Markowitz Mantra

In Early June 2017, Meera Krishnan (MK) was in her office considering new goals
and directions for her company for the coming year. MK was the founder and
CFO of the Alpha Management Group, a small investment management company
based in a Mumbai suburb. She deals with a growing number of HNI individual
clients and had 30 crores rupees in assets under management. Alpha’s
investment success during the past year had brought in a steady stream of new
clients and additional money from existing clients. At the same time, MK had
inquiries from some small institutions, and was hoping to expand her business in
2017.

Alpha Management Company was founded in 2010. A wealthy couple had

become fed up with their investment losses stemming from the stock market
crash and had asked their friend MK, to manage a portion of their money. While
business was slow at first, she gradually developed a client base through good
performance and word of mouth. She considered herself a market strategist, and
Alpha Management’s stated goals were to enhance returns but reduce risks for
clients via market timing. Given the small size of her accounts, the easiest way for
her to maintain and adjust equity exposure was to invest in few selected stocks
for each client. She would keep a majority of Alpha fund invested in equity
market (with a rest of it in money market instruments), adjusting the level of
equity exposure between 50% and 99% of Alpha’s funds in an attempt to ‘time
the market’. She had tried with various methods of identifying equity stock for
investment.

While Alpha’s performance had lagged market returns in 2015, MK had been
quiet successful in 2016. She had reduced Alpha’s equity position to 50% in mid
2016, partially missing a large two-month market decline. After nervously
waiting for two months, she began moving money back into the equity market.
The report in front of her showed that as of Jan 2017, Alpha management had
80% of its AUM invested in equity market; Alpha had also made money for its
clients during a down market year.

This success had brought in enough new money to double the size of Alpha in
less than six months, allowing MK to finally make the move to work full-time
managing money. But she had lost some potential new clients who had thought
that its unusual that Alpha Management tried to time the market and it was not
using any stock selection skills. MK had felt this same resistance in conversations
with a few of the potential institutional clients she was courting. As result, one of
her New Year’s resolutions had been to begin looking at some undervalued
individual stock for possible purchase for Alpha Equity portfolio. She would
focus on familiar stocks, since she didn’t want to compete with larger, analyst-
staffed funds on their own turf. She also decided to increase the proportion of
Alpha’s assets in equities, since she felt the market was still a good value and that
2017 would be a good year.

As a first step towards both of these goals, MK was considering immediately

increasing her equity exposure to 80% for a new client by purchasing of any of
five stocks recommended by her newly hired analyst. The companies are BSE-
listed companies whose stock price had eroded below their intrinsic value over a
period of time to levels that seemed unreasonably low. She tried doing some
back test to understand how these five stocks would have resulted as
investments, if she stayed invested in them during the past three years. The
Exhibit 1 provides a brief details about these candidate stocks. The monthly
closing prices of the candidate stocks are given in Exhibit 2. The Exhibit 3
provides the efficient frontier (constructed using 5 stocks) and extreme
portfolios’ annualized return and risk.

MK felt that now was the right time to begin her program of adding more
individual stock investments and increasing her equity position. A Rs. 5 Crore
investment in these five stocks would increase her total equity exposure to about
Rs. 22 Crores. Still, she had some doubts. She was quite worried about the
variability in individual stocks in general, and these stocks in particular, After all,
she had always promised her clients reasonable returns with a focus on keeping
their exposure to risk under control. She noticed that some of these stocks
seemed to bounce around in price much more than the market, and she
wondered if she was doing the right thing exposing her clients to these new
risks.
Exhibit 1: Brief Details about Candidates Company

Infosys
Provides business consulting, information technology and outsourcing services.
It’s the second largest Indian IT services company. On Jan 12, 2017, its market
capitalization was $34.38 billion. This NYSE listed company had about 1,045
client across 50 countries. It provides software development, maintenance and
independent validation services to companies in banking, finance, insurance,
manufacturing and other domains. One of its known product is Finacle, which is
a universal banking solution with various modules for retail and corporate
banking. Infosys has a total of 193,383 employees as of 15 Jan 2016, of which
35% were women.

