Our last report discussed a possible balance sheet for a hypothetical “man on the Clapham omnibus”. Ignoring the liability side the example below details one hypothetical asset mix for different age groups. We have bolded below the investable assets.
Age Group | 30-40 | 40-50 | 50+ |
Long term assets | £k | £k | £k |
Property | 200 | 300 | 400 |
Intangible assets / i.e. State pension / SIPP/ life policies | 10 | 20 | 50 |
Personal effects/ Furniture | 10 | 10 | 10 |
Realisable commodities gold coins / alt assets | – | – | – |
Bonds/ NS certificates | 10 | 20 | 60 |
Equities | 30 | 40 | 50 |
Short term assets | |||
Cash /Cash ISA | 10 | 10 | 10 |
CFD other cash positive Derivative assets | – | – | – |
Total Assets | 270 | 400 | 580 |
Portfolio Assets/ Total Assets | 60 (22.2%) | 90 (22.2%) | 170 (29.3%) |
Liquid Assets/ Portfolio Assets | 50 (83.3%) | 70 (77.8%) | 120 (70.6%) |
Illiquid Assets/ Portfolio Assets | 10 (16.7%) | 20 (22.2%) | 50 (29.4%) |
Source; CSS Investments Ltd
The above provides pointers for measuring asset mix weightings. Certain features are apparent which could be broadly relevant for the majority of individuals:-
Broadly this helps determine how to allocate / supervise assets within an asset mix.
The next step is to diversify an investment portfolio in that our focus is on an “optimal portfolio” of portfolio assets that will move independently of each other as possible. This means the portfolio return (μ) and risk (σ standard deviation) is managed.
Asset Diversification is a key factor- how can this be determined?
A number of assumptions / objectives were made to derive a balanced portfolio.
*An objective to obtain a sector diversified UK 100 portfolio that uses the assumption that returns over the last 60 months (5 years) are representative of returns going forward.
*A decision to take out mining companies due to a decision that exposure to China going forward is undesirable in the short-term.
*Using equity average returns measured against the riskiness of those returns as measured by standard deviation, to derive a balanced portfolio that optimised returns and minimised portfolio risk.
*The following equities were chosen as being a UK 100 representative portfolio; Aviva, Bankers Investment Trust, BP, Carnival Corp, GSK, HSBC, Unilever and Vodafone.
Using a time series analysis I set up a regression analysis of monthly returns (dividends and split adjusted) to obtain a variance/ covariance matrix and a correlation matrix.
EPIC | μ | σ | μ/σ (Sharpe R) |
AV. | 0.659% | 7.692% | 0.09 |
BNKR | 0.855% | 5.187% | 0.16 |
BP | 0.000% | 8.610% | 0.00 |
CCL | 0.425% | 7.399% | 0.06 |
GSK | 0.648% | 4.146% | 0.16 |
HSBA | 0.143% | 4.992% | 0.03 |
ULVR | 0.896% | 4.004% | 0.22 |
VOD | 0.628% | 4.948% | 0.13 |
Source; CSS Investments Ltd
The selection above gives the game away in identifying high risk stocks (high σ ) that are not providing compensating returns (μ) ie (HSBC and BP). Both GSK and ULVR have attractive Sharpe ratios over the 5 year period. Sharpe returns (third column) are returns per unit of risk after subtracting a risk free rate (which is disregarded above due to its fractional size sub 0.5%).
Correlation | AV. | BNKR | BP. | CCL | GSK | HSBA | ULVR | VOD |
AV. | 1.0000 | 0.3300 | 0.4544 | 0.2731 | 0.0648 | 0.5076 | 0.0243 | 0.1138 |
BNKR | 0.3300 | 1.0000 | 0.5545 | 0.2926 | 0.2764 | 0.4839 | 0.2963 | 0.0992 |
BP. | 0.4544 | 0.5545 | 1.0000 | 0.4792 | 0.2783 | 0.3600 | 0.3199 | 0.1857 |
CCL | 0.2731 | 0.2926 | 0.4792 | 1.0000 | 0.1476 | 0.3291 | 0.3185 | 0.1915 |
GSK | 0.0648 | 0.2764 | 0.2783 | 0.1476 | 1.0000 | 0.0921 | 0.4619 | 0.2928 |
HSBA | 0.5076 | 0.4839 | 0.3600 | 0.3291 | 0.0921 | 1.0000 | 0.1672 | 0.1486 |
ULVR | 0.0243 | 0.2963 | 0.3199 | 0.3185 | 0.4619 | 0.1672 | 1.0000 | 0.0269 |
VOD | 0.1138 | 0.0992 | 0.1857 | 0.1915 | 0.2928 | 0.1486 | 0.0269 | 1.0000 |
Source; CSS Investments Ltd
The correlation between various stocks provides a useful insight into assets that provide diversification benefits (<0.3) and those with limited diversification (>0.4). The checker for the data is the 1.0 correlation of each asset with itself across the diagonal (bold).
