TABLE OF CONTENTS

1. Introduction.2
Scope...3
Research Methodology.4
2. Review of Literature......................................................................5
Types of Risk..5
Factors Affecting Risk Profile...7
Risk Profiling...8
3. Risk Profile Segmentation.10
Recommended Asset Allocation14
4. Analysis of Questionnaire Response.15
Risk Profile segmentation by analysis variables.15
5. Portfolio Construction21
Modern Portfolio Theory.21
Investment Risk Pyramid23
Portfolio Construction..27
Comparison of Index Funds...34
6. Findings and Limitations of Study..35
7. Annexure38
Questionnaire38
8. Bibliography..44

INTRODUCTION
Footwear is the product to protect human feet from effects of all biological damages.
Footwear industry is age old traditional industry in India and it has been changed
structurally into different segments like casual-wears, dress-wears and sportswear. New
segment is emerging for medical purposes as medical-wear like diabetic footwear. Many
companies use to concentrate different segment like mens-wear, womens-wear and
childrens-wear separately. Footwear industry has been giving considerable amount of
employment to the nation especially weaker sections and minority sections of society in
India. Population growth, exports, domestic markets are the factors of expansion of
footwear industry and creation of employment opportunities in this sector. This case
study reveals the production capacities, structure of industry, exports growth, global
imports, per capita consumption and estimates of future requirements of human
resources in footwear industry in India.

CONCENTRATION OF FOOTWEAR INDUSTRY IN INDIA: The major production of

footwear manufacturing concentrated in these centers.

Tamil Nadu - Chennai, Ambur, Ranipet, Vaniyambadi, Trichy, Dindigul

Maharashtra Mumbai

West Bengal Kolkata

Uttar Pradesh - Kanpur, Agra & Noida

Punjab Jalandhar, Ludhiana

Karnataka Bangalore

Andhra Pradesh Hyderabad

Haryana - Ambala, Gurgaon, Panchkula and Karnal

2

Delhi and Surroundings

MICRO, SMALL & MEDIUM ENTERPRISES IN INDIAN FOOTWEAR SECTOR

According to Micro, Small & Medium Enterprises, Government of India estimates that
there are 20463 units registered as working enterprises, with employment of 97,741
people, with the net worth of Rs. 3993.99 crores in micro, small & medium enterprises in
India. These units are having Rs.737.17 crores in Plant and Machinery investment and
Rs.2324,94 crores in fixed assets and Gross output of Rs.6008.77 crores. All these
units are manufacturing all kinds of footwear like leather, non-leather and other types of
footwear. These units had the 1.31 percentage in the total Indian units of 1563974
(100%) in micro, small & medium enterprises in India. [1]

PRODUCTION CAPACITIES OF INDIAN LEATHER INDUSTRY: As per Council for

Leather Exports, Chennai estimates, India produces 2065 million pairs of different
categories of footwear (leather footwear - 909 million pairs, leather shoe uppers - 100
million pairs and non-leather footwear - 1056 million pairs). India exports about 115
million pairs. Thus, nearly 95% of its production goes to meet its own domestic demand.
[2]

Leather shoes and uppers are manufactured in medium to large-scale units and the
sandals and chapels are manufactured in the household and cottage sector. The
industry is poised for adopting the modern and state-of-the-art technology to suit the
exacting international requirements and standards. India produces more of gents
footwear while the worlds major production is in ladies footwear. In the case of chapels
and sandals, use of non-leather material is prevalent in the domestic market.

PER CAPITA CONSUMPTION

Some estimates available for population growth and per capita footwear consumption
and there is a significant rise from 1.65 in 2008 to 1.87 in 2011 and again to 2.19 in
2013. [3]

FOOTWEAR PRICING SEGMENTS

4

Mass Market Target price of Rs.185-700 is dominated by Bata and Liberty

Economy Market - Target price of Rs.700-1000 is dominated again by Bata and Liberty
Sports Market - Target price of Rs.1000-3000 is dominated by international brands
Nike, Adidas
Premium Leather Market - Target price of Rs.3000-5000 is dominated by different
brands
Luxury Market - Target price of Rs. 10,000 50,000 is dominated by GUCCI, Louis
Vuitton, etc.

Scope
This is a study for understanding the risk profile of the investors and portfolio
construction.
1) The main objectives of this research are to estimate the risk aversion and classify the
investors into different risk categories and study their profile.

Sub-Objectives
Identify the type of risks.
Identify the main factors / attributes in customer's profile which determine the risk
taking ability.
Classify the investor's into risk segments.
Compare the investment done by individuals vs recommended as per their
profile.
Recommend Asset Allocation.

Hypothesis
Investors Risk profile depends on various demographic factors and which in turns
determine the structure of the portfolio. The hypotheses are as follows H0: There is no relationship between investors portfolio and risk-tolerance.
5

H1: There is no relationship between investor's portfolio and risk-tolerance.

Research Methodology
The report has been compiled on the basis of secondary data sources from books and
literature. internet websites like NSE, BSE and investopedia.com etc. for risk profile,
segmentation etc.
Risk Profiler, investment portfolios management, modern portfolio theory etc. have been
collected from the information like EBSCO, Google Scholar available on the internet
validated from various recognized websites like NSE, SEBI, BSE, Investopedia.

Technical books have been studied along with many research papers on the subject
from EBSCO and Google Scholar.

Steps followed for the research work on the project work are as follows:
1) Review of earlier research papers on risk profiling and segmenting the customers
based on risk profile.
2) Design of questionnaire for assessing the risk profile of the individuals.
3) Design questionnaire to capture the investment details for individual in percentage
terms (as people are not comfortable sharing the absolute investment numbers.
4) Compare the current asset allocation with the recommended asset allocation for the
investors.
5) Recommend portfolio combinations of various asset for the user based on mutual
funds, index funds, debt funds and retirement funds.
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REVIEW OF LITERATURE
Types of Risks
Investment risks can be of following types

Systematic Risk - Systematic risk influences a large number of assets. A

significant political event, for example, could affect several of the assets in your
portfolio. It is virtually impossible to protect yourself against this type of risk.

