What I Learned About Building a Match Winning Portfolio in 2020 - I

May 11, 2020

Rahul Shah, Editor, Profit Hunter

14%.

That's how much the Indian benchmark Sensex has returned over the since December 2014, point to point.

In terms of CAGR, it translates into a paltry 2.5%.

Not enough to beat even the average inflation during this period.

To be honest, the sharp correction in 2020 has muddied the water a great deal.

At its peak i.e. around December 2019 - January 2020, the Sensex was up a cool 50% from December 2014.

Although not great, it is still an acceptable CAGR of 8.4%. This is better than the FD rate going around and of course, better than inflation.

But it has been all downhill since then.

The Covid-19 outbreak has seen the Sensex crash big time. It has shed 40% from the top before settling at the current levels.

Now, this is something that has been bothering me over the past few days.

Was there a way to earn 50% from the Sensex adopting a different strategy than the buy and hold returns of 14%?

In other words, was it possible to maximise gains and minimise losses in a portfolio that mimicked the Sensex and earn 50% returns without making any prediction of any sort?

Well, I could think of two such methods.

These are approaches that could have beaten the Sensex - using an exact replica of the Sensex.

Here's the chart that highlights their entire journey from December 2014 to now.

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These two approaches are worth giving a shot only if you believe Sensex will go through a 40%-50% correction every few years.

If you don't think so and if you believe Sensex will keep going up without having a meaningful correction of any sort, then 'Buy and Hold' is the best strategy.

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It is clearly evident from the chart that the Sensex Buy and Hold i.e. the red worm on the chart, was the best performing as long as the Sensex did not have any meaningful correction.

But the moment there was a big correction, the other two worms took over. And they ended up outperforming the Sensex by a significant margin.

What are these other two worms by the way? Well, the one named 75:25 is a valuation based strategy.

Here, at the end of every quarter, the stock allocation is decided based on the Sensex valuation.

If the Sensex price to earnings multiple is below 25x (historically, most of the big corrections in the Sensex have happened at a price to earnings multiple of 25x or more), the portfolio remains 75% in stocks in 25% in liquid funds or fixed deposits (assuming an avg. interest rate of 6.5% p.a.).

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Well, the reason it did not lose as much as the red worm i.e. the Sensex in the recent correction is because the portfolio was 75% into cash right since June 2019.

Put differently, this portfolio found Sensex expensively valued and thus, vulnerable to a significant correction since the middle of last year.

When the correction finally arrived, it found itself only 25% in stocks. It was able to avoid the huge correction that the Sensex had to suffer.

This is the reason it ended up earning 50% over the last five years while the Sensex could only manage 14%.

What about the grey worm i.e. the portfolio titled 50:50 rebalancing?

Well, its workings are even less complicated than the valuation based portfolio.

However, more about it in my next Profit Hunter editorial. Stay tuned.

Good Investing,

Rahul Shah
Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

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1 Responses to "What I Learned About Building a Match Winning Portfolio in 2020 - I"

PREMKUMAR R

May 13, 2020

Interesting comparison.

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