Financial portfolio construction and rebalancing, or management, is based on risk and returns estimations. Moreover, it requires a certain predefined risk tolerance level to be selected by the investor. Estimating an optimal portfolio from a pool of securities entails maximizing the expected risks and returns.
The subsequent data and financial analysis explores how the efficient frontier ranks a pool of mixed oil&gas and renewable energy stocks in terms of volatility and returns. The analysis is based on historical data for the last ten years obtained from Yahoo finance. It is also estimated if there is notable difference in volatility and risk associated with energy stocks from the oil&gas industry compared to energy stocks from the renewable energy sector. The analysis answers the question as to how much exactly one needs to invest in each security in order to obtain an optimal portfolio.
Public companies selected for the portfolio modeling - 10 of the largest market cap companies in the oil&gas and renewable energy industry:
Company | Trading symbol | Operations |
Exxon Mobil Corp | XOM | The Company's principal business involves the exploration for, and production of, crude oil and natural gas, and the manufacture, trade, transport and sale of crude oil, natural gas, petroleum products, petrochemicals and a range of specialty products. |
Chevron Corporation | CVX | Chevron Corporation is an American multinational energy corporation predominantly specializing in oil and gas. The second-largest direct descendant of Standard Oil, and originally known as the Standard Oil Company of California |
Shell plc | SHEL | Shell plc is a British multinational oil and gas company headquartered in London, England |
PetroChina Company Limited | 601857.SS | PetroChina Company Limited is a Chinese oil and gas company and is the listed arm of state-owned China National Petroleum Corporation, headquartered in Dongcheng District, Beijing |
TotalEnergies SE | TTE | TotalEnergies SE is a French multinational integrated energy and petroleum company founded in 1924 and is one of the seven supermajor oil companies. |
Brookfield Renewable Partners | BEP | Brookfield Renewable Partners LP engages in the ownership of a portfolio of renewable power and sustainable solution assets. |
Green Plains | GPRE | Green Plains is an American company based in Omaha, Nebraska that was founded in 2004. The company is the third largest ethanol fuel producer in North America. |
Innergex Renewable Energy Inc | INE.TO | Innergex Renewable Energy is a developer, owner and operator of run-of-river hydroelectric facilities, wind energy, and solar farms in North America, France and South America |
NHPC Limited | NHPC.NS | NHPC Limited is an Indian public sector hydropower company that was incorporated in 1975 to plan, promote and organise an integrated and efficient development of hydroelectric power. |
Suzlon Energy Ltd | SUZLON.NS | Suzlon Energy Limited is an Indian multinational wind turbine manufacturer headquartered in Pune, India. It was formerly ranked by MAKE as the world's fifth largest wind turbine supplier. |
Volatility for all companies' stocks based on the available data:
Volatility indicates how stable is the price level of the company's market shares. Higher volatility may be a source of trading opportunities but also means higher risk associated with investing in those securities. Notably, renewable energy companies have the highest volatility - both Green Plains and Suzlon exhibit approximately twice the volatility of the rest of the stocks in the selected pool.
Efficient frontier for the pool of selected securities:
The efficient frontier is the set of optimal portfolios that offer the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are sub-optimal because they have a higher level of risk for the defined rate of return.
Based on computations performed for the construction of the efficient frontier, the most conservative portfolio (the one with the least risk) is:
Expected return: 0.108813 or ~ 11%
Volatility: 0.146715 or ~15%
Top picks are Innergex Renewable Energy Inc, NHPC Limited, Brookfield Renewable Partners LP and PetroChina. The renewable energy companies make up for more than 50% of the portfolio with lowest volatility.
However, the least volatile portfolio is not the optimal portfolio. An optimal portfolio is one designed with a perfect balance of risk and return. The optimal portfolio looks to balance securities that offer the greatest possible returns with acceptable risk or the securities with the lowest risk given a certain return.
The optimal portfolio:
Expected return: 0.169641 or ~17%
Volatility: 0.2065715 or ~21%
The top selections in the optimal portfolio are Suzlon, Green Plains, Brookfield Renewable Partners and Innergex Renewable Energy Inc. The top four shares amount to even higher percentage of renewable energy stocks in the final portfolio mix.
A conclusion can be made that the standard portfolio management theory and corresponding financial analysis suggest that large cap renewable energy companies are a good investment choice.
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