Ideal number of stocks to hold in a Portfolio

Individual Investors who manage their own portfolios often grapple with the question of the ideal number of stocks that they should hold in their portfolio. This question is very relevant since a low number of stocks can significantly increase portfolio risk while a high number of stocks can considerably dilute portfolio returns and also increase transaction costs. This question is particularly relevant to those investors who are prone to buying stocks from ‘stock tips’ that come their way via various channels, and who therefore have to decide at some point of time whether enough is enough.

It is pertinent to note that when determining the number of stocks to be held in the portfolio, investors implicitly deal with two types of risk – systematic and unsystematic risk. Unsystematic risk is the risk associated with a particular company or Industry. It can be reduced to near zero levels by holding a portfolio of well diversified stocks.  Systematic risk on the other hand, is the risk associated with the entire stock market. No amount of diversification in your portfolio can reduce it.

Hence the exercise behind trying to understand the ideal number of stocks to hold in a portfolio is one of striking the right balance between minimizing unsystematic risk and maximizing portfolio returns. While there is no right answer to this question, the factors that will influence the answer are

• The Portfolio corpus
• Stock market that you are investing in (US, India, etc.)
• Your Investment time horizon
• Your Risk tolerance

In this context, the celebrated economist John Maynard Keynes proposed in 1938 that investors should hold concentrated investment portfolios. He believed that skilled investors can maximize their long-term returns through a deliberate selection of well researched and diversified stocks. This concept has stood the test of time to this day as confirmed by the fact that fund managers of most diversified equity mutual funds hold no more than 30 stocks in their portfolios. While such funds have access to considerable research resources from a variety of sources, individual investors generally lack these resources. Researching quality stocks with the potential for generating above average returns in the long runs takes considerable amount of time and resources.

Hence at Attainix Consulting, we believe that as a thumb rule individual investors should hold no more than 15 stocks in their portfolio at a given time, which is half that held by most equity mutual funds. We also practice this philosophy when advising our Clients for the icAdvisor service, wherein depending on the four factors enumerated above, we recommend between a minimum of 5 and a maximum of 15 well diversified stocks. Even the back-testing of the icTracker software has been performed using a maximum holding of 15 stocks at any point in time and the results published on the website only confirm the superior returns that can be had from a concentrated portfolio, with the minimum of risk!

Sources:

1.   concentrated-stock-portfolios.html. (n.d.). Retrieved Feb 24, 2017, from www.maynardkeynes.org: https://www.maynardkeynes.org/concentrated-stock-portfolios.html

2.   optimalportfoliosize.asp. (2005, July). Retrieved Feb 24, 2017, from www.investopedia.com: http://www.investopedia.com/ask/answers/05/optimalportfoliosize.asp

Why do so many Indian Companies delay their quarterly results?

In my ten years of tracking Indian stocks, the one thing that has intrigued me the most is the delay with which most Indian companies report their quarterly earnings. Let me illustrate this point with a delay summary for the current quarter, i.e. quarter ended Dec 2016. In the chart below, the x-axis shows the lag in reporting earnings in days from the end of the quarter and the y-axis shows the percentage of companies that have reported their quarterly earnings within that lag. This data comes from the icTracker database which tracks more than 400 of the largest Indian companies. 

Data from the chart lead us to the following conclusions

• Less than 10% companies reported their quarterly earnings within 20 days of the end of the quarter
• Despite a spurt of reporting activity in the next 10 days, less than 30% companies reported their quarterly earnings within 30 days of the end of the quarter
• At the end of 35 days of delay, less than 50% of companies had reported their quarterly earning
• At the time of writing this article, it is exactly 39 days of delay and yet less than 60% of companies have reported their quarterly results as of now.
• More than 40% of companies will be reporting their results with a delay between 40 and 45 days – which is the SEBI mandate for maximum delay.
• More than 20% of companies will be reporting their results on the last 2 days before the mandated reporting period end.

Isn’t this situation very appalling? This kind of lackadaisical attitude in reporting quarterly earnings by Indian companies not only smacks of apathy towards the capital markets but also betrays the trust with which investors have invested their hard earned money in such companies. More importantly it also raises questions in the mind of the investor about the (lack of) prevailing Corporate Governance within the Company. Management credibility is surely eroded in every company that this happens on a regular basis.

Why then do managements delay results so much at the risk of seriously eroding their own credibility? Here are some plausible answers and my own responses to them.

We have many locations and subsidiaries and have to collect and collate data from all of them - If large companies such as Infosys, TCS and Reliance Industries which have multiple locations and subsidiaries – and many of them overseas subsidiaries - can report their quarterly results within 15 days of the end of quarter, so can you.

