The Art Of Portfolio Management

The Art  Of Portfolio Management


It’s not enough to simply invest. As an investor, you will not be able to make the right gains and cut back on losses or achieve your financial goals unless and until you monitor your portfolio regularly and learn the tricks of rebalancing it to stay on top of the game

You aim for the palace and get drowned in the sewer.” So said author Mark Twain. And it’s something that applies well to your investment as well. In recent times, a majority of investors looking at their portfolio would be staring at huge losses, especially if they had started investing only over the last three years. With the exception of a few sub-categories such as international, pharmaceuticals and MNCs, all the other categories of equity-dedicated funds are on an average yielding negative annualised returns in the last three-year period. Even if we extend the period of study to five years, the returns generated are not exceptional and below the bank fixed deposit rate, thus barely beating savings account rate of interest.

The real returns for many investors would be even worse than what is being reflected in the above graph as they would have been trying to time the market and chase returns. So is there any way through which investors could have improved the performance of their portfolio? Yes, the logical alternative to performance chasing and market timing is structuring a long-term asset allocation plan and then staying on that course. Many a time, sticking with an asset allocation plan is hard to do as it may require some counter institutive action. For example, it may ask you to sell performing assets and buy underperforming assets. At times like these, it calls upon your confidence to use your knowledge and stay on the chosen path.

If you have done enough research and taken care to make a portfolio that suits your goals and time horizon, it will help you gain that confidence and there’s very little reason to spend time trading in and out of funds. Over the years it has been witnessed that investors inflict far greater damage on their portfolios by trading too frequently than by not trading enough. The following paragraphs will walk you through some of the important aspects that you should keep in your mind while investing. Most of the successful investors set aside time for regular portfolio check-ups throughout the year to ensure that their portfolios are on the right track. Even if nothing materially significant has changed about your investments, it will give you a sense of your asset allocation.

Quarterly Portfolio Review

You cannot afford to make your portfolio and forget it. If you fail to regularly re-evaluate what you are investing in and how those investments are performing, you are skidding off the rails as far as your goals are concerned. This is especially true in the current equity market condition. This does not mean that you should rush to change your asset allocation. Therefore, you should review your portfolio regularly, if not every month then at least every quarter. This is not an alternative to the thorough annual review. However, the purpose of this review is to spot any areas of concern that need deep investigation. The goal of the quarterly review is to check for major changes or trends within your holdings and portfolio overall. Therefore, you should revisit the following items.

Performance of the Portfolio: Check the overall return of your portfolio for the past three months. Besides, you must also check the best and worst performing funds of your portfolio in this period. The best and worst performing funds should be evaluated against an appropriate mutual fund category. There could be an instance that a fund might be the worst performing in your portfolio and yet be the best performer in its category. Therefore, comparing the performance of the fund against its peers will help you to see the performance of the fund with the right perspective. Besides, it is not only the returns that matter; you may have to keep it in your portfolio to maintain the required diversification. The key here is not to place too much emphasis on the gains or losses you incurred on your portfolio in a single quarter. The purpose is to keep an eye on the holdings you need to buy or sell while undertaking an annual check-up of your portfolio.

Fundamental Changes and News : This remains one of the most important aspects to check while doing your quarterly portfolio review. It will help you to determine if any qualitative change has taken place in the last three months that will have a quantitative implication on the fund’s performance. For example, you may find that your mutual fund has undergone a managerial change in the last quarter. As the performance of the fund is very much tied to the capabilities of its fund manager, the variables may change going ahead. This does not mean that you have to immediately exit from the fund when you find that such a change has taken place.

Before taking any decision you should learn about the new manager’s background in terms of the funds he managed earlier and if the style he follows suits you. It would also be important to know the kind of changes that he is planning to bring about in the fund portfolio. In addition to any such managerial change, you could also check if the fund is being merged with other funds or getting acquired by any other fund house. These changes will have far-reaching implications to your fund and your portfolio. These changes require a closer look and understanding as to how will they impact the management of the fund and its performance.

