Beta Management Company Case Study

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Table 3. Data calculated for each potential portfolio

IV. Analysis

After completing the calculation for the different stocks and the portfolio we looked at four concepts to compare the results obtained and select the better portfolio.

Concept 1 – Portfolio Return

The return of the portfolio after including 1% of REIT or 1% of Brown came out to be approximately the same. The expected return is calculated using CAPM. In that sense there is no preference in selecting one stock versus the other.

Concept 2 – Individual Stock Risk

Looking at the total risk of each stock we find that REIT has a higher Standard Deviation of 9.23% compared to Brown which is 8.17%. After combining the stocks with index in the percentages shown, we got a standard deviation for index-REIT of 4.57% and for index-Brown of 4.61%. So even that REIT has a higher standard deviation alone, we got a lower standard deviation when combined with the index. This is due to the fact that REIT correlation with the index is much lower than Brown correlation with the index. In that sense, Sarah should select the REIT to include in her portfolio since the total risk will be lower for the same return.

Concept 3- Individual Stock Correlation with the market

Looking at the correlation with the market, we got a value for the covariance of 0.0003 for REIT and 0.0024 for Brown. Hence Brown stock is much more correlated with the market than the REIT stock. Hence adding the Brown stock will not introduce much benefit for the portfolio and would be as if we invested the money in the index itself. In that sense, REIT stock should be selected.

Concept 4 – Individual stock Beta

Again as we see from table 3, Beta of Brow is 1.163 which is very close to the market beta of 1. While REIT beta is 0.147 and hence provide so immunity against market risk since it is not greatly affected by market downturns (beta much less than 1). So in that sense also the manager of the portfolio should go with REIT stock.

V. Conclusion

As a final conclusion, we see that the portfolio manaer should introduce the REIT stock to her portfolio.