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The antidote to Momentum if there is any, lies in the domain of Value investing. Momentum and Value are often seen as two sides of the same coin even though believers may think that the world is flat and there is only one side to it.
When it comes to building portfolios, though, Value and Momentum can be as different as chalk and cheese. One looks for stocks making new lows while another looks for stocks making new highs. Value investing requires in depth business analysis, while momentum is a heavily data driven approach.
At Portfolio Yoga, we believe that an investor need not be chained to one factor that is currently fancied. This is why we introduced the Quality Portfolio which looks at stock picking differently from the Momentum Approach with a much longer holding period.
Stocks that qualify for Quality for most part are already well known companies that have shown the mettle for many years. On the other hand, there are stocks – stocks that may not be currently fancied for whatever reason but one with high potential. Lack of interest provides opportunities for the discerning investor who is willing to wait for the market to recognize its potential.
With thousands of companies, searching for a few good companies is more like searching for a needle in a haystack especially since quantitative filters can only filter out only the really unreasonable leaving hundreds of others available for picking. To build a sensible portfolio, we need to drill it down to a couple of dozen stocks and this requires a lot more than just historical data.
Building Wealth | Building Relationships is not just our tagline but how we wish to live in reality. Building relationships is never easy but once built, good relationships can last a lifetime. Building Wealth on the other hand, it’s all about being with the right people.
With the launch of Portfolio Yoga Fundamental Bets portfolio, we are expanding our team by collaborating with people who have been in the world of fundamental investing for more than a decade.
With their expertise and our experience, we hope to be able to deliver a portfolio that produces a decent reward for the risk taken. We hope you can join us in the journey we are about to begin.
Strategy
The portfolio is designed for long term investors with a time horizon of two to five years.
The criteria for inclusion of any stock into the portfolio will be based on businesses we understand and one we feel have a long runway for growth. We dislike companies with high debt ratios and would try to stay away from the same even if they seem to be available cheap.
A pure value portfolio is one where the firm is being sold for less than its intrinsic value for any number of reasons. While finding such companies in India is not an issue, the issue always is the ability of the management to unlock such assets. As we have in multiple cases, even when such assets are unlocked, the retail shareholders may be left high and dry with the management deciding to use the funds based on their own rationale and reasons.
This portfolio hence is a combination of Value and Growth. Our Universe of stocks is across all market segments and hence will be multi-cap in approach. The portfolio currently holds nearly 38% of the capital in Cash and which shall be deployed as and when new opportunities are found.
Current Market Cap Distribution of the Portfolio
The minimum capital we advise for those wishing to subscribe to the portfolio is Rupees Six Lakhs. The reason for the high commitment is to ensure that the fees you pay are inline with fees you get charged at Mutual Funds when going through the distributor mode.
The portfolio stocks shall be in either Buy Mode, Hold Mode (wherein those who have bought can hold the same though new investments aren’t recommended) or Sell (either complete exit or partial exits based on each stocks individual situation).
Given that the market doesn’t wait for a weekend for opportunities to surface, additions may happen at any time during the week and shall be communicated via email. In future we are also contemplating using other tech tools to provide you with timely alerts on mobile and one that is not easy to miss.
Benchmarking: This portfolio would be benchmarked against Category Returns of “Value Oriented Funds”.
Want a sneak peak at the portfolio before you decide? Check out the sample here
Do note that this is part of the real starting portfolio though changes in the real portfolio will not be reflected here. This is just a sheet to provide you with a clue on the kind of stocks we shall pick.
The Fee for this portfolio has been set at Rs.12,000 (Rupees Twelve Thousand Only}. Link for the payment is available on the Philosophy & Services page.
To maximize return, the focus of any investor should be on a single factor, be it Momentum, Value or Quality. But the risk of a single factor is high in the sense that one can go through long periods of under-performance before seeing the light of the day.
Internationally, the accepted norm for advisors is to minimize that risk by having a multi factor approach. More diversified the portfolio is, the smoother the returns will be. For large accounts, advisors recommended exposure to more investments such as Gold or Trend Following to reduce the net volatility of the portfolio.
