Portfolio Planning

In this section of PWM we analyse two model portfolios constructed according to particular investment strategies. Each month we will look at a different European and global basket of stocks. EUROPEAN PORTFOLIO Momentum Investing It is standard dogma that momentum investing is a bull market phenomenon and that it has no chance of succeeding in a clear-cut bear market like the present one. Well, there is no doubt that times are difficult for this particular style and that returns are below the incredible track records of the 1980s and 1990s. However, based on research using Brainpower’s products, it appears that momentum investing continues to beat most other strategies or significantly enhances other styles. The momentum strategy below has consistently produced positive absolute returns (+17.47 per cent) over the last 30 months and has beaten the “buy and hold” approach (–15.21 per cent) by a large margin. The basic idea is to first weight the sectors of the DJ Stoxx600 on an optimised risk and reward basis. At the end of March, the following five DJ Stoxx600 sectors showed the highest weighting: real estate, tobacco, medical products, transportation, food & beverages. We can see on the charts how this group has outperformed the DJ Stoxx600 Index on a consistent basis since the middle of 2000. We then searched for the top two stocks of each sector by again optimising on a risk reward basis. This strategy is called “the power combination” because it uses two very efficient portfolio-optimising approaches. The resulting portfolio shows a good probability of outperforming the DJ Stoxx600 Index over the next few months. Why? The difference (spread) between the Power Sector portfolio and the DJ Stoxx600 continues to grow and the 108-day moving average of the difference continues to point to the upside. GLOBAL PORTFOLIO Active vs Passive Portfolio Management Many portfolio managers prefer to invest in line with a benchmark by taking only minor risks in terms of deviation. They have to split their portfolio into a large number of positions in order to achieve this. Private investors and retail portfolio managers prefer to use exchange traded funds in order to avoid underperformance against the benchmark in the case of a bad stock selection and many smaller investors cannot buy more than a few stocks in order to achieve the best relationship between risk and return in terms of diversification. We have shown here how portfolio optimisation (active) might produce higher returns over time than the benchmarking approach (passive). Passive management (benchmarking) A portfolio of the major worldwide equity markets is created containing securities with a market cap of over $35bn. The portfolio is then benchmarked against the MSCI World index in order to determine the eight securities that most closely correlated to the index performance. Active Management (optimisation) A risk return optimisation is performed on the global portfolio and the eight highest weighted securities are chosen to comprise the active portfolio. The optimised portfolio is comprised of the eight stocks shown in the table and is represented on the chart by the blue line. The red line shows the performance of the benchmarked portfolio. The scatter diagram shows the better return to risk relationship of the active portfolio (optimised) against the passive (benchmarked). Which strategy will outperform the other? We will return to this analysis in a few months to determine the winner.

For further information on Brainpower’s professional portfolio analysis software, please visit www.brainpowerweb.com or contact Alan Paramenter on +44 (0) 20 7392 7108