If one has over-committed to certain themes / sectors, then it needs to be brought to a more normalized level. On the other hand, if there was under-commitment to themes that look promising now, then this is the time to increase the stakes.
What matters now is how we re-balance our portfolios & re-check the initial investment hypothesis. If a mistake has been made, one should be ruthless to reverse it.
2018 has turned out to be a tumultuous year for Indian stock market investors. Most of the gains made during 2017 have been washed out. We often hear things like, “I should have sold last year”, “I should have raised more cash”, “my portfolio is underperforming” & so on.
But the truth is - If you cannot take underperformance & drawdowns, you cannot stick to a certain style of investing. Many investing styles are lumpy & demand staying invested throughout. Few years of zero returns are covered up by very high returns in just one year.
Tweedy, Browne Company LLC, carried out a paper called ‘10 ways to beat an index’. It analyses track record of nine value-oriented fund managers with careers spanning over few decades & having exceptional track record. It included Buffett Partnership, Walter Schloss Limited Partners, Wheeler Munger & Co. Partnership, Pacific Partners Limited, Tweedy Browne, Templeton Growth Fund & more names.
None of them outperformed the index every year. Stretches of underperformance ranged from one year to six consecutive years. Almost everyone underperformed for 30% to 40% of the time, and yet achieved superior investment outcomes which were beating the index by a large margin.
For example, Sequoia returned just 0.07% from 1970 to 1973, compared to S&P 500’s 9.97% during the same period. However, in the subsequent period from 1974 to 1983, Sequoia did exceptionally well & returned 24.4% compared to S&P 500’s 10.5% CAGR return. Similar examples can be found in India, and other parts across various time frames. Underperforming the broader market for 30 to 40% of the time is a normal part in any investors as well as fund managers long term success.
The point is – investors must stop hitting themselves if no money is being made for extended periods of time. Outperformance in each & every financial year is not a given. The harsh reality of equity investing is that returns are always non-linear & come in spurts. Investors tend to tire themselves out by continuously chasing what has worked in the recent past & eventually end up nowhere.
The key to outperformance over a period is to stick to the process & staying invested. Most investors tend to abandon their process just because it has not worked in the previous 3 years.Preparing for the next cycle
Temporary underperformance is okay, but if mistakes have occurred, then we must be open to correct them immediately. For most investors, major part of their present equity & mutual fund portfolio was constructed over the last 2 – 3 years. As markets gained momentum, big churn has happened. Some themes like unorganized to organized, transitioning from Business to Business (B2B) to Business to Consumer (B2C) models, ‘asset heavy’ to ‘asset light’ were overplayed & witnessed all-time high multiples.
In the last leg of the bull market, FOMO (fear of missing out) plays a big role. 2017-18 was no different. The street just rushed into buying the hottest stock of the hottest sector, those who missed out went looking for the second hottest idea & the quality of ideas just kept dropping with every rise. In such period, mistakes are bound to happen. And this is the time to deal with them.
What matters now is how we re-balance the portfolios & re-check the initial investment hypothesis. If a mistake has been made, one should be ruthless to reverse it. There is no point in betting on the purchase prices to come back. Rather than thinking you are booking a loss, think as if you are switching to a better horse.
If one has over-committed to certain themes / sectors, then it needs to be brought to a more normalized level. On the other hand, if there was under-commitment to themes that look promising now, then this is the time to increase the stakes. Momentum buyers vanish on the way down & drawdowns in the stock price can be used to take advantage in such cases.
The economy has witnessed subpar credit growth over the last 3-4 years. Capacity utilizations across old economy sectors is picking up, orderbook enquiries are building up and capex cycle is poised for a fresh start. Sectors which were laggards of the previous cycle may turn out to be the leaders for the next several years.
There will be lot of noise in the run up to 2019 Loksabha elections. It has already begun with populist farm loan waivers. As the sense of uncertainty grows, markets might throw interesting opportunities occasionally. One should be fully prepared to take advantage of them. There can not be a better time to correct the mistakes of the past & re-construct the portfolios.The author is the founder & CIO at Alpha Invesco. Views are personal.