Equities X

Chapter 2
Module 10 - Learn To Manage Your Portfolio.

Importance of diversification. Diversification helps you protect your investments from market fluctuations. Diversifying means allocating your money to different investments avenues and shields you from price risks. As you pick the best stocks from the hottest sectors, the fluctuation risk of the stock eroding your investment rises correspondingly. Since some stocks in the IT and media sectors are highly volatile, you need to protect your portfolio by investing in some defensive stocks or other industry groups. It would also be wise to diversify your investments into bonds or FDs as these are low risk - fixed income avenues. The primary objectives of any Portfolio management are Security of principal amount invested Stability of income Capital growth Liquidity – nearness to money to take up any new buy opportunities thrown open by the market Diversification Diversifying means buying stocks belonging to different industries with very low correlation i.e to find securities that do not have tendencies to increase or decrease in price at the same time. What you're working towards should be at least five industries for the stock portion of the portfolio with each stock being the best stock, in your opinion, in their respective industry group. There should still be money invested in a money market fund (the equivalent of cash) as well as some in fixed income. On the flip side, a diversified portfolio is unlikely to outperform the market by a big margin for exactly the same reason.

Portfolio – Age relationship. Your age will help you determine what is a good mix / portfolio is Age Portfolio below 30 80% in stocks or mutual funds 10% in cash 10% in fixed income 30 t0 40 70% in stocks or mutual funds 10% in cash 20% in fixed income 40 to 50 60% in stocks or mutual funds 10% in cash 30% in fixed income 50 to 60 50% in stocks or mutual funds 10% in cash 40% in fixed income above 60 40% in stocks or mutual funds 10% in cash 50% in fixed income These aren't hard and fast allocations, just guidelines to get you thinking about how your portfolio should look. Your risk profile will give you more equities or more fixed income depending on your aggressive or conservative bias. However, it's important to always have some equities in your portfolio (or equity funds) no matter what your age. If inflation roars back, this will be the portion of your investments that protects you from the damage, not your fixed income. Also, the fixed income of your portfolio should be diversified. If you buy bonds and debentures directly or if you invest in FDs, then make sure you have at least five different maturities to spread out the interest rate risk. Diversifying in equities and bonds means more than buying a number of positions. Each position needs to be scrutinized as to how it fits into the stocks or bonds that already are in your portfolio, and how they might be affected by the same event such as higher interest rates, lower fuel prices, etc. Put your portfolio together like a puzzle, adding a piece at a time, each one a little different from the other but achieving a uniform whole once the portfolio is complete.

Review of portfolio Portfolio Management is an incomplete exercise without a periodic review. Every security should be subject to severe scrutiny and a case made out for its continuation or disposal. The frequency of review will depend on the size, amount involved and the kind of securities held in the portfolio. Spend a bit of time; you'll get a little bit of results. If you spend more time, your results should improve. We would suggest you spend a minimum of one hour a day during normal times while on the days of high volatility, its suggested that the investor monitor the situation closely.

Look analyze and do some adjusting Look at your portfolio and do some adjustments. But don't just sell the losers (or the winners) randomly. There are several consequences of any action whether it's the taxes, the asset allocation, or the timing of the transaction. Here are a few things to consider. If you liked a stock because of its earnings and it continues to deliver, hang on even if the price has not moved up. It will because earnings are the engine of any stock's price. As always, patience is heavily rewarded in the market because it is the rarest commodity. As for selling a stock and then thinking you can buy it back after some days. There are two problems with that type of thinking. One, you generate two rounds of commissions (sell, then buy) and two, you may not get to buy the stock back at a decent price because the stock might have run dramatically in the month you did not own it. If you sell a stock, do it with finality and move on. Don't try to time the market. No one can do that with perfection. Another aspect: look at your portfolio allocation. Are you tech heavy? At the moment that's the place to be. But that changes, quickly as we had seen in the month of May 2000. Put your portfolio in shape by allocating your investments evenly over at least five different industry groups and 10 stocks. That way you won't feel the full impact of any one sector getting hit hard.