Portfolio Allocations : Last but not the least, in each quarterly review you should check your asset allocation to see if and how the big picture of your portfolio has changed. You also need to investigate your overall portfolio’s sector weightings. A small difference from the original asset allocation over three months does not mean that it’s time to buy more of a given holding and sell another. But by keeping a close eye on major portfolio-related changes as they develop, you will make your year-end review easier and will come to realise the trends or movements before your overall portfolio changes too dramatically.

Annual Portfolio Review

A quarterly review of your portfolio may not take much time. However, while doing your annual portfolio review be sure to devote extra time as it is based on this review and its outcome that you would need to take real action. This means that based on your annual review you will buy and sell funds and make necessary adjustments. Following are the areas you should check to know if any changes are called for.

Asset Mix : If you do nothing to your portfolio over a period, the weightage of cash, stocks and bonds will shift in your portfolio. In normal circumstances and in most cases, stocks typically post better returns than bonds or cash and therefore you may continue to see increasing equity weightage in your portfolio if left untouched. Nonetheless, in a situation that we are currently facing when the equity markets are not in good shape, the opposite may happen and your equity may have lower weightage in your portfolio as compared to the start of the year. Your stock portfolio would be losing money, thereby leaving your equity allocation smaller than you would like.

Therefore, keeping tabs on your stock and bond mix and making adjustments if the need arises is the single most important thing that you can do to keep your portfolio’s volatility in check and to protect the gains you have made. For example, in the year 2017, BSE 500 gained by 35 per cent followed by a 3 per cent loss in the following year. Again, in the year 2019, BSE 500 gained by around 8 per cent. And for the year 2020, it is down by nearly 20 per cent. The important lesson that it teaches is that returns from the stock market keep on fluctuating and no one can predict the outcome. This is even true for other asset classes. However, it has been observed that except for a few occasions, the returns of different asset classes do not move in unison. Therefore, keep an eye on your asset mix.

Investment Style : Just as you have seen that the mix of stocks and bonds changes over a given period, your portfolio’s investment style mix also shifts over such a period. In a given year, different kinds of themes play out and funds dedicated to such themes vary accordingly. Therefore, it gives you a reason to diversify within an asset class. For example, in 2017, small-cap and mid-capdedicated funds performed exceedingly well and generated returns of more than 50 per cent. Nevertheless, in the following two years they suffered huge losses and are yet to recover from this setback. The funds were down by almost 55 per cent from the peak they had reached at the start of 2018.

Besides the market-cap, what also keeps on changing is the scenario of the different sectors at different points of time. For example, from 2004 to 2007, infrastructure and real estate generated huge returns for investors. Later, it was the pharmaceutical sector which played a pivotal role in providing better returns to investors and till recently it was the NBFC sector that was a market outperformer. As a result, funds dedicated to such sectors grew to be considerably larger portions of investors’ portfolios in those periods. Investors who weren’t paying attention to their portfolios suffered tremendously once the tide was over for these sectors. Now, the infrastructure and real estate sectors are quite unlikely to reach their previous highs.

Concentration on Individual Securities : While HDFC Twins or Bajaj Twins were the most common for many of the funds, you will do well to know exactly how much you are holding in terms of such individual stocks. Checking on stock overlap or concentration of stocks in your portfolio will help to ensure that you do not increase your exposure to any stock beyond 15 per cent of your total assets. If for any reasons a single stock has occupied more than 15 per cent of your total portfolio, you should bring it down as you do not know when it may go through a sharp downturn. In the current scenario if you had exposure to Bajaj Finance or HDFC Bank of more than 15 per cent, you would have been in for a crude shock as these stocks are down by half and one-third respectively.

To accurately assess the largest stock positions in your portfolio, you will need to add the entire mutual funds’ corpus. After that you calculate the weightage of individual stocks in each fund and multiply with AUM of that fund. Now you sum up all the individual stocks that you own and divide it by the total equity portfolio value. It’s not unusual to discover that many of the most popular mutual funds have invested in the same securities and hence you may have one of your stocks exceeding the 15 per cent limit. In such a case you should consider scaling back on the fund that’s heavy on that holding.

