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Risks of a concentrated portfolio
The English translation is as under:
Risks of a concentrated portfolio
The English translation is as under:
In some of our earlier articles, we mentioned about the benefit of
transparency offered by mutual funds. There are several documents that enable
one to take an informed investment decision. Fact sheet is one such document.
Though it is not one of the mandatory documents, it is extremely important for
an existing as well as a prospective investor. The mutual fund companies
publish the fact sheet every month.
The most sought after information in the fact sheet is the portfolio
of investment for each of the fund schemes. Though you may find some fact
sheets containing top 10 holdings in a portfolio; whereas in most cases, you
would find the list of all the securities held by the fund scheme. It allows
different people to evaluate the scheme in different ways. Some look at the
portfolio to see the kind of securities the fund is holding. A detailed
analysis of the top securities gives one some idea about the prospects of the
scheme. A better way of looking at the portfolio of holdings is to understand
the style of the fund manager. Once you have invested with a fund manager, it
makes more sense to evaluate the fund manager’s style rather than evaluating
the securities individually.
The portfolio holding statement helps look at certain risks that the
portfolio manager is taking in order to generate higher returns. At this stage,
it is important to clarify that risk is not necessarily bad. An investor (in
this case, a fund manager) takes certain calculated risks in order to deliver
good returns. If the manager’s judgment is correct, the portfolio delivers good
returns. However, if the judgment is not good, one may see inferior
performance.
We will look at the equity funds and debt funds separately and see
what the fact sheet can tell us.
Let us start with the equity funds.
One can start with checking whether the portfolio is concentrated.
When a fund manager has high level of conviction in certain stocks or sectors,
one is likely to have a concentrated position. If the fund manager’s view turns
out to be correct, there are huge gains to be made. At the same time, if the
prices move against the fund manager’s judgment, the portfolio would
underperform. As compared to a concentrated portfolio, a portfolio diversified
across stocks and sectors would be protected from downfall in the prices of few
stocks.
Some funds may also mandate the fund manager to take concentrated
positions. This may be checked from the fund’s Scheme Information Document.
You may check for concentration among stocks or sectors. Check for
investment in the stock as percentage of the total (this is explicitly
mentioned in the fact sheet).
According to SEBI guidelines, a scheme cannot investment more than
10% of the AUM in an individual stock. However, if due to some reasons, the
holding goes beyond 10% afterwards, there is no need to sell the stock. One can
continue to hold, but cannot add more. There are many reasons why the stock
holding may cross this 10% limit. It could be on account of faster rise in the
price of the top holding as compared to all the other holdings, or the fund
manager might have sold some other stocks to fund redemptions or to pay
dividends.
This could indicate that either the fund manager has tremendous
confidence in the prospects of the stock.
The same holds true if the portfolio is concentrated in a sector or
an industry.
Coming back to the stock level, one may also check how much of the
portfolio is invested in top 10 stocks, or how many stocks the fund has
invested in. that also is an indication of the concentrated position the fund
manager might have taken.
Portfolio concentration is an indicator of the risk the fund manager
has taken based on his conviction. Invest in these schemes if you are
comfortable with that risk.
-
Amit Trivedi
The author runs Karmayog Knowledge Academy.
The views expressed are his personal views. He can be reached at amit@karmayog-knowledge.com.
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