'Invest & forget' does not work, long term should be a series of short terms: Samir Arora

NEW DELHI: One might have heard many quotes on ‘invest and forget’ and on the virtues of holding a ‘concentrated portfolio’ from market veterans, including the legendary Warren Buffett.

Samir Arora of Helios Capital says such an approach simply doesn't work in reality.

At a webinar arranged by PMS AIF World, Arora shot holes in some of such popular beliefs.

He argued that one does not need 20 ‘concentrated’ stocks to beat the market. In his presentation, he offered 16-year data – from 2005 to 2020 – that 131 of the top 300