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Natural Diversification via the balance sheet

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:-

  1. As the holders age increases; illiquid portfolio assets such as pensions are a higher proportion of the portfolio assets.
  2. Portfolio assets tend to be in the range of 20%-30% of total assets over the holder age groups (unless the holder sells his home and rents!)
  3. The holder of an illiquid portfolio ie pensions may have more/less control over it.
  4. The hypothetical individual has quite a lot of “natural” asset diversity via property and pensions that arguably he can do little about in the short-term.

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%).

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.

  1. Equal weight – the portfolio (A) delivers monthly return of 0.532% with a standard deviation ie risk of 3.659%. This is the easiest to understand result.
  2. In B the aim is to maximise portfolio return (σρ) but with the minimum level of risk- this means the constraint is set at 4.004% the lowest standard deviation in the portfolio (Unilever). This triggers some substantial changes to the weightings but a higher return of 0.87%. This portfolio becomes a two asset portfolio of Bankers Trust (64.51%) and Unilever (35.49%)
  3. Arguably the least interesting – if you want to maximise returns the idea would be to have 100% Unilever – this is not recommended.
  4. Mirrors A and returns an equally weighted portfolio.

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

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 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 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


  1. i) GSK business risks include concentration on the performance of key drugs and litigation risks.


  1. ii) GSK recent sales performance has been weak with sales declines in its major territories.


iii) GSK asset swap with Novartis could be subject to regulatory restrictions.


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.

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