Chetan Phalke writes that most investors spend a lot of energy on emerging themes and new stock ideas. But quite often, we spend less than the required time thinking and tracking their existing portfolio. For most investors, portfolio rebalancing is centred on price action alone. As stock prices move up, the conviction goes up and the regret of not buying more creeps in. If stock prices tumble, it works the other way round.
Phalke created a 2 x 2 matrix with investment hypothesis and allocation as variables. An investment hypothesis can be any metric or a combination of them based on investors’ assessment of the business. There are businesses with various characteristics, and we must arrive at key factors to monitor to see if the story is on track or not. Allocations vary from investor to investor. Some investors, as a rule, will never go above 5 per cent in a single stock idea and will keep trimming exposure whenever it crosses the threshold. For some, it doesn’t make sense to have less than 8-10 per cent in a single stock. Some investors work around sectoral allocations. Investment allocation is more of a personality-driven decision.
Q1 – Investment Hypothesis Is on Track and Full Allocation: These are the anchor stocks in the portfolio. They must be held till the investment hypothesis is on track and you have a very high level of comfort in holding them. Even if the stock price hasn’t done well, these positions are not to be touched unless there is an overallocation issue. Unless the position becomes too large and causes concern. That’s the time to take some money off the table.
Q2 – Investment Hypothesis Is on Track and Low Allocation: As the business keeps performing, conviction level goes up. As you spend more time tracking the stock, you discover more and can separate the wheat from the chaff. There comes a time when the valuations are right and you are willing to scale up your position. Or, your understanding of the business is much better than the initial stage, and you are willing to pay a fair price/premium and buy more. These are ideas that can move to Q1 and can become anchor stocks in the future.
Q3 – Investment Hypothesis Is Not on Track and Low Allocation: We can put them in the ‘ideas for the future’ bucket. They don’t have any impact on the portfolio even when they move since the position size is too small to matter. You develop a reasonably good understanding of the business and key parameters. Since you track these positions for a while, you can act quickly when it matters. When you see some symptoms of change, the ability to spot them well ahead of the market gives an advantage. These ideas can move to Q2 as and when things turn.
Q4 – Investment Hypothesis Is Not on Track and High Allocation: These are obvious mistakes in the portfolio and most difficult to tackle as our biases are involved. Most of us keep holding the stock, hoping for things to turn one day. Anchoring against the entry price is another factor. It is important to be ruthless and cut the positions or just move them to Q3. Ability to deal with this category is very crucial to have a sustainable performance over the long term.
Phalke’s system can help us make rational decisions and make better portfolio allocation decisions. His point regarding stocks in Q4 is especially relevant and will need a lot of mental discipline.
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