Exploring the dynamics of portfolio risk and return; “Sensex” V/S “Hypothetical optimal portfolio”

Over the last few years, there has been a rapid change in the Indian securities market. With increased number of institutional investors, in the form of FIIs, Mutual Funds, Hedge Funds etc., the way of investment has also changed. In Indian Stock Markets, “Sensex” is considered to be representative of the entire stock market. Thus, it represents an optimal portfolio in terms of CML. Are there any portfolios, which lie above this CML in Indian stock markets? If yes, what type of financial assets do these high performing portfolios include? Further, it may be of interest to find out whether “Sensex” is actually an optimal portfolio or there can be some other portfolio created out of Sensex stocks, which could give better returns? This paper tries to answer the above questions. It tries to construct “Hypothetical optimal portfolio” using, the return and risk data of BSE 30 stocks, for 5 years, without the procedure of short sales by applying the concept of modern portfolio theory and CAPM by using the Sensex stocks. These Hypothetical Optimal Portfolios created with the help of optimization technique, are then compared with Sensex and top performing mutual funds on the basis of Risk, Return, Sharpe ratio and Risk tolerance. The study concluded that the CAPM has great importance in constructing the hypothetical optimal portfolio and these portfolios are better than Sensex in terms of risk and return. This study also suggested that there are only few outlier portfolios in Indian stock market, which includes the gold fund and FMCG funds, give the better return as compare to hypothetical optimal portfolio and the Sensex return was lower than the return of Hypothetical optimal portfolio in all five years. The finding of the study will be of practical value for investors as it provides realistic insights on actual performance of Sensex and Mutual funds and expected performance of Hypothetical optimal portfolio.