Unsystematic Risk - Unsystematic risk is sometimes referred to as "specific

risk". This kind of risk affects a very small number of assets. An example is news that
affects a specific stock such as a sudden strike by employees.

Now that we've determined the fundamental types of risk, let's look at more
specific types of risk, particularly when we talk about stocks and bonds.

Credit or Default Risk - Credit risk is the risk that a company or individual will be
unable to pay the contractual interest or principal on its debt obligations. This type of
risk is of particular concern to investors who hold bonds in their portfolios. Government
bonds have the least amount of default risk and the lowest returns, while corporate
bonds tend to have the highest amount of default risk but also higher interest rates.
Bonds with a lower chance of default are considered to be investment grade, while
bonds with higher chances are considered to be junk bonds. Bond rating services, such
as Moody's, allows investors to determine which bonds are investment-grade, and
which bonds are junk.

Country Risk - Country risk refers to the risk that a country won't be able to honor its
financial commitments. When a country defaults on its obligations, this can harm the
performance of all other financial instruments in that country as well as other countries it
has relations with. Country risk applies to stocks, bonds, mutual funds, options and

futures that are issued within a particular country. This type of risk is most often seen in
emerging markets or countries that have a severe deficit.

Foreign-Exchange Risk - When investing in foreign countries you must consider the
fact that currency exchange rates can change the price of the asset as well. Foreignexchange risk applies to all financial instruments that are in a currency other than your
domestic currency.

Interest Rate Risk - Interest rate risk is the possibility that a fixed-rate debt instrument
will decline in value as a result of a rise in interest rates. Whenever investors buy
securities that offer a fixed rate of return, they are exposing themselves to interest rate
risk. This is true for bonds and also for preferred stocks.

Taxability Risk - This applies to municipal bond offerings, and refers to the risk that a
security that was issued with tax-exempt status could potentially lose that status prior to
maturity. Since municipal bonds carry a lower interest rate than fully taxable bonds, the
bond holders would end up with a lower after-tax yield than originally planned.

Call Risk - Call risk is specific to bond issues and refers to the possibility that a debt
security will be called prior to maturity. Call risk usually goes hand in hand with
reinvestment risk, discussed below, because the bondholder must find an investment
that provides the same level of income for equal risk. Call risk is most prevalent when
interest rates are falling, as companies trying to save money will usually redeem bond
issues with higher coupons and replace them on the bond market with issues with lower
interest rates. In a declining interest rate environment, the investor is usually forced to
take on more risk in order to replace the same income stream.

Inflationary Risk - Also known as purchasing power risk, inflationary risk is the chance
that the value of an asset or income will be eroded as inflation shrinks the value of a
country's currency. Put another way, it is the risk that future inflation will cause the
purchasing power of cash flow from an investment to decline. The best way to fight this
type of risk is through appreciable investments, such as stocks or convertible bonds,
which have a growth component that stays ahead of inflation over the long term.

Liquidity Risk - Liquidity risk refers to the possibility that an investor may not be able to
buy or sell an investment as and when desired or in sufficient quantities because
opportunities are limited. A good example of liquidity risk is selling real estate. In most
cases, it will be difficult to sell a property at any given moment should the need arise,
unlike government securities or blue chip stocks.

Reinvestment Risk - In a declining interest rate environment, bondholders who

have bonds coming due or being called face the difficult task of investing the
proceeds in bond issues with equal or greater interest rates than the redeemed
bonds. As a result, they are often forced to purchase securities that do not
provide the same level of income, unless they take on more credit or market risk
and buy bonds with lower credit ratings. This situation is known as reinvestment
risk: it is the risk that falling interest rates will lead to a decline in cash flow from
an investment when its principal and interest payments are reinvested at lower
rates.

Social/Political / legislative Risk - Risk associated with the possibility of

nationalization, unfavorable government action or social changes resulting in a
loss of value is called social or political risk. Because the U.S. Congress has the
power to change laws affecting securities, any ruling that results in adverse
consequences is also known as legislative risk.

Factors Affecting Risk Profile

According to numerous research done on factors affecting the risk profile of an investor.
The following are most important characteristics.
(a) Males are more risk tolerant than females.
(b) Younger individuals are more risk tolerant than older individuals.
(c) Single individuals are more risk tolerant than married individuals.
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(d) Individuals employed in professional occupations are more risk tolerant than those
employed in non-professional occupations.
(e) Self-employed individuals are more risk tolerant than those employed by others.
(f) High income earners are more risk tolerant than lower income earners.
(g) Whites are more risk tolerant than non-Whites.
(h) Individuals with higher attained educational levels are more risk tolerant than those
with lower levels of attained education.
Source: Investor Risk Tolerance: Testing the efficacy of demographics as differentiating
and classifying factors. By john e. Grable

Risk Profiling
Risk profiling is a process for finding the optimal level of investment risk for your client
considering the risk required, risk capacity and risk tolerance, where,

Risk required is the risk associated with the return required to achieve the clients
goals from the financial resources available,

Risk capacity is the level of financial risk the client can afford to take, and

Risk tolerance is the level of risk the client is comfortable with.

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Risk required and risk capacities are financial characteristics calculated using financial
planning software. Risk tolerance is a psychological characteristic which is best
determined by way of a psychometric test.

Risk profiling requires each of these characteristics to be separately assessed so that

they can be compared to one another. Risk capacity and risk tolerance both act
separately as constraints on what your client might otherwise do to achieve their goals
(risk required). It is unusual for a client to be able to achieve their goals from the
resources available within both their risk capacity and risk tolerance.
Where a mismatch between risk required, risk capacity and risk tolerance has been
found, the advisors role is to guide the client through the trade-off decisions that are
required to reach an optimal solution.
The final step in the risk profiling process is to ensure that the client has realistic risk
and return expectations so that the advisor can be given the clients properly informed
consent to implement the investment strategy.
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Unlike risk required and risk capacity, which are financial parameters, risk tolerance is a
psychological parameter. Risk tolerance is how an individual feels about taking risk.
Where does the person strike the emotional balance between seeking a favorable
outcome versus risking an unfavorable outcome?

