Equity investing: Why allocation matters more than what you buy

The first principle of allocation is, 'Invest first, investigate later,' said Harini Dedhia, fund manager at Tamohara.

Disclaimer: This article is written by Harini Dedhia, fund manager at Tamohara, Investment Managers. Views expressed are his own. Readers' discretion is advised.

 

  Most ‘guides to equity investing’ spend the meat of their discourse on what to buy. As a result, the majority of us know this internally; even if we choose to follow this compass only occasionally. This knowledge domain within the field of equity investing has largely been democratised. Questions of allocation however remain under-appreciated. How much? How quickly and When? These three questions on both buy and sell sides of the transactions lie at the heart of your portfolio performance and the volatility therein. I would deem this as the wisdom domain within the field of equity investing. This remains non-democratised.

 

 

There are three strong tenets of allocation that I have found to hold true. The first of them being, ‘Invest first, investigate later.’ This by no means is to be an excuse to not put in the work to understand a business. Often a strong structural tailwind, akin to a rising tide, lifts all boats with it. In such cases, waiting to ‘complete’ the entire work on an investment idea will result in prices that are prohibitive for generating meaningful returns. There are two additional truths that contribute to this tenet. One, you can never know everything about a company. Two, the pareto principle holds true as with most things in life. 20 per cent of the research time yields about 80 per cent+ knowledge on the company. Should the knowledge gained align with a strong sectoral tailwind, one should strongly consider executing, albeit a smaller position to begin with. The tailwind acts as a natural floor to the price in the short term. A classic case of this would be to invest first in any data center infrastructure linked company at the start of this financial year. A month’s wait to complete research on the idea, was detrimental to one’s ability to buy into the respective companies.

 

The second principle of allocation that works wonders is a paradoxical one to most classical investors- ‘average up’. It is a natural corollary to the first wherein you buy smaller quantities to participate in a strong trend. As delivery comes through and you have gained incremental knowledge to be more confident of the performance sustaining, it is but natural to average up. Averaging up on proven execution is key to smoother wealth creation journeys in equities. While it sounds paradoxical to most ‘value investors’, it is actually a practice luckily adopted by the majority of the retail investors in doing an SIP into Indian equities over the course of their careers.

 

The third tenet is perhaps the simplest to state and the most difficult to implement, ‘ride your winners’. If a tailwind is in place and proven execution is resulting in superior stock price performance, it is imperative one stays put in the stock rather than booking profits on the first 20 per cent pop. Pareto principle works in the outcomes of greatest investment track records of all time- a handful of trades deliver the majority of lifetime returns. Be it Titan and Lupin for Shri. Rakesh Jhunjhunwala or Coca-Cola or American Express for Mr. Warren Buffett. Cut your winners early consistently, and you will miss out on those exceptional outcomes.

 

A framework that then emerges to judge a long-term investor’s allocation is; ‘Portfolio churn should be more concentrated in the tailenders.’ The top holdings are so because of proven execution resulting in appreciation of stock prices and your ability to ride those winners out. That core of your portfolio should be far more consistent than the tailenders, where execution is yet to be proven and conviction is yet to be fully built.

 

This framework and the above tenets are by no means a comprehensive guide to allocation. They however are the most impactful ones I have deduced after over a decade of investing.