Of course, nothing is free and the cost of spreading across does mean a slightly lower return but if that comes at the cost of a better sleep, it’s any day better than losing sleep but ultimately getting a high return especially if you are not prepared mentally for the risks.
When we started off with Momentum Portfolio, we made a promise that in addition to Momentum at some point of time we would be providing a Coffee Can style high quality stock portfolio. Today we are delivering on the said promise.
The concept of Coffee Can Strategy goes back to 1984 when Robert Kirby wrote a paper titled The Journal of Portfolio Management. Yet, in India, we owe the familiarity of the strategy to Saurabh Mukherjea when he first wrote the book The Unusual Billionaires in 2016.
Since then, Saurabh has been a strong supporter of the said strategy while laid down very simply asks you to build a portfolio of stocks that carry two characteristics. As he writes in his book and I quote,
Thus, my stock-selection filters are companies that deliver revenue growth of 10 per cent and ROCE of 15 per cent every year for the past ten years.
When I first stumbled upon the strategy thanks to the book, I was impressed because here lay a simple strategy that had in the past delivered a return better than a benchmark but also one that seemed logically sound.
Most Analysts and Fund Managers try to make it seem like their process is ultra complex. From trying to figure out the management quality to understanding the company better than the company’s own management.
It’s not that there is no value in trying to determine how good or bad a management is but it’s easy to get misled for we are finally humans and gullible in nature. The reason guys like Madoff or Ramalinga Raju were able to do what they did for so long has more to do with not their own abilities as sales guys but also the fact that most of us want to look at things from a positive spirit.
Buying good companies and holding them for long is the long and short of the Coffee Can Strategy. In many ways, if you were to read between the lines of any fund manager, this is what the aim ultimately is.
While most retail investors try to chase the next best thing, fund managers continue to bet on what worked in the past in anticipation of them working in the future as well. HDFC Bank was a well known wealth generator in 2010 which at that point of time its 10 year returns were to the tune of 20% at the beginning of that year. Today, its 10 year return stands at 20%.
Yet, most investors will rather chase the next HDFC Bank (the current fancy being IDFC Bank) than buy HDFC Bank. As Charlie Munger says,
Avoiding Stupidity is Easier than Seeking Brilliance
and yet, we seek brilliance by attempting to find the next best stock. Not that it really matters when it comes to final returns for very few will wish to bet on the next best stock a substantial amount of money, but always nice to claim as having identified it – maybe even before the promoters knew about it themselves.
While the basic idea for the portfolio has been borrowed from the Coffee Can strategy laid out by Saurabh, it’s not the same implementation. I have made some slight changes based on my understanding of the strategy as also the portfolio being more diverse than what is generally advertised. As the above Charlie Munger quote says, we are here not to seek Brilliance but avoiding stupidity and a diversified portfolio is a hedge against our stupidity in ways more than one.
Not every stock out there would be a winner but I strongly believe that the portfolio as a whole would give decent long term returns to the investor.
The portfolio has no cap on Individual sector weights though it is nicely spread across with a larger weight in two focus sectors – Tech and Pharma.
We expect very little churn in the portfolio in line with the basic strategy of Coffee Can which is to buy and hold for a decade. Yet, this is not a copy of the Marcellus Portfolio {last time they disclosed the same, these were the constituents}. Do note that there is a slight amount of discretion in the portfolio that can be alluded to us.
For a while, Quality stocks have been richly valued compared to peers. The premium for quality is not going to go out even though we may see a period of flat returns which generally allow for the excess valuations to dissipate.
The risk at the current stage as far as my observation and understanding goes is with respect to flat returns. But most of these companies have showcased excellent growth in the past and the business model is sufficient tuned to continue to grow in the future as well
The portfolio comes at no additional cost to existing or new subscribers. If you have any questions, do mail me or DM me on Twitter
In 2017, I was testing various ideas. Most did not have much value but some did and went into production mode. While I have been invested in Momentum since 2017, another portfolio that I invested family money into was a Buy and Forget Portfolio that did not have anything to do with the one key criteria for Buy and Hold – fundamentals.
