In Part I of Index Valuations, we showed how the relative PE (price-to-earnings ratio) and PB (price-to-book ratio) of the NIFTY 50 and NIFTY MIDCAP 50 indices have varied over time. What would a portfolio that weighted each of these based on the relative valuation ratio look like?
Suppose, the relative ratio (R) = Ratio(MIDCAP)/Ratio(NIFTY)
Then, at the end of every month, re-weight the protfolio so that portfolio (S1) = R * NIFTY + (1-R) * MIDCAP, and
portfolio (S2) = (1-R) * NIFTY + R * MIDCAP
Ratio can either be PE or PB
It looks like:
- a portfolio with PB based weights is a lot less volatile than the PE based one.
- PB portfolio recovers much faster that the PE or plain-vanilla indices from deep drawdowns
- PB out-performs an equal weight portfolio
You can track and map this strategy to your portfolio using the PB weighted NIFTY/MIDCAP Theme.
Code and charts on github.