Risk management is paramount

Approximately a year and a half back a few of us fund manager friends were sitting around discussing our portfolios over tea, of which I wanted to highlight a particular interaction. We happened to talk about the software sector and one of us remarked upon my portfolio namely the extra-large holding of a stock we can call “I”. One top performing fund manager immediately compared it to other large capitalisation stocks in the sector, saying it was a non-performer for many years and that the management had no clue what it was doing. He further added it was preferable to buy a stock; we shall call “T” as its management was more aggressive and seemed to know what it was doing. After trying to explain, on his insisting of the rightness of his point, I kept my silence.

Forward to today the stock “I” has become the new darling of the market having returned almost 50% in the time period, while the stock “T” returned approximately 12%. The point I am making is, at a price, risk is minimal in a stock. A particular stock may also do better than another in the short term purely because it has a higher risk model which is currently delivering growth, but such growth may be at high risk, as we have seen with the US FDA notices to many popular Indian pharmaceutical companies. What makes you money is not whether the company is good, bad or ugly, but whether the price you buy it at, gives you a margin of safety, considering the present business model and its risk. Therefore exposing your portfolio to unnecessary risks in pursuit of returns, will most likely not deliver reasonable returns in a 5 to 7 year horizon.

Dinesh da Costa, CFA

Please note the information given above is not a recommendation to invest, but an educational illustration.
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