Instead, the portfolio was created based purely on the stock price. To qualify for the portfolio, all that the stock had to do was be one of the most expensive ones among the listed stocks in the National Stock Exchange.
There is no rhyme or reason for such a portfolio to work. Stock prices don’t reflect anything other than how much one is willing to pay for a single equity share. A stock that trades at 100 may be expensive vs a stock that trades at 10,000.
Mining stock data for patterns is one of the easiest ways to find strategies that worked in the past. Unfortunately most of them have no rationale other than the fact that somehow in the past a lot of things lined up correctly and hence this strategy was seen as one among the best.
A strategy that is curve fitted will start wobbling the moment the rubber hits the road and more or less likely to fail within the next few months. Yet, mining is a great way to figure out what works and what doesn’t.
So, how does one come to a conclusion as to whether a strategy really has value or not. This from my own understanding and experience comes down to testing it in the real world. While you can always test the strategy in different markets or use a different set of data to test (this test is called Walk Forward Testing), the best test is unfortunately the real market and even here judgments can be passed after a minimum period of 3 years.
<Full Post along with Portfolio available for Paid Clients Only>
We now have 3 Portfolios. Pricing is NOT per Portfolio. One Price – multiple Portfolios. 2021 should see at least one more if not two more offerings. Our objective is to provide portfolios that have low correlation between themselves (only exception is the Large Cap Momentum Portfolio which has a high correlation and overlap at times with the Multi Cap Momentum Portfolio).
Do check out our Philosophy, Process and Fees here
Historical Performance of the Portfolio – Rebalanced Yearly in January
Since my first blog post highlighting my own move to Momentum Investing, I keep getting queries by friends and acquaintances who wish to learn more about it. The number of queries have increased in recent times though many are in telephone calls and not shareable with others. Once in a way, I do receive very thoughtful questions that I think require more than a simple answer. Yesterday, I was asked one such set of questions by Prashant.
I think these questions and my views on the same can add value to a better understanding and hence rather than it being a one to one conversation, am posting this here in the hope that it helps clear some doubts that others may have themselves.
1) First thing, would like to discuss about the conducive environment for momentum investing –
Many researchers and authors suggest keeping track of sentiment, be it breadth of the market or some kind of trend indicator (200/50 DMAs) for overall market trend. My point is one or other sector or stocks are always there which shows momentum even if broder market breadth is not good or range bound or even falling/downtrend, So is it a good idea to be invested all the time – based on backtest and purely from your experience ?
My View: In his book, Stocks on the Move, Andres Cleanow writes and I quote
I will declare the market to be bearish if the S&P 500 Index is below its 200 day moving average. That’s a very long term filter. Using such a simple approach, we immediatelyhave a firm way to identify if the market is in a bear trend or not. Practically all equity portfolio strategies can be improved significantly by simply adding this one rule. If the index is in abear market, just don’t buy stocks
Andres Cleanow
While theoretically this is sensible, there is an issue when you look at the data. For the Indian Markets, I shall use Nifty 500 as the Proxy. The issue is whipsaws. From 2010 to 2020, Nifty 500 has crossed below its 200 day moving average 40 times (average of 4 times a year). Using an envelope rather than the 200 average reduces the trade numbers but adds a bigger lag on either side.
Even without bothering about Timing Luck which would impact this tremendously, this constant moving to cash and getting back to full position has a cost. Personally I don’t see value in adding this filter even though this could have gotten me partially out of the market in March of this year (I would be back fully only in August and hence lost quite a lot on the way down while losing the opportunity on the way up as well).
But when market breadth as measured through say % of stocks trading above their 200 day EMA is on the lower end, the performance of Momentum like any other market strategy will be below par. Hence a better strategy will be to sit out when % of stocks trading above their 200 day EMA drops below a certain parameter and pick it up only when the broader trends are back in place.
Because it’s not as volatile as the 200 day EMA on a Index, this has a lower number of trade-offs. But trade-offs shall remain regardless for there is no Free Lunch.