Sector Rotation You've probably noticed that tech stocks are hot, financials are not. Neither are the Consumer durables or some of the large-cap FMCG or Pharmaceuticals. If you're thinking about jumping onto tech stocks now because that's where all the action is, think again. While traders can bounce in and out of stocks several times a day, an investor should look to where the action isn’t much, meaning less of “Extreme Volatility”. Sector rotation happens all the time in the market. Several groups are hot (like ICE – Infotech, Communication and Entertainment Stocks) while other groups are getting dumped (names like Gujarat Ambuja, Grasim, Tata steel are examples). As an investor, you should look at taking profits from stocks that are fully valued and re-investing in stocks that have a big 'Buy' sign written all over them. In other words, dump some of the winners and buy some of the losers who are not down because of major problems that look to be insurmountable but because of temporary concerns that can be closely scrutinized. Sector rotation occurs because of fear and greed, the two emotions that run markets. The real challenge for an investor is to determine what the right entry price is and what is out of favor at the moment. Some of the Technology stocks such as Infosys have PE multiples of over 100 times. Whereas some of the fundamentally sound stocks such as Tata Steel whose stocks can be bought for less than 10 times earnings. The very bullish will point out that tech is where the growth is while financials are always hurt in an upward moving interest rate environment. They're right on both counts. However, the tech stocks are priced to perfection. If any of them don't deliver earnings at or better than expected, they're going to get hammered. And the financials are priced for interest rates going up dramatically from here, not another 25 basis points or so. The point here is not to recommend financial stocks (or non-durables or drug stocks) but to make investors aware of this sector rotation phenomenon. Take the time to build separate portfolios in each of the sectors you have an interest. It becomes very obvious where the money is flowing and where it's coming from. As an investor the challenge is to wait for prices that you can't believe in quality stocks, and then make your move. You will not catch the bottom of the stock (OK, maybe a few of you will). But you will own a stock that will come back into favor whenever the current troubles have passed and sector rotation occurs once again. Only this time, you'll be riding the hot stocks.

Measuring Portfolio Performance The performance of a portfolio has to be measured periodically – preferably once a month. The performance of the individual will have to be compared against the overall performance of the market as indicated by various indices such as the Sensex or Nifty. This way a relative comparison of performance can be developed. Lets now learn to compute the “Total Yield”. For example if the portfolio value of Mr. X is Rs 2,00,000 at the beginning of this month. During the month he added Rs 8000 to the fund. During this month he also received a dividend income of Rs 1000. Assuming the value of the portfolio at the end of this month is Rs 2,20,000. The total yield will be = ((220000 – (2,00,000 + 9000)) / ( 2,00,000 + (1/2 * 9000)) ) *100 = 5.38% per month To elaborate, in the numerator we are trying to find out the increase in value of portfolio after deducting the extra amount of Rs 8000 and the income of Rs 1000. It is assumed that this sum of Rs 9000 is put to use somewhere in the middle of the month and hence only half of Rs 9000 is added to the value of the fund at the beginning. The denominator can be adjusted as per the amount that you reinvest (part or fully) out of dividend income and what point of time during the period do you actually plough back such part of the money. Beta Factor “Beta” indicates the proportion of the yield of a portfolio to the yield of the entire market (as indicated by some index). If there is an increase in the yield of the market, the yield of the individual portfolio may also go up. If the index goes up by 1.5% and the yield of your portfolio goes up by 0.9%, the beta is 0.9/1.5 i.e 0.6. in other words, beta indicates that for every 1 % increase in the market yield, the yield of the portfolio goes up by 0.6%. High beta shares do move higher than the market when the market rises and the yield of the fund declines more than the yield of the market when the market falls. In the Indian context a beta of 1.2% is considered very bullish. You can be indifferent to market swings if you know your stocks well. Or you can put your portfolio into neutral or bias for the upside if you're bullish or a little for the downside if you're bearish. One way to do that is to have a mix of stocks that have certain betas in your portfolio. When investors are bullish on the market, they like to have high beta stocks in their portfolios because if they're right, then their stocks go up faster than the market in general, and their performance is better than the market. If investors are bearish on the market, then they use the low beta or negative beta stocks because their portfolios will go down less than the market and their performance will be better than the general market. And if they want to be neutral, they can then make sure that they have stocks with a beta of 1 or develop a portfolio that has stocks with betas greater than 1 and less than 1 so that they have the whole portfolio with an average beta of 1. A beta for a stock is derived from historical data. This means it has no predictive value for the future, but it does show that if the stock continues to have the same price patterns relative to the market in general as it has in the past, you've got a way of knowing how your portfolio will perform in relation to the market. And with a portfolio with an average beta of 1, you can create your own index fund since you'll move more or less in tandem with the market. Read about them in detail in the next module. Equites XI