Have You Weighed Your Portfolio Weights Carefully?
It is crucial that investors have a strategic perspective when it comes to equity investing. Portfolio weighting strategy is often ignored by a majority of investors in their initial investment strategy. Yogesh Supekar & Tanay Loya bring forth the huge be
Markets are at record highs globally and Indian equity markets are no exception. In spite of such a spectacular upmove in the stock prices, you will find that majority of the investors are not able to outperform the relevant benchmark index. Even for a professional fund manager, it is a tough challenge to outperform the benchmark index consistently over a long period of time. The fact that almost 58 per cent of large-cap oriented mutual fund schemes have not been able to outperform their benchmark indices when we consider a ten-year period speaks volumes on the chances of beating the markets.
Why are investors not able to outperform even in a bull market phase that we are in currently? What determines portfolio performance? Is stock selection and market timing the ultimate mantra for beating the markets? Or is there something more to ‘portfolio outperformance’ than simply identifying stocks and timing the market right? Well, we have observed that investors tend to focus only on certain aspects of portfolio management and ignore some of the most essential aspects over time.
To understand what determines performance of a portfolio, one must simply focus on the basics of portfolio management and get every aspect of portfolio management correct. This way the odds of beating the market increases manifold. There are very many investors who do not even adopt a portfolio approach in equity markets and are prone to participate in markets randomly.
Our observation after interacting with lakhs of investors over the past decades suggests that investors err on portfolio construction and majority of the investors do not allow their investments to grow. In other words, majority of the investors take a short-term approach towards equity investments and this is at the root of a big chunk of the underperformance.
One of the most neglected aspects by retail investors in equity investing is the portfolio allocation, assuming that an investor adopts a portfolio approach towards equity investing. Unfortunately, there is not much of empirical research available on the subject which can help investors to determine scientifically the most appropriate portfolio weightages that investors can assign to a particular stock in the portfolio.
For a portfolio to outperform, we believe there are at least three things that any investor should be able to get right:-
Investor should know which stocks to buy and when (stock selection and market timing)
Investor should know how much to buy of each share (portfolio weightages)
How long to hold on to the investments (Long-term)
Even though it sounds simple to know the aforesaid three things that can help investors beat the markets, practically it is not always easy to identify the optimal portfolio weightages. That is the reason why portfolio management is considered a mix of art and science. How does an ace investor know how much to bet on which stocks? Isn’t it worth pondering what must be going on in the ace investors mind while making decisions on portfolio allocations. The point we are making here is- While majority of retail investors do focus on the stock selection aspect of the portfolio, it is observed that portfolio weightages do not get the attention they rightly deserve.
It is absolutely important that an investor focuses on determining the portfolio weightage aspect as much as he or she does on selecting the stocks that can be a part of the portfolio. The portfolio weighting is crucial and can often determine the success (or otherwise) of your equity investing adventure.
Most of the successful money managers will have a proven track record of investing a greater percentage of their money in stocks that do well and place lesser amount in bad picks. That judgement, that ability to allocate higher weightage to winners, comes from experience and cannot be formulated in order to be used or replicated by one and all. However, it is highly recommended that investors start focusing seriously on the portfolio weighting aspect of portfolio management as we find that portfolio weighting along with stock selection are the key determinants of portfolio performance.
To beat the markets, portfolio weighting needs to be taken care of along with market timing and stock selection. For example, let us say an investor has selected HDFC Bank for investment purpose in the portfolio and assigns a weightage of 10 per cent to the stock. If the stock goes up by 30 per cent in one year it would mean that HDFC Bank will contribute almost 3 per cent to the portfolio returns. If the investor had allocated merely 1 per cent of the portfolio to HDFC Bank then, in that case, the contribution of HDFC Bank to the portfolio would have been a meagre 0.3 per cent assuming HDFC Bank inched up by 30 per cent in one year.”
One of the perennial problems faced by investors is also on the number of stocks to be included in the portfolio that should be good enough to beat the markets. There is no empirical evidence that throws up a specific number, however there is widespread belief amongst the experts that a concentration strategy is essential to beat the markets. Several studies have shown that 13 to 20 stocks diversified across sectors are good enough to minimise the risks of the portfolio. Any further addition to the portfolio beyond 20-odd stocks will not meaningfully help improve the portfolio performance, neither will it help reduce the risk of the portfolio substantially. According to Ritesh Asha, Chief Strategy Officer, KIFS Trade Capital, “If an investor adds more stocks in the portfolio beyond 30 stocks, it would not reduce any further risk in the portfolio. On the contrary, it would make the portfolio unnecessarily large and the good performance of any one stock would not be able to produce meaning impact on the total portfolio performance. Increasing the number of stocks beyond 30 might prove counterproductive for the investor. The ideal number of stocks in the portfolio is an outcome of the investor’s risk appetite.”
While there is abundance of research available on ‘How to identify quality stocks?’ and on ‘market timing’, there is not much literature available on how to assign portfolio weightages. Portfolio weighting and rebalancing are useful risk management strategies for value investors.