Risk tolerance is a psychological trait - a relatively enduring way one individual differs
from another. Like personality generally, risk tolerance is a function of nature and
nurture, i.e. genetics and life experiences, and is largely settled by early adulthood, as is
personality generally. Risk tolerance does decrease slowly over time and, as with other
aspects of personality, may be changed by life events but otherwise is stable even
through financial market highs and lows.

RISK PROFILE SEGMENTATION

The life factor that has the most influence on portfolio construction, the mix of asset
classes someone should hold, and how risky they should be, is called their "investment
risk tolerance."
These five categories are summaries of how the investor feels about investment risk,
how much downside market fluctuations can be tolerated, and how much they expect to
profit when markets are going up.
The biggest reason for needing to classify someone into a pre-defined category, is
because most investment advisors use Asset Allocation Models that correspond directly
with each category.

Conservative: This investor isnt willing to tolerate "noticeable downside market

fluctuations," and is willing to forego most all significant upside potential, relative to the
markets, to achieve this goal.

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Most conservative investors want their portfolios to provide them with an inflationadjusted income stream to pay their living expenses. They're either currently depending
on their investments to give them a retirement paycheck, or are expecting this to
happen soon. Some are on tight budgets and are barely making a living as it is, so they
are very afraid of losing what little money they have left. They do not have time to
recoup any losses.
The majority of their money should be held in cash and high-quality short- and
intermediate-term maturity bonds. Very risky asset classes are typically avoided
altogether.
So the investments most desired by Conservative investors are the ones that lose the
most value from inflation (e.g., fixed annuities). In this case, the potential for the large
loss of nominal Rupees (how many rupees one has relative to how many they started
with) is low, but the loss of real rupees (the inflation-adjusted worth of those rupees) is
guaranteed. This is caused by the loss of purchasing power due to the prices of
everything in their family budget going up.
Cash (savings accounts, money market funds, and FDs) most always lose real value
over time because of the combined effect of taxes and inflation. There isn't much one
can do if this happens, except to have exposure beforehand to asset classes that
benefit when inflation increases (real estate and tangible / commodity-based mutual
funds, like the precious metals and energy sectors). The catch is most of these are the
same asset classes that are usually minimized, because they're "too risky," or don't
provide a reasonable income yield.
Moderately Conservative: If a worried investor can tolerate a little more risk than the
Conservative investor, but still is adverse to large short-term downside fluctuations, and
wants a little more return with a little less income, then this is the category for them.
The typical investor in this category is either retired or getting their paycheck from
portfolio income, soon to be retired. These folks want to be protected somewhat from
large downside market fluctuations and are willing to not fully-participate when markets
rally upwards to get it.

13

Informed investors realize that if their life expectancy is more than a decade, then
having exposure to investments that increase in value is needed to provide adequate
income in the later years. These folks want to be protected somewhat from large
downside market fluctuations and are willing to not fully participate when markets rally
upwards to get it.
This is achieved by having a significant exposure to fixed income securities, several
different types of stocks, real estate, and tangible commodities that somewhat track
inflation. Core equity asset classes are used, but very risky asset classes are still held
to a minimum.
Moderate: The majority of investors are in this middle-of-the-road category. The mostcommon is the desire to invest long-term for retirement or child education or dream
house. The current need for portfolio-generated income is usually several years
away.These investors want good returns, and know they're taking some risk to get
them. They should expect returns similar to a basket of similarly weighted market
indices. Their portfolio should go up less than the markets as a whole, but should also
go down less when markets go down.
A Moderate portfolio will hold a balanced mix of most all-major viable asset classes (for
maximum diversification), which will include conservatively-managed bond funds as well
as high-risk stock funds. This category typically uses the largest number of asset
classes to both reduce risk and increase profits. Both safe and risky asset classes are
utilized pragmatically. Balance between profits and loss reduction is the goal.
They know they will lose money if the markets go down, but also expect to be along for
the ride if they go up.
Moderate investment portfolios are usually compared to the S&P 500 to see how well
they're doing. When the S&P 500 is going up, it should be up a little more than a
Moderate investment portfolio (if it's very well managed). When the S&P 500 is down,
the Moderate portfolio should be down less.

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Moderately Aggressive: If an investor wants to outperform a basket of similarly

weighted indices when the markets are up, and doesn't mind too much being down a
little more than the markets when they are down, then this is the category for them.
They are taking on more downside risk than the markets, but expect to be substantially
ahead of the game when markets go up. Fixed income positions are minimized and
risky asset classes are fully utilized. Most of the bond and international stock mutual
funds in this portfolio are aggressively-managed.
These investors want to take the risks of winning the game by playing hard offense, but
still don't want to lose too much in a short period of time. Most Moderately Aggressive
investors want to accumulate a significant amount of wealth in the future, are willing to
wait a significant amount of time for the rewards (and to recoup short-term losses), and
have earned-income to contribute to the portfolio over time.
They know they will lose a high percentage of their money if the markets go down (more
than the S&P 500), but also expect to profit greatly if they go up. More emphasis is put
on making money than preventing the loss of money.
Aggressive: These investors want to substantially outperform the markets and (should)
know they are exposed to much more risk than the markets. They could easily lose up
to 40% of their portfolio value in a few months, and it may take years, if ever, to recoup
these losses.
These investors typically hold mostly growth, small-cap, and sector mutual funds (or
stocks or ETFs). Any fixed-income mutual funds in the portfolio are a small percentage
of the portfolio, and also are of the riskier types that are aggressively-managed.
The purpose of any cash held is to handle any unexpected withdrawals, and to take
advantage of perceived buying opportunities.
Aggressive investors are typically younger (The Invincible), and intend to contribute
relatively large amounts into the portfolio periodically over time via contributions coming
from earned-income.
Most aggressive investors either want to accumulate substantial wealth in the future,
are in a hurry, have enough income from other sources to fund their living expenses,
15

and/or have plenty of time to work and recoup losses. Some just may have not yet
personally experienced significant losses in the markets, so their bravery usually ends
up being their own downfall.
They should know they would lose a very high percentage of their money if the markets
go down, but also expect to profit greatly if they go up. Most all emphasis is put on
making money and little, other than the diversification benefits of using mutual funds
with asset allocation, is used in preventing the loss of money.

