PORTFOLIO DIVERSIFICATION

A couple of days back, Brigadier Ajit Katoch, a dear friend, called me up. He wanted some advise on his Portfolio. I asked him to tell me the shares he was holding in his demat account. I asked him, “How many stocks are there?”. He said about 23 shares. I assumed, it must be a big portfolio. Assumptions, and wrong assumptions at that, are the mother of all f@#$ ups. Never, assume what

you can ask and seek information about. He opened his ICICI direct.com account, went to the portfolio section and started rattling out the businesses. As he started off, with the first company, Bellary Steel , I said sell. Then it was Manali Petrochem, I said sell. It went on like this for three minutes and I asked him to sell 17 businesses and retain only 6. He was non plussed for a minute. It must have sunk in that I had almost asked him to sell 80% of his portfolio. He countered me with a question,”Do you even know about these companies? You have in two seconds each decided the fate of my share portfolio, which I painstakingly bought 8 years back.”

I was on the phone, still I smiled. It is a common human tendency to believe someone when he takes a bit of time to give you advice. And doubt him, if he or she is too quick in giving a solution. One reason, I can think of is, our bias to accept our fallibility and accept that we could also make a mistake.  

I then gave him an example of a Doctor. I said, the specialist, listens to the patient, and then in precisely 40 seconds, writes the prescription, medicines and tests. Though I am no specialist, but still a learner in the vast ocean of knowledge, I had followed a similar methodology. The businesses Brig Katoch owned were pathetic. Then, to humor him, I did tell him about the businesses he owned. He was himself not aware of what areas of business ‘HIS’ companies dealt with.  I then told him, I am giving a medicine, it is upto you to take it. if you take it your portfolio health will improve, or else, it will stay like this only. He probably understood.

He was candid enough to tell me that  without knowing his purchase price or date of purchase, the six businesses I had advised him to retain were the only ones which were in green or profitable. The balance 17 were all loss making. I then asked him to tell me how much would he receive, if he sold those 17 companies, he said Rs 55000. And I asked him, “How much are the balance 6 companies worth?” He said, “Rs65000”.  I told him to buy one of the existing stocks in his portfolio or IPCA Labs at the current prices.

What I wish to highlight is the aspect of portfolio diversification. A lot of us sail in the same boat as Brig Katoch. I too had shares of 43 companies in my portfolio in 2010, before I swept a broom and realized the stupidity of it all. Diversified portfolios are what mutual funds do. They are safety mechanisms. One share rises, other falls, on an average you do not lose. Is that your aim when you invest? 

The aim of every investment is to beat inflation. Period. Protect the principal and beat inflation. It is as simple as that. If you can remember this simple truth. Your investing life will be very easy and smooth.

Diversification   of Rs 1 Lakh into 23 businesses does not make sense. Let me ask you a simple question. If I give you Rs 1 Lakh and ask you to go and buy some business, would you buy 23 businesses worth Rs 5000 each or buy one or max two businesses? That should give you an answer.

A good business is inherently diversified. Look at Maruti — it has cars from 800 cc on wards, it has a mix of diesel and petrol, sedans and hatch back, etc. One model may sell more than others, etc. So, with smaller amounts, it may make sense to keep your portfolio simple. The aim is to get returns more than inflation over a long period of time. If one business can steadily give it, why own 43 business?

As a thumb rule, you should have 10-20% investment in one business. Therefore, any share portfolio should ideally consist of 5 to 10 companies. Only when the corpus becomes too large, you may make it 5-10% per business. At about Rs 1 Cr and above of investments, you may look at 20 companies in your portfolio. But never more than that, even if you have  Rs 100 Cr invested in stocks. 

Portfolio Diversification is a strategy propounded by smart alec MBAs to derisk their performances. For an intelligent investor, it is meaningless garbage.

Post Script: I have only seven shares in my portfolio. And I take buy and sell decisions, once in a year after reviewing the performances of my businesses. If they are doing well, I leave them untouched. BTW My broker is pissed off. 🙂