Preparation of Project Report

Preparation of Project Report

Preparation of Project Report

View more presentations from Sunny Sabharwal.

Measuring Sector Performance

Periodically investment managers and investors take a stock of performance of various sectors. Objective is to find out which sector(s) have been the best performers (those which provided returns i.e. increased in value, above what the market did) and worst performers.

A convenient way of measuring performance of a particular sector could be using the sectoral indices provided by NSE or BSE. I have used NSE indices for the analysis. For gauging market performance, one can look at the broad market index like NIFTY.

This analysis tells us how much each sector has risen/fallen vis-à-vis the market. Then, a fund manager digs into the facts that why a particular sector outperformed/underperformed the market. Was it because of the fundamentals or bullish/bearish opinion of the investors? In the first case, fund manager may accept the respective rise/fall in the sector. However, in second case, the fund manager can see an opportunity to invest in companies in underperformed sectors and liquidate companies in outperformed sectors.

Following graph depicts the performance of various sectoral indices maintained by NSE. The graph shows performance from 01-Sep-08 to 18-Sep-09.

Let us now try to figure out the performance of various sectors.
The above graph tells us that Realty has been the worst hit sector despite the ongoing rally. The reasons could be bleak demand, pressure of borrowings, and still not-so-positive consumer confidence due to poor job market.

Banking sector has been a sure-shot winner with PSU banks enjoying a whopping rise of 51% and overall index of banks witnessing a performance of 37%. This could be attributable to the unjustified/excessive thrashing which these banks bore when everyday a US bank was going burst. With no such case being witnessed in India, investors have reposited their confidence back. Also, the expectation of rising of policy rates like CRR, repo rate, etc. in future, from their 10-year lows, can be looked at as an indicator of better results in banking and financing sector.

The fall of IT sector during 2008 was taken by some investors as justified with the view that recessionary business conditions in US and other developed countries will lead to diminished outsourcing business of Indian IT companies. Again, the fall was felt unjustified by some investors who grabbed the opportunity and did value-investing. Hence we observe a return of 27% in just over a year.

Infra has been one of the most talked about sectors in India, especially in the past two years. Reasons could be – Commonwealth Games 2010, widespread unemployment due to diminished business activities in slowdown, poor-to-late monsoon, agenda of the once-again elected Congress government, China’s drive in infra development, etc. Companies included in this index are - ABB, BHEL, Bharti, DLF, GMR, IVRCL, Idea, Indian Hotels Co. Ltd., Jaiprakash, Jet Airways, L&T., MTNL, NTPC, Reliance Communications, Reliance Infrastructure, Reliance Power, Siemens, Suzlon, Tata Communications, Tata Power, Unitech.

A periodic analysis of sectors helps us in finding out which sectors were given a treat by the market and which were hit badly. For a value investor, this is fishing time as it might be that some stocks in the second case fell unnecessarily. Such stocks can provide opportunity to earn above market return in a small duration. But now we are talking only on base of fundamentals. So be careful.

Update on Pairs Strategy article

It has been a great bull rally since I wrote the article on pair strategy. The nifty has risen from 4387.90 on 17 aug 09 to 5020.20 on 22 sep 09, an increase of 14% in a matter of 5 weeks. Though we discussed in the article that this strategy is not ideal for bull or bear markets but can be optimally used in volatile sessions, it might not be a bad idea to check the performance.

I wanted to see if the strategy actually works and so compared the prices of IDEA and RCOM. The closing price on 24 sep 09 of both the stocks were Rs. 76.95 and Rs. 305 respectively. The ratio of prices of the two works out to 4.01 which is within our maximum limit of 4.71.

The closing prices tell us that IDEA has seen a fall of about 4%. My view was that "IDEA is overpriced and needs a revision of Rs. 10 (the corrected price should be Rs. 69)". For RCOM, stock has risen by ~ 25%. Regarding this I said "RCOM is under priced by Rs.37, making it a buy with target price of Rs. 282".

Since the strategy was based on only past relation among prices of two stocks, I admit that it is a coincidence that the stocks behaved much like we assumed them to be. But similar analysis and actions based thereon could be a strategy that even a retail investor can venture with.

Pairs making money

No No. We are not talking about some couple making money. Here we will discuss about making bucks through “pair-trading” strategies. This strategy is adopted by those keen on generating absolute returns through the equity market but are wary of market risk – Hedge Funds, Institutional players, FIIs, HNIs and some individuals (maybe you can count me also, once I learnt much about it).

Honestly speaking, I do not believe in such strategies which have no fundamental reasoning behind them. What they have is just a belief that future prices of stocks have relationship with their past prices or other stocks. Being a true Grahameeze and Buffetian, I should not even look at such theories. In his historic book “The Intelligent Investor”, Graham says “The one principle that applies to nearly all these so-called “technical approaches” is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success on Wall Street. In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus “following the market.” We do not hesitate to declare that this approach is as fallacious as it is popular.”

But being a rational investor, who is open to new ideas, I am exploring whether such strategy can provide me a good return (above 10% in a matter of months) on my risk capital. In the same book mentioned above, Graham explains what an investor can do with the risk capital “Speculation is always fascinating, and it can be a lot of fun while you are ahead of the game. If you want to try your luck at it, put aside a portion— the smaller the better—of your capital in a separate fund for this purpose.”

In most simple terms, pair trading is –

• identifying a pair (of two stocks; or an index and a stock; or similar combination), which has in past shown some relationship in their price movements;
• assessing any mispricing if market has made to any or both of them, in relation to the above;
• finally, making trades based on such anomaly

I think example should help us get more clarity.