Personally since I started, my portfolio has been completely invested but for one month (April 2020). I do keep working on new ideas and strategies and willing to change if evidence points to a better way to invest.
2) Second point is Exit, somewhat related to first point and of utmost importance –
Is it better to exit all positions when sentiment for the whole market turned bearish based on above trend criteria OR can follow stock specific checks be it fixed SL(5% or 10%) or Trailing SL or momentum ranking criteria (if it falls out of list lets say top 20 or 40 depending upon one’s strategy of ranking/sector allocation/volatility). What is the best practice given the kind of experience you have ?
My View: As outlined above, exits when we feel the market is bearish (based on quantitative measures) has its drawbacks. I don’t feel it compensates for what we are aiming for – lower drawdowns in any meaningful way other than once in a blue moon kind of event.
Stocks are generally volatile and stocks that are making new highs (and hence generally tend to be part of the Momentum Portfolio) are more likely to be a bit more volatile. Having a fixed percentage stop is injurious to returns. Each stock has its own volatility and trying to force every stock to align with a single stop will guarantee bad returns.
I use WorstRankHeld as the criteria to decide whether to hold the stock or exit. This is not strictly speaking required – you can just exit any stock that moves past the portfolio size and replace it with others. But the reason I use is to limit churn in the portfolio. Churn has a very high cost (both visible and invisible) and lower the churn, lower the cost we pay.
I don’t believe that a stock in momentum has to continuously rocket upwards all the time. Many a time stocks do move into a range before launching into another fresh rally. Constant checking and weeding out such stocks will only mean that you aren’t allowing much time for the stock to make its move.
To give a recent example – Birla Soft got into my portfolio in October 2020 (a tad too late maybe). Stock decided to drop right after my entry. But in the ranks, did not go below the WorstRank held and this ensured that the stock wasn’t dropped like a hot potato. The next month (November 2020), it moved up enough to get back to my purchase price. It was only in late December that the stock finally made its move. Without a worst rank held, this would have gone out. There is always a chance that the replacement could have done better, but could have done worse as well.
I have tested for both and find it kind of a yin and yang. Sometimes cutting off once it drops below 30 works better than Worst Rank Held while some other times, it works bad. But overall, I have seen that the difference it makes isn’t too huge and if I can get the returns without too much of a churn, I am game for that.
3) Third point is allocation –
There are quite a few theories related to this: few researchers suggest equal weight portfolio while few suggest volatility based using
20 ATR and start allocating funds from rank 1 based on volatility of stock till the fund exhausts.
Sectoral allocation – Some suggest keeping sectors in check but some suggest to invest even if all the stocks come out from only one sector.
What’s your point of view ?
My View: This is a very good question.
Let’s start with portfolio construction. Equal Weight, Weight based on Trend Strength, Inverse Volatility weights, Market Cap based weights are among the one’s generally used. I have tested for Volatility and Equal weight and found not much of a difference in returns. Bigger difference and volatility happens due to Portfolio Size. Equal weight is simple and easy to adjust when one is adding new capital and hence my preferred choice.
Sector Allocation can be controversial. In August, I made this tweet
The biggest risk with strategies such as Momentum – Sector Concentration. My own portfolio as of today's close for instance pic.twitter.com/Szp4WgsFxc
Not much has changed since then. Pharma remains the highest weight in the current portfolio. Is this Risky – of course it’s Risky. But sectors and industries don’t generally fall off the cliff so as to speak with little time to adjust one’s position.
In early 2018, 80% of my portfolio was in Small and Mid Caps which had just then made a high that is yet to be broken. But in the course of a couple of months, the portfolio switched out to Large Cap Stocks. But this 80% exposure was what gave me 60% returns in the period between May 2017 to December 2017. While some of it was given back, a large part was retained.
Rather than an overweight in a sector, I am more concerned with being overweight in a single stock. This is because stock level risk is always much higher and hence my willingness to cut down stocks that have gone above a certain weight in the portfolio. Reversals in Individual stocks can be nasty with very little time to adjust one’s positions.
