Portfolio Construction and Management

With few opportunities available in the market (as per my liking), it has been a long time since I wrote specifically about a stock. However, there is a topic on which there is so much debate and even experts have varied views on the same. Portfolio construction and management is the key to long term out performance that is desired by all of us and that is the topic wherein I want to share few of my views. This is by no means comprehensive but touches on some key aspects.

Number of stocks in the portfolio: There is no correct answer here but from my experience I have observed that a portfolio of 10-12 stocks works for me. But there is nothing to suggest that in a country like India, a portfolio of 25 stocks cannot do as well over the long term (read 10 years). It can depend on variety of factors such as the prevailing market scenario and your risk appetite.

Maximum allocation to a single stock: I believe that as much optimistic as one is about the future prospects of a company and the margin of safety in the price etc., one need not have more than 20% exposure in a single stock. The basic philosophy here is of risk mitigation Respecting all outcomes in a given situation howsoever remote they are and having a healthy fear of the unknowns. As Howard Marks would say.. More things can happen than should happen based on your analysis..

Minimum allocation to a single stock: I think if you are not as confident about a business such as to give it 5% weightage in your portfolio, you might as well stay away from that business.

How to make sure than you have enough dry powder for opportunities that may arrive from time to time?

I follow the following allocation strategy to ensure that I have cash at disposal for such opportunities:

  • Investment in First 80% of the portfolio: Return expectation is at least 25% p.a. with long term potential (at least 5 years).
  • Investment in Next 10% of the portfolio: Return expectation is at least 35% p.a. in short to medium term (at least 2 years), ideally with long term potential 25% post 2 years.
  • Investment in Next 10% of the portfolio: Return expectation is at least 45% p.a. in short term opportunities (generally up to 1 year), there may or may not be long term potential in these stocks.

In most cases, this will make sure that you will have at least 10% in cash for short term opportunities. Again, this is a personal view and yours may be very different from mine. You may have several strategies in place (short term/ momentum trading/ special situations etc.) and the portfolio construction will vary accordingly.

Views are welcome.

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