Portfolio Analysis

Introduction

The coursework centres on portfolio analysis and comprises three tasks.

The word limit for all 3 tasks combined is between 1500 to 2500 words.

The tasks are related. Task 2 is founded on the work done for task 1. Similarly, task 3 is founded on work carried out for tasks 1 and 2.

Please keep tasks separated.

Task 1

Task 1 is primarily a set of preparatory undertakings essential for the asset and portfolio risk-return analysis in tasks 2 and 3. It comprises three stages: 1a, 1 b and 1c.

1a. Choose five company shares

• In the Sector drop down, tick every category except:
  • Closed End Investments
  • Mortgage Real Estate Investment Trusts
  • Open End and Miscellaneous Investment Vehicles
  • Real Estate Investment Trusts

(This removes the companies linked to the listed sectors. The reason is that you will be analysing the risk reduction effect associated with creating a five-asset portfolio. The business of companies included in the four sectors listed above is investing in other listed enterprises. They are, themselves, asset portfolios).  

• Apply the filter

This should generate a list of 261 companies. Any five can be chosen. However:

• They must be from five different business sectors. A straightforward way of ensuring sector diversity is to use the sector drop-down on the LSE website. Select a specific sector and choose one from the list of companies shown. Repeat the process for four more sectors
• Before finalising your choice of shares, check that each has a share trading track record of at least five years. This is easily done: on the London stock exchange site, click on the company and adjust the price graph to show five, or more, years. If the price schedule stretches across the whole graph, it’s OK
• Choosing companies outside of the parameters outlined will incur penalties.    

1b. Assemble data for the market and your five companies

Performance data for your five companies and for the market portfolio must be collected. Use either Capital IQ or Bloomberg for data collection.

The Market

Portfolio analysis requires something to represent the market portfolio. We will use the FTSE All-Share (Ex-Investment Companies) Index. Type this title (or its ticker ^ASXX) into the search box. A chart appears (plotting the index level) together with summary performance information.

Beneath the chart is a box, ‘Type’, with two options: Price Return or Total Return Gross.

• Choose Price Return (this is likely to be the default) and click ‘Go’.
• This reveals an interactive chart of the index, based on daily values over one year to the present. You will need monthly index data for a five-year period from 1^st December 2016 to 1^st December 2021. Adjust the dates accordingly using the date setting function above the graph on the right-hand side.
• Scroll below the chart to ‘Pane 1’ and click on the ‘Edit’ icon for Index Value. Alter the data frequency from Daily to Monthly and apply the change
• Scroll up to top right and click the Excel download icon
• The downloaded file contains the graph plus the list of monthly index values. Double-check that the dates tally with the instruction above.
• Save the file.    

The Five Shares

Repeat the above steps for your five companies, acquiring monthly share price data for each from 1^st December 2016 to 1^st December 2021.

• It is vital that the timelines for the index and share data match

[These guidance notes focus on Capital IQ. Capital IQ can be accessed remotely using log-in credentials. Please use Bloomberg if you prefer.]

1c. Data Modelling

Collect the FTSE index and share price data into a single Excel file. For the index and each share, separate the data into two parts:

• Time Series 1: Three years of monthly data from 1^st December 2016 to 1^st December 2019
• Time Series 2: Two years of monthly data from 1^st December 2019 to 1^st December 2021

[Note that the value for 1^st December 2019 will appear in both series; being the end value of series 1 and opening value for series 2]

Leave the time series 2 data aside (it will require your attention in Task 2). The rest of this task focuses exclusively on Time Series 1; the data from 1^st December 2016 to 1^st December 2019. For this three-year term:

• Calculate the lognormal monthly market returns and lognormal monthly individual share returns
• Run an ordinary least squares regression for each individual share return time series, using the monthly market return time series as the determinate variable.
• From the regression outputs, highlight the following factors for each share:
  • The beta value
  • The total risk (sum of squares) and how it is divided between systematic and non-systematic risk
  • The coefficient of determination, R²
  • The alpha return
  • The statistical significance of the alpha and beta coefficients

Task 1 Report

The written report should be organized in sections corresponding to 1a, 1b and 1c above:

1. Present your five chosen companies, the sectors of the market from which they are drawn, size of issued share capital and market capitalisation.

Avoid explanations of reasons you may have had for choosing the companies and narratives on company history, headquarters, directors and so on. None of this will attract marks.

(5 marks)

1. Present graphs of the FTSE index and share prices over the three-year period 1^st December 2016 to 1^st December 2019. State the start and end values for each and, briefly, assess the performance of each.

Marks depend on the clarity of graphical representations and appropriateness of the commentary. Avoid instructions along the lines on ‘see the excel spreadsheet for…’. Also avoid the opposite; simply cutting-and-pasting everything from Excel to Word. The onus is on you to incorporate into the written report elements of spreadsheet output relevant to the issue being tackled. Omission or inclusion of irrelevant detail are liable to prompt penalties.