Sector concentration risk is also a reason I choose to go with 30 stocks even though it may not be the most optimal. It’s unlikely to find the top 30 stocks all belonging to the same sector. But this is entirely possible if you are buying just 10 stocks for instance.
4) Fourth point is Momentum/Ranking and about entry –
Have read many articles ranging from simple strategies like
(a) simple rate of change(max gains) to
(b) 90 days linear regression kind of complex strategies to
(c) Again rate of change over 3,6,9,12 months period.
My point of view while deciding the rank/momentum to give more weightage to short timeframe gainers – e.g.,
let’s say I want to rank on the basis of 12 months return but weighted kind of formula while ranking want to take care of all 3,6,9,12 months returns and apply some kind of function which gives more weightage to 3M returns than 6M returns than 9M returns than 12 returns and assign ranking for my universe of stocks. For one stock, I want to consider all four (3,6,9,12 M returns) timeframe in weighted terms.
Any suggestions on this ?
My View: Keep it simple.
Currently the trend is with a lookback of 6 months, previously it was with 9 months and before that it was 12 months. But the shorter the lookback, more the churn and more the volatility. Trying to optimize on everything I feel is a fool’s errand. Rather go for one that allows the maximum amount of capital to be deployed. It doesn’t matter how great your system is if you can only risk say 10% vs a lower yield system but one where you can live with a 70% exposure.
Adding too many constraints in backtests opens up risks in terms of data mining and curve fitting. There are a lot of assumptions already built into any backtest, you don’t want to load them up even further.
If you were to analyze Mutual Fund assets under management, you shall find it dominated by essentially two styles – the Multicap which now thanks to new rules is changing over to Flexi Cap and Large Cap.
This isn’t much different from what we have seen elsewhere in the word. Large Cap is basically preferred for its lower volatility and ability to be able to absorb a larger pool of capital vs the small and midcap category. The Multicap is where the bet is on the fund manager more than the category.
The Portfolio Yoga Large Cap Momentum runs the same algorithm that drives the Portfolio Yoga Multi Cap Portfolio with the only difference being in the Universe of selection. Rather than have the entire market as the Universe as is the case with Multi Cap, with the Large Cap, we restrict ourselves to the 100 largest market capitalization companies.
The NIFTY 100 Index represents about 76.8% of the free float market capitalization of the stocks listed on NSE as on March 29, 2019. Our Portfolio will select stocks from this Universe while applying the same filters and logic as we apply elsewhere.
The Portfolio is a Equal Weight Portfolio of 20 stocks that shall be rebalanced Monthly. We estimate a low churn compared to the Multicap Momentum Portfolio. While one can invest a lower sum that what we recommend, we recommend you invest a minimum of Rs.2 Lakhs in the fund.
Backtest of the Large Cap Portfolio
When backtesting a portfolio that takes all stocks as the Universe, the only requirement is to ensure that dead stocks of today are available for selection in the day when selection is made. But when dealing with a subset of the data – an Index for example, not only should the data exist but also one should pick up only stocks that fulfill the criteria as on that day.
Idea for example is today close to a penny stock. But back in its heyday not only was it one of the top 100 stocks but also the top momentum stock. The constituents of most Index go through changes twice a year. Thankfully NSE provides the complete list of stocks that were part of the Index in historical times making it possible to recreate the Index as on those dates.
Creating and backtesting is a painstaking process but one that is absolutely necessary. The difference between testing on the current set of stocks that constitute the Index and the historical can boost up historical returns by a factor of nearly 2 times the return you would generate if you used the correct constituents.
The above chart showcases the equity curve if you used the Current Nifty 100 constituents vs using the Constituents available at the time when rebalancing was carried out. As you can see, Survivor Biased trumps Survivor Free. If only we had an Almanac to the future 🙂
Beating the Index is tough – this applies for Mutual Funds as much as much as Individual Investors if the portfolio sticks 100% to the Index itself. For large parts of the time as is seen currently a few stocks are able to move up the Index higher without the active participation of other stocks.
