We have all heard of longevity with respect to life but what do we mean by longevity with respect to stock portfolio management? Longevity in equity portfolios obviously means the ability of the portfolio to weather many a storm and cycles. It is not about having the most profitable portfolio but it is about creating and managing your stock portfolio such that is able to survive over a longer time period and also performing better than the benchmarks. Here are some factors affecting portfolio performance and these 6 strategies will ensure longevity of your equity portfolio.
1. Ensure that your portfolio is adequately diversified
A portfolio has to be well diversified to be effective in the long run. That means you must spread your equity portfolio among different sectors and themes so that your risk is reduced. Here you need to focus on a portfolio where each additional stock reduces the risk rather than substituting the risk. Also be wary of diversifying beyond a point. A portfolio requires around 12-14 stocks of different hues to be adequately diversified. Beyond that point, you only substitute risk instead of diversifying it. One of the basic rules of longevity is that your portfolio should not be too dependent on events and cycles. For example, a portfolio long on commodities can work negatively when the cycle turns around. Similarly, a portfolio that is long on rate sensitives can underperform if the interest rates are hiked.
2. Check that your portfolio is in tune with the times; at least broadly
Be it Indian markets or global markets, stocks typically go through cycles of popularity, high returns and also of low returns. Take the case of GE in the US. It had been an outperformer for over 70 years but has been a gross underperformer in the last 10 years. In India, stocks in IT, Pharma, commodities, infrastructure, and consumer goods have gone through their upswings and downswings. When we talk of being in sync with the times we are talking of giving your portfolio a tilt of stocks that are outperforming in terms of profitability, growth and margins. Ultimately, it is fundamental in nature and GE is suffering because it sunk too much of its capital and bandwidth into the financial services business.
3. Exit when you are wrong and hang on whey you are right
This may appear to be a very simple rule but very important in practice. Normally, all investors only get a handful of their stock ideas correct. What differentiates a good investor from a great investor is their approach to losses and profits. Successful investors make sure that when they are wrong, they exit the position quickly. At the same time, they also ensure that when they are right they hold on to the story as long as possible. You are going to have some outperformers and some duds in your portfolio. The trick is in exiting these duds quickly at a loss and hanging on to the stars in your portfolio. Also, if you want to ensure portfolio longevity then avoid the tendency to average your positions!
4. Base your equity portfolio on broad set of rules
What do we understand by a broad set of rules? This is the framework on which you base your portfolio decisions. For example, you can have a portfolio level rule that if the share of equity in your portfolio diverges more than 10% from the base, then you must bring it back to the original level. That will not only force you to book profits at higher levels but also make cash available for opportunities at lower levels. Within the gamut of equities, you can have rules based on P/E ratio, P/BV ratio, margin ratios, dividend yield etc. What these rules will do is to warn you when your portfolio performance is touching its outliers.
5. Regularly monitor your equity portfolio and rebalance if required
The reason you should not keep a very large and unwieldy portfolio is that it becomes hard to monitor and track on a regular basis. Of course, you do not need to treat your equity portfolio like your trading portfolio. But some basic checks are called for. Is your portfolio in tune with your long term goals? Are a set of companies in the portfolio consistently underperforming? Is there is a structural shift or new competition that is emerging in some stocks that you are holding. Once you monitor, you will have to take a call on whether you want to maintain status quo or rebalance the portfolio. At least, regular monitoring instils in you the discipline take a zero-base approach to your stocks on a regular basis.
6. Focus more on the qualitative aspects
At end of the day, it is the qualitative aspects that really matter to the longevity of a portfolio. Profitability and efficiency are already well documented. What you need to assess is the quality of management, standards of corporate governance, ability of the company to sustain and build brands etc. Great companies like Unilever and Nestle have survived over the years by their strong brands and corporate governance standards. The more you focus on qualitative factors, the more is likely to be your portfolio longevity.