Recommended Asset Allocation

Score

Client Risk Profile

Recommended Asset Allocation

Equity %

Debt %

211-250

Very Aggressive Investor

80-100

0-20

166-210

Aggressive Investor

60-80

20-40

165-121

Moderate Investor

40-60

40-60

76-120

Conservative Investor

20-40

60-80

75-34

Cautious Investor

0-20

80-100

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ANALYSIS OF QUESTIONNAIRE RESPONSE

Total Respondents: 120
1.Segmentation of respondents based on risk profile

Analysis: 80% of respondents are Moderate risk takers.

17

2.Risk Segmentation by Marital Status.

Analysis: Married people are low risk takers compared to single people.

3.Risk Segmentation by Gender

Analysis : Females are less risk taking compared to males. Females are more inclined
to Moderate risky investment.
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4. Risk Segmentation by house ownership at place of work.

There is not any difference between risk profile and house ownership.

SAVING GOALS

19

 Majority of investors are saving for retirement, followed by child education and
then Dream house.
Saving for Retirement and children education shows the lack of social security in
India and people tend to plan for them in advance.
Another major investor segment is saving just for tax saving without any specific
goal in mind.

BEST INVESTMENT

20

More than 50% of Investor considers property as the best form of investment.

Investment % of Salary

Equity Investment % by Risk segment

21

Retirement Fund Investment % by Risk Segment

Debt fund investment % by Risk Segment

22

Investment Time
framework

MODERN PORTFOLIO THEORY

Modern Portfolio Theory attempts to maximize expected portfolio return for a given
amount of portfolio risk (or equivalently to minimize risk for a given level of expected
return) by carefully choosing the proportions of various asset classes in the portfolio.

MPT gave rise to the idea of an efficient frontier where the frontier represents the
optimal risk/return relationship. For retail investment advising, this meant that advisors
needed to be able to (1) offer portfolios that were on or close to the efficient frontier and
(2) determine where, on the efficient frontier, a particular investor's portfolio should
appropriately be positioned.
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Efficient Frontier The level of risk associated with that return is known as the risk
required. In terms of the efficient frontier, portfolio selection based on risk required can
be envisaged as follows -

24

Identifying and Resolving Mismatches

Mismatches are common. Anecdotally, in about 60% of cases, there is no investment
strategy that will achieve the clients goals (with the desired risk capacity) where the risk
is consistent with risk tolerance - an undershoot. In a further 30% of cases,risk required,
risk capacity and risk tolerance are more or less in line.
In the remaining 10% of cases, the risk required to achieve the clients goals (with the
desired risk capacity) is less than risk tolerance - an overshoot.
Undershoots are common because we tend to be overly optimistic about our futures.
Further, we are inclined to overweight the present as against the future and to
underestimate the monies that will be required to fund retirement. In simple terms, given
the resources we have available, we have overly ambitious goals.
In both undershoot and overshoot situations, trade-off decisions will be required.
However, an undershoot is the more difficult of the two because here the trade-off
decisions will require the client to give something up.

Undershoot Mismatch for Risk Tolerance

25

INVESTMENT RISK PYRAMID

After deciding how much risk is acceptable in your portfolio by acknowledging your time
horizon and bankroll, you can use the risk pyramid approach for balancing your assets.
This pyramid can be thought of as an asset allocation tool that investors can use to
diversify their portfolio investments according to the risk profile of each security. The
pyramid, representing the investor's portfolio, has three distinct tiers:

26

Base of the Pyramid The foundation of the pyramid represents the strongest portion,
which supports everything above it. This area should consist of investments that are low
in risk and have foreseeable returns. It is the largest area and comprises the bulk of
your assets.

Middle Portion This area should be made up of medium-risk investments that offer a
stable return while still allowing for capital appreciation. Although more risky than the
assets creating the base, these investments should still be relatively safe.

Summit Reserved specifically for high-risk investments, this is the smallest area of
the pyramid (portfolio) and should consist of money you can lose without any serious
repercussions. Furthermore, money in the summit should be fairly disposable so that
you don't have to sell prematurely in instances where there are capital losses.

Measuring risk and returns in the customer portfolio

A widely used approach to portfolio management is the capital asset pricing model
(CAPM) which was developed from work in the 1960s and 1970s by Sharpe, Lintner
and Black to look at risk and returns on common stocks.12 When evaluating shares,
risk and return are understood to be positively correlated. High-risk (high-volatility)
investments are associated with higher returns, which rational investors require to
compensate them for taking on higher risk. CAPM has long been associated with the
estimation of risk. There are extensive debates in the accounting literature about CAPM
and its shortcomings. The debates are around two issues: how to apply it in practice;
and its power to explain actual portfolio performance. According to CAPM, the return
that an investor would expect from an investment would be the risk-free rate obtainable
from a safe investment (such as a government bond, called a gilt) plus a risk premium
27