If beating the markets is tough if not impossible, why should one bother investing in the portfolio would be a question that can crop up in your mind. Why not go with a simple Index Fund where the tax is advantageous and the work much lower.
The answer lies in the fact that while the strategy will always outperform the Index, it has its moments when it does and does in a big way. Of the 189 months for which we have conducted a back-test, the Strategy wins nearly half the months while the other half is won by the Index. But if you look at the complete performance over the entire cycle, you shall see that the Strategy outperformed the Index comprehensively.
Long Term Charts are used everywhere for a reason – they hide the short term glitches that abound. Same is the case with the above chart as well. Rather than just stop with a one chart that contains 15 years of data, let’s break it down to rolling return charts. The back-test data file has the charts and the data backing it up.
Observe closely the 3 year rolling returns. For most part, the Strategy has outperformed all the other available Indices but the difference is not major in recent times.
But if you move to the 5 year rolling returns chart or the 7 or even the 10 year rolling returns chart, the outperformance is pretty evident.
What this means is that while the strategy may not outperform the underlying in the short duration but as you extend the duration, the outperformance starts to showcase itself. While the portfolio can be invested by anyone, I believe that it holds a great value to investors who are new to the concept of Momentum Investing. Investing in well known stocks is mentally easier than investing in stocks that have great momentum but are unknown.
The entire data set is available here {Link}. Do let me know if you have any questions in this regard.
The current open positions of the portfolio is available on the Google Spreadsheet shared with you. The first rebalance will come up at the end of this month.
Finally the BIG Question I think which will crop up in many minds. Should I have both the Portfolios?
My Answer is No.
The underlying strategy being the same, the correlation between the two portfolios will be high. The Large Cap Momentum will have a lower churn compared to the Multi Cap. It from the back-test also has a lower Volatility. Max Draw-down similarly is lower for the Large Cap Portfolio vs the Multi Cap Portfolio. Sector Concentration is lower for most of the time in the Large Cap Portfolio.
All these benefits come with a trade off that the returns will be lower. The backtest CAGR over the 15 years for Multi Cap comes to 24% while its 18% for the Large Cap Portfolio.
The Multicap Universe benefits from its ability to move into the Mid and Small Cap universe and hence take advantage of the Size Factor (which is basically Beta). The downside is that we will have a few bummers on the way that could even make one question the thesis as a whole.
If you are comfortable with allocating money to stocks that are lower down the pecking order in terms of market capitalization and also willing to suffer a higher churn ratio, go for the Multicap Portfolio. On the other hand, if you want to be invested in the best of the Indian Companies and have a lower churn ratio, go for the Large Cap Portfolio.
Either way, we believe that to really showcase the advantages of an approach such as Momentum, you will need to be invested for at least 3 to 5 years. Please mail me if you have any questions with regard to either portfolios.
We at Portfolio Yoga Capital Advisors are excited to announce the launch of our Premium Portfolio Advisory Services.
Investing in stocks directly has its share of risks and one which is very different from what you would experience when investing with a fund. We hope to help you in the path of becoming a successful do it yourself investor by providing not just a portfolio but also the education on how to approach portfolio construction.
We are a strong believer in evidence based investing and our portfolios are built based on deep research carried out by academics and one which shows the persistency of alpha.
We have outlined our Process and the Fee we intend to charge here. Do check it out
Serendipity the occurrence or development of events by chance in a happy or beneficial way. For me, meeting Sameer as his family lovingly calls him was no different. Its been 8 years of learning from some one who has an innate ability to question (with data) and think out of the box. Its a pleasure for me to have him co-write this post (my contribution is just the narrative, the real deal is his data and numbers).
If you are on Twitter, you should by now be used to ism’s of every kind on how to go about building wealth in markets.
Bhave Bhagwaan Che say Investors who follow Price without really explaining how one reduces the number of stocks from hundreds to something more meaningful and easy to execute.
Buy Stocks for the Long Term say Classical Fundamental Investors without mentioning how to find stocks that will still be around 10 years from now let alone have generated wealth.