Using the correlation data derives the portfolio standard deviation from the basket of equities above. The table below identifies the portfolio standard deviation at 3.66% meaning there is a 68.3% chance in any given month of a movement +/- 3.66%. This portfolio standard deviation is considerably below the individual stock standard deviations; Aviva 7.7%, Bankers 5.2%, BP 8.6%, Carnival 7.4%, GSK 4.14%, HSBC 4.99%, Unilever 4%, Vodafone 4.95%. The main benefit therefore of an equal weighting between these stocks is to substantially reduce portfolio risk to 3.66%.
The next step is to vary the weights of the portfolio to maximise the portfolio efficiency with the starting point being an equally weighted portfolio.
Portfolio Optimisation | Equal Weight (A) | Max Return (B) | Min St Dev (C) | Max Sharpe R |
Constraining Variable | None | at σ<= | at μ= | μ/σ |
Value of Constraint | N/A | 4.0040% | 0.8965% | 0.22 |
AV. | 12.50% | 0.00% | 0.00% | 12.50% |
BNKR | 12.50% | 64.51% | 0.00% | 12.50% |
BP | 12.50% | 0.00% | 0.00% | 12.50% |
CCL | 12.50% | 0.00% | 0.00% | 12.50% |
GSK | 12.50% | 0.00% | 0.00% | 12.50% |
HSBA | 12.50% | 0.00% | 0.00% | 12.50% |
ULVR | 12.50% | 35.49% | 100.00% | 12.50% |
VOD | 12.50% | 0.00% | 0.00% | 12.50% |
Ʃw¡ | 100.00% | 100.00% | 100.00% | 100.00% |
μ | 0.532% | 0.870% | 0.896% | 0.532% |
σρ | 3.659% | 4.004% | 4.004% | 3.659% |
(μ)/σ | 12.033% | 19.217% | 19.889% | 12.033% |
Rf | 2.50% | 2.50% | 2.50% | 2.50% |
Source; CSS Investments Ltd
Using the optimisation solution it is possible to derive the following portfolios that alter the weights to optimise returns and/ or minimise risks.
To conclude therefore B) the optimal portfolio – in effect a 2 asset portfolio probably does not offer the asset diversity, but would have a theoretical higher return 0.87% for only modestly higher risk 4.004%.
The data proves the point often made by the index tracking fraternity that a good tracker fund (Bankers) can do the same job as holding a portfolio of individual stocks.
Portfolio Particulars – individual equities details
Aviva (AV.) BUY
Aviva is UK 100 listed life assurer/ fund manager/ savings/ pensions/ healthcare assurance specialist. The Sept-Oct 2014 sell off has brought Aviva back close to MCEV (488p)
Company | Aviva |
Share Price | 489 |
Target Price | 550 |
52 Wk Hi/Low | 535/412 |
Shares O/S | 2.948bn |
Market Capitalisation | £14.4bn |
Avg Daily Volume | 4.27m |
Dividend Yield | 3.20% |
Source; Fidessa plc
Key Risks to Price Target
i) Aviva is subject to changes in pension market legislation in the UK and overseas
ii) Sensitive to capital market events which may impact Aviva’s capital surplus of £8bn
iii) Subject to insurance market claims risks and in particular weather related risks.
Please note the risk warnings and disclaimers on the last page of this document.
Bankers Trust (BNKR) BUY
The Bankers Investment Trust is a UK 250 listed investment trust run by Henderson Group, itself a UK 250 fund management co. An in depth report on Bankers Investment Trust was written on 9th October 2014 and is available on www.css-investments.com.
Company | Bankers Trust |
Share Price | 527 |
Target Price | 600 |
52 Wk Hi/Low | 595/519 |
Shares O/S | 112.1m |
Market Capitalisation | £590.8m |
Avg Daily Volume | 83.2k |
Dividend Yield | 2.80% |
Source; Fidessa plc
Key Risks to Price Target
i) Bankers Investment Trust is subject to equity market related risk factors
ii) Sensitive to movements in net asset value in accordance with AIC formula
iii) Bankers Trust investment track record may change / charges may change.
BP (BP.) BUY
BP recent weak newsflow, Rosneft, US Dept of Justice, lower oil prices during Q3/Q4 and knocked an improving story on E&P and shareholder returns. As the divestment phase winds down, we expect increased share buybacks /QTR dividends and improving clarity on liabilities.
