Equity portfolio management : a practical approach

Abstract

In this paper I will explain some of the pricing models of capital assets which try to explain financial assets behaviour, the more relevant ones, studied previously in “valuation of financial instruments”. These are: Markowitz model, Sharpe diagonal model, Capital Asset Pricing Model (CAPM), Arbitrage Valuation Model (APT) and the three factor model by Fama-French one of the latest in finance literature which is as APT a multifactor model. In the analysis I will include: birth of theories, hypothesis, planning and development and reviews of each of the models exposed trying to contrast them with the latest available models used by the Academia and professionals and describing their limitations. I will deeply explain them and compute some basic parameters for each model with Excel such as portfolio return, variance, covariance, correlation coefficient, CML in the case of Markowitz, SML in the case of the CAPM model comparing each portfolio against a benchmark, mainly the reference index for the stocks (IBEX, S&P500, etc.) to obtain some concussions and to see whether it is possible through an active strategy in the management of portfolios to beat the market or is just a chimera and we should just conform with passive management strategies such as buying ETF´s which replicates the stock market behaviour. Moreover, I will see the benefits or not of an active portfolio strategy in contrast to a passive one, in my research I will consider mainly two type of financial assets: European equities and American equities, benefiting of the recovery of this economic regions and the better business results that are experiencing many well diversified companies, leaving aside emerging market ones considered not suitable for the risk profile of my investors. The reason for this is that I will set up a fund consisting of two funds available mainly for value investors that want to invest their money and get a good return for their retirement plan, investing in companies that are probably underperforming and are able to grow because fundamental analysis tells us so and their intrinsic value is higher than the one market is actually giving. I will provide empirical market data as if I were a fund/portfolio manager assessing, advising and giving information to my client’s which are investors.