consisting of the market risk premium (measured as the excess of equity market over
gilt market returns) multiplied by the specific risk of that individual investment. For
example, if an investor can get a 5 per cent return by investing in a 20-year gilt and an
extra 10 per cent by investing in a stock market index fund, the investor will require a 20
per cent return to invest in a company which is 50 per cent more risky than the market
average (5 percent (10 percent 1.5)).
WACC AND CUSTOMER RISK - Since shareholder value is only created where the
return on investment exceeds the weighted average cost of capital (WACC) the forecast
free cash flows now have to be adjusted by the WACC. WACC is the true cost of capital
of the business. It is calculated as the cost of debt multiplied by the proportion of debt
funding, plus the cost of equity multiplied by the proportion of equity funding. The cost of
debt is the companys current after-tax borrowing rate; the cost of equity is usually
calculated as the amount by which the return on equities exceeds the return on longdated government securities. This represents the additional compensation that stock
market investors demand for investing their money in risky companies rather than in
safe gilts. The WACC is the real cost to companies of borrowing money from the
financial markets; if it then invests that money in developing customer relationships, the
returns from those customers must be greater than the cost of capital if shareholder
value is to be created. When calculating the value of a relationship with a specific
customer segment, many organizations apply a corporate discount rate to future cash
flows to determine their net present value. Using the actual cost of capital (the WACC)
to discount future cash flows from each segment will, however, give a truer picture of
the total value of the customer portfolio than using a notional discount rate.
The analogy between the customer portfolio and the share portfolio can be extended
still further. Some shares such as those in technology or biotechnology companies
are more risky than others. In the same way, some customers are more risky than
others. Risk is defined as unanticipated volatility in returns28 so the riskiness of a
segment could include the risks of sudden swings in buying patterns or amounts,
defection (loss to a competitor) or even default. This could lead a company to overvalue
certain customer segments and perhaps to invest disproportionate time and resources
in them while other, less capital intensive or less risky segments are neglected. All other
28

things being equal, if two segments have the same level of expected future returns but
one is more risky, the riskier segment will be less valuable to the company. Therefore, a
discount rate higher than the WACC should be used to reflect the higher risk attributable
to that customer segment. How much higher the discount rate should be will depend on
how risky that segment is. So, managers need to be able to assess the risk of a
customer.
HOW WELL DOES PORTFOLIO THEORY FIT THE CUSTOMER PORTFOLIO?
The use of the risk-weighting technique can be viewed as a departure from classic
portfolio theory in which the specific risk of the individual asset is diversified away. The
justification for this approach is that the analogy between the customer portfolio and the
market portfolio is imperfect. For example, the weighting and therefore the impact of a
major segment may be substantial; moreover, diversification may not reduce risk in the
customer portfolio since the covariance of returns from certain segments might be
positive, not negative. This might come about when two different segments are in fact
related, such as certain mobile phone account customers and a younger, pay-as-you-go
segment. If the former segment contains a high proportion of parents of the pay-as-yougo segment, switching behaviours in both segments might co-vary.

DEVELOPING RISK AWARE CRM STRATEGIES

From a customer relationship management perspective, analysing the risk of a
customer or segment assists account managers to develop strategies to minimise the
impact that risky segments might have on the supplier. For example, risk evaluations
allow the marketing manager to make pricing decisions based on risk as well as return.
The weighting and scoring approach has the merit of making it clear what the drivers of
risk are; this is easier for marketing managers to turn into actionable customer
management strategies such as differential pricing; or such risk reduction strategies as
credit limits, cash deposits, insurance or guarantors. Using a manager-defined concept
of risk allows for a deeper study of the expected risk-return relationship. A wider
definition of risk can be developed, enabling account managers to view the expected

29

risk and return of the entire customer relationship. This in turn may suggest new
customer relationship management strategies

Portfolio Construction
Portfolio Construction is all about investing in a range of funds that work together to
create an investment solution for investors. Building a portfolio involves understanding
the way various types of investments work, and combining them to address your
personal investment objectives and factors such as attitude to risk the investment and
the expected life of the investment.
There are two types of approaches for portfolio construction.

1) Bottom-up investing -Bottom-up investing, often used by individual private

investors, typically starts by choosing a manager or fund they like, only subsequently, if
ever, considering how to construct the portfolio as a whole. This ad hoc approach takes
no account of the investors objective or risk profile. In addition, studies of investor
behaviour show that individual investors often chase top-performing investments or
funds, by which time the performance has already been delivered, which leads many to
lose money by buying at the top and selling
at a loss.
2) Top-down Investing - By comparison, professional investors begin by exploring
investment risk and what they need the investment to do for them. They then work
through a series of steps, creating a framework to decide which types of investments
are needed. Only then do they choose individual funds or other investments. Planning a
portfolio based on risk tolerance and investment objectives gives you a better chance of
meeting your goals within a level of risk you are comfortable with.
At a very general and simplified level, the top-down approach generally goes through
four broad stages:

30

a)

Decide how to allocate your money between the different types of investments

(asset allocation).
b) Choose where to invest within each investment type.
c) Decide on the balance between actively managed and index passive funds.
d) Evaluate individual funds and fund managers.

Stage 1 : Asset Allocation - The most important decision when constructing a portfolio
is asset allocation. This means making sure your portfolio has the right mix of assets to
suit your individual circumstances, investment aims and attitude to risk.
Asset -An item of value, including bonds, stocks and other securities, cash, or physical
items such as inventory, a house or a car.
Diversification can reduce risk. In order to reduce your risk, you need to diversify that
is, spread your portfolio across a broad mix of assets. Investment markets move in
different cycles, reflecting the underlying strength of the economy, industry trends and
investor sentiment. Individual assets also move differently according to external factors.
So for example, during hard economic times many people will stop buying luxury items
and companies that make them might experience a fall in sales, but makers of essential
items, like food, may not. Diversifying your portfolio can help smooth out market ups
31

and downs: so returns from better performing assets help to offset those that arent
performing so well.
Balancing risk and return - The concept of risk/return suggests that low levels of
investment risk will result in potentially lower returns, while high levels of risk will
generate potentially higher returns. Of course, there are no guarantees. While increased
risk offers the possibility of higher returns, it also can lead to bigger losses. Your adviser
can help you construct a portfolio with the potential to give you the best possible returns
for a given level of risk.
Avoid dangerous fads - Using an asset allocation strategy helps free you from the risk
of following temporary investment fashions. Even professional investors sometimes get
their timing wrong, following the herd into a temporarily popular asset or market that has
reached its top and may fall dramatically. Having a formal strategy can help by ensuring
that your portfolio stays balanced.
Select uncorrelated assets - For effective asset allocation, professional investors often
seek to combine assets that tend to do well at different times. A simple everyday
example might be how sunscreen will sometimes get discounted during a cold summer,
while coats and jackets might be marked up. At a simple level, these two items could be
said to be uncorrelated.
The major asset classes
Investments are divided into different asset classes such as equities, bonds,
property and cash. These provide the basic building blocks of an investment
portfolio.

