Mutual Fund Portfolio Spring Cleaning Time

The Independence Day speech by the Prime Minister may or may not have excited the equity fund managers. It did however touch upon a very important subject on hygiene and need for proper sanitation and cleanliness.

Many years ago while doing research on global building material companies, I came across a company called TOTO which was based in Japan, and claimed that it was the world’s largest toilet manufacturer. It was fascinating to read about their products. The toilet picture I saw showed more buttons than I could imagine. The various reviews seem to suggest that these toilets had heated seats, warm water to wash and warm air to dry. Some of them could check the blood pressure and some models could even play music!

While a developed country like Japan could indulge in such sophisticated products, India requires widespread basic sanitation.

Hygiene is important, disposable of sewage is paramount. Not giving importance to this imposes a huge risk in the form of diseases on the society. While there are many research papers available on the impact of poor sanitation, i refer to Rose George in the book “The big necessity” which says that it is children who suffer the most. Diarrhoea- nearly 90% of which is caused by faecally contaminated food or water- kills a child every fifteen seconds. Proper disposal of can reduce diarrhoea by 40%. A government that provides adequate sanitation saves money on hospital visits does not lose labour days to dysentery or workers to cholera or children – the future of our country to diarrhoea. Where good sanitation exists, people are wealthier, healthier and cleaner. Coming back to India, while we may not have musical toilets, at least we have a government that is taking cognisance of the need for social hygiene.

Sanitation and disposal of sewage is important no doubt, and the same can be said of investment portfolios. To keep the portfolio healthy there is a need to continuously clean the portfolio of all toxic elements and also to closely monitor it so that toxic investments do not get into the portfolio in the first place. A single bad investment or a collection of poor investments can have serious impact on the portfolio. Toxic elements can creep into the portfolio through very subtle means. A sweet talk by your broker, or by the smooth talking or good looking relationship manager may result in a “not so worthy investment” creeping into your portfolio. The unworthy company could be one with poor business strategy, one with weak balance sheet or one which cannot attract great talent or even retain them.

Sometimes the toxicity is hidden, by a surging share price. The increase in share price may further tempt you to hold on to what you have or worse still may tempt you to buy further. Beware...keep an eye (or both!) on your portfolio.

Let’s look at the following data:

*Data from Sep 2013 – Sep 2014
Data Source: Bloomberg

Past performance may or may not be sustained in the future.

If you dig deeper; in the BSE 500 there are at least 40 companies with a negative return on equity and the share price of these companies have increased to anything from negative 20% to positive>300% (-20% to >300%) with the average increase being 89%. Maybe some of them deserve the increase on some other valuation parameters than return on equity. But it might be worthwhile to evaluate these companies further and decide to hold on or to purge them from the portfolio. There were at least another 50 companies with return on equity being below 10%. (data as on 20th August, 2014)

In the BSE small cap, which has about 455 companies, there are at least 59 companies with negative return on equity. The share price increase of these companies range from negative 39% to positive 281%. There are approximately another 163 companies with Return on equity being less than 10%. The share price increase of these companies range from negative 91% to positive return of > 4,000%. So while you might get carried away, looking just at the share price there are high chances that these lofty share prices may not hold on.(data as on 20th August, 2014)

Therefore if you have been holding any of these companies, it would be advisable to research a bit deeper and decide to hold on or purge and move on.

In every aggressive move of the market, there are tempting stories to buy into. But many of these fairy tale stories do not have that happy ending that all fairy tales are supposed to have.

Remind yourself of the times in the mid 1990’s and early 2000’s when Aquaculture, Floriculture, IT, Granite, Leasing and Internet companies, were supposed to do great things and deliver great profits. Where are they today? Similarly, at current levels of the market which is finding new highs, there might be interesting stories to invest or it could turn out to be traps.

Along with cleaning your stock portfolio, also check your mutual fund portfolio and your exposures. It might be a good idea to relook at the weight of some of the funds particularly the mid cap and small cap funds.Be invested, but check what you own and what needs to be thrown out.

If you do not have the time and patience to research, invest and continuously monitor the stocks, then it might be a better idea to invest in a good fund. A fund which has a long track record and proven research skills. A fund house which is not afraid to swim against the tide but take calls which are ultimately good for your portfolio.

Do your research, consult a good financial advisor and do your best to ensure that your portfolio is sparklingly clean.

Above article is authored by Quantum.

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