Clearing laggards from your portfolio is like cleaning your messy, unorganized closet. All those spare clothes and accessories that have been lying there taking up space need to go, to make room for the new. It looks like a daunting task, but all you need is the intent and a plan to get started.
In times of a bull market, the opportunities to make quick gains often entice even long-term investors, causing them to stray away from the basic principles of investing. Herd mentality and greed kicks in when they pick stocks for short-term gain, without analyzing its growth prospects. No sooner do the market sentiment turn, these investors find themselves holding penny stocks with a minuscule probability of gains. Often investors tend to hold on to these in the hope of an upturn. However, after a while, these stocks harm the portfolio. As per the Buffalo Theory, a herd of buffalo can only move as fast as the slowest buffalo. The same is true for your portfolio, the laggards can slow down its growth.
There are four ways to deal with laggards in your portfolio.
Cyclical patterns: As investors, we tend to forget that markets are cyclical in nature. Recognizing these cycles for every asset class requires an in-depth analysis and understanding of the different phases of the market. Consider the comparison of equity versus debt market over the past decade, debt has been outperforming equity. Take IDFC Nifty Fund which has provided 8.06% returns over a decade, while IDFC Government Securities Fund – Investment Plan has returned an approximate of 10.20% over the same decade. Most investors would look at these past 10-year results and consider their equity investments as laggards. But considering a cyclical asset class performance with a long-term view, equities are bound to perform as there is no single asset class that has remained a constant winner or loser. Insight into cyclical performance of each asset class can save you from booking your losses at “bottom-out”, just before a rise.
Emotional investments: Investors often prefer choosing stocks or assets that they are familiar with. These are usually investments recommended by friends and family or the ones keenly followed due to past performances. Some may hold assets that have sentimental value. But past performance is not a great yardstick for future returns. Unfortunately, investors end up holding on to such investments due to deep emotional connect in the hope that some day it will reap gains. Cutting out sentiment is the key. As Warren Buffett says, “If you cannot control your emotions, you cannot control your money.”
Asset trap: Once you have done your due diligence in ascertaining the laggards in your portfolio and have weeded them out, your decision to invest in new instruments must be independent of what you had. A disconnect between buy and sell will ensure you do not fall into an underperforming asset class trap and return to where you began in the first place.
For instance, if you sold a real estate holding that has been dragging your portfolio down as the sector has been stagnant, reinvesting in another real estate holding would be futile considering the future seems dim from an investment point of view.
Rebalancing: Booking profits in your top-performing assets to reinvest it in laggards is a good strategy to sell high and buy low, considering you have done your homework on the assets you hold. It makes sense to hold laggards that have the probability to grow in the future and sell those with an uncertain future. Consider opportunity costs while rebalancing.
Acknowledging that some of your investment decisions were not in your best interest, is the first step to working around laggards. Rebalancing helps keep your portfolio on track ensuring you focus on good quality stocks of effectively managed organizations. The safest way to ensure your portfolio is delivering consistent risk-adjusted returns is to commit to regular reviews, and periodical exercise of risk profiling. Diversifying your investments based on geographies, asset classes and fund sizes can also help you make the most of the cyclical nature of the market.
Tarun Birani is founder and CEO, TBNG Capital Advisers