32

The table highlights the characteristics of the different asset classes and outlines who
they may potentially be suitable for.

Asset Class

Key Characteristics

Potentially suitable for

Equities

Potential for capital growth, and may

offer income through the payment of
dividends. You can choose to invest
in India and overseas companies.

Medium-to-long-term
investors (five years plus).

Bonds

Can provide a steady and reliable

income stream with potential for
capital growth and usually offers a
higher interest rate, or yield, than
cash. Includes Indian government
bonds (gilts), overseas government
bonds, and company loans
(corporate bonds).

Short, medium or longterm investors.

Property

Provides the benefits of

diversification through access to
properties in retail, office, industrial,
tourism and infrastructure sectors.
You can
invest in both India and international
property.

Medium-to-long-term
investors (five years plus).

Cash

May be suitable for short-term needs, Short-term investors (up to three

such as an impending down payment years)
on a new home. Usually includes
higher interest paying securities, as
well as bank and building society
accounts or term deposits (a cash
deposit at a
financial institution that has a fixed
term).

33

Stage 2: Sub-asset allocation

Once overall asset allocation is decided, The investment sub-asset allocation needs to
decided that is, how to divide your money between the sub-assets, or different kinds
of asset within each asset class.
Sub-asset class types
Each asset class comprises of a broad variety of sub-asset classes. For example, a
sub-asset class within equities might include: large companies, smaller companies,
growth funds, income funds and global equities.
1) Fund (or pooled fund) -An investment vehicle in which investors combine their
money in a pool, which then invests in a range of securities. Each investor shares
proportionally in the funds investment returns.
2) Asset classes - A category of assets in which you can invest, such as equities,
bonds, property or cash. Investments within an asset class have similar characteristics.
3) Securities - Freely tradable assets that are quoted on an exchange including shares,
bonds and derivatives.
4) Equity/share - A share is a stake in the ownership of a company. Also known as a
stock.
5) Bonds - A loan certificate issued by a government, public company or other body.
The issuer agrees to repay the original amount borrowed after an agreed time (when
the bond matures). Bonds usually repay a fixed interest rate (known as the coupon)
over a specified time.
34

6) Investment Grade bonds - A bond given a relatively high rating by the credit
agencies (from a minimum grade BBB up to AAA, as rated by Standard & Poors). It
typically aims to offer higher expected returns than government bonds, as a reward for
taking on credit risk.
7) High yield bonds or junk bonds - Bonds rated BB or lower on Standard & Poors
credit rating scale. These bonds tend to pay higher yields to offset their greater risk of
default (that is, the bond not being repaid) than with investment-grade bonds.
Stage 3: Balance actively managed and Passive funds
Passive funds - Index Funds dont try to pick individual securities. Instead, they
aim to reflect the performance of the market. They work by attempting to closely
track an index, such as the BSE Index fund, Nifty Index funds. Index funds buy
and hold rather than trade frequently and require no analysts to research
companies they are much cheaper to operate. When you own all the stocks
that make up a market, youll earn just average returns of all the stocks in that
market.
Active funds employ managers to research and pick equities or bonds in an
attempt to beat the relevant index or market average though in practice, it is
difficult to do over the long-term. Active funds have not delivered impressive
performance in long run. Higher expenses associated with active management
and the inherent difficulty of picking winning stocks consistently over long periods
of time means that most funds that aim to beat the market actually end up behind
in the long run.
Advantages of Index funds over Mutual funds
1. Markets Are Efficient. The indexer basically believes that the market as a whole is very
good at quickly pricing all the available information about a stock or a market into the
market price (i.e. efficient market hypothesis). It is therefore almost impossible for a
given money manager to outguess the market consistently over a long period of time.

35

2. It Is Very Difficult to Identify Winning Fund Managers in Advance. Analysis of the

returns provided by the top fund managers every year shows in the vast majority of
cases, a fund manager will be flying high for a year or two, riding a market trend. But
after the markets have run their course, another investment style becomes popular, and

last years heroes are this years goats. The indexer believes it doesnt pay to try to
guess who will be this years best performing manager.
3. Mutual Fund Managers Cannot Reliably Add Value Beyond Their Costs. The
advocate of passive management reasons that in the aggregate, mutual fund managers
and other institutional investors cannot reliably beat the market. Why? Because,
collectively, they are the market. They are therefore all but doomed to under-perform a
well-constructed index by approximately the amount of their costs.
4. Index Funds Have Lower Turnover. It costs money to churn or excessively trade
securities in your portfolio. Mutual funds have to pay brokers and traders, and must also
absorb the hidden costs of bid-ask spreads every time they trade. The bid-ask spread is
the difference between what a stock exchange market maker pays for the stock and
what they sell it for. Brokerage firms identify the overlap between what investors are
willing to pay for a security and what investors are willing to sell a security for, and make
part of their money by pocketing the difference. The more trading a fund does, the
higher these costs. But index funds never have to trade, except when new securities are
added to the index, or to buy or sell just enough to cover fund flows coming in and out
as investors buy or sell.

36

Comparison of Index Funds

Its possible to select a range of uncorrelated active and index funds in an effort to
reduce overall portfolio volatility.

37

Source: Performance of ETFs and Index Funds: a comparative analysis on NSE

website. (http://www.nseindia.com/research/content/RP_15_Mar2014.pdf)
.

