January 4, 2010

Stocks Tips are not portfolio management

The standard service provided by most brokers, analysts and blogs is stock tips. The analyst typically analyses a company (often superficially) and after declaring it cheap, gives a price target. The brave ones may attach a time frame to the target too. There are several points missing in the above model for a typical investor

- How much of the stock should the investor buy?
- Should the investor buy a full position at the current price or build it over a period of time?
- What is the level of risk of the stock and how does it correlate with the stocks in the portfolio?
- Most importantly, when and under what conditions should the investor buy or sell the stock?
The analyst or the broker involved gets paid for recommending the stock and their responsibility stops at that point. None of the above points are considered when providing the service. In addition, there is sometimes no follow up and review of the stock on an ongoing basis which would help the investor decide whether he or she should buy, hold or sell the stock.

The above missing points in the standard model of the industry are provided at a high price via portfolio management services. I am not aware of the exact pricing, but have been told that it is generally around 2% of the portfolio and some percentage of the gains achieved by the portfolio manager.

This model is ofcourse stacked against the typical investor. The portfolio manager makes money irrespective of whether the investor makes a profit or not.

A decent portfolio management service should have the following features

Stock idea: The service should provide the stock idea with an estimate of fair value and a clear explanation of the risk involved in the stock. I don’t believe that a stock can have only an upside without a downside risk.

Position sizing: The service should provide a recommendation on the position size (amount of stock) and also provide regular inputs if the position has to be built over time.

Correlation risk: There is no diversification if one buy 3 cement and 2 telecom stocks in a portfolio. A lot of times the risk is not as obvious, but should be analyzed when recommending a stock and deciding on the position size

Regular update and sell recommendation: This is sorely missing from the current model. You will rarely find a sell recommendation from an analyst.

I am not aware if the above comprehensive service is available at a decent price. Most of the brokers provide stock tips or similar such recommendations with an eye on generating commissions through buy or sell action of the investor. As a result it is impossible for brokers and analyst to have their incentives aligned with yours.

An example
I discussed my portfolio in
this post. I provided a listing of all the stocks in the portfolio with their 2009 gains and also an analysis of the idea in some cases. Does this list give an idea of the portfolio performance ? hardly. Some the ideas in the portfolio were analysed in 2006, some in 2007 and some in 2008. I don’t build a full position at the time of the analysis unless I think that the stock is extremely cheap and there is no point in waiting. The positions were built over the course of time as the stocks got cheaper or the fundamentals improved.

It is important to understand one point – A decision to buy need not be made at the time of analyzing the stock. One should analyse the stock and make a note of it (in my case I have a tracking spreadsheet). If the price drops below a certain threshold, one can start buying or increasing the position. If the price rises, well then move on to something else. It pays to do your homework in advance.

I typically analyse a stock and provide the readers with all the required information to make a decision. However there is still quite a bit of ongoing effort required to track the fundamentals and the price and make buy, hold or sell decisions. These decisions have to be made in context of one’s personal situation.

In my own case, I exited most of my positions in 2006-2007 time frame. I started buying a little bit in mid 2008. My main buying came during Oct 2008 – Jan 2008. As a result I did not hit the precise bottom of the market, which anyway has never been my goal. If the market keeps going up, I will keep exiting my overvalued positions slowly over this year. If however, the market crashes, and I can find undervalued ideas, I will start buying again.

I may have a long term view on stocks, but I am constantly evaluating my ideas on the four factors discussed about and making changes to the portfolio. A long term approach is not a brain dead approach.

The relevant returns
The relevant returns for any portfolio should be for the two year period 2008-2009. Most of the long term investors lost money in 2008 and made it back in 2009. If one has to evaluate the success or failure then one should look at the combined returns for these two years. In my case, I am more than pleased with my returns as I cleared my target by a wide margins (target being to beat the market by 5-8% per annum). I don’t expect to have a repeat performance in 2010.

Conclusion
Building a low risk portfolio and maintaining it, involves quite a bit of effort. If one is not ready to put the effort behind it, then a sensible option is to invest in mutual funds (inspite of all their drawbacks) or in index funds. Stock picks and tips will help you trade and have the thrill of jumping in and out of the market, but if you want to build your networth over a period of time, don’t expect these services to help you on that.

