Many people have asked us about individual stocks in our portfolio and about portfolio construction. Identifying individual stocks in the portfolio, as a process, is very different from constructing a portfolio. We would like to draw a parallel with a sport many Indians are quite familiar with – cricket; even though the same can be applied to any other team sport.
The job of a portfolio manager is similar to the job of the captain (or selectors) of the cricket team.
To win games of cricket consistently, a team can’t afford to just have all Sehwags – who can score very quickly, but also are unpredictable and can get out quickly. Neither can they have all Dravids (who was known as “The wall”) who can hold one end up but may not score as quickly. And similarly, neither can the team just rely on many Tendulkars/Dhonis or just spinners or fast bowlers. This is not withstanding the fact that in reality it is also extremely difficult, if not impossible to the find more than one Sehwag, Dravid, Tendulkar/Dhoni or a Kumble at the same time to make a team. It is important to build a team with complementary skills, so that one can perform when others don’t do as well.
To win consistently over long periods, one has to be prepared for different situations, weather and pitch conditions, opposition strength and so on. Similarly, to deliver consistent performance, the portfolio manager needs to construct a portfolio which can do well in different economic conditions. While selecting a company is a bit of science, the art is in constructing the portfolio with a mix of companies in certain proportions (read weightages).
This mix of science and art is what makes this job very interesting and challenging.
There are various factors like economic headwinds, unpredictable monsoons, currency fluctuation, interest rates spikes, inflation, global or domestic political events, etc. which affect stock prices. These factors are highly unpredictable and can swing in any direction, like the different kinds of pitches the team is likely to play on. What we really need is, not the best 11 players, but the best mix of players who as a team will do well under different economic conditions. One needs a ‘balance’ in the portfolio.
The last few months have been a difficult period for stock market investors – as we pointed out in our last newsletter, the steady performance of the Nifty hides the internals of the market which have seen large drawdowns from the peak for a very large section of stocks. Many market participants have struggled, as new factors have come into play which have changed the performance leaders in the market. The pitch conditions are very different now than a few months back. A weaker rupee, higher oil prices, some degree of political uncertainty and global events have shifted the markets to favour exporting companies – which were cheap – and away from the domestic consumption oriented companies, some of which were quite expensive. Our portfolios have benefited by being patient and having the right mix of stocks, while some strong performers have helped deliver reasonably good portfolio performance.