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

Dalal Street Investment Journal - - CONTENTS -

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.

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