Financial Planners on the other hand say, don’t worry about Portfolio or Returns but about whether you can reach the goal.
Everyone loves to talk about stocks and why not. Stocks are more volatile, Stocks can be storified and Stocks finally are about their underlying Business and it’s easy to make a case for or against a stock. Add to it, it makes for good party talk.
So, What is a good portfolio?
A good portfolio is something that contains just the right amount of stocks and yet is diversified enough to provide protection from the vagaries of nature.
Charlie Munger whose quotes you will find tough not to come across for example has a portfolio that consists of just 3 stocks. Thes stocks he holds, Berkshire Hathaway, Costco and Wells Fargo. A caveat though – Gurufocus shows his portfolio as 3 but omits Berkshire and instead has Bank of America.
When you look at the number you may tend to feel that this is an overly concentrated portfolio but if you dig deeper you know that though Berkshire Hathaway is a single stock, it’s actually made up of more business and variety than what many indices can provide.
When we invest in real estate, we don’t diversify. We make a commitment that is most of the time larger than our Networth in a single investment. Never do we worry what if I have picked up the wrong location and one that will go down in value. While it’s true you cannot really compare a house with a stock, even in the world of investing there are options where you can safely invest 100% of your net worth and be diversified enough even though you hold a single ticker symbol.The Vanguard Total Stock Market Index Fund for instance.
From Mutual Fund advisers to Asset Management Owners, I am yet to come across someone who will suggest that a portfolio can be diversified by holding just one fund. On the other hand, I have come across Advisors who suggest their clients to buy 2 of everything – Large Cap, Mid Cap, Small Cap, Multi Cap and for good measure a couple of thematic / balanced funds.
In a way, this is a hedge for Career Risk. In 2017, Client is happy seeing the returns of the Small Cap fund while in 2019, the large cap funds would have given him solace and in March of 2020, the Balanced Funds would have proven their worth. Client is Happy, Distributor is Happy and of course the AMC is happy. What more can you ask for?
But, when it comes to stock, how many stocks should you hold? Well, it depends – if you are betting on say Nano Cap Stocks, the more the better for the odds of success is low but it provides the optionality when a few stocks hit the jackpot. But if you are betting on large cap stocks, do more stocks add value or just another number
Vijay Mallik has a post (2015) where he says that you need nothing more than 30 stocks to be well diversified
This month I completed 1 year on Single stock investing. Yes, you read that right – the entire portfolio is composed of a single stock. This post is a note on experiences – the good and the bad of holding just one stock as against a portfolio composed of multiple stocks.
What do I mean by a Single Stock Portfolio?
Well, it means what you think it means – the whole portfolio consisted of just one stock at any point of time unless I went to cash in which case, it would be Zero stocks.
But isn’t such a portfolio risky? Well, it depends.
Prashanth a couple of days ago ran a poll asking whether a portfolio of just 3 stocks invested in 10% of Networth was more Riskier than 30 Stocks invested across 100%
Which strategy would you consider MORE risky {NW = Net Worth}
Though it can be argued either way, the distinction is pretty clear – a 30 stock portfolio may offer diversification but when you invest all your money is more riskier than a 3 stock Portfolio that is diversified across just 3 stocks.
Among the many manifestations of risk 2 of them are well known
1) Market Risk – The part of risk that comes because of the market. In March when the bottoms of the market fell off, stocks regardless of their fundamental strength took a tumble. You can view this as being similar to collateral damage suffered by Innocents during a War. Unfortunate and rarely can be avoided
2) Stock specific risk – This is the risk where you have a much better control. A fundamental investor would say that given that he knows the company better, he is able to reduce the risk even though other factors – Market Risk for example can cause the stock price to cause quotation risk.
One way to limit the impact of Market Risk on any given portfolio is by having a trailing stop that exits the whole portfolio on breach of certain levels. Larger the portfolio, tougher is to execute. On the other hand, with a one stock portfolio this becomes fairly easy – the number of decisions you need to take is just one.
