Does portfolio optimization favor sector or broad market investments?

Abstract

In the Indian context, we have applied the Sharpe Single Index model with Elton's portfolio optimization framework and Markowitz Portfolio Theory framework for optimizing intra and inter‐sectoral equity portfolios. Literature provide less evidence on the inter and intra‐sector relationships to which we contribute. We compute 11 sector‐specific optimal portfolios and one inter‐sector optimal portfolio using the NSE sectoral indices like automobiles, banking, financial services, FMCG, IT, media, metals, pharmaceuticals, private banks, PSU banks, realty, and broad‐market inter‐sector index Nifty50. We use the month‐end adjusted closing returns data comprising 15,834 observations from 191 scrips during 2013 to 2019. We create in‐sample optimal portfolios and out‐sample mimic portfolios under the Sharpe and Markowitz models for comparison and validation with optimized weights. Our results show that inter‐sector portfolio performs better than some of the intra‐sector portfolios. Also, the intra‐sector portfolios like realty, metals, information technology, and media generated higher returns with relatively moderate or less risk than their sectoral peers and benchmark indices. We found that Sharpe's model performs better than Markowitz's model. We validated our findings with statistical testing. Thereby, we documented the applicability of the Sharpe Single Index for portfolio optimization in the Indian context. Our research has several implications. Fund managers can make use of our optimal portfolio performance matrix to recommend portfolios to their clients. With our optimized portfolio weights, investors can make sector‐level or inter‐sector investments. Regulators can get a synoptic view of the performance of industry‐level portfolios. Researchers can extend the literature by improvising our portfolio optimization procedure.