Globally, renowned investors such as Warren Buffett, Charlie Munger and Phil Fisher have, among others, one thing in common - they follow or propagate a concentrated investing strategy.
Simply put, they invest in fewer stocks, rather than spreading out their investment over a larger number of stocks to create wealth for their investors/shareholders.
In its 21st Annual Wealth Creation Study (2011-2016), domestic brokerage Motilal Oswal (MOSL) has looked at “focused investing”, wherein apart from other aspects it highlights the importance of “power of allocation” in creating wealth, and how investors could fetch phenomenally higher returns by allocating a larger share of money to fewer stocks.
After 20 annual studies that focused on “what to buy”, the latest study also moves a step forward by focusing on “how much to buy”. Using a hypothetical example of 10 stocks, it explains how allocation could significantly influence the performance of a portfolio.
If funds are allocated in different proportion to these 10 stocks, the returns can be as low as minus 8.5 per cent to as much as 18.5 per cent. A higher allocation to outliers can boost returns and vice-versa.
“Rakesh Jhunjhunwala made it big because of his three big investments namely CRISIL, Titan and Lupin, which have delivered phenomenal returns for him,” says Raamdeo Agrawal, joint managing director, Motilal Oswal Financial Services, explaining how investors can also fetch exceptional returns.
He also cites the example of how a bigger allocation in Eicher Motors in Motilal Oswal PMS’ fund helped it deliver significantly higher returns than a scheme from Motilal Oswal AMC, which also owned the two-wheeler maker.
Focused investing (15-20 stocks) takes a middle path compared to diversified (50-plus stocks) and concentrated (10-odd stocks) investing strategies. It also takes a lesson from John Larry Kelly Junior, who was a scientist at Bell Labs in the mid-1950s.
MOSL’s study says that the key factors to achieving success in focused investing is to define the portfolio goals (absolute return), superior stock selection capabilities (which is where the previous studies on what to buy comes handy) and rational allocation (bet big on stocks where the odds are better without taking undue risk).
And, all these need to be consistently followed and monitored. “Disciplined investment practice should lead to exceptional returns rather than acceptable returns,” says Agrawal.
There are downsides as well. Investors need to avoid common mistakes such as over-allocation, staying with winners/losers for longer than desired periods, etc. Also, opportunities to bet big don’t come often.
The latest study on wealth creation (defined by MOSL as the difference between market capitalisation over a five-year period) shows that the top 100 wealth creators created Rs 28.4 lakh crore during 2011-16.
Tata Consultancy Services topped the list for the fourth time in a row, followed by HDFC Bank and Hindustan Unilever. For a second time in a row, the fastest wealth creator is Ajanta Pharma.
Asian Paints, Kotak Mahindra Bank and Sun Pharma are among the most consistent wealth creators. Over the past few studies, consumer-facing companies have mostly figured in the top, and between private and public sector, the former has done consistently well.
On the flip side, companies from the commodity sectors have seen big wealth destruction. The study pegs the wealth destroyed at Rs 1.5 lakh crore during 2011-16.
Illustration Uttam Ghosh/Rediff.com