We are ready, but our auditors are not available - Appoint an auditor who will be available.

A complete audit takes a lot of time - Investigate and fix the reasons for the delay in the audit. Consider reporting unaudited results with only a limited review by the auditors in the meantime.

Our auditors have submitted audit findings which we need to rectify - Do it quickly. This should not warrant delays of weeks.

And to those companies that delay results with the intent of delaying bad news, remember that the Internet is a great leveler. Capital Markets have an uncanny knack for sniffing out news about bad results much before the company reports them. Hence, discovery of such malicious intent only ends up denting the credibility of the management. On the other hand, the few companies that have made investments and efforts in reporting their earnings as quickly as possible not only find favor with analysts, but also with investors in the long run.

Stocks provide the best return in the long term

When we buy a business, we try to look out and estimate the cash it will generate and compare it to the purchase price. We have to feel pretty good about our projections and then have a purchase price that makes sense. Over time, we have had more pleasant surprises than we would have expected.

Warren Buffet

Long term investing requires an understanding of the performance of various asset classes over an extended period of time. Traditionally, only two asset classes have existed – debt and equity. However, as investment options have extended beyond the capital markets, other options such as real estate, currency and gold have opened up and found favor with investors. 

Real estate is a practical investment option only for those investors who can afford a large ticket size, high transaction and switching costs, long holding periods and the risk of illiquidity. 

Currency markets are not meant for long term investors at all – rather they are meant as a means of hedging the exchange rate risk of businesses having income in foreign currency. 

Gold is a defensive asset class, since its primary objective is to serve as a hedge against inflation. Nonetheless, since Indians have an insatiable appetite for holding gold assets, we will consider it as an asset class for the purpose of this article. 

The following table shows the return from PPF (proxy for debt), Gold and the Nifty (proxy for equity) over 5 different time periods – ranging from 1 year to 15 years.

Date	PPF rate	Gold rate	NSE Nifty
1-Jan-02	9.50%	4274	1058.85
1-Jan-03	9.00%	5320	1093.6
1-Jan-04	8.00%	5989	1880.35
1-Jan-05	8.00%	6128	2080
1-Jan-06	8.00%	8400	2836.8
1-Jan-07	8.00%	10800	3128.2
1-Jan-08	8.00%	12500	6136.75
1-Jan-09	8.00%	13670	2963.3
1-Jan-10	8.00%	16665	5200.9
1-Jan-11	8.00%	20688	6177.45
1-Jan-12	8.60%	27322	4640.2
1-Jan-13	8.80%	30893	5937.65
1-Jan-14	8.70%	28430	6323.8
1-Jan-15	8.70%	26699	8272.8
1-Jan-16	8.70%	24966	7938.45
1-Jan-17	8.10%	27445	8210.1
Annual Return
1 year	8.10%	9.93%	3.42%
3 years	8.50%	-1.17%	9.09%
5 years	8.60%	0.09%	12.09%
10 years	8.36%	9.78%	10.13%
15 years	8.31%	13.20%	14.63%

As can be seen from the above data, debt returns are consistently above 8% over the long term and appear to be a good option, especially for risk averse investors. However, if we factor in inflation even at a modest rate of 6%, the real rate of returns from the debt market shrinks to a meager 2%. Clearly this is not enough of a reward for long term investors.

Turning next to Gold, we see that it has offered double digit returns over the long run. However, this is primarily due to price appreciation during the years 2006-2012 when inflation in India was quite high. As inflation has moderated in recent years, returns from Gold have stagnated, as proved by the 3 year and 5 year gold return data above. 

Finally, turning to equity we see that the Nifty has returned close to 15% over the long term. This is the expected long term return from Indian equities and it has also been established by numerous studies. At this level of return, the investor is left with a real rate of return of 9% after budgeting for inflation at 6%, which is a decent return for any long term investor. However, the Nifty is an index of the top 50 large-cap stocks in India – which by definition do NOT provide the most capital appreciation. That comes from mid-cap and small-cap stocks. Investing in equities can be very rewarding, but the challenge lies in picking stocks with a high return potential. That is where an Investment Advisor can help.

At Attainix Consulting, we have developed the icTracker software that assesses the Knowledge Assets (aka Intellectual Capital) of the underlying business every quarter. The reason for doing this is simple - Knowledge Assets provide long term competitive advantage to a business. These are the businesses with the most return potential especially if they have not yet been noticed by the capital markets. Back-testing of the icTracker shows that returns from such stocks can be easily more than twice the expected returns from the Nifty! Now, wouldn’t you consider that as an icing on your cake?