Buy & Hold: Are your Portfolio Stocks forever?
Is the behaviorally easy 'Buy & Hold' good for the health of your Portfolio too? Let's see what data has to say!
The default holding period of stocks by investors (especially retail) is usually forever. In fact holding onto a stock for a very long time is considered as the demarcation between identifying between trader or an investor persona. Market enthusiasts tend to lean on this practice for demonstrating patience, which is a must have for a successful investor. It is very likely that you have come across ‘If you had invested INR 10,000 in XYZ stock in year 19XX, it would be worth few millions today’ post irrespective of the social media you are active in. Like always I am back taking a stab at this practice to see if this mental make up of an ‘investor’ is indeed helping him generate better returns with the help of some data.
An ideal stock portfolio is difficult to define as it means different things in different context. Irrespective of that every portfolio is constructed for delivering highest possible returns with a certain accepted level of volatility (aka risk). Every investor, either investing his personal money or managing it on the behalf of someone else has this goal to achieve. Each of them using a different approaches to reach this same goal.
Mutual Funds have professionals manage such portfolios. Each manager trying make the best possible returns. Portfolios (in the same level of risk) while being compared to portfolios managed by other managers are also compared with a benchmark. Benchmark is defined as a standard which the performance of security, mutual fund or investment manager is measured against. In the case of Indian Large Cap/Bluechip Funds (portfolios investing only in large companies, thereby translating to lowest possible risk compared to investing in medium and small companies) the benchmark is the NIFTY 50 index. It simply is the market capitalization weighted index of the top 50 listed companies in India. When a stocks ceases to be one of the top 50 due to fall in its market cap (which is in turn due to its stock price erosion) it is replaced by another which has meanwhile climbed up on the market cap ladder.
The interesting bit starts from here! As per the data from Value Research out of 191 large cap equity schemes only 22.5% (43 funds) could fare better than NIFTY 50 returns in 2021. The number has stayed similar (and equally disappointing) in 2019 as well.
For whatever the reason (I am tempted to digress into this favorite theme of mine - passive fund vs. active fund et al. but I will resist for the time being) NIFTY 50 has consistently been doing something which is making it perform better than the rest of the managed portfolios (most of them at least). It can thus seems to serve the purpose of being a perfect proxy of an ideal portfolio for the purpose of this article.
NIFTY 50 was launched in November, 1995 with 50 stocks. Today (2022), after 28 years only 12 stocks from these has been able to continue being part of it. That’s a 76% churn straightway! In case you are looking at your portfolio and hoping that the stocks that you hold are next Reliance Industries (or any of the other 11 stocks like HDFC, SBI, L&T, ITC etc.) you might have already fallen prey to survivorship bias unknowingly.
For the stocks that had become part of NIFTY 50 only to be churned out later, the average duration they have been part of the index is 5.5 years. If all such stocks are also taken into account which hasn’t yet been churned out as of today (April, 2022) the average time increases by 32.7% to 7.3 years. The extent of skewness of the time spent by stocks in the index is more pronounced from the chart (histogram) below.
From the total of 85 stocks (there were 104 stocks, I removed the ones which were merged or delisted) that have ever been part of this index, the bulk of them (77% ) have spent less than 10 years in the index before dropping out and making way to new entrants. Between these, 44% has spent less than 5 years and remaining 33% between 5-10 years.
The evolution of sectoral contribution has been equally dramatic. NIFTY currently has exposure to 13 sectors but how they have changed over the years has some key take away for investors.
Financial service sector has seen its contribution increase in the index from 20% in 1995 to 37% in 2021. So banking stocks would give a bias that if equity is held for a really long time they tend to do better. But Consumer Goods or Metals didn’t have the same fate neither did Automobiles. So holding on to stocks belonging to these sector would only lead to capital destruction let alone under performance. In few cases, a new sector stormed its way into the index and grew from strength to strength, like the IT sector. While having zero contribution in 1995 this sector now has 2nd highest exposure at 17.9%. But Telecom which became a hot sector in 2005 (with contribution of 6.3%) quickly lost investor interest and its contribution remained flat at 2.2% almost over 2 decades. So holding onto a IT stock vis-à-vis Telecom stock would lead to a starkly different performance of your portfolio.
Warren Buffet has been famously quoted saying “Our favorite holding period is forever”. While I don’t intend to challenge market wizards, one has to appreciate that such players have an in-depth & nuanced understanding of the businesses which they invest it. A part time private investor might find hard to replicate given the lack of time, money, resources or motivation. I am not even talking about the stomach and discipline needed!
And the data above gives a quantitative sense that while you might have to hold onto your stocks long enough for them to play out to their full potential, probability that they are multi baggers which would keep delivering for over 10-15 years is very slim. Rebalancing your portfolio regularly is a must if you wish to keep generating respectable return over a prolong period of time. Quoting the renowned English singer, songwriter & musician Ray Davies before I end this piece
Patience is not passive waiting. Patience is the active acceptance of the process required to attain your goals and dreams.
Diamonds might be forever, but stocks in your portfolio, not so much!
Hope you found this article thought provoking & interesting. If you missed reading Paytm Payments Bank saga: Road to profitability gets longer? by Dalal Street Rafting check it out below.
Disclaimer: Views presented in this article is personal opinion of author and doesn’t not represent any firm’s view that he is currently associated or might have been associated in the past. No part of it should not be considered as a recommendation to buy or sell any stocks etc. This is an educational article at best. Although care has been taken for correctness of the data, author does not take any responsibility for any errors or omissions. Readers should consult their financial advisers before taking investment decision.