FINDINGS
Actual Asset Allocation
GROUPING

aggressive investor

Debt %

Equity %

26-40%
26-40%

26-40%
40-55%

26-40%
26-40%
26-40%

<10 %
10 to 25 %
10 to 25 %

26-40%
40-55%
26-40%
40-55%
26-40%
40-55%

<10 %
<10 %
10 to 25 %
10 to 25 %
26-40%
40-55%

Total
conservative investor
Total

moderate investor

Total
Total Result

Total
3
2
5
11
5
2
18
20
22
12
27
12
4
97
120

Matching as per
recommendation

16

The analysis of the response data shows that Indian investors are more conservative
than suggested by their risk profile. The investors are wary of investing in equity and try
to avoid it due to speculations. Only 23 out of 120 respondents are matching equity
allocation as per their risk profile.

38

The main reasons for non-matching of less equity allocation are as follows
1) Lack of social security schemes in India make investors vary of equity market and not
ready for risker investment avenues.
2) Investors are wary of loss of investment principal due to scams. e.g. Stock market
scams like Harshad Mehta scam which caused share market crash and loss of principal
amount invested.
3.) Lack of awareness / education on equity market makes people not choose and go
for safer returns from debt market.
4. High interest rate in debt market.
5. Stock market crash due to global crisis. Like Lehman brothers, makes investor feel
that even the principal is not secure and do not want to invest in them.

39

Low risk equity investments available for Indian investors.

1) Index Mutual funds As shown in the table below the CAGR of Index mutual
funds is good. 5 year CAGR for Index mutual fund is approximately 7% for Nifty
50 when the markets have crashed around 12% in last 1 year.

Fund Name

Fund House

Index

Launch Date

1 yr
(%)

Returns
2 yr
3 yr
(%)
(%)

5yr
(%)

Principal
Index Fund

Principal Mutual Fund

Nifty 50

Mar 2000

-13.3

11.4

8.3

UTI Nifty
Index Fund

UTI AMC Private Ltd.

Nifty 50

Jun 2000

-12.7

12

8.4

7.1

Franklin India
Index Fund

Franklin Templeton
AMC (India) Private
Ltd.

Nifty 50

Dec 2001

-13

11.6

8.1

6.9

SBI Nifty
Index Fund
ICICI
Prudential
Index Fund
HDFC Index
Fund - Nifty
Plan

SBI Funds
Management Ltd.

Nifty 50

Feb 2002

-13.5

10.9

7.5

6.6

ICICI Prudential AMC

Ltd.

Nifty 50

Jul 2002

-13

12.1

8.8

7.4

HDFC AMC Ltd.

Nifty 50

Sep 2002

-12.6

12.2

8.8

7.2

Birla Sun Life

Index Fund
LIC
NOMURA MF
Index Fund Nifty Plan
Tata Index
Fund-Nifty
Plan
IDFC Nifty
Fund

Birla Sun Life AMC

Ltd.

Nifty 50

Nov 2002

-13.1

11.4

8.1

6.5

LIC Nomura Mutual

Fund AMC Ltd.

Nifty 50

Feb 2003

-13.4

11.3

7.8

6.9

Tata AMC Private Ltd.

Nifty 50

Mar 2013

-12.9

11.7

8.1

--

IDFC AMC Ltd.

Nifty 50

Jun 2010

-12.9

12.2

8.8

8.1

Taurus AMC Ltd.

Nifty 50

Jun 2010

-13.5

11.2

7.7

6.2

Taurus Nifty
Index Fund

40

IDBI Nifty
Index Fund
Reliance
Index FundNifty Plan

IDBI Asset
Management Ltd.
Reliance Capital
Asset Management
Ltd.

Nifty 50

Sep 2010

-13.8

10.9

7.7

6.6

Nifty 50

Nov 2008

-13.4

11.6

8.2

7.3

Source: www.moneycontrol.com for data or index funds.

2) National Pension scheme (NPS) - It is a retirement pension scheme started by
Government of India. It is tightly regulated by Pension Fund Regulatory and
Development Authority (PFRDA). This is an excellent investment avenue for the
investors are it invests into Equity and Debt according to the age of the person It safe
guards the investment from equity risk by keeping a balanced allocation into debt and
equity.
The return from this scheme has been above 15% for past 5 years.
Source: www.npstrust.org.in

Limitations of study
1) The above analysis is done on 120 respondents mainly based out in Metro cities in
India. So for more real analysis of the risk profiling and portfolio construction bigger
sample size should be used.
2) The analysis does not takes into consideration if the investors knowledge about
investments avenues available and how informed he is about the investment
opportunity.
3) The analysis can be further enhanced by taking the salary and investment in absolute
numbers if the confidentiality of data is guaranteed. Thus we can apply some of the
statistical models to derive better results.

41

APPENDIX A
Questionnaire
Risk Profiler
Name _______________________________

1) Your current age is:

Mark only one oval.

under 30

30 - 40

41 - 50

51 - 60

above 60

2) How much do you depend on your total income for meeting your expenses?
Mark only one oval.

< 25%

between 25% 50%

between 50% 75%

above 75%

42

3) You provide financially support to:

Mark only one oval.

only yourself and/or working spouse

yourself and non-working spouse

yourself, non-working spouse and 1 dependent

yourself, working spouse, children and parents

yourself, non-working spouse, children and parents

yourself, working spouse and children

4) You are
Check all that apply.

owner of your dream house

living with parents in inherited house

own a house for which you pay home loan

presently saving to buy a house

Given own house on rent

staying in rented house

5).Your job/business in coming future:

Mark only one oval.

may decrease substantially

may decrease moderately

will remain almost the same

43

will grow moderately

will grow substantially

6). Describe your knowledge and experience about investments:

Mark only one oval.

familiar and experienced

not too familiar but experienced

familiar but not experienced

not familiar and not experienced

7) How many years you think you can save before your financial goals arise?
Mark only one oval.