This is similar to trading say a Dual Momentum Strategy using Nifty and Liquid Bees with the only difference here being that instead of Nifty we are long a single stock.
In most diversified portfolios, you may find that on any day the number of winners and losers tend to be in line with the broader markets. On days when the markets bullish, you find a lot of your stocks to be doing well and when markets are bearish, most of the portfolio stocks
This is not too different in a single stock portfolio where unless there is company specific news, one tends to observe that stock is up when markets are up and stock is down when markets are down.
The key to ensuring that the portfolio doesn’t destruct itself is by ensuring that the stock is chosen with a certain amount of care to eliminate the risk of getting caught in stocks that can go up in flames in no time at all.
One year generally is too small a time frame to analyze any strategy let alone a strategy that is dependent on the fortunes of a single stock at any point of time but 2020 is not any normal year and while its too early to say that we have seen all we need to see, the correction and the recovery has been something that we have never seen in the past. In the US, a technical correction like the one they saw in 1987 took 3 months for recovery vs just a month this time around even though much of the country is closed and the Virus seems not to let up regardless of how strictly people are quarantined either.
Almost every Entrepreneur is by nature holding a portfolio of just one stock – the company he owns. In fact, for most, its 100% of their networth and more given that in addition to owning the business, their debt is backed by personal guarantees and personal assets. While theoretically they have a greater knowledge of the business than we as shareholders can claim to, they also suffer from the illiquidity of not being able to exit when the tide turns around.
The way to become rich is to put all your eggs in one basket and then watch that basket.
– Andrew Carnegie
In a way, the single portfolio is similar. We place our bets on a single stock and then watch the stock very carefully. There is this risk that some news may come out either during the trading day or post close and one that could know the steam out of the stock and that risk gets magnified since instead of our exposure being 5 or even 10%, it’s 100% which means a death blow from which one can not easily recover.
But this is actually rare even though news would suggest it to be normal. Take for example the recent case of Luckin Coffee. The stock fell 80% when it disclosed that an internal investigation has found that its chief operating officer fabricated 2019 sales by about 2.2 billion yuan ($310 million).
But this did not happen with the stock trading at an all time high. Rather, the stock as you can see in the chart below was already down 50% from it’s all-time high. This is not a one off either as history shows that rare are the occurrences where the stock reverses immediately from an all time high without giving the slightest of opportunity. As with everything, there are exceptions to the rule – Vakrangee for instance gave barely breathing space to any investor before getting locked in lower circuits.
It goes without saying that there is ample amount of Luck involved. But where it isn’t really speaking for Luck plays the role of a catalyst that can change fortunes a great deal. So, how has been the performance. The chart below provides a visual of the same. Do note that at any point of time my allocation was limited to 50% which means that true stock return would be double. But given that allocation was my choice, it’s important to be true to the objective which in this case is to try and observe the Pro’s and Con’s of such a strategy.
Net Asset Value of the single stock portfolio
Risk as you know can be defined in many ways but one of the best ways is to measure the draw-down from the peaks. This provides us with an ability to understand how much we lost at any point of time.
Maximum Draw-down seen at any point of time since Inception
As soon as I started, the portfolio hit a draw-down of 8% and one that was reclaimed by the end of August. As the NAV shows, the strategy equity kept moving higher without deep interruptions till we got bit by Corona. The stock I was in breached the pre-existing stop and the portfolio went to cash.
I will not go deep into the stock selection strategy other than saying it’s based on Montecarlo based evaluation of historical draw-downs and tries to select a stock that provides max buck for the risk taken. Exits happen when the stock draw-down goes below a certain quartile that has already been seen in historical data as the point after which risk starts to balloon up but not so much for the reward.
It’s a strategy that I am sure most will not be comfortable with, but also a strategy that allows you to understand the nature of the market better than what you could accomplish by being long 100 stocks at any point of time. Diversification in itself reduces but never can eliminate risks as we have seen time and again.
If you have any questions, do ping me on Twitter or better still, Portfolio Yoga Slack Channel. If you are not there, do join using this link (Portfolio Yoga Elite Slack)
