I recollect a time in 1987, when I had to explain to a gathering of investors the meaning of the word 'portfolio'. Many of them thought that the process of computing risk and return of the portfolio was a very complicated task.
Those were the days when one had to make a booking at the lab for an XT machine and write macros to be able to get portfolio risk numbers. That a young woman was reeling out these concepts fresh out of her thesis did not help matters either.
When I look at investor portfolios today, I understand the distance we have travelled. Several are regular investors allocating their funds, managing their portfolios on the Net and switching fund managers with ease, given current facilities and processes.
But I still find that the basic principles of risk, return and diversification continue to elude most. There are several issues I think most investors fail to fix, when it comes to their portfolio and its performance. I will list three for the New Year resolution list.
First, there are too many securities and funds in most investor portfolios, and many do not even know all the names. Some portfolios have become so unwieldy over time that they are tough to rebalance.
A product-oriented approach that considers including a fund or a stock because it is being recommended by friends and others, adds to the list. Today, there are facilities to consolidate holdings, and we must take a shot at doing that.
Each choice is but a part of the larger portfolio, and has to be viewed in that context. More the scatter in the investments, less the ability of any single choice, however good it is, to impact overall portfolio return. Investors seem to think that the number of stocks and funds they hold represents diversification, without giving a thought to the damage it can do to their returns.
Second, there is very little strategic thinking in terms of the components of the portfolio. If the holdings can be chunked into equity, debt, property, gold, commodities and the like, the allocations to each of these assets are not driven by how they all combine together. Ergo, there is the tactical need to hold more of what is considered currently attractive.
If some portfolios hold over 50 per cent in real estate, others have over 90 per cent in equity. Diversification has to apply at the asset class level to benefit the investor. Every decision will have to work within that plan, so that additional investments are made keeping these ratios in mind. There is no better way to manage portfolio risks. If equity is strategically 50 per cent of the portfolio, and is tactically increased given market opportunity, it has to happen with the consciousness that this is opportunistic and has to be reviewed for risks if markets correct.
Third, there is the need to benchmark portfolio performance. Investors love to talk about their gains, forgetting the losses and bad choices. I have known of portfolios that shine in parts, but under-perform even a simple bank deposit in their entirety.
There is the need to understand what components are under-performing, and review them in the context of our objective. Investors tend to look at individual choices they made and seek to churn them, managing the components without considering the whole.
A fund manager may not promise a return, and markets may not offer a fixed rate, but an investor can set a benchmark and manage it, if she so wishes. I have seen few who set themselves benchmarks, even as they blame everything else for their returns.
In the modern world we live in, there are better choices and tools. Creating and running a well-structured portfolio for our target returns is completely doable. If we reduce this exercise to hunting for the next best pick that will become the 98th holding in our portfolio, we are too far away from strategically managing our money.
The author is chief R&D officer, Optimix, and can be reached at uma.shashikant@optimixnet.com
