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How to assess your investment portfolio?

The year has ended with a 21% return at NSE 50 level. Your portfolio might have grown better or worse than this, depending upon your investment objective.


Investment Review

Often, people look at the news that the index has done so well, but their portfolios have not. This is not a proper comparison.


An individual may have a combination of investment objectives ranging from short-term, medium-term, to long-term. Equity investment is a long-term investment with a minimum five years’ time horizon. When you compare your portfolio designed to meet short-term needs with a long-term asset class, you will be disappointed.


The sole purpose of financial planning is to meet financial objectives. Once the goals are defined, you create specific investment portfolios catering to those financial needs.


Additionally, you consider the kind of person you are. For example, if you have funds but do not like to take positions in long-term assets, naturally, the return expectations should be muted.


So how should you assess the performance of your portfolio?

First, break down the portfolio into debt and equity asset classes. The benchmarking must be at debt and then at equity level. At this stage, you do not worry about the sub-asset class level.


In 2020, RBI reduced interest rates impacting FD returns across all financial institutions. The benchmark return may be a fixed deposit return for one year.


SBI 1 year FD rate is 5%, so this may be a benchmark return for a debt portfolio.

Now compare your debt portfolio return to this fixed deposit rate. If the return is lower than the FD rate, understand why. Often an interest rate movement may impact the return for a brief period, so that must be adjusted. Similarly, a higher return due to increased credit risk should also be factored in. These nuances may be better understood at a granular portfolio level. We will discuss this when we investigate sub-asset class-level benchmarking.


Similarly, the broad equity market return may be gauged from NSE S&P 500 Total Return Index (TRI). You should not base your benchmarking for equity portfolio on one year. Instead, you should base it on five years.


5-years NSE S&P 500 TRI return is 18% p.a.

Now compare 18% p.a. to your equity portfolio return. Again, any difference, positive or negative, must be studied more deeply.


Benchmark return for the portfolio will be arrived at by assigning specific portfolio weights to the asset class return.


Let’s assume that you weighted 40% to debt and 60% to equity.


2021 Benchmark portfolio return = (5% X 40%) + (18% X 60%) = 12.80%

This should be the anchor number to compare portfolio returns.


Now we understand sub-asset class returns.


Debt

Often investors take positions in various debt categories—the return expectation changes across the spectrum. The least risky, i.e., the least volatile category, is the liquid.


The benchmark return for liquid, i.e., Treasury bills in 2021, is 2.05%.

Government bonds are not always low volatility. As the duration of the bond increases, so does the volatility—a 10-year government bond, maybe as volatile as equity. Investors should be careful when they invest in long-duration bonds.


In 2021, G-Sec 10 year generated 2.58%.

Corporate bonds are yet another category. Often returns may be made in this segment by assuming a certain level of credit risk.


The one-year credit risk category varies greatly across fund managers, but a 7% return in 2021 should be reasonable.

As you can see that the within debt, the returns may vary drastically. A good sense of what drives the return is critical for fair benchmarking in the sub-asset debt class.


Equity

As you may be aware, equities are broken down as big to small companies depending upon the company's market capitalisation.


In 2021, a large-cap generated a return of 26.5%, a mid-cap has generated 48.7%, and a small-cap has generated 59.1%. This is a one-year return. You will not look at this return because a low-quality investment often leads to a run-up in the short run.


A five-year return, a large-cap has generated a return of 17.5%, a mid-cap has generated a return of 20.3%, and a small-cap has generated 17.4%.

Individual allocations must be benchmarked against specific categories.


If an investor is holding a direct portfolio of equity investments, the benchmark returns may be NSE S&P500 TRI index return, i.e., 18% p.a. over five years. Do not celebrate short-term success because low-quality companies often do well and may hide reality in a bull run.


“Only when the tide goes out do you discover who's been swimming naked.” – Warren Buffet

Bull run sows the seed for sorrow in the future. It is better to prepare yourself for a marathon than run a sprint and hurt yourself. Portfolio evaluation can help you understand whether you are walking on the right path or not.


Portfolio evaluation takes time but can provide a great insight into your portfolio. This is exceptionally challenging when working with your banker or advisor and bulking up the portfolio.


We can help you provide unbiased portfolio reviews that can help you not just evaluate your portfolio but also your advisor/banker. <<Know more>>


Plutus Capital is an investment advisory firm founded by Ankur Kapur, CFA, CFP. We are a registered Financial Advisory firm with SEBI license no INA100001406. We provide financial planning, investment, stock advisory, and investment review services.


Disclaimer

The information on this website and the resources available for download through this website are not intended as, and shall not be understood or construed as, financial advice. You should consult with a financial professional to address your particular information.


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