Let us take IDEA & RCOM as out two stocks whose part price ratios we will study and use for trading. Past closing prices of the two stocks are shown in the table below.

Data from NSE website

Date	IDEA*	RCOM*	Price Ratio
06-Apr-09	53	218	4.09
08-Apr-09	55	214	3.88
09-Apr-09	55	212	3.84
13-Apr-09	55	219	3.98
15-Apr-09	57	230	4.03
16-Apr-09	53	218	4.12
17-Apr-09	54	218	4.04
20-Apr-09	56	216	3.86
21-Apr-09	58	219	3.74
22-Apr-09	57	214	3.76
23-Apr-09	58	224	3.86
24-Apr-09	61	232	3.84
27-Apr-09	60	224	3.75
28-Apr-09	59	208	3.55
29-Apr-09	58	215	3.70
04-May-09	63	229	3.66
05-May-09	61	237	3.86
06-May-09	60	235	3.94
07-May-09	60	240	3.99
08-May-09	59	230	3.89
11-May-09	58	219	3.81
12-May-09	61	228	3.74
13-May-09	60	223	3.73
14-May-09	60	225	3.72
15-May-09	65	233	3.57
18-May-09	76	290	3.82
19-May-09	76	316	4.19
20-May-09	73	309	4.26
21-May-09	69	324	4.71
22-May-09	71	316	4.43
25-May-09	73	322	4.41
26-May-09	70	291	4.15
27-May-09	79	304	3.86
28-May-09	79	298	3.77
29-May-09	84	306	3.63
01-Jun-09	82	321	3.90
02-Jun-09	81	320	3.97
03-Jun-09	81	333	4.10
04-Jun-09	82	343	4.19
05-Jun-09	83	340	4.10
08-Jun-09	78	309	3.96
09-Jun-09	83	333	4.03
10-Jun-09	83	350	4.24
11-Jun-09	87	347	3.99
12-Jun-09	83	332	3.99
15-Jun-09	83	319	3.85
16-Jun-09	86	328	3.80
17-Jun-09	81	309	3.82
18-Jun-09	78	299	3.83
19-Jun-09	80	305	3.80
22-Jun-09	79	296	3.76
23-Jun-09	78	296	3.78
24-Jun-09	82	302	3.70
25-Jun-09	79	300	3.78
26-Jun-09	80	312	3.93
29-Jun-09	78	307	3.96
30-Jun-09	71	289	4.06
01-Jul-09	74	299	4.02
02-Jul-09	74	293	3.95
03-Jul-09	74	293	3.93
06-Jul-09	69	269	3.88
07-Jul-09	73	264	3.64
08-Jul-09	69	255	3.67
09-Jul-09	70	256	3.67
10-Jul-09	68	243	3.59
13-Jul-09	65	237	3.63
14-Jul-09	68	249	3.65
15-Jul-09	73	262	3.58
16-Jul-09	72	270	3.77
17-Jul-09	74	273	3.69
20-Jul-09	75	270	3.59
21-Jul-09	76	268	3.52
22-Jul-09	75	262	3.51
23-Jul-09	78	275	3.52
24-Jul-09	82	276	3.39
27-Jul-09	80	282	3.53
28-Jul-09	78	291	3.73
29-Jul-09	76	283	3.72
30-Jul-09	76	282	3.71
31-Jul-09	79	276	3.49
03-Aug-09	80	290	3.64
04-Aug-09	79	282	3.59
05-Aug-09	78	280	3.59
06-Aug-09	76	270	3.55
07-Aug-09	73	255	3.49
10-Aug-09	74	252	3.42
11-Aug-09	75	253	3.39
12-Aug-09	76	256	3.39
13-Aug-09	78	265	3.39
14-Aug-09	78	259	3.31
17-Aug-09	77	245	3.39

* Figures have been rounded off

Using the above data and doing some basic calculations, one can obtain the following information:

	IDEA*	RCOM*	Price Ratio
As on Aug 17 ‘09	79	245	3.10	-	-
	AVERAGE			MIN	MAX
90 days	72	273	3.81	3.31	4.71
60 days	77	290	3.76	3.31	4.41
45 days	76	279	3.67	3.31	4.06
30 days	75	267	3.57	3.31	3.88

* Figures have been rounded off for simplicity

The price ratio (RCOM/IDEA) has been in the range of 3.31 to 4.71 during a 90 days period. But based on closing price of August 17, 2009, the price ratio is 3.10. Taking the minimum past price average (during 90 days and 30 days periods) is 3.57 and current ratio is 3.10, which means that either - IDEA is overpriced and needs a revision of Rs. 10 (the corrected price should be Rs. 69) - or RCOM is underpriced by Rs.37, making it a buy with target price of Rs. 282.

Hence, based on the above statistical relation between the two stocks, I should buy RCOM with a target of Rs. 282 and sell IDEA with a target of Rs. 37.

Another variant of pair trading is through fundamental analysis. After careful and thorough analysis, an analyst gives an overvalued rating to Stock A and undervalued rating to Stock B. Using this strategy, he will go short (i.e. sell) on A and long (buy) on B.

But if a strategy has only a few calculations, why is it not being followed by all mathematicians and every trader and investor for that matter? Let us try to guess the obvious reasons. First, what if the empirical relation was just a coincidence and nothing else i.e. there was no relation as such among the two stock prices. Second, what if the market acted otherwise. Market Gurus say that this strategy is best suited for markets which move sideways, and not in an uptrend and downtrend. Reason? We are betting that one stock will go up and other down. In an uptrend it is quite possible that both stocks ride the price charts and reverse is also probable in a downtrend.