc rsks), and stock desrablty can be determned thus, ( R R f ) Where, R = Expected stock return or the rate of stock return for the prevous day. R f = Rsk free return. β = s the stock beta whch s the senstvty degree of the stock toward general rsks nfluencng all securtes. 64 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

6 5.1.. CUT OFF POINT The cut off pont s nothng but to determne the stocks for whch the excess return to beta rato s hgher than a partcular unque cutoff pont C*. The value of the cutoff rate C* s gven by: C m m 1 ( R 1 R m 1 f e e ) / Where, C = Cutoff pont per stock m = varance n the market ndex R = Expected stock return R f = Rsk free return. β = s the systematc rsk per stock e = unsystematc rsk per stock (varance) CAPITAL DISTRIBUTION ON GOOD STOCKS To fulfll the goal of an nvestment portfolo; the realzaton of hghest return wth lowest rsk, there should be a good dstrbuton, whereas the best stock enjoys the hghest share, and so on. The followng mathematcal equatons acheve ths: X n Z 1 Z Ths Equaton s a percentage determnng the captal for each asset of the portfolos, where the total of the percentages, at the end of the day, s an nteger number whch s number one. Therefore, they are weghted averages per stock. They, however, are calculated n accordance wth the mportance of the stock. The Z value s mathematcally defned by the followng equaton Z ( R R ) C f 65 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

7 6. OPTIMAL PORTFOLIO FOR NSE-ENERGY & NSE FMCG The task s to determne and select only those stocks whch are traded contnuously wth return greater than the rsk free rate of return and wth postve beta. The expected returns, varance, beta () for all the 0 stocks. It has been that a few stocks have negatve returns. Ths could be due to a host of reasons ncludng sluggsh market condtons. As the crtera for selecton mentoned above gnores stocks wth negatve returns, stocks wth negatve beta have been gnored. The Sharpe model wll automatcally exclude such stocks as ts rankng s based on excess returns (return greater than rsk free rate of return). For determnng whch of these stocks wll be ncluded n the optmal portfolo, t s necessary to rank the stocks from hghest to lowest based on excess return to beta rato (from hghest to lowest). Ths rankng s shown n (Table 1). TABLE 1: RANKING OF SECURITIES BASED ON EXCESSRETURN TO BETA RATIO: Excess Return to Beta Rato Securty Mean Return Beta Unsystematc Rsk NEW RANK BRITANNIA HUL DABUR GODREJ MARICCO EMAMI LTD JUBLIANT ITC BPCL MCDOWELL Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

8 CAIRN NTPC HIND PETRO TATAGLOBAL GAIL POWER GRID IOC RIL TATA POWER The next step s to determne the stocks for whch excess return to beta rato s hgher than a partcular unque cutoff pont C*. From (Table 3) t may be noted that the cut off rate C* s and only the top Nne securtes make t to the optmal portfolo. TABLE : CALCULATION OF SYSTEMATIC RISK: Securty Name R β б m BRITANNIA HUL DABUR GODREJ MARICCO EMAMI LTD JUBLIANT ITC BPCL MCDOWELL CAIRN NTPC HIND PETRO Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

9 TATAGLOBAL GAIL POWERGRID IOC RIL TATA POWER TABLE 3: CALCULATION OF C*: Securty Name 1+б m BRITANNIA HUL DABUR GODREJ MARICCO EMAMI LTD JUBLIANT ITC BPCL MCDOWELL CAIRN NTPC HINDPETRO TATAGLOBAL GAIL POWERGRID IOC RIL Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

10 Once the composton of the optmal portfolo s ascertaned, the next step s to calculate the percentage to be nvested n each securty whch s shown n Table 4. The optmum portfolo can be broken down nto two parts: 1. The stock that s comprses. The percentage of funds allocated to each of these stocks TABLE 4: CALCULATION OF PROPORTION TO BE INVESTED: How Much to be Invested n Each Securty BRITANNIA % HUL % DABUR % GODREJ % MARICCO % EMAMI LTD % JUBLIANT % ITC % Total % The above table shows the proporton of nvestment n each stock. And t ndcates the weghts on each securty and they sum up to 100 percentage. By usng Sharpe ndex model thus, we are able to fnd out the proporton of nvestments to be made for an optmal portfolo. The maxmum nvestment should be made n Dabur wth a proporton of 5%. Followng that Brtanna (19%), HUL (15%), Marcco (14%), Godrej (13%), Emam Ltd. (6%), ITC (5%) and Jublant(%) are the next sx companes where major percentage of nvestment can be made. 7. MANAGERIAL IMPLICATION Sharpe ndex model (SIM) provdes a rsk and return analyss of the stocks, to select the securtes to be ncluded n the portfolo. The companes were selected based on the return on 69 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