22 comments:

Anonymous said...

dear rohit
the same ,hooked on to ur bandwagon, guy
i have ur portfolio for value stocks and 5 stocks of ramesh damani for some heady returns
rohit:ramesh is 95:5
the portfolio is balanced for growth and value, dividend, and deep value
hope it works

Rohit Chauhan said...

Hi anon
dont hitch the bandwagon too tight :)
my own portfolio is not fixed and may change without disclosure on the blog
rgds
rohit

karthik said...

Hi Rohit,

Great point.I was about to point out the same thing to Anon..

Anon,
We dont have the same level of expertise of Rohit..I feel it is ok to take ideas but please do your own analysis before buying anything. As rohit pointed out he might have bought it at different times..A stock which was cheap when he bought may be expensive now (Ex maruti,Asian paints e.t.c).Also He may sell and might not be able to blog it immediately.

Madhav said...

Rohit,

Happy New Year.

Regarding the broker's calls I have a few complaints to add:

- No analysis of competition

- No discussion of competitive barriers or economic moat that will help the company to achieve the said targets

- Hardly any discussion of market size, room for growth, changes in legislation

- Each broker touts a different number for different stocks. Due to the inconsistency its impossible to make an apples to apples comparision. Example: One broker says low PE and low PB, while the other talks about cash in the bank and the third talks about impact of monsoon.

- All broker's calls are short term and hardly ever discuss anything beyond 6 months.

- Even paid services like Poweryourtrade.com are guilty of the same.

I am awaiting Morningstar.in to build out its services like ranking stocks based on their economic moat as they do on their .com site.

By the way, have you considered providing paid research services?

Rohit Chauhan said...

Hi karthik
I agree..coataling or following some else's portfolio is not a bad idea ..i do myself too, but it should be done blindly. Following mine or anyone else's portfolio at this stage is risky at current valuations
rgds
rohit

Rohit Chauhan said...

Hi madhav
the incentives of all brokers and other sites is misaligned with an investor. they are geared to trading and make money when u buy and sell and not on holding a stock.

also the list you mention would require experienced analysts which most brokerages cannot afford with the commisions they make

finally, investors share equal or more blame ..how many are interest in wealth creation ? a lot of people look at the market as a casino

i really dont like the paid service model ..to take analogy ..it is like selling vegetables by the pound. i am planning a paid service on my blog but it will not be limited to research alone ..i plan to take a portfolio and wealth creation approach for the service.

rgds
rohit

Madhav said...

Hi Rohit,

"I plan to take a portfolio and wealth creation approach for the service.". So you don't believe in selling fresh vegetables but also cook based on your own recipe. That's interesting.

As you may expect it may be difficut to get your first bunch of investors. Despite respecting your value investing views and seeing your portfolio, I may not become your client simply because I have burnt my fingers by using a similar service from a respected brokerage.

As a result I manage my own funds doing my own research and getting some ideas and feedback from experienced people like you.

All said and done - All the very best.

Vic said...

Rohit,

Your response to Karthik: It should be done blindly? :-)

I agree, it will be difficult to make much money at current valuations.

So what strategies would you adopt to make higher returns in such market scenario (hardly anything undervalued by decent margin) if you were to run a PMS?

Thanks,

Vikas

Nanuni Kokoritu said...

Nice post!

Rohit Chauhan said...

Hi madhav
thats perfectly understandable. if you have the capability (most of us do) and the interest to do the work, then it never makes sense to use outside services to manage your money. i have never used any outside service , not even brokers or their research for the simple reason that i dont trust them and have intrest in doing it on my own.

i realise that getting the first clients will be tough , but hopefully not impossible..which is why i am not leaving my day job :)

rgds
rohit

Rohit Chauhan said...

Hi vic
yes thats a typo.
to your other question - you may not like my answer, but still here goes

i will actually not chase returns at such a time. there is a time to play and a time to withdraw ..if i dont find attractive opportunities i would hold cash than do something silly.

ofcourse a small portion of the portfolio would be dedicated to arbitrage and maybe options ..but i doubt i can beat the marktet during a huge bull run.

maybe the above reason will make it diffcult to run a PMS or get clients ..but then so be it. it is easy to get carried away by greed as much by fear ..a lot of people learnt that the hard way in 2007-2008

Madhav said...

