Fundamental indexing for APLHA returns over conventional index funds enhanced NIFTY

Abstract

Fund managers have sought to enhance the returns of their index funds through different methods. Normal market capital indexation causes over weighting of over valued stocks and under weighting of undervalued stocks. The current project aims at developing a fundamental indexation model to enhance NIFTY returns. Fundamental Parameters Considered for the same are: Revenues, Net Income, Operating income, Operating Cash flow, Free Cash flow, Dividends paid, Total Shareholder equity and No of Employees. Weight of the stock in a portfolio is determined as the percentage contribution of the company to the total sum of the fundamental parameter value of the selected companies. Daily, weekly, monthly, quarter and annual returns of portfolios made from different fundamental parameters as well as composite score were calculated along with draw downs. Different scenarios were tried for rebalancing period (Daily-Weekly-MonthlyQuarterly- Annual), quarterly data consideration (Yes-No), different weights of all the fundamental parameters in determining the composite score and screening criteria. The returns summary with details of Sharpe Ratio (SR), Information ratio (IR), Compounded annual growth rate (return), Standard Deviation of return, End value of Rs I 00 invested(E V), Excess return over Index(Alpha), Transaction costs incurred throughout the period, Standard deviation of Alpha are analyzed. The results show that fundamental indices have higher returns with a slight increase in standard deviation with respect to NIFTY. The risk return profile of the portfolios is tested through Sharpe ratio and Treynor ratio. The annual drawdown details and trends indicate that dividends as portfolio sub performs in all indicators. An equally weighted composite portfolio has done better than few parameters but could be improved if the weights for superior parameters are weighted more in the composite portfolio. A recommended portfolio with composition of different parameters is developed by rating the parameters on different criteria and weighing them according to their total scores. A recommended portfolio is constructed with following weights for different parameters. Parameter Net Weight Revenues 1 1 .824% Income 9.01 8 % Op.lncome 1 1 .022% Operating Cash Flow 15.230% Free Cash Flow 1 6.633% Total Dividends 0.401 % Share Equity 1 9.238% No. Employees 1 6.633% The performance of recommended portfolio has improved over the equally weighted composite on all the criteria. Recommended portfolio is found to have weighted Oil and Finance higher while under weighing Software and Pharma as compared to benchmark. Significance tests are also done to test the robustness of the results. Fama decomposition also has revealed "Net selectivity" reinforcing the superiority of fundamental portfolios over NIFTY.