Monday, May 11, 2015

Understanding the risks of a concentrated portfolio

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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

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