It’s mid-year and a perfect time to assess your share portfolio.
Many investors who run their own portfolios via their stock brokers often end up with a “neglected portfolio” or become frustrated with the performance of their portfolio. In my experience, one of the key drivers of this frustration is that most portfolios managed by private investors suffer from both over-concentration and over-diversification. How is this contradiction possible? They typically have a few shares that have done very well and come to dominate the portfolio and many shares that have done very poorly and start to become insignificant in the portfolio.
It is important to examine and assess your portfolio at regular intervals to ensure that it remains true to its goals. Here are eight ideas on what to watch for in your portfolio to avoid potential frustration:
1. Review winners to avoid over concentration
If shares perform well, don’t be afraid to take some profits. If the share continues to do well, you still have some in your portfolio, but if its fortunes do decline, at least you have taken some money off the table. No share can outperform the market indefinitely and even the greatest companies will eventually give market-like returns.
2. Avoid “Long Tails” through not selling out and buying more losers
Most investors like to look for new ideas in their portfolios and they typically don’t like to sell shares. They reason that either it has done well so don’t sell it, or it has performed poorly so don’t sell as it might bounce. Hence, over time, the portfolios get more and more names in them, with smaller and smaller weights. This is called a “Long Tail”. You want to avoid long tails.
Beware of holdings that make up small fractions of your portfolios, for example 0.2%. Even if these shares double in price, they won’t make a material impact on the portfolio’s performance. Either sell them or take them up to a material weight in the portfolio – we believe a minimum holding for any share in a portfolio shouldn’t be less than 2%.
But how do you assess whether to sell out or top up? If the original motivation for buying the share is intact, and it’s near term sentiment that has pushed the price down, then top up. If, however, the price has fallen because the original motivation to buy the share has gone, then sell.
3. Avoid biases towards well-known large cap shares
Most investors often have a strong bias to large cap, blue chip shares. This gives them a sense of comfort and security, but will also hamper their performance in the long run. Over time, mid cap and smaller companies outperform large companies so make sure you have a few good quality mid and small companies in your portfolio that have attractive growth prospects. In other words look to include some future blue chips in your portfolio as well as current blue chip stocks.
4. Be aware of single factor drivers in the portfolio
The reason for a diversified portfolio, with several different shares, is to diversify one’s risk: if one share blows up, it won’t sink the whole portfolio. However, make sure that there is not a single common theme or driver of the portfolio. For example, if you own a portfolio of many shares, but all are rand hedges, the portfolio has actually been reduced to one bet, namely currency. If the rand strengthens, it will impact negatively across the whole portfolio. In this instance, you would actually have no diversification in your portfolio but would have a false sense of security.
Take a step back and see if your portfolio is dominated by a single theme, or factor driver. Common themes to watch out for are a weak rand view (favours rand hedge stocks), consumer stocks (very popular until recently), resource shares, banks and financial stocks, Africa-facing companies, property and so on.
This is not to say you shouldn’t take a view on a theme and build a portfolio around it, but just be aware of the risks if a theme dominates the stock selection. A high quality portfolio is one that owns many shares that have different drivers, rather than a single-factor driver.
5. Watch rights issues and other corporate activity
Don’t ignore correspondence that your stockbroker sends you. Sell rights issues or use them to buy more stocks. Understand the impact of mergers or other corporate activity, or taking scrip dividends or cash. Whenever you get some correspondence about a share that you own, call your broker and ask them for an opinion on what to do. They are paid to help you with this.
6. Be aware of cash and dividends
As companies pay dividends into your stockbroking account and you don’t need the money, don’t forget to re-invest the cash. Over the last 60 years, the South African stock market has delivered a total return of 7.7% p.a. ahead of inflation. But only 3.3% of that came from capital growth and, staggeringly, 4.4% of this growth came from re-investing dividend flows. Put your dividends back into your share portfolio.
A corollary of this is: don’t forget to include companies in your portfolio that have a high, sustainable dividend yield, even if they are not as sexy as the “hot stocks” that are experiencing fast price appreciation that everyone seems to be making money on.
7. Beware of minimum trade costs
Stockbrokers charge a stockbroking fee as well as a minimum fee per transaction. For smaller investors, or smaller trades, beware that the minimum charge does not make the transaction unviable. For example, a R100 minimum charge on a R5,000 trade is a 2% charge. If you are both selling and buying another share, that implies a 4% trade cost which means that the share you are buying needs to go up 4% before you start making a profit.
8. Consider your time frame for each share
When you buy a share, note if you see this as a long-term investment holding or a shorter-term speculative trade. This allows you to manage your emotions and better guide your decision if there is a big price shift. If the share rallies and it’s a speculative holding, exit the share rather than keep hoping for more. Likewise, if it falls and it’s a speculative share, sell out. But if it is a long-term investment, consider buying more.
An extension of this is to avoid investing in shares that have a binary outcome unless you are willing to take speculative risk on the share. Binary shares typically rely on some event in the future happening or not happening. If it happens, the share will run, if it doesn’t, it will fall.
By assessing your portfolio at regular intervals, you will be able to ensure that your portfolio remains consistently relevant and that your long-term investment objectives are being met.
Issued by BayHill Capital