Introduction to Investment

Prof.(Dr). Meda Srinivasa Rao

Professor,
Faculty of Management Studies,
Marwadi University
Investment Process
 Successful investing is a journey,
 Not a one-time event, and
 you'll need to prepare yourself as if you were going on a long trip.
 It is concerned with how an investor should make decisions
about what assets should be invested in,
how extensive the investments should be,
and when the investment should be made.
Investment Process
1. Specification Of Investment Objectives
And Constraints
Objectives:
Return requirements: ( warren Buffett, Jhunjhunu Wala)
Income: Regular /time interval
Growth: Capital appreciation
Stability: How secure in total investment
Risk tolerance:
-Financial situation: Character, Capital, Condition, Capacity, Collateral,
-Temperament: Upset with small loss; Not upset even huge losses even financial situation weak
Life cycle analysis
Accumulation,
consolidation,
spending, and
Gifting phase
Risk return position at various life cycle stages
Ronald Kaiser
)Accumulation Phase: Young age (25-35)
i

Early age, small net worth, the time horizon is long, effort to take large risks
ii) Consolidation Phase: Middle age (up to 55)
Mid to later career stage,
income exceeds expenses,
the investment portfolio can be accumulated,
portfolio balance is sought to provide the moderate trade-off between risk and return
iii) Spending Phase: old age ( 55 to 65) Acc
Living expenses are covered from accumulated assets
rather than earned income Con
The emphasis is only on safety Return
S&G
some risk-taking is still preferable
Low position on risk and return trade-off
iV) Gifting phase: Extreme old age ( above 65)
Attitude about the purpose of investment changes Risk Risk
and return is similar to the spending phase
Continue……….
Constraints

Liquidity
 Investment Horizon: Long, short, and very short
 Taxes: Individual and institutions (tax slabs)
Regulations
Unique circumstances: aging parents,
 2. Choice of Asset Mix
 Choice of Asset Mix is nothing but
 Involving Divide your investments among different assets,
 In a simple sense Appropriate mix of Bonds and stocks in the portfolio
 Broader sense of Bonds Includes:
 NCDs, PSU Bonds, Gilt edge securities, Debt oriented MF schemes, NSCs
 KVPs, Bank deposits, Post office savings deposits, PPF
 Broad sense of stocks includes:
 Equity stocks like income stocks, Growth stocks, blue chip shares, cyclical
shares, Speculative shares, and equity/growth-oriented MFs.
 The asset allocation decision is a personal one
Note: 90% of the variance of Portfolio return is explained by Asset Mix
10% of the variance of portfolio return by other elements like sector rotation,
security selection .
Given the significance of asset mix decision , spend enough time and effort in
articulating it.
General preference of Indian investors for
choice of asset mix
 Human Resources Investment
 Insurance to protect family members
 Housing for their secured life
 Cash
 Fixed deposits in Public sector Banks and post office
The Conventional wisdom of assets mix:

Greater tolerance for risk should move to the portfolio in favor of stocks.
Less tolerance for risk should move to the portfolio in favor of bonds.

Longer investment Horizon portfolio in favor of Stocks

Shorter investment horizon portfolio in favor of bonds

Experts opinion Experts 'on Asset Mix :

Benjamin Graham :
Never have less than 25% or more than 75% of funds in stocks
Never have more than 75% or less than 25% of funds in Bonds

Note: For defensive investors 50:50 of Stocks and Bonds

General thumb rule:100- Age of individual = % of investment in Stocks

John Bogle: Vanguard Mutual Fund Chairman The conventional
Asset Allocation According to AIMR
Association for Investment Management and Research (AIMR)