Rebalancing : Once you are done with your annual review of the portfolio, the next logical step is to rebalance your portfolio. Rebalancing is simply the act of bringing your portfolio back to your target asset allocation path after market forces and your investments in between have changed the percentages of various asset classes in the overall portfolio. Some of you will argue and question the need for rebalancing when everything is running fine and on expected lines. One of the greatest reasons for rebalancing is to control the risk. The process helps us to bring our portfolio back to the level of risk that we determined was appropriate for us and something that we were comfortable with. The objective should always be to achieve your financial goals – the ones that you may have set up when you first established your asset allocation plan.

Assume you are at the start of 2017 and have Rs200 to invest. You may have invested 50 per cent of your portfolio in stocks (BSE 500) and 50 per cent in long duration bonds. At the end of 2017, your portfolio would have become around Rs238.50 since the equity part gained 35 per cent and the debt part 3.5 per cent. Now, at the start of year 2018, you do your annual review of the portfolio and rebalance it to restore the original asset allocation. This would mean you need to sell around Rs15.75 from the equity part and invest that into the debt fund. This would mean that you are now invested in equity and debt for Rs119.25 each. At the end of 2018 your portfolio would have become Rs242.30. The gain came from the debt part of the portfolio that increased by 6.5 per cent while equity lost 2.35 per cent in the same duration. If you had not opted for rebalancing, your portfolio value would have been around Rs241.

Rebalancing forces us to sell high and buy low. We are selling the outperforming asset class or segment and buying the underperforming asset class or segment. This may seem very counter-intuitive; however, that’s exactly what smart investors do. By rebalancing you are protecting the gains that you made by taking some money off the table. And by buying into the funds that haven’t done so well, you are potentially getting more shares on the cheap, which can enhance your returns going ahead. This is based on the principle that returns from asset classes revert to the mean over time. Once you know the importance of rebalancing, the next question is when to rebalance?

Some people will recommend rebalancing on a strict time interval, such as each quarter, semi-annually or annually. Others suggest rebalancing based on percentage changes in your portfolio known as expansion bands. The choice of the right time to rebalance will depend upon two factors: costs and taxes. Costs would include any exit load applicable to the funds. Taxes would be a crucial factor too because you may realise capital gains. Keep in mind that long-term capital gains are taxed at a lower tax rate than short-term capital gains and equity and debt have different tax treatment.

Therefore, rebalancing annually makes sense as it will help you to lower your cost since many funds charge exit load if you exit before one year and moreover, if you sell your equity portfolio after one year you may have to pay lower taxes. Besides, as you progress to a different life stage, you should rethink and possibly change your asset allocation, which means that you need to rebalance the portfolio in accordance with your new asset allocation plan.

Conclusion

We now understand the importance of monitoring our portfolio and how to manage it. A quick review every quarter followed by a thorough review at the year-end – this is considered an ideal scenario. The year-end review should be done to analyse asset allocation, sector weightage and positions in individual stocks. Once you have done this, you should rebalance your portfolio to control risks that might also increase returns. In short, to make your investment journey smooth and enjoyable you should monitor your portfolio regularly and rebalance it annually.

Rate this article:
No rating
Comments are only visible to subscribers.

DALAL STREET INVESTMENT JOURNAL - DEMOCRATIZING WEALTH CREATION

Principal Officer: Mr. Shashikant Singh,
Email: principalofficer@dsij.in
Tel: (+91)-20-66663800

Compliance Officer: Mr. Rajesh Padode
Email: complianceofficer@dsij.in
Tel: (+91)-20-66663800

Grievance Officer: Mr. Rajesh Padode
Email: service@dsij.in
Tel: (+91)-20-66663800

Corresponding SEBI regional/local office address- SEBI Bhavan BKC, Plot No.C4-A, 'G' Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400051, Maharashtra.
Tel: +91-22-26449000 / 40459000 | Fax : +91-22-26449019-22 / 40459019-22 | E-mail : sebi@sebi.gov.in | Toll Free Investor Helpline: 1800 22 7575 | SEBI SCORES | SMARTODR