Strategy For Retail Investors: ‘Buy and Hold’ vs ‘Actively Managed Portfolio’

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 duration despite 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 on September19, 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’ portfolio became 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.