< 5 years

5 - 10 years

> 10 years

already enough / met

8) After you make an investment, you typically feel:

Mark only one oval.

preserving wealth

generating regular income to meet current requirements

balance current income and long term growth

long term growth

9) When you think of the word "risk" which of the following word comes to mind first? *
Mark only one oval.
44

thrill

opportunity

uncertainty

loss

10). If over a three-month period, an investment you owned lost 20% and the overall
stock market lost 20%, what would you be most likely to do?
Mark only one oval.

buy more of the investment

do nothing with the investment

wait for the stock to regain the loss, then sell it

sell and go back to fixed deposit

11). you are in a game show with following options to choose. The option appealing to
you is
Mark only one oval.

10% chance of winning 25 times of annual income

25% chance of winning 15 times of annual income

50% chance of winning 5 times of annual income

cash worth one time of your annual income

12). Please estimate how long you will leave your investment in place until you expect
to withdraw it?
Mark only one oval.

less than 1 year

45

from 1 to 3 year

from 3 to 5 year

more than 5 year

13). How do you feel when your financial decision goes wrong?

I still remain confident to overcome obstacle

I generally don't take risk because of which I suffer financial loss

I view it as personal failure

I feel guilty

14). How much is your existing investments worth as a multiple of your current annual
income?

3 years and above

between 2-3 years

between 1-2 years

between 6 months-1 year

< 6 months

15). The ideal range of end value of investment of Rs. 100,000/- for you would be
Mark only one oval.

best case 250,000/- worse case 60,000/-

best case 200,000/- worse case 80,000/-

best case 160,000/- worse case 100,000/-

best case 150,000/- worse case 110,000/-

16). When it comes to investing, are you most comfortable with investments that:
46

Mark only one oval.

are stable and protect against loss even if it means low returns

have little risk of short-term, and offer some opportunity for long-term growth

have moderate risk of short-term loss, but offer moderate Opportunity for longterm growth

have higher risk of short-term loss, but offer very high opportunity for long-term
growth

Investment Portfolio
1) Marital Status
Mark only one oval.

Single

Married

2) Number of Kids
Mark only one oval.

N/A

Upto 2

Above 2

3) Are you living with dependent parents?

Mark only one oval.

Yes - Both parents

Yes - Single parent

47

None

4) Do you own a house at place you work?

Mark only one oval.

Yes

No

5) What % of your income you invest?

Mark only one oval.

<10%

11-25%

26-40%

40-55%

Above 55%

6) What is the main motive of your saving?

Mark only one oval.

Child education

Dream house

Retirement planning

Other:

Rate the following questions 1 as least important and 5 as most important.

7) I prefer my money to be safe from risk.

48

Mark only one oval.

Least
Importan
t

Most
important

8) Even if I could get high returns, I would prefer not to invest my money in something
that might decline in value.
Mark only one oval.

Least
Importan
t

Most
important

9) I would never make a high-risk investment.

Mark only one oval.

Least
Importan
t

5
Most
important

10) What is the share of your investment in equity?

Mark only one oval.

<10 %

10 to 25 %

49

26-40%

40-55%

Above 55%

11) What is the share of your investment in Fixed Deposits / Bonds?

Mark only one oval.

<10 %

10 to 25 %

26-40%

40-55%

Above 55%

12) What is the share of your investment in Retirement Funds?

Mark only one oval.

<10 %

10 to 25 %

26-40%

40-55%

Above 55%

13) Which is best investment according to you?

Mark only one oval.
50

Property

Mutual Funds

Retirement funds like PPF

Equity / Stocks

Bonds / Bank Deposits

14) What % of your investment can be liquidated in 1 month?

Mark only one oval.

<10 %

10 to 25 %

26-40%

40-55%

Above 55%

15) What is your investment time frame?

Mark only one oval.

< 1 year

1-3 years

4-7 years

8-15 years

Above 15 years

51

Bibliography
1. The Risk of Trading: Mastering the Most Important Element in Financial
Speculation - Michel Toma
2. Investments: Analysis and Management, - By Charle P. Jones.
3. Investing in Frontier Markets: Opportunity, Risk and Role in an Investment
Portfolio Gavin Graham
4. Modern Portfolio Theory and Investment Analysis, 9th Edition Edwin J. Elton.
5. BSE and NSE websites for research reports on portfolio and risk.
6. Ivestopedia.com
7. Moneycontrol.com and relevant websites for Investment and risks.
8. Research articles on Google Scholar, EBSCO etc.
9. ASSESSING FINANCIAL RISK TOLERANCE OF PORTFOLIO INVESTORS
USING DATA ENVELOPMENT ANALYSIS - International Journal of Information
Technology & Decision Making Vol. 4, No. 3 (2005) 491519 c World Scientific
Publishing Company
10. Making customers pay: measuring and managing customer risk and returns
LYNETTE RYALS Cranfield School of Management, Cranfield University,
Cranfield, Bedford MK43 0AL, UK
11. INVESTOR

RISK

TOLERANCE:

TESTING

THE

EFFICACY

OF

DEMOGRAPHICS AS DIFFERENTIATING AND CLASSIFYING FACTORS John

E. Grable
12. Are Options on Index Futures Profitable for Risk-Averse Investors? Empirical
Evidence GEORGE M. CONSTANTINIDES, MICHAL CZERWONKO, JENS
CARSTEN JACKWERTH, and STYLIANOS PERRAKIS
13. Measuring risk and returns in the customer portfolio Received (in revised form):
8th October, 2001 Lynette Ryals
52

14. INVESTORS'

RISK

TOLERANCE

AND

RETURN

ASPIRATIONS,

AND

FINANCIAL ADVISORS' INTERPRETATIONS: A CONCEPTUAL MODEL AND

EXPLORATORY DATA Business Source Complete.
15. Performance of ETFs and Index Funds: a comparative analysis NSE
16. Risk tolerance: Essential, behavioral and misunderstood Received (in revised
form): 12th November, 2013 Greg B. Davies

53