RIL

Biocon
This company manufactures generic active pharmaceutical ingredients (APIs)
that are sold in the developed markets of US and Europe. It also manufactures
biosimilar insulins, which are sold in India as branded formulations and in both
bulk and formulation forms. Biocon has two subsidiaries – Syngene, a custom
research organization, and Clinigene, a clinical research organization. Biocon’s
presence straddle four main therapeutic areas – Diabetology, Cardiology,
Nephrology, and Oncology – and plans to introduce two new divisions,
Comprehensive Care, and Immunotheraphy. During 2005 and 2010, Biocon
entered into more than 2,200 high-value R&D licensing. It employs about 4,500
personnel.

State Bank of India

Its an Indian multinational, public sector banking and financials services
company. It has about 278,000 employees, 420 million customers, and more than
24,000 branches and 59,000 ATMs. It has 198 offices in 37 countries; 301
correspondents in 72 countries. SBI has about 20% market share in deposits and
loans among Indian commercial banks.

Tata Steel
Exhibit 2: Monthly Closing Stock Prices

Infosys Ltd
Industry : Computers - Software - Large

Open High Low Close

Date -Unit Curr -Unit Curr -Unit Curr -Unit Curr Volume
201706 969 988.7 923.05 943.35 4,998,333.00
201705 924.8 1,000.00 915.65 976.95 6,347,010.00
201704 1,027.10 1,030.50 910.4 919.4 4,931,308.00
201703 1,014.60 1,043.95 999 1,020.80 3,299,425.00
201702 921.9 1,028.10 906 1,012.30 6,096,919.00
201701 1,012.00 1,045.00 905 929.3 7,841,706.00
201612 976 1,020.95 957.9 1,010.70 3,696,839.00
201611 1,009.85 1,009.85 900.3 975.45 4,382,558.00
201610 1,038.10 1,080.70 994 1,002.50 4,603,095.00
201609 1,036.00 1,068.65 1,024.00 1,038.10 6,188,665.00
201608 1,074.00 1,094.00 1,009.20 1,036.80 5,318,517.00
201607 1,180.00 1,195.05 1,056.00 1,073.95 9,618,741.00
201606 1,241.00 1,278.00 1,156.00 1,170.75 3,533,314.00
201605 1,214.00 1,270.00 1,171.55 1,249.85 2,460,696.00
201604 1,212.00 1,267.90 1,151.40 1,210.85 9,720,735.00
201603 1,098.00 1,234.65 1,089.00 1,217.95 3,844,043.00
201602 1,170.00 1,193.60 1,067.00 1,083.75 4,550,793.00
201601 1,100.00 1,169.70 1,031.85 1,164.85 4,656,171.00
201512 1,088.50 1,110.00 1,023.50 1,104.55 3,107,839.00
201511 1,130.00 1,155.60 1,012.25 1,088.45 2,840,405.00
201510 1,169.90 1,219.00 1,087.10 1,136.05 4,661,304.00
201509 1,089.95 1,165.35 1,052.35 1,160.45 2,954,461.00
201508 1,080.00 1,186.00 1,045.00 1,095.20 4,063,176.00
201507 990 1,127.75 932.55 1,078.05 5,187,880.00
201506 1,015.00 1,031.50 968.5 985.35 3,660,511.00
201505 980.5 1,030.50 955 1,011.20 4,304,606.00
201504 1,104.70 1,122.00 966.33 971.2 4,363,097.00
201503 1,150.00 1,156.75 1,065.00 1,108.30 2,303,093.00
201502 1,070.00 1,167.60 1,051.53 1,147.43 1,851,141.00
201501 983.9 1,111.00 957.05 1,071.38 5,027,583.00
201412 1,097.00 1,100.25 949 985.6 7,823,318.00
201411 1,018.75 1,099.75 1,008.70 1,089.81 1,082,469.00
201410 937.5 1,017.50 900 1,012.86 2,013,556.00
Exhibit 3: Efficient Frontier and Extreme Portfolio