Asset performance assessment here should be summary in style, not lengthy. There are only 5 marks on offer for the entire element.

(5 marks)

1. Provide, in tabulated form, the statistical outputs listed in section 1c guidance. Focus on the data that offers insight into asset risk. Analyze the scale of total risk for each asset, including the breakdown into systematic and non-systematic elements. The discussion should conclude with a comparative analysis of the risk attached to each asset.

As with 1b, appeals to refer to the spreadsheet will result in lost marks rather than gained marks. Unlike 1b, the marks on offer here are considerable. To score well, the depth of the analysis must reflect this.

(20 marks)

(Maximum mark Task 1: 30)

Task 2

In Task 1 you chose five UK quoted companies and obtained risk information for each, based on sample share price data. For Task 2, you will assess the returns on your five shares over the two-year period from 1^st December 2019 to 1^st December 2021. In particular, you will analyse the differences between the actual returns and expected returns, the latter being based on applying the Capital Asset Pricing Model.

2a. Set up the investment

Imagine it is the start of December 2019. You invest £20,000 in each of your five companies – a total investment of £100,000.

• Assume the per share purchase price for each company is the price on 1^st December 2019
• Calculate the number of shares bought in each company

[Note: Only whole shares can be bought. Therefore, it is extremely unlikely that the investment in each company will be exactly £20,000. Round the investment to a number of shares that produces an outlay nearest to £20,000 (the deviation will be small, probably no more than a few pence or pounds for each company)

2b. Measure actual returns for the first year of your investment

Calculate the money and percentage returns on each of your five investments over the term 1^st December 2019 to 1^st December 2020. Measurements must incorporate the effects of changes in each share price plus any dividends paid by the company to shareholders during the year.

• Irrespective of how many dividend payments a company made during the year, or when they were paid, aggregate the amounts and assume the money was received at the end of the year (on 1^st December 2020). You will need to undertake a little research to find your companies’ dividend payments. The information is readily available on stockbroker websites and company corporate websites
• If the company did not pay dividends, ensure that this is noted in the submission

2c. Measure actual returns for the second year of your investment

Begin by reinvesting the dividend income from the first year in additional shares of the same company. Show how many extra shares are bought in each company (based on the share price at the end of first year of the investment), the total number of shares held in each and the opening market value of each holding at the start of the second year.

• Again, bear in mind that it is highly unlikely that the dividend received from a company equates to an exact whole number of shares. Adjust the calculation to the nearest whole number of shares

Calculate the money and percentage returns on each of your five investments over the term 1^st December 2020 to 1^st December 2021, using the opening market values on 1^st December 2020 for comparison. Be sure to include dividends received during the second year in the measures of return.

2d. Assess the two-year holding period returns

Calculate the money and percentage returns on each of your five investments over the term 1^st December 2019 to 1^st December 2021. Be sure to include dividends received during the second year in the measures of return.

• Do not simply add the first and second year returns from Tasks 2b and 2c as this will be inaccurate

2e. Calculate the expected return on each investment based on the Capital Asset Pricing Model and analyse differences between expected and actual returns.

Apply the CAPM to generate expected annual returns for each of the five assets for both years of the investment. You should:

• Use the beta values from Task 1 as estimates of the exposure of each investment to market risk
• Produce a measure of the risk-free return for the period from December 2019 to December 2021. You will need to investigate returns during the period, on assets considered risk-free. Information around yields on government securities or standard bank savings is relevant. The reasoning behind for your chosen risk-free return must be explained. You might or might not consider it necessary to apply a different risk-free return for each year. Either way, the reasoning should be provided
• Measure the actual annual market return for each year of the investment. This should be based on measures of the percentage change in the market index plus the dividend yield for the market (Remember you have included dividends in the actual returns for your five shares. Therefore, comparison of actual with market-determined expected returns must incorporate the effect of dividend payments on market returns)

[For obvious reasons, you will not be able to calculate the FTSE All-Share Index dividend yield from source (it is rooted in the dividend payments of over 600 companies of differing sizes). An online search will yield a workable measure. Ensure that you reference the source

Measure the differences between the actual annual returns (those in tasks 2b and 2c) and the CAPM-determined expected annual returns for each asset – known as the ‘abnormal’ or ‘excess’ return. Repeat this comparative exercise with respect to the two-year actual return for each asset and the CAPM-based two-year expected return.

Analyse the significance of the abnormal returns for each asset. Consider issues such as whether abnormal returns are positive or negative, how abnormal returns for each of the two years compare, how the abnormal return over the two-year period compare to those of each individual year. In particular, discuss the implications of these abnormal returns for the predictive status of the CAPM as a theory of asset returns.

