By: Yashodhan Khare
Pune, Oct, 13, 2016: With Volatility being what it is, the retail investor has been completely left out in the current bull market. Most investors have taken to the Mutual Fund route. Inspite of this, equity exposure to the capital market by Indian households is still very low. The reasons are many. Retail investors are scared to commit capital. After having burned their fingers badly, first in the year 2000 and then again in the year 2008, the apprehension and dour sentiment is understandable. Is there a way out? In my opinion, if investors were to change their investing horizon from the short-term to the long-term, they might be surprised with the results.
How does one define the long-term? When investing in bonds or any kind of fixed income instrument one has a clear idea of (1) the date of maturity of the instrument and (2) the rate of return. When investing in stocks, one doesn’t have the foggiest idea of either of the two. In that sense, the maturity period for an investment in the stock market is infinity. I am not trying to suggest that investors must have ‘infinity’ as the time horizon for an equity investment. At the same time, one has to remember that investing is stocks is a long-term idea, not a short-term fix. In other words, investors must be able to ‘put away’ invested sums for long duration of time and be patient.
How to build a long-term Portfolio?
What does one look for while building a stock portfolio? Investors might be well served if they followed the broad guidelines given below:
- Any portfolio should consist of fundamentally strong businesses that are professionally run, have a proven track record and a consistent dividend paying history. In any case, the number of stocks in the portfolio should not exceed twenty-five.
- In any stock portfolio, diversification is essential. The idea behind having a diversified portfolio is primarily to reduce risk. The only way one can compile a diversified portfolio is by selecting stocks of companies whose businesses are non-correlated. Since the businesses are not correlated, all of them don’t sink or swim together. Effectively, risk is reduced and diversification is possible.
- In a nutshell, investors must (a) concentrate on the choice of stocks, (b) focus on the long-term, (c) avoid churning their portfolio. The emphasis is on the long-term and on not churning the portfolio. Hence, stock selection is critical.
- Since no churn is envisaged, it follows that stocks that one selects must meet certain minimum qualitative criteria. As a thumb rule to ensure quality, one should stick to large cap stocks only.
The Rip Wan Winkle Portfolio
Long-term investing is often referred to as Rip Wan Winkle investing. There is a mythological tale behind this. It seems that Rip Van Winkle was a character in a short story who went to sleep before the American War of Independence and woke up twenty years later in an independent United States of America. Rip woke to a vastly different world. What if we did this with an investment portfolio?
I constructed a Rip Wan Winkle portfolio using stocks that form part of the Nifty50 Value 20 Index. Since data for twenty years is not readily available, I have used data for ten years instead. The value of the ‘Nifty50 Value 20 Rip Wan Winkle Portfolio’ and its returns as on 23 September 2016 would look like this:
I need to clarify the following:
- CAGR is the acronym for Compound Annual Growth Rate. It is defined as the growth rate over a period of years. The basis of the CAGR calculation is that each years growth is compounded year over year.
- The basic assumption is that a sum of Rs. 5000 is invested in each of the stocks shown in the table below on 04 January 2006. In other words, the portfolio is equal weighted. If the stock-wise weightage were to differ, so will the returns.
- After that date the investor does nothing – no further investment or activity is envisaged; no churn whatsoever. In my opinion, this is the only way in which one can embrace Rip Wan Winkle Investing.
- I have considered only eighteen of the twenty components of the Nifty50 Value 20 Index. BAJAJ-AUTO and COALINDIA have been excluded. The reason is that historical prices of these two scrips (for the entire period) are not readily available. In my opinion, it will not affect the outcome of the analysis in a material manner.
To me, the returns look impressive. What I want to highlight are the three shaded columns. These columns show the drawdowns, in layman terms, the amount or percentage by which these shares corrected at some point in time during the last ten years. The rate of return generated by the ‘Nifty 50 Value 20 Rip Wan Winkle Portfolio ’ would have been realised if and only if an investor had remained passive for the entire period of ten years. In other words, he or she did not panic and sell when markets corrected. Remaining passive at times of heightened Volatility in todays Information Age is easy to preach but difficult to practice. That’s why Benjamin Graham has said: ‘The investor’s chief problem – and even his worst enemy – is likely to be himself’.
How do the returns of the Nifty50 Value 20 Rip Wan Winkle Portfolio compare with the benchmark? What if one had invested on 04 January 2008, when the market was at its high? The comparison is shown in the table below:
The above is illustrative and not suggestive. Nothing stops an individual investor from devising his or her own Rip Wan Winkle. I’ll conclude with a quote by Warren Buffett on long-term investing: “Nor do we think many others can achieve long-term investment success by flitting from flower to flower. Indeed, we believe that according the name “investors” to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”
