(26 Jan 2022) TANKY

Note: This write-up looks at the importance of continuous measurement and tracking of the wealth portfolios we create and amass over the period of our lifetimes. While excessive control and fretting over the portfolio for its short time performances may be pointless or even counter-productive, the requirement for proactive handling of such portfolios could never be over-emphasised. This blog should not be construed as financial advice but rather as a pointer towards using data science in one’s financial decisions.

“If you can’t measure it, you can’t improve it” - Peter Drucker

Portfolio Building. The main aim of an investor during his/her earning years is to slowly but steadily create a healthy, balanced and well diversified portfolio, which could help in generating above average but consistent returns in the future with minimal intervention. Considering the tumultuous nature of the economy with all its uncertainties, this is easier said than done and therefore requires a very diligent and scientific approach on the part of the investor. It is but well known that wealth is made not as much by hefty income as it is made by a disciplined investing approach. Taking the case of Indian investors, the few investment options available towards portfolio building are:

Portfolio needs to be built bottoms up one brick at a time with the financial goals in mind, be it long term or short term. Planning for that foreign vacation or buying that dream car are short term goals, whereas amassing a retirement corpus is a long-term goal. A goal-based portfolio building approach is any day better than a random haphazard ‘saving as a you go’ approach, since one gets to measure and track the portfolio growth and fine tune his investment approach periodically to reach the goal.

Portfolio Diversification

Portfolio Diversification is extremely important to reduce the volatility in its value. In order to get the maximum benefit, the thumb rule says that the one should hold (100-age)% of one’s portfolio in equity. However, today with many more options like crypto currencies and REITs available, a more apt breakup of the portfolio for a risk-neutral individual could be as shown:

Equities (90-age)%

Cryptocurrencies & NFTs (5 to 10)%

Commodity/Bullion (5 to 10)%

Debt Instruments(10-20)%

Real Estate – Balance (Does not include residential property where one is staying)

Since the major chunk of healthy portfolio is equity, it is important to ensure that diversification approach is implemented in creating the equity sub-portfolio as well. For the same, analytical tools freely available today may be used. As far as possible, we would like to keep non-correlated stocks in our equity bucket to reduce the volatility. A typical correlation plot of ten scrips from a sample bucket based on the data of previous 5 years is as shown below:

In the above case, the highest correlation value is 0.52 between Bajaj Finance and HDFC Bank. Whilst Bajaj Finance and HDFC Bank belong to different sectors of microfinance and banking respectively, both are still related as both are part of finance domain. The higher the correlation values, the stocks are not a good fit in a diversified basket. In an earlier blog <TANKY - Portfolio Creation & Optimization (datawiz.co.in)>, we covered the strategy required to be adopted for creation and optimisation of an effective equity portfolio.

Portfolio Optimisation

The portfolio allocation needs to be reviewed annually or even six-monthly for any requirements of rebalancing based on the portfolio growth. For example if the equity part of the portfolio has grown substantially and exceeded the (90-age)% of the total portfolio, then the equity exposure needs to be brought back to the acceptable level and the proceeds distributed to debt or real estate as the case may be.

Additionally, python libraries like PyPortfolioOpt could be employed to arrive at most optimal allocation of fresh financial resources towards picking equity scrips or crypto coins based on their historical performances.

Portfolio Tracking

It is a known fact that for any process to be improved, its parameters/results need to be measured and monitored on a periodic basis. Same is the case with the process of portfolio management. If one cannot measure one’s portfolio, then the process of portfolio management cannot be improved. Today the issue being faced by investors is that their portfolios are spread across various asset classes and are held by different financial institutions (supported by own websites and applications). While one needs to track one’s equity portfolio on various trading applications, one may need to track the crypto portfolio on numerous crypto wallets, or the government debt scheme holdings like post office savings on post office account, or FDs and savings on individual banking websites thus making it too cumbersome for continuous monitoring. The best option available today is to make an excel file as a repository of the information from the myriad of the sources and continuously/periodically update it to see the trend over a period of time.

Conclusion. The need of the hour is for a single point portfolio tracker powered by AI & ML, where one’s net worth could be tracked to facilitate follow on action as deemed necessary. Such a product once available would result in the true democratisation of the portfolio building process by removing information asymmetry.