EFFECT OF PORTFOLIO ALLOCATION STRATEGIES ON PORTFOLIO PERFORMANCE

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EFFECT OF PORTFOLIO ALLOCATION STRATEGIES ON PORTFOLIO PERFORMANCE

CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Developing the portfolio is a financial art. The art that enables the investors to manage the funds or more precisely means managing the scarce funds. Investors have the options to select and invest according to the conditions of market. Mattei and Mattei (2016), defined that strategies of asset allocation are devised to help investor in diversifying their portfolio and for lessening the risk. In the rapidly moving financial markets, domestic and global, the seasoned experts could make the best choices out of the various available investment options, suiting to their financial goals.

Four Types of portfolio strategies are considered namely; buy and hold Strategy, dynamic asset allocation or constant mix strategy, strategic asset allocation and tactical asset allocation.

Ling, Yat, and binti Muhamad (2014) described buy and hold as passive conservative investment strategy, in which an investor holds the stocks for a longer period of time. Buy and Hold Strategy is based on the ratio of 40/60 between the bonds and stocks respectively. Mattei and Mattei (2016) defined that among all the most significant division of portfolio is to invest 60% in stocks and 40% in bonds. In this research, the significant ratio 60/40 is used for generating the portfolio.

The dynamic asset allocation based on the strategy of shifting to debt when equity market is rising and towards equity, if equity market falls. Frequency of rebalancing is not rigid. Perold and Sharpe (1995a) described that dynamic strategy will maintain a constant proportion of wealth to the value of stocks and stocks will be hold at all wealth levels. Price to earnings ratio is the tool for defining the shift between the ratio of stocks and bonds. In this research, the dynamic asset allocation is based price to earnings ratio of stock. The stock with more price to earnings ratio will get more weightage in portfolio.

Strategic asset allocation is another strategy which is based on the long term investment goals with less correlation among the stocks. Anson (2004), described that under the normal market conditions strategic asset allocation is defined to meet the long term investment goals of the organization. It lasts for up to ten years for full stock market cycle. This research based the strategic asset allocation lower correlation among stocks.

The fourth Strategy, tactical asset allocation is based on the analyzing the trends and inefficiencies in the market. Anson (2004) described that tactical asset allocation attempts to beat the market and is chosen to get the benefit from the market in case the market is out of order. This research worked on price to book value anomaly to capitalize the stock returns. This anomaly says that if the company has lower price to book value ratio in the last quarter of the year, the stock is likely to outperform the next year.

The First ratio of measuring the risk-adjusted return is the Sharpe ratio presented by William F. Sharpe. The ratio considered the standard deviation of the portfolio instead of considering the systematic risk, as measured by Beta. The higher the Sharpe ratio, the better the portfolio performance. Jobson & Korkie, (1981) tested the hypothesis using the Sharpe ratio. Sharpe (1994), discussed the Sharpe ratio with various aspects of its measurements.

The measurement techniques used are Treynor measure or reward to volatility measure was presented by the Jack L.

Treynor measures the portfolio performance on the risk-adjusted basis. It also calculated the investment‟s performance per unit of the risk. The higher the Treynors measure, the better the portfolio. Jobson & Korkie, (1981) tested the hypothesis using the treynor measures.

The third measure is Capital Asset Pricing Model (CAPM) that helps to calculate the investment risk and what return on the investment we should expect. Rizwan Qamar, Rehman, and Shah (2013)used the CAPM for the comparison of the portfolio performance among various companies in Nigeria. Jorion (1991) used the CAPM for measuring the expected returns of the active portfolio. A. Marathe & Shawky (1994) used the CAPM for finding the Beta and concluded that time interval and frequency of evaluating stock return effects the beta.

The fourth measuring tool is the Jenson measure that calculates the excess return that a portfolio generates over its expected return. This measure is also known as Jenson Alpha. Naidenova, Parshakov, Zavertiaeva, and Tome (2015), applied the Jenson Alpha for 85 equity funds of Russian Economy.

The fifth measurement is the Diversification ratio, which is measured by volatility of portfolio as denominator and the summation of the product of each asset volatility with its weight.

Glancing at the 50 years back in a time machine, people knew nothing about the investment portfolios until 1960‟s there was nothing like fundamentals of investment portfolios. Shipway (2009) worked on the portfolio based on modern portfolio theory. As a matter of fact, before the advent of the portfolio theory people still had “portfolios” although their perception of portfolios building is totally different. In the year 1938, John Burr Williams wrote a book “The Theory of Investment value” discussing the “Dividend Discounted Model”.

1.2 Statement of the problem

This study explored the idea of simulated portfolio generation with the application of major investment strategies. Moreover, the strategies are further divided into various forms that provide a reflection into different dimensions of investment. Data is based on Nigeria stock market with three large sectors of KSE-100 index. This study provides an insight into the Nigeria stock exchange market as very little work is performed on generation of simulated portfolios containing both stocks and bonds. Moreover, the implementation of four investment strategies will provide a wide scale work on data.

1.3 Objectives of the study

1. To understand the effect of portfolio allocation strategies on portfolio performance

2. To understand the relationship between portfolio allocation strategies and portfolio performance in banks and other financial institutions listed on Nigeria stock exchange.

1.4 Research Questions
1. What is the effect of portfolio allocation strategies on portfolio performance

2. What is the relationship between portfolio allocation strategies and portfolio performance in banks and other financial institutions listed on Nigeria stock exchange.

1.5 Significance of the study

This thesis pushes the boundaries of knowledge in this area of research. It provides more depth, and of resources and information for future research.

1.6 Research Hypothesis

H0: There is no relationship between portfolio allocation strategies and portfolio performance in banks and other financial institutions listed on Nigeria stock exchange.

H1: There is a relationship between portfolio allocation strategies and portfolio performance in banks and other financial institutions listed on Nigeria stock exchange.

1.7 Definition of terms

Portfolio performance: It is essentially the process of comparing the return earned on a portfolio with the return earned on one or more other portfolio or on a benchmark portfolio

Portfolio allocation: Portfolio allocation encompasses the classes of assets included in a portfolio and the proportion of investment dollars assigned to each asset class

Investment portfolio:

A portfolio is a collection of financial investments like stocks, bonds, commodities, cash, and cash equivalents, including closed-end funds and exchange traded funds (ETFs).

Stock Exchange:

A stock exchange is a marketplace where securities, such as stocks. An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved).

Capital Project: A Capital Project is a project that helps maintain or improve a City asset, often called infrastructure. … It is a new construction, expansion, renovation, or replacement project for an existing facility or facilities

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