Index Valuations, Part II

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?

Backtest

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

PE based weights:
PE weights

PB based weights:
PB weights

It looks like:

  1. a portfolio with PB based weights is a lot less volatile than the PE based one.
  2. PB portfolio recovers much faster that the PE or plain-vanilla indices from deep drawdowns
  3. 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.