Portfolio planning

From Archive 11 December 2003

By PWM Editor

In this section of PWM we test the performance and volatility of two investment strategies using model portfolios. Each month we look at two distinct approaches – one global and one European.

EUROPEAN PORTFOLIO

A small and medium capitalisation portfolio in the search for performance In the previous issue it was highlighted how the small and medium capitalisation segment of the European equity markets had assumed a leader position.

A few interesting leading sectors were also located, for example medical products, because of the superbly favourable risk reward ratio in the long run. It is also about the only sector that shows a consistent out-performance on all major stock markets. A recent strong out-performance on a global basis was discovered in the metals and mining sectors. Real estate is strong both on a euro and pan-European basis.

Let us search for the ideal portfolio of 10 stocks that best represents the small and medium cap segment of the above sectors. Momentum and value are a good combination of styles when trying to build a portfolio that is limited to companies with a market cap of at least $500m and no more than $1bn. The actual strength of the lower cap market segment is the good value it represents. This is the reason why only stocks with a price-to-earnings ratio of less than 17 times are included and a price-to-sales ratio of less than two. Just 17 companies achieve this requirement.

Chart 1 (above): The selection window shows the details for the selection process that was used with a global data base of more than 17,100 stocks.

The table below shows how a simple risk reward allocation process helped to locate those 10 funds that make part of the ideal portfolio.

Chart 2 (below): The portfolio has recently reached a new all time high. This portfolio is not for the faint-hearted because of the typical wide swing of small and medium cap stocks due to their limited liquidity. The average valuation is very low with a dividend yield of +2.588 per cent, a price-to-earnings ratio of 11.772 times and a price-to-sales ratio of 0.2445 times.

Chart 3 (below): The heat map shows that the iron sector predominates the list as steel and scrap steel prices have skyrocketed over the past few months.

GLOBAL PORTFOLIO

The results of guaranteed investments: how good are they?

The number of guaranteed funds has mushroomed since the big equity bear market of March 2000. Only 15 per cent out of a sample of 566 funds show a price history of five years or more. The number increases to 41 per cent for those with a price history of three years or more.

An increasing number of investors must have got worried about the safety of their investments at the beginning of 2000. The flow of new funds appears to have continued unabated, as 22 per cent of the funds show a price history of less than one year.

How has the quality of products evolved on the basis of performance? A look at the average results over the last 12 months of guaranteed funds shows a rather consistent performance of +16.74 per cent for funds five years or older, +21.3 per cent for those three years or older, and +17.32 per cent for those with a price history of one year or more.

Only the category of funds with a price history of two years or more suffered a decline of performance (+7.86 per cent). It is nevertheless a remarkable result when taking into account the dismal conditions of the financial markets.

What kind of figures have the guaranteed funds achieved against the different categories of investments?

Guaranteed investments on the basis of the LGC Guaranteed Index and over a time frame of five years have done better than money market or equity investments. Other alternative investments such as arbitrage funds or hedge funds have done better. Guaranteed investments, however, have been among the best investment over the past three years.

Which are the best guaranteed investments on a risk reward basis? Ten funds were selected, and in one case (Athena Financials 2) the investor’s money was more than doubled over the past three years while the financial markets in general went through crisis.

Chart 1 (above) shows that the absolute leader over the past five years has been the hedge fund category.

Chart 2 (below) shows that hedge funds have disappointed over the past three years while guaranteed investments have achieved the third position in the general ranking. Bad times on the financial markets have been favourable for guaranteed investments.

The table shows the 10 best funds.

Charts 3 and 4 : The best 10 funds have shown a remarkable return over the past five years although the performance has flattened out somewhat over the past six months.