Monthly Archives: October 2014

Diversification vs concentration debate

hi friends,

often I witness ongoing debates on concentrated vs diversified portfolios. Most knowledge on one approach to the other stems from historical evidence or books. Many argue that one should only have a concentrated portfolio of best bets. This enables one to read up on the companies that are owned, track them, allocate capital in a meaningful way and maximize returns. Another school argues that concentrated positions can underperform, for example when a stock in the holdings underperforms or goes through a black swan event. I have seen that even savvy funds had to face this with the recent likes of SBI and perhaps others being a large allocated amount.

my personal take on this is that books and hIstory both borrow from some ifs and buts. Let me try and discuss some that come to my mind.

1. Most books that one reads were written in a period where cos did not face issues such as institution or fii limits to ownership. There was just one category of ownership ie promoters vs non promoters. While the percentage shuffled between non promoter holdings the percentage owned more or less remained same. In this scenario, when spread across multiple listed companies lies a cardinal presumption, one that centers around mass public (non promoter) holding. Advanced markets such as usa have large public holding and thus shareholding frequently changes amidst such large portion of shareholders. India on the contrary has a very low public participation. Almost every fund presentation where I was invited as a guest saw the fund manager in india trying to attract public money into investing. The issue has not been which cos or sectors as much as it has been that public needs to participate. Our markets thus remain largely owned by promoters or foreign funds. Promoters resort to several fund raising measures. Earlier the easiest was equity dilution in traditional forms such as a sale or rights issue. Now we have new forms including QIP or optional convertible debentures. We also have non voting shares, warrants and the most dangerous pledging. The later has had a toll on many good businesses specially when in the quest of expansion or opportunity, promoters have pledged shares or issues foreign convertible bonds and there is a swing of either exchange rates of interest payments go hay wire. In my assessment the factors that are impacting investment decisions are far more than simple investing books advocate and thus more variables are increasing risk to investing.

a¬†FIi like any normal investor should be buying and selling stocks for profits. Simple. But no. Things like fii limits, liquidity crunches caused when they dry up, country specific taxes, issues such as GARR, corporate governance issues which strangely now include missed revenue or profit targets are at play. A fii may also sell investments in india if it has a portfolio liquidity or a country specific opportunity, unlike many retail investors who only buy or sell in india. They also arbitrage with derivatives and since what matters is overall portfolio returns, the behavior towardsTraditional ownership of scrips becomes complex. Let’s assume an fii owns dlf and there is a sell order of the kind that came in last week.mthe fii can even sell the shares in derivatives holding its physical holdings intact and take advantage of price corrections by the derivative profits. A entail investor may not even hav the sophistication to understand calls or puts or shorting in derivatives or other hedges including against currencies, commodities etc.

2. All theories on concentrated or diversified usually emanate from fund managers or investment legends.thentheries however assume availability of large corpus of funds at one go. Thus they pick the bets cos. A cardinal rule of investing is to buy right. The words but right have two functions ie to buy at an attractive price vs future expectations and to buy the right companies. Usually the best companies have many friends ie owners. Most multi bangers are made by buying companies at an unknown or lesser known time and holding on. Companies that are unknown or lesser known have lesser or no reports or history and that itself means that the risk to Reward is interesting. By definition of risk, it is always a function of rears, to say one should not buy more cos as it increases risk is thus like saying it can also increase rewards. Similarly if I own cos with lower risks my rewards could also be lower. In 100 to 1 in stock investing, an awesome book of basics, a point is made.myou could buy 100 cos. 99 can fail but if you get one right and hold it through the chances are that one can make 100. If you get two right you could have 2 cos with 100 x and so so on.

3. Many people like me have a regular source of incoming funds. Many buy from salary or earnings receipts. At that point of incoming money, it seems silly to be that I should force myself to either buy no equity (overpriced or expensive though good enough to hold) or buy expensive but best companies knowing I will “eventually” make money though in the interim will most certainly lose better investment options. In economics, we were taught money has an opportunity cost. It is limited in your hands and can be put to multiple uses that compete. Also in life we are taught there is no feta unity over eventuality except eventually we will all be dead.

that brings me to what I call and follow. Opportune investing. Many people and friends confuse this and think it means trading. If it did I would not have a core portfolio. Further I find that my core portfolio has almost no churning. It has positions added when prices are attractive but usually never sold. However I do not let new money stagnate waiting for opportunities as if opportunities arise I can always chose how to deploy or redeploy money. My money goes into what I think is the right or good price for a co on that moment. This way to borrow from a presentation that mr ashish kila, a friend, made “you can buy a railway ticket and enter a train. Later you can chose if you want to be in that compartment or find a better seat. Don’t miss the train however just because you didn’t get the first seat you wanted as it was not at your price”. On the contrary my core vs non core focus has given me many rewards. It makes me read more, and reading is directky proportionate to learning. When markets rise it gives me the benefits of better returns. When markets fall and core positions also have price erosions I can decide better to switch simply as the mind is reconciled to money already invested vs in a trap of whether to invest.

the only debate is how many scrips can you own. Going by warren buffets ownership of over 90, Peter lynch ownership of several and a fund like hdfc ownership off several I find there is no trap. The cardinal rule still remains own the right companies and be disciplined to add if you find the going good or retract if you made a judgment error or are subjected to black swans. Recently the highest market cap co and market darling, TCS tanked 9 percent which is a lot if you examine the year to date returns of tcs.

It is also imp you own enough of a co so that when you get it right you make a difference. I recall a brilliant sentence that mr samir arora makes in one of his interviews: it does not matter so much if you are right or wrong. What matters is when you are right how right are you and when wrong how wrong.

i have been bullish on markets for a while now and continue to believe timing and its endless pursuit is a waste of time. On any day when you have money look for a good company and buy regularly. Hold the company that rewards and be skeptical of those that don’t.

last few months my best returns came in from discovering value when it was ignored and not by buying obvious at expensive prices just for concentration. The best returns for me came from hindustan composites, poddar developers, Cupid limited, kiran vyapar while consistent returns came from core companies. Please note I am not advocating buying the cos I detailed here as I have myself reduced or sold some or even completely and now remain focussed on:

a) core holdings

b) emerging companies in auto and auto ancillaries where there is a qualitative shift in production or order size intake

c) a media content company with huge cash vs market cap and a new business head

d) a Pharma co that is less than one time sale and with an enterprise value far in excess of market cap. And a ownership by an unlisted Pharma giant.

e) a railway sector connected co which is and has been a monopoly and where I am inspired by our PM’s emphasis on railways and the statement govt has no business to be in business and hence a hint to privatization. With huge cash in the balance sheet and a network that seems impossible to replicate for years.

f) a play on telecom and 4g and supported by a technology giant.

happy investing and happy diwali to all of you.

Caveat: I am not an investment advisor. I have no intent to suggest a buy sell or hold. I am only reflecting my personal views without any company names or targets or projections.

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