Don’t miss the wood for the trees - Views on News from Equitymaster

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Don’t miss the wood for the trees

Mar 29, 2001

We have often heard market experts say India is a ‘stock pickers’ market. That’s actually quite true – as a long-term investor if you had picked Infosys, Hero Honda, Cipla or Britannia or even Zee for that matter (Zee now trades post split 10 for 1), you should be congratulating yourself. As a stock picker, one did the right thing if one bought Hero Honda instead of Bajaj Auto five years ago because it took some astute judgement then to figure out the huge trend away from scooters to motorcycles and with it the fact that Hero Honda with its 4-stroke motorcycle technology was very well positioned to capitalize on that boom. Over this period, Hero Honda has made handsome returns for its shareholders while Bajaj Auto shareholders have to rue the fact that they were poorer despite investing in one of India’s cash-rich ‘solid-as-a-bank’ company. For a moment, I am not suggesting that ‘stock-picking’ is unimportant but equally important if not more is ‘asset allocation’ especially in these exciting times of high market volatility. Simplistically, on a very broad level, one decides what amount of money is to be parked in real assets and financial assets. Going down a notch, one decides how much of the financial assets portfolio should be in fixed-income and equity. Equity obviously has with it a greater variability of returns, which all the more underlines the need for diversification in a successful equity portfolio. So as an investor, before you start wearing your thinking hat and picking up the stocks you want in your equity portfolio, you first have to decide how much of your hard earned money should be in IT, pharma, consumer, cement or any other sector. Asset allocation basically imparts a discipline to the investment process and is a good risk control measure.

Simple as it sounds, but asset allocation is not something which many lay investors, or for that matter, even high profile (and highly paid) fund managers paid much heed to in recent times. So while your neighbour, Mrs. Sharma is telling you about the huge losses in her portfolio, she is only telling you half the story – what she probably missed telling you is those huge losses were mainly because of her following her broker’s great idea of putting all the money in a few ‘hot’ momentum stocks (‘momentum’ for the better part of the last year meant IT). Some consolation for her though - many fund managers did the same not-so-bright thing. So we had equity funds which had at some times over 60-70% invested in the TMT sector, balanced funds which to start with itself were unbalanced with close to 70-75% invested in equities and a major portion of those equities invested in the TMT sector. Some enterprising funds even tweaked definitions to get TMT stocks into so-called broad-based equity funds. The huge sell off in the TMT sector has seen many of the fund NAVs dropping steeply and causing the unit holders much pain and disillusionment. Investors henceforth would do well to closely study a mutual fund’s sectoral composition before investing.

In my opinion, the key lesson for investors and fund managers alike, is to first get the asset allocation right and then go about picking stocks.

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