Company | BP |
Share Price | 425 |
Target Price | 500 |
52 Wk Hi/Low | 524/416 |
Shares O/S | 18.32bn |
Market Capitalisation | £77.85bn |
Avg Daily Volume | 56.5m |
Dividend Yield | 5.60% |
Source; Fidessa plc
Key Risks to Price Target
i) BP faces unknown final liabilities ref the US Dept of Justice/ Macondo spill that could reach in excess of $18bn.
ii) BP reserves and income statement are sensitive to its holdings of 19.75% of Rosneft a Russian oil major- BP is likely to be impacted by US sanctions on Russia.
iii) Subject to oil market related risks, oil prices, royalty and tax regimes, nationalisation and seizure of oil assets in some countries and risks related to exploration and production.
Carnival (CCL) BUY
Carnival Corp is a cruise line owner operator with brands, Carnival, Princess, Holland America, Cunard, AIDA, Costa, Ibero Cruises, P&O Cruises.
Company | Carnival Corp |
Share Price | 2180 |
Target Price | 2400 |
52 Wk Hi/Low | £26/ £20.60 |
Shares O/S | 216m |
Market Capitalisation | £4.7bn |
Avg Daily Volume | 912k |
Dividend Yield | 2.75% |
Source; Fidessa plc
Key Risks to Price Target
i) Carnival’s cruise liners are high maintenance assets with high rates of depreciation and impairment.
ii) Carnival suffered reputational loss after the Costa Concordia disaster which entailed loss of life
iii) Carnival is sensitive to US discretionary spending trends, the ageing demographic and fuel
Portfolio Particulars – individual equities details
GSK (GSK) BUY
GSK is a leading global pharmaceutical company specialising in oncology, HIV, respiratory, cardiovascular, vaccine and consumer goods.
Company | GSK |
Share Price | 1336 |
Target Price | 1600 |
52 Wk Hi/Low | 1690/1324 |
Shares O/S | 4.85bn |
Market Capitalisation | £64.79bn |
Avg Daily Volume | 6.1m |
Dividend Yield | 6.04% |
Source; Fidessa plc
Key Risks to Price Target
iii) GSK asset swap with Novartis could be subject to regulatory restrictions.
HSBC (HSBC) BUY
HSBC is a top financial institution, headquartered in the UK with its core businesses in the UK and Hong Kong.
Company | HSBC |
Share Price | 619 |
Target Price | 700 |
52 Wk Hi/Low | 703/589 |
Shares O/S | 19.18bn |
Market Capitalisation | 118.7bn |
Avg Daily Volume | 18.5m |
Dividend Yield | 4.79% |
Source; Fidessa plc
Key Risks to Price Target
i) HSBC core franchise in Hong Kong could be impacted by significant popular unrest directed against the China installed government.
ii) Risks include litigation and fines stemming from HSBC’s ownership of the Household franchise in the USA, PPI mis-selling and capital markets activities including LIBOR.
iii) HSBC withdrawal from smaller countries and repositioning is underway but will result in a smaller global footprint.
Unilever (ULVR) BUY
Unilever is a leading consumer goods company operating in personal care, foods, refreshment and home care. Unilever brands include Hellmanns, Flora, Ben & Jerry, Magnum and Persil.
Company | Unilever |
Share Price | 2465 |
Target Price | 2700 |
52 Wk Hi/Low | 2729/2306 |
Shares O/S | 1.283bn |
Market Capitalisation | 31.65bn |
Avg Daily Volume | 2.22m |
Dividend Yield | 3.72% |
Source; Fidessa plc
Key Risks to Price Target
i) Unilever €2.5bn pension liability is sensitive to movements in discount rates.
ii) Unilever trading performance is sensitive to competitive, supply chain and demand factors.
iii) Unilever is seeing debt levels rise, due to higher capital spending / promotional activity.
Vodafone(VOD) BUY
Vodafone is a leading telecommunications group with significant presence in EU, Middle East, Africa and Asia Pacific.
Company | Vodafone |
Share Price | 187 |
Target Price | 220 |
52 Wk Hi/Low | 252/184 |
Shares O/S | 26.5bn |
Market Capitalisation | 49.58bn |
Avg Daily Volume | 52.5m |
Dividend Yield | 5.96% |
Source; Fidessa plc
Key Risks to Price Target
i) The slowdown in large EU economies is likely to impact Vodafone’s EU operations and increase competitive pressures.
ii) Vodafone remains overexposed to voice communications and needs to increase its revenues from data services
iii) Vodafone valuation is sensitive to perceptions of the company as an acquisition target.