• You may wish to include commentary on the possibility of returns unrelated to market risk, in the form of alpha returns for the sampling period (those alpha returns contained in the regression outputs from Task 1) 

Task 2 Report

The report should be organized in sections corresponding to 2a, 2b, 2c, 2d and 2e.

• Outline the number of shares bought for each of the five companies, the total size of the investment in each and the total investment overall.

(5 marks)

• Ensure a clear presentation of the extent to which the values of your five investments have changed in cash and percentage terms. Did your £20,000 stake in each company grow or fall in value during the first year? To what degree?

(5 marks)

• Whilst similar in some ways with 2b, there is a novel twist in the instruction to reinvest dividends in the respective companies. Ensure that this feature of the exercise is clearly explained with the results given due prominence.

(7 marks)

• The emphasis is on considering the two years as a single holding period for the investment.

(5 marks)

• This is the least prescriptive, most analytical, component of Task 2. It tests the depth of your appreciation and understanding of to what extent actual outcomes offer conclusive evidence of the credibility of theory-based expected outcomes, in this case the credibility of the Capital Asset Pricing Model.

[Note the significant weighting linked to 2e. To score well, you will need to produce a carefully articulated and nuanced examination of the implications of the relation between expected and actual results for the CAPM] 

(18 marks)

(Maximum mark Task 2: 40)

Task 3

In Task 1 you chose five UK quoted companies and obtained risk information for each, based on sample share price data from December 2016 to December 2019. For Task 2, you analysed the return performance of each of your five investments over the two-year period from December 2019 to December 2021, emphasising differences between actual asset returns and measures of expected return based on the Capital Asset Pricing Model.

Task 3 is the final element of the coursework and requires adoption of an explicitly portfolio approach to risk and return.  

3a. Portfolio risk and sample data

Based on the individual asset risk information for task 1, calculate:

1. The beta for an equally weighted portfolio of your five companies
2. The portfolio market risk, non-market risk and coefficient of determination (R²)

Employ the principles of portfolio theory to compare the portfolio risk and the individual asset risks.

3b. Portfolio return

Calculate the:

1. Expected, actual and abnormal portfolio return for December 2019 – December 2020
2. Expected, actual and abnormal portfolio return for December 2020 – December 2021
3. Expected, actual and abnormal portfolio return for December 2019 – December 2021

To carry out the calculations:

• Use the risk-free returns and market returns from Task 2.
• Use the portfolio beta from 3a to calculate the expected return December 2019 – December 2020
• Use a new portfolio beta to calculate the expected return December 2020 – December 2021. The new beta should retain use of the original individual asset betas but be based on the portfolio’s asset weightings on 1^st December 2020.
• All portfolio actual returns should be weighted averages of the individual asset actual returns from task 2.

Based on portfolio theory, compare the scale of the portfolio abnormal returns with the abnormal returns of the individual investments and explain how this is linked to the issue of portfolio risk.

3c. Statistical significance of alpha and beta

The section comprises two elements.

1. From the regression output in task 1, highlight the measures of statistical significance for the asset alpha and beta estimates. Explain what these measures indicate about how much confidence we can have in the alpha and beta values. Discuss the implications for the return expectations based on portfolio theory.

1. For each share, regress the monthly return data for the period December 2019 – December 2012 against the monthly market return data. Note the beta values from this period and compare them to those used to generate the individual asset and portfolio expected returns for the period. Discuss the extent to which differences invalidate using historic betas to forecast future returns.   

Task 3 Report

The report should be organized in sections corresponding to 3a, 3b and 3c above:

1.  
2.  
3. One half of the marks are linked to the numerical work, one half to the analysis.

(10 marks)

1.  
2.  
3. One half of the marks are linked to the numerical work, one half to the analysis.

(10 marks)

1.  
2.  
3. You do not need to upload a separate Excel file with the new regression data. Having undertaken the exercise in Excel, it is sufficient to incorporate the resulting beta values into the main document. One half of the marks are linked to 3ci, one half to 3cii.

(10 marks)

(Maximum mark Task 3: 30)

Notes for Moderator

1. With the coursework requiring students to undertake numerical and statistical work on self-chosen data sets, it is not possible to provide specific solutions to the numerical components.

• The marks are structured so that a student able to carry out the quantitative aspects in a competent manner can expect to achieve a mark falling solidly within the second-class range, but not above.

• To score well on the analytical elements, especially prominent in Tasks 2 and 3, a student must show an appreciation of the subtleties and qualifications present in any exercise where outcomes are used to appraise the status of theoretical propositions. Vague and loosely articulated narratives on portfolio theory will not receive high marks. Nor will overly-conclusive assertions, unwarranted expressions of proof, when the evidence is bound to be much less definitive.