Ex­pert Speak

Dalal Street Investment Journal - - CONTENTS -

In this ar­ti­cle, we dis­cuss two im­por­tant in­vest­ment strate­gies for re­tail in­vestors: ‘Buy and hold’and ‘Ac­tively Man­aged Port­fo­lio’and pro­vide em­pir­i­cal ev­i­dence to sup­port our view. Let us first un­der­stand each of the in­vest­ment phi­los­o­phy and the mer­its and de­mer­its. The ‘Buy and hold’ sug­gests that when an in­vestor se­lects a par­tic­u­lar stock and re­mains in­vested in it for a longer du­ra­tionde­spite volatil­ity in the price of the stock, he is more likely to gen­er­ate higher re­turns. For ex­am­ple, Ar­jun, a re­tail in­vestor, in­vests in a stock “XYZ” on 15 Jan­uary 2005 and gives his in­vest­ment some time to gen­er­ate re­turns ig­nor­ing the volatil­ity in the eq­uity mar­kets. This school of thought sug­gests that once a stock is bought,the in­vestor should for­get about the stock and should look at the re­turns only af­ter a long pe­riod of time, may be 5 to 10 years.

The sec­ond ‘Ac­tively Man­aged Port­fo­lio’ strat­egy sug­gests that once a stock is se­lected, in­vestor should con­stantly mon­i­tor the stock and when­ever the stock does not fit into the pa­ram­e­ters of in­vest­ing, it should be re­moved from the port­fo­lio. Reg­u­lar mon­i­tor­ing en­sures that you have only those stockin your port­fo­lio that meet your in­vest­ment cri­te­rion.this phi­los­o­phy, how­ever, has a mon­i­tor­ing and churn­ing co­stand needs time and ef­fort. More­over, there is a pos­si­bil­ity that for any aber­ra­tions in fi­nan­cial per­for­mance in one year,in­vestor may re­move a good in­vest­ment ca­pa­ble of gen­er­at­ing higher long term re­turns.

To em­pir­i­cally eval­u­ate th­ese strate­gies, we cre­ate two port­fo­lios on the ba­sis of fi­nan­cial per­for­mance and cer­tain other cri­te­ria. We then cal­cu­late re­turns of the port­fo­lio to as­cer­tain which of the two port­fo­lios gen­er­ates bet­ter re­turns. We be­gin with se­lect­ing all com­pa­nies with a mar­ket cap­i­tal­iza­tion of more than Rs10,000 crore as on Septem­ber 19, 2017. This cri­te­rion was im­posed to en­sure that we se­lect large cap­i­tal­ized stocks with ad­e­quate liq­uid­ity. A to­tal of 210 com­pa­nies met this cri­te­rion. We fur­ther fil­tered com­pa­nies on three pa­ram­e­ters: com­pa­nies with sales growth more than 15%,re­turn on eq­uity (ROE) greater than 15% and the pro­moter hold­ing more than 40%. In our pre­vi­ous stud­ies, we had found that com­pa­nies which qual­ify on th­ese pa­ram­e­ters do bet­ter than other com­pa­nies.we had a fi­nal sam­ple of 55 com­pa­nies that met all the cri­te­ria.

We cre­ated a port­fo­lio of the stocks se­lected to ap­ply ‘Buy and Hold’ strat­egy and cal­cu­lated re­turns on the ba­sis of price as on Septem­ber 19, 2013 and Septem­ber 19, 2017. Ta­ble-1 in­di­cates that the ‘Buy and hold’ port­fo­lio, which has 55 stocks, has gen­er­ated an av­er­age CAGR of 34% as com­pared to S&P BSE Sen­sex Re­turn of 12%.

We fur­ther test the re­turns gen­er­ated if we ap­ply ‘Ac­tively Man­aged port­fo­lio’ strat­egy. To the se­lected stocks in the study, the only change that we made is to ac­tively man­age the port­fo­lio, i.e., ev­ery year on­septem­ber19, we again ap­plied the three fil­ters.

For ex­am­ple, all the stocks that we pur­chased on Septem­ber 19, 2013 were re­viewed based on the three cri­te­ria on Septem­ber 19, 2014. We sold the stocks that did not meet the cri­te­ria and in­vested the money equally amongst the stocks which qual­i­fied for in­vest­ment based on the cri­te­ria on Septem­ber 19, 2014. The same steps were re­peated in each of the year. Ta­ble-2 in­di­cates the an­nual re­turns gen­er­ated by the port­fo­lio ev­ery year. The num­ber of com­pa­nies (N) changes ev­ery year. It is also no­tice­able that the num­ber of com­pa­nies in the port­fo­lio is de­creas­ing ev­ery year,which in­di­cates that fewer com­pa­nies are able to earn ROE and sales growth above 15%.

The dis­tinc­tion in the re­sults for both the strate­gies is quiet clear.on Septem­ber 19, 2013,Rs10,000 in­vested in ‘Buy and hold’ port­fo­liobe­came Rs31,963 (a growth of 34%). The same amount in­vested in ‘Ac­tively man­aged port­fo­lio’ be­came Rs38,307(a growth of 40%).

We con­clude that in­vestors would be well off with ‘Ac­tively Man­aged” strat­egy. Fi­nan­cial in­vest­ments need to be man­aged ac­tively and if in the sub­se­quent years of your in­vest­ment, the rea­son why you had in­vested in the stock does not fit into your in­vest­ing scheme, then you have to de­cide whether you wish to still hold on to your in­vest­ment or exit.ex­er­cise of vig­i­lance and due dili­gence in in­vest­ment pays in the long run.

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