An analysis of the local equity market’s performance and diversification according to various portfolio models

Abstract

This dissertation explores the risk-adjusted performance and level of diversification offered by the stocks publicly listed on the Malta Stock Exchange from 2013 to 2017. This is achieved by observing the returns and level of concentration offered by five portfolios. Specifically, the traditional market capitalisation model is compared to four other smart beta indices (weighted according to gross dividends, book-value, price and equal weight allocation) to decide which investment strategy fits best in the Maltese equity scenario based on the given five-year period. From a methodological perspective, the study takes a quantitative approach, where the outcomes regarding performance are achieved by computing the annualised returns that the weightings of each model, which are then used to compute four risk-adjusted metrics: the Sharpe, Sortino, information and omega ratio. In order to determine the risk-adjusted performance, the 2013 five-year average risk-free rate is taken into consideration. With respect to diversification, three main outputs are implemented; namely the Lorenz curve, on which the Gini coefficient is based, and the diversification ratio. The findings from the research conducted conclude that the models based on gross dividends, price and equal weightings achieve both a high level of risk-adjusted performance and diversification, with the former being the best performer out of the five models. On the contrary, the book-value and market capitalisation weighted models provide poorer returns and are more concentrated. This result is thus in line with Markowitz’ Modern Portfolio Theory, asserting that diversification is positively related with performance. It can thus be concluded that, based on historical prices of publicly listed stocks, constructing two sub-portfolios, one weighted based on dividends and another having equal weightings is the optimal strategy to maximise returns for the level of risk incurred.