Age group cash Bonds Stocks

25-44 6 34 60
45-54 6 36 58
55-64 7 43 50
65 and above 9 55 36
Empirical results for Asset Mix
 100% Bond Portfolio
 Vanguard offers data on the historical risk and return of various portfolio
allocation models based on data from 1926 to 2018.
 For example, a portfolio consisting of 100% bonds has experienced an average
annual return of 5.3%.
 Its best year, 1982, saw a return of 32.6%.
 It fell -8.1% in its worst year, 1969.
 Of the 93 years of historical data cited by Vanguard,
 a 100% bond portfolio lost value in 14 of those years.
Continue…..
 100% Stock Portfolio
 At the other extreme,
 a 100% stock portfolio had an average annual return of 10.1%.
 Its best year, 1933, saw a 54.2% return.
 Its worst year, just two years earlier in 1931, experienced a decline of
43.1%.
 The portfolio lost value in 26 of the 93 years covered by Vanguard’s
analysis.
 Comparing these two extreme portfolios underscores the pros and cons
of both stock and bond investments.
 Stocks over the long term have a much higher return
 The decision investors need to make is how much volatility they can
stomach, while also considering the returns they need to meet their
financial goals.
Continue …….
 Income, Balanced, and Growth Asset Allocation Models
 We can divide asset allocation models into three broad groups:
 • Income Portfolio: 70% to 100% in bonds.
 • Balanced Portfolio: 40% to 60% in stocks.
 • Growth Portfolio: 70% to 100% in stocks.
 For long-term retirement investors, a growth portfolio is generally
recommended.
Different schools of thoughts on the Asset mix
 12 20 80 Rule: (Quantum group)
 investors need to allocate at least 12 months’ worth of their
monthly expenses in a liquid fund which can thus be easily
liquidated in times of emergencies,
 Allocate 20% of the overall portfolio to Gold to provide
downside protection during uncertain times, and
 Dedicate 80% of the total investable funds on diversified fund
 3. Formulation of Portfolio strategy
Active strategy: Passive Strategy:
An investment strategy that tries to An investment strategy that creates a
generate maximum value to a well-diversified portfolio at a
portfolio. use various techniques that predetermined level of risk. Hold the
evaluate which financial securities will portfolio relatively unchanged.
yield the greatest returns.
The idea is to avoid the fees and the
4 principal vectors for an active strategy drag on performance that potentially
occur from frequent trading.
1.Market timing
•Investor
 Efficient Market theory(Fama)
deviate Normal/ investor asset
mix  Indexing (John.C.Bogle)
businessCycle analysis, Moving Average, Random walk theory
Econometric models
(Burton and Malkiel )
2. Sector rotation and its analysis
3. Security selection (search under priced
stocks)
4. Use of specialized investment concept
Note: Dow theory
 Passive strategy
 It assume that
 Capital markets is fairly efficient with available
information
 Hence, the search for superior returns through an active
strategy is considered futile
Guidelines:
 Create well diversified portfolio at predetermined level
of risk
 Hold it unchanged overtime
According to Jason Zewing : investment
commentator useful advice for investment strategy
 If you have a time to spare, are highly competitive, think like a sports fan
relinguish a complicated challenge this about active approach
 If you are rushed, crave simplicity and donot relinguish thinking about
money follow passive strategy.
 4.Selection of Securities

Selection of bonds: Selection of Stocks

Fundamental Analysis(EIC)
Yield to Maturity (YTM):
Rate of return received up to  Technical Analysis
maturity  Random selection
Risk of Default (ratings) Peter Lynch selection of stocks:
Tax Shield 1.Slow growers: TCS,HCL
Liquidity 2.Stalwarts: Bajaj auto
3.Fast Growers: Eitcher Motors
4.Cyclicals: Auto and Metals
5.Turnarounds: Surat textiles
6.Asset plays: SBI, ONGC
 5.Portfolio Execution
 Implement the portfolio plan by buying or selling securities in given amounts.
 Normal Business transactions vs. Trading stock transactions
Possible transaction for execution and key players
 Value-based information Transactors (VBIT)
 Information-based transactors (IBT)
 Liquidity-based Transactors (LBT)
 Pseudo information-based transactors (PIBT)
Dealers (Bid and Ask Prices )
 Who win , who losses
 IBT - VBIT- LBT- PIBT
Guidelines : i) Dialogue with the broker
ii) place an order which serves your interest
iii)Avoid serious trading errors
6.Portfolio Revision
 The process of addition of more assets in an existing portfolio or changing
the ratio of funds invested is called as portfolio revision.
 The sale and purchase of assets in an existing portfolio over a certain
period of time
 To maximize returns and minimize risk is called as Portfolio revision.
 Two approaches :
1.Portfolio Balancing : reviewing and revising the portfolio composition
2. Portfolio Upgrading :
* Reassessing risk and return of securities
* selling over priced stocks and buying under price stocks
Constraints portfolio Revision:
i) Transaction Costs ii)Taxes iii) Statutory stipulation
Portfolio Performance Evaluation
• It is a process of comparing return earned on a
portfolio with the expected return
Two aspects in performance evaluation
1. Performance Measurement
Return :Market return , stock return , similar stocks return
2. Performance Evaluation
Methods for evaluation
• 1.Sharpe Ratio
• 2. Treynor Ratio
• 3. Jensen Alpha
Performance Evaluation
methods
• The Sharpe ratio is a reward-to-risk
ratio that focuses on total risk.
• It is computed as a portfolio’s risk
premium divided by the standard
deviation for the portfolio’s return.
Rp  R f
Sharpe ratio 
σp
 Performance Evaluation Measures
2. The Treynor Ratio
The Treynor ratio is a reward-to-Volatility ratio that looks at systematic risk only.

It is computed as a portfolio’s risk premium divided by the portfolio’s beta coefficient.