11 nvestment. Out of 50 companes that are lsted n Natonal Stock Exchange (NSE) only 19 companes were selected for analyss snce others have negatve return. These stocks were ranked based on the return to systematc rsk. The securtes wth a hgh return of about seven companes have been selected from the estmaton of cut-off rate. The cut-off rate specfes the mnmum return on rsk below whch the securtes should not be ncluded n the portfolo. The proporton of nvestment n these securtes s proceeded to make an optmal portfolo. 6% % 5% 19% 14% 15% 14% 5% BRITTANIA HUL DABUR GODREJ MARICCO EMAMI LTD JUBLIANT ITC Thus, eght companes namely, Dabur, Brtanna, HUL, Marcco, Godrej, Emam Ltd., ITC and Jublant wth ther respectve proporton have been nvested to construct an optmal portfolo wth a hgh return on nvestment. Sharpe ndex model (SIM) resolves the problems nvolved n the selecton of securtes to construct a portfolo of an nvestor wth a hgh return. 70 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

12 8. CONCLUSION Sharpe Sngle Index Model provdes soluton to a challengng task for the ndvdual as well as the nsttutonal nvestors n constructng an optmal portfolo. The Sngle Index Model uses less number of varables as compared to Markowtz model that provdes an ease on computaton for nvestors. Out of the stock selected from Natonal Stock Exchange (NSE), nvestors are advsed to nvest n the eght companes namely Dabur, Brtanna, HUL, Marcco, Godrej, Emam Ltd., ITC and Jublant. The Sharpe Sngle Index Model also provdes the detals of proporton to be nvested n each securtes of ther portfolo. Apart from ths, Investors must contnuously montor ther portfolo based on the changes n the market stuatons. It s mportant for the nvestors to make changes n ther portfolo to get an optmal return on nvestment. 9. REFERENCES 1. Debassh, S. S., & Khan, J. S. (01). Optmal Portfolo Constructon n Stock Market- An Emprcal Study on Selected Stocks n Manufacturng Sectors of Inda. Internatonal Journal of Busness Management, (), Devarajan and I.Francs Gnanasekar (014) Constructon of optmal portfolo usng sharpe's ndex model:a comparatve analyss of ndan prvate and publc sector banks n post global fnancal crss perod. Golden Research Thoughts, 3(1). 3. Naln, R. (014). Optmal portfolo constructon usng sharpe s sngle ndex model-a study of selected stocks from bse. Internatonal Journal of Advanced Research n Management and Socal Scences, 3(1), Naveen, C. (014). Applcaton of Sharpe Sngle Index Model to BSE. Internatonal Journal Of Management Studes, 4() 5. Poornma, S., & Remesh, A. P. (015). Constructon of optmal portfolo usng Sharpe s sngle ndex model-a study wth reference to bankng & IT sector. IJAR, 1(13), Ramanathan, K. V., & Jahnav, K. N. (014) Constructon of optmal equty portfolo usng the sharpe ndex model wth reference to bankng and nformaton technology sectors n nda from Internatonal Journal of Busness and Admnstraton Research Revew, (3). 71 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com

13 7. Ravchandra, T. (014). Optmal Portfolo Constructon wth Nfty Stocks. 8. Shah, C. A. Constructon of Optmal Portfolo Usng Sharpe Index Model & Camp for BSE Top 15 Securtes. 9. Varadharajan, P., & VIKKRAMAN, D. (011). A study on constructon of equty portfolo (ol, t, steel and bankng stocks) wth reference to the sharpe ndex model. Chef patron chef patron. 7 Internatonal Journal of Physcal and Socal Scences Emal: edtorjme@gmal.com