Strategy to adopt if your Portfolio is underperforming
Apr 06, 2018 | Source: AxisDirect
Equity markets are inherently volatile by nature. It must be noted that short term volatility is not necessarily indicative of long term trend. There are many variable factors that affect the performance of markets many of which are beyond the comprehension of a common investor. Markets generally behave like an oscillating pendulum- never ever resting at the equilibrium. Volatility in markets, in general, is then passed on to the individual portfolios. In such a scenario, there is possibility of underperformance of one’s portfolio vis-a-vis the benchmark. Ahead of comparing the performance of a portfolio, ensure that it is pitted against the right benchmark, else the whole assessment exercise is in vain. The asset allocation of the portfolio is to be decided at the beginning of investing keeping in view the objectives to be achieved. First rule to make an all weather portfolio is to select stocks after making proper due diligence about the business, management and future potential of the business.
To start with one should dig deeper to understand the reasons for underperformance of the portfolio. One of the common reason for divergence in the performance of a portfolio is the constituents- a portfolio may not necessarily mirror the constituents and weightage associated with every stock in the benchmark. One would have to bear with the deviation in portfolio’s performance due to this reason if one wants to retain the distinctiveness of his portfolio from the benchmark.
Another reason for underperformance can be allocation in the portfolio- the distribution of ‘growth’ and ‘value’ stocks/ sectors in the portfolio. In the rising markets, the ‘growth’ stocks outperform the markets, command high or extremely high valuations. In intermittent corrections, these stocks happen to witness rerating in their valuations, hence see a correction in prices, which may or may not be sharp. There is probability of portfolio underperformance if it is highly skewed towards growth stocks. The excesses that are built in terms of high or extremely high valuations in rising phase of bull markets are tempered during intermittent corrections to bring it closer to the reality or even maybe on the other side. It would be a prudent call to analyze the valuation of the growth stocks in such turbulent times and if the long term growth story is intact, one must look at adding more at different price points with long term investment horizon. One must take help of your financial advisor to assess the valuation and the investment rationale of the stock and do the needful. Similarly, if a value stock is available below the previous purchase price and the investment rationale is intact, does it require a rethink on adding more?
Markets have tendency to exhibit irrational exuberance on either side of equilibrium and so does the market participants. The general behavior of market participants never changes. Time and again, it has been statistically proven that the investors follow a herd mentality; they turn greedy when they should have turned cautious and vice-versa. Investors end up making irrational and illogical decisions with their investments especially in wake of event which many a times happens to be extraneous to the country/ stock market/ specific stock. They tend to overreact to the events without giving due consideration of its impact on fundamentals of the stock. As pointed out earlier, the markets react to reasons which are beyond the comprehension of an average investor and many a time the investor extends the same analogy to the specific stocks in his portfolio without giving a thought to whether the changed conditions have led to any changes in the fundamentals of the company. An investor has to undertake due diligence of fundamentals of specific event on the stock/ investment before taking any hasty decision. He should not panic, practice patience, have faith in his investment and avoid unnecessary churning of his portfolio, if the event that leads to market volatility has little to do with the future prospects of the investment. It has been proven time and again that the investments held for long periods tend to exhibit lower volatility than those held for shorter periods. The longer you invest, the more likely you will be able to weather lows in the market.
To conclude, the investor should not get carried away by the short term volatility of the markets and the temporary underperformance of the portfolio if he is convinced about the potential and prospects of the stocks in it. Use the opportunity to recheck the fundamentals and if convinced about its potential infuse more funds to add at lower levels thereby taking the advantage of lower prices to average the acquisition cost.
One of the major virtues to be practiced by an equity investor is to stay put and do nothing when the markets around are painted in red and act only when needed. Avoid unnecessary temptations to make changes in your portfolio and stay invested for long term to reap the real benefits.