Rp  R f
Treynor ratio 
βp
Performance Evaluation Measures

Jensen’s Alpha
 Jensen’s alpha is the excess return above or below the
security market line. It can be interpreted as a measure of
how much the portfolio “beat the market.”

 It is computed as the raw portfolio return less the expected

portfolio return as predicted by the CAPM.

α p  R p  R f  β p  ER M  R f  
“Extra” Actual CAPM Risk-Adjusted ‘Predicted’ Return
Return return
Clientele of Investment
Environment
 Household sector
 Business Sector
 Government Sector
 Others in the system
* Pension funds
* Insurance companies
* Trusts
* FIIs,
* DFIs,
* Sovereign wealth funds
India’s Investment environment
 Fastest growing economy in the world on Health consciousness ( 80
millions)
 Infrastructure is the main concern by the government ( Roads, Ports,
water ways , Air ports )
 Reformed Tax system ( GST) with pan India tax
 Insolvency and Bankruptcy code -2017,
 Moderate inflation to increasing inflation (3.89% in Jan 2023 to 3.78 %
in Feb 2023)
 Surging fiscal deficit to nearly 4.9%
 Sufficient forex reserves ($589 billion)
 Ease of doing ranking to 63 ( 2022)
 Rupee stabilized at 82
 Twin balance sheet problem (Corporate debt and NPAs)
 ( 17 lakh crore, NPAs : 10 lakh crore)
 Warren Buffett
 An American investor
 Business Tycoon, philanthropist
 Chairman and CEO of Berkshire Hathaway
 Net worth: 96.5 Billion USD ( Sept,2022)
 World’s sixth wealthiest person
 Books :
 1.The Essays on Warren Buffett: Lessons for investors and Managers
 2.Berkshire Hathaway Letters to shareholders 1965-2014
 Key People :
 1. Charlie Munger – Vice-chairman
 2. Ajit Jain –Vice Chairman- Insurance operations
Case study
 Mr. Chetan has a roadways business in Vijayawada and often travels to
Hyderabad and Chennai.
 He has one daughter and one son, aged 14 and 16 yrs respectively, and his
wife helps him in his business.
 After a number of tiring business trips, he is going with his family to visit
Goa and Mumbai.
 He strongly believes that a holiday trip with his family once in a year makes
him fit to work with full energy.
 No matter, even if it is expensive.
 Chetan also promised his wife to take the entire family to Singapore within
a couple of years.
 Chetan loves investment but he invests to meet short-term needs.
 He argues that his present investment objective is his planned trip to
Singapore and a budget with a long-run perspective does not work well.
 For him, budget is just a method of worrying before and after spending
money. His present investment portfolio includes
 Equities- 20%, Growth Funds - 20%, Income Funds-30%, Bonds- 10%,
 Company FDs –10%, Bank FDs- 10%
 Liquidity Focus: 70%- High, Safety Focus: 30%- Low Earnings Focus
 Sensex at 59,200 on 5th Sept 2022 at 12:52 (sept 24,reached to 60,000 mark)
 India has emerged as one of the fastest growing economies
 Increase the disposable income of the household
 Relaxing FDI norms most sectors are open for 100% FDI undethe r Automatic route
 The share of Retail investors in Companies listed in NSE reached to 7.42 as of March 31,
2022
 It offers a growing and thriving environment for investment in India and foreign
 Retail investor’s investment worth Rs.19.16 lakh crore listed stocks in NSE
 FDI Annual inflow of $ 83.57 billion during the FY 2021-22
 FDI equity inflow stood at $ 21.34 billion FY 2021-22
 Singapore was the country with the high(27%), followed by the USA (18%) and
Mauritius(165) FDI equity inflow in India FY 2021-22
 Startup investments were the highest, standing at $13.3 billion across 506 deals.
 First half of Jan-June 2022, PE/ VC investment activity stood at US 34.1 billion across
714 deals
 In FY 2021-22, Net inflow into Mutual Funds stood at 2.46 lakh crore
 SBI Report on Indian Economy stated that By 2027, the country will reach 4 trillion and
surpass Germany
 By 2029, the country will reach the 3 rd largest economy
Security Analysis Vs. Portfoli Management
 It is a method of evaluating a security that entails
attempting to measure its intrinsic value by examining
related economic, financial and other qualitative and
quantitative factors.
 Fundamental analysis is done with the help of financial
statements, competitor’s market, market data and other
relevant facts and figures whereas technical analysis is
more to do with the price trends of securities.
Portfolio Management
Taking a bunch of different securities and putting them
together to create a less risky asset.
 You care more about correlations, variance, and
risk/reward relationships than earnings or growth.
 SENSEX 30 COMPANIES WEIGHTAGE IS HERE
SL Company Industry Weight
1 Reliance Ind Integrated Oil & Gas 13.36%
2 HDFC Bank Banks 9.65%
3 ICICI Bank Banks 8.78%

