How should one construct a portfolio?
It is all very well to have half of your portfolio in structural plays which have strong gross cycle performance but you can also think about timing the economic cycle. You might not be able to time it to the precise month or the quarter, but the broad thrust of the economic cycle can be timed.
The other half of your portfolio should look to play the economic cycle and therefore for clients of ours who are also interested not just in structural plays, but also want some degree of economic cycle timing, we are creating a bifurcated portfolio. Half of it will be long-term compounders, structural plays, consistent compounders and the other half of your portfolio will be plays on the economic cycle.
For instance, at the current juncture, I reckon growth is coming down, interest rates are rising, the currency is weakening. Therefore in the other half of the portfolio, I will play sectors which benefit from that. I am still taking a two- to three-year view but I am trying to play the economic cycle in the direction of say what Howard Marks is saying in his latest book.
In the last couple of years, mutual funds AUMs have swelled and you along with a lot of your peers have become individual professional investors. How big is the opportunity which some are ignoring and should we take it more seriously over the next 10-15 year period?
The RBI published a superb piece of research around August 2017 and that says in suburban Mumbai, 95% of household wealth is in real estate, gold and consumer durables. Barely 5% of wealth in affluent neighbourhoods is in financial assets. That is not going to be sustainable because that 95% which is in physical assets is not really growing at any real rate.
As affluent Indians head towards retirement over the next 10-20 years, they are going to need to compound their money at a decent rate and that is leading to this impetus into equities from which mutual funds have already benefited.
What people like me are seeing and why several of us are becoming money managers is that numerous people from affluent backgrounds are coming to us and saying can you please help me over the next 10-20 years get a good return on my portfolio so that at age 60 or 65, I can have a decent retirement? That impulse is strong. I reckon 10 years out, there will be close to a trillion dollars a year in financial savings. At the moment, we do around $200 billion a year in household financial saving. That number will grow 5x over the next 10 years.
That indicates the what size of market capitalisation or size of overall GDP can grow to in our country.
Yes. At the moment, the Indian market cap is $3 trillion and 10 years hence, every single year we will save a trillion dollars a year.
On the one hand investors are open to taking help from professionals like you, at the same time they want to take part of that portfolio and manage it themselves as well. For those who want to go out by themselves, how critical is mapping the state of the economy? How critical is it to analyse which sectors will benefit or decelerate in that particular state of economy?
I would say there are three phases to an investors’ evolution. If I take my own career, the first 10 years I basically learnt how to analyse financial statements, how to quiz company management teams, how to look for data from distributors, dealers, etc. You basically train yourself to analyse companies over the first 10 years.
The next 10 years, you train yourself to invest without trading. Investing means you buy, you train yourself to invest for the long run without hitting the buy-sell button every three-four weeks. That is the hardest phase because you are learning and you are growing but you are teaching yourself to act less instinctively; to act without acting on reflex.That is the sort of second phase and most investors who are investing for themselves would do well to be in that phase where you are buying great companies and are letting them run for great periods of time.
The third phase in investors’’evolution which people like Marks and Seth Klarman have obviously reached once the 10-20 years is over is that besides buying great companies, you have also been able to figure out in a broad way the economic cycle.
Ray Dalio is another great investor who figured this out. A broad set of metric parameters which give you a guide as to where we are in the economic cycle and therefore which sectoral bets you should ramp up and which you should ramp down. I would suggest this third phase should only be tried by full-time professional investors and even retail investors who are doing trading full time. This hard stuff and you are in the realms of trying to time sectors which is always tricky.
So, the second phase is a sweet spot and a lot of your viewers sitting at home can do it themselves. They can buy great companies and grow rich as those companies compound by 100-200-300x over the next 20 years.
Let us talk about the portfolio construction approach. Some people believe that diversification is the key and 30-40 good names in your portfolio should be enough, Others believe that concentration is the key. You figure out 12-15 good names and stick to it. What is your view?
Modern portfolio theory that all of us learnt in our formative years as investors is that 15 stocks give you broadly the diversification you need. So,if you are diversifying your portfolio beyond 15, you are not doing it strictly from a diversification perspective, you got other reasons for doing so. That being said, my reckoning increasingly is that you do not even need 15 stocks. What you need is a dozen really high quality names in your portfolio though if you find 14 or 15 top notch names, by all means have 15. But as long as you have dozen outstanding names in your portfolio, you are fine and in that approach.
I do not think I am deviating too far away from Kirby’s approach in his original coffee can paper in 1984, where if the client feels uneasy, to give them some comfort we say, for the first dozen of your stocks we are buying you a structural compounders. If you want some additional mental comfort, we can buy you a further buffer of 5 to 10 stocks which allow you to capitalise on the current phase of the economic cycle.
But from the purest perspective, left to me, I would have a portfolio with 12 top quality names in it. That gives investors adequate diversification and gives them a focussed ability to generate wealth over time.