Belgian Stocks Portfolio Management

Question 1: Quick summary of selection

The management has decided to enter into a new market and set up an investment fund either in Belgium, the Netherlands, France or the UK. In this case, I choose to focus on Belgium. The first step of an investment fund is to identify the investment products. An investment fund can invest the total capital that it has over various investment products, such as stocks or bonds. In this case, I will look for the biggest stocks to invest in. I selected five stocks from the entire Belgian market. It’s important to include not too few stocks, but also not too many stocks. You have to include more than 1 or 2 stocks, because it will be less riskier. If you diversify, you will eliminate the non-systematic risk. On the other side, if you include 20 stocks, you will have to pay a lot of transactions. That’s why you have to hold just the minimum number of stocks to eliminate the non-systematic risk. That’s the reason why I picked out five stock, which can be seen in the table below

If you look at the market capitalization, these 5 stocks are among the largest Belgian stocks. There is one Belgian share that has a higher market capitalization than some of these 5 shares, namely ING. Like KBC, this is also a bank. That’s the reason why I haven’t include ING in the investment fund. There are a lot of traders who only invest in stocks of banks, but in my opinion this is too risky. I will illustrate my opinion by means of the graphs below. (These graphs are generated from Euronext.)

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In the graphs, you can see the price trend over 5 years of ING and KBC respectively. Like you can see, they have quite a similar trend. This means that the two shares are very correlated. So if KBC does badly, chances are that ING will also do badly. It’s better to choose shares that are not very correlated to optimal reduce the non-systematical risk.

The risk free rate  of return is the return an investor expect from an investment with zero risk over a period of time. The risk free rate I selected is the Belgium Government Bond (10 year). The reason for choosing this as risk free rate is quite simple. Government bonds are seen as very safe and are frequently and widely used as a proxy for risk-free rates. We could also choose the treasury bond (US Government Bond) as risk free-rate, but they have more risk than a Belgium government bond, because of the possible currency difference.

The market index I selected as benchmark is the BEL20. This is a very suitable market index because the Bel 20 is the reference index of the Brussels stock exchange. The Bel 20 is a basket consisting of the 20 largest shares listed on the Brussels stock exchange. This size is determined on the basis of the market capitalization or market value and on the basis of the liquidity or marketability of the share. The 20 companies in the index together account for around 62% of the Brussels stock market value, which makes the Bel 20 a good indicator for the entire stock exchange.

Question 2: Beta and other coefficients (alpha)

We used a linear regression in Excel to obtain the beta, with respectively the market return and the stock return as x-values and y-values.

In a financial context, the beta stands for the degree of volatility of the return on a particular financial instrument compared to the return of the rest of the market. The beta indicates the risk of a financial instrument. As the table above shows, there is a big difference between the shares when it comes to volatility (risk). AB Inbev and UCB have a beta less than 1. This means that the return on these shares rises/falls more than the increase/decrease of the market index (BEL20). The shares are less volatile than the market. So they are more defensive. Engie and Solvay have a beta more than 1. This means that the return on these shares rises/falls more than the increase/decrease of the market. They are more volatile than the market and are therefore riskier. The last one, KBC, has a beta of more than two. This means that the stock of KBC is two times as volatile as the market index. So this share has a lot of risk. It will has a lot more return than the market, but on the other hand, if the market is doing bad, this share will do even worse. Therefore KBC is a very aggressive stock. The regression shows that all these betas are significant, so there may be concluded that these stocks are more/less volatile than the market.