4 Infosys IT Consulting & Software 8.70%

5 HDFC Personal Products 6.51%

6 TCS IT Consulting & Software 5.13%

7 Kotak Mahindra Bank Banks 4.23%
8 ITC Cigarettes,Tobacco Products 4.10%
9 HINDUSTAN UNI FMCG 3.72%
10 Larsen & Toubro Construction & Engineering 3.37%
11 State Bank of India Banks 3.11%
12 Axis Bank Banks 3.05%
13 Bajaj Finance Holding Companies 2.63%
14 Bharti Airtel Telecom Services 2.62%
15 Asian Paints Furniture,Furnishing,Paints 2.18%
16 Maruti Suzuki Cars & Utility 1.85%
Vehicles
17 Mahindra & Cars & Utility 1.78%
Mahindra Vehicles
18 HCL Technologies IT Consulting & 1.54%
Software
19 Titan Co Other Apparels & 1.53%
Accessories
20 Sun Pharma Pharmaceuticals 1.49%
21 Bajaj Finserv Finance 1.22%
22 Tata Steel Iron & Steel 1.19%
23 UltraTech Cement Cement & Cement 1.18%
Products
24 Power Grid Electric Utilities 1.13%
25 NTPC Electric Utilities 1.12%
26 Nestle Packaged Foods 1.07%
27 Tech Mahindra IT Consulting & 1.03%
Software
28 Wipro IT Consulting 0.96%
29 IndusInd Bank Banks 0.95%
30 Dr Reddy’s Labs Pharmaceuticals 0.84%
BSE Sensex milestones
Date Timeline

January 1, 1986 Sensex launched by BSE with a base price of 100 (base year 1978-79)

Touched the four-digit figure for the first time and closed at 1001 in the wake of a good monsoon and excellen
July 25, 1990
corporate results
October 11,
Crossed the 5000-mark as the Bhartiya Janata Party-led coalition won majority in the 13th Lok Sabha election
1999
August, 2005 BSE becomes a corporate entity and offers shares to its members

February 7, Closed above the 10000-mark

2006
December 11,
Closed at a figure above 20000-mark backed by aggressive buying of funds
2007
May 16, 2014 Surpassed the 25000-mark as Narendra Modi-led BJP won the 13th Lok Sabha election
March 4, 2015 Sensex breached 30000-mark after the Reserve Bank of India cut policy repo rates
January 17,
Settled above the 35000-mark for first time ever
2018
Sensex breached 40000-mark as Narendra Modi-led BJP was re-elected at the Centre for the 2nd time with
May 23, 2019
thumping majority
December 4, Sensex crossed the 45000-mark for first time ever on RBI's statement that Indian economy was recovering
2020 faster than expected from Covid-19 slump
January 21,
Sensex breaches 50000-mark
2021

September 24,
Sensex breaches 60000-mark
2021
Concepts
 Investments: involves the study of Investment Process
 Investor’s wealth
 Marketable and Non Marketable securities
 Portfolio
 Risk : uncertainty in the probability distribution of Return
 Return
 Security Analysis: Process of estimating returns and risk for individual
security
 Portfolio Analysis: considers blending / interactive effects of combining
securities
 Portfolio selection: choosing the best portfolio to suit the risk and return
preference of the investor
 Portfolio Management: it is a dynamic function of evaluating and revising
the portfolio in terms of stated investor objective
The investment Process
 Ballard, Biehl, and Kaiser Five-Way Model
 The Ballad, Biehl, and Kaiser (BBK) model plots
 investors along two axes, confident-anxious and careful impetuous.
The five investor types generated by the BBK model are:
1. Adventurer: Confident Impetuous Reluctant to take advice
2. Celebrity: Anxious Impetuous y be willing to take advice
3. Individualist: Confident Careful Will listen to advice
4. Guardian: Anxious Careful May seek advice
5. Straight Arrow: Mid-point Rational
2. Quantification of Capital Market Expectations
 Specifically, investment decisions
 The decision maker’s expectations concerning factors and events believed to affect
investment values.
 The decision maker integrates these views into expectations about the risk and returns
prospects of individual assets and groups of assets.
Capital Market expectations depend on Macro Economic Variables
 Interest Rate, Market Return, and Expected Inflation
 For instance:
 Expected Return = Risk-free Rate + Market Risk Premium
 Market Risk Premium = Market Return – Risk-Free Rate
Prediction of the investment environment
 Equity investment worth of 10.7 Trillion USD
 National Pension funds shift from zero risk to risky portfolios