Rohit,

This is off-topic. I would like to understand the impact of options, futures, open interest, month-end buy-sell etc., on stock prices. I understand that some traders/ fund managers might use these to hedge their portfolios or for short term gains. As a stock investor I want to understand the correlation, impact of the above on stock prices. Appreciate if you can point me to some resource or write a post on the same.

Thanks in advance.

Lucky said...

What a start for 2010!!!

Great article. Start your PMS Rohit, I will be (one of) your first client :-)

BTW, 2010 looks like the right time to remind ourselves of Buffett's second rule :-)

Wish you a very very happy year!!!

PS: I believe a really fair compensation for a PMS should be directly linked to the out-performance compared to a pre-decided benchmark. So e.g. you beat the Sensex by 5%/10% and get a cut of 1%/2% + a fixed 0.5% or something like that. What do you say?

Rohit Chauhan said...

Hi madhav
i have rarely looked at these indicators in the past as the stocks i pick are generally out of favor. they typically have very low volumes and poor technicals.
there are some people who combine technical analysis with fundamental analysis ..but i have never done that as i feel that it would create more confusion in my mind

rgds
rohit

Rohit Chauhan said...

hi lucky
yes, 2010 is the time for me to be cautious ..i was aggresive in 2009, but i dont plan to be in 2010.

on the PMS ..thats getting ahead ..i frankly dont have immediate plans to start one now ..i am planning to experiment with some paid service by end of this year which is likely to be low cost too.

on the fee ..i agree it should always be for performance which is by the amount a manager beats the market ..and actually the fixed component should very low ..why should an investor pay fees for parking money with the manager ..unfortunately most PMS and broker also charge a flat fee which results in wrong incentives for them ..chase assets instead of returns for the investor

rgds
rohit

Madhav said...

Rohit,

You are spot on about this - "unfortunately most PMS and broker also charge a flat fee which results in wrong incentives for them ..chase assets instead of returns for the investor".

In my case, when the sensex went from 7k to 21k, my portfolio lost 25% value, and broker charged me 5% or something of the asset. I was furious because an idiot could have invested in the index and be laughing their way to the bank and these good for nothings had made a fool of me.

I am not trying make a comparison between what you plan to provide and the PMS scheme where I burnt my fingers, but I reiterate that I may consider paid research services as against PMS scheme. Just my view.

Cheers and all the very best to you.

Rohit Chauhan said...

Hi madhav
i dont want to step into a painful area for u, so we can take this through emails - but how did the broker manage to lose 25% when the sensex more than tripled ? i cant believe these guys can pull this off !!
a brain dead monkey do better ..actually if you dont do anything u will not lose anything ..

Rohit Chauhan said...

actually my own broker keeps wanting to sell research and give me portfolio advise :)
To stop him from irritating me i half jokingly have given him an offer ..if you dont bug me i will give a bonus of 500 rs

Shruti said...

Hello Sir,

Good to read your blogs. They are always very informative. I have started investing recently and am very much trying to follow value investment approach. I have also been very much inspired by benjamin graham and warren buffett. Sir, I would really appreciate your guidance in investing. Is it possible to have have contact through mails? Can I have your email ID?

thank you.

Shruti

Vic said...

Hi Rohit,

Not only I like but I love your answer on the alternative strategies in the current market:-)

The reason I asked is you had experimented with some of these hedging options.

I love ur idea regarding Paid Service/PMS fee structure. Ultra low annual Fee + decent performance linked incentive. Anyway you're always reasonable.

Thanks,

Vikas

Rohit Chauhan said...

hi shruti
email id is rohitc99@indiatimes.com

vic - options is still in a learning phase, so any gains and losses are very small and just for learning

rgds
rohit

Manish Jain said...

Hi Rohit,

I share Crisil and Grindwell Norton in my holding.

On Grindwell though at P/E of ~ 15 is looking fairley valued I feel it has bright future considering its consumer industries like automobiles,auto components are going great guns and construction has started picking up.

If I look at 5-10 year horizon my feeling is It will give more than 12-15% (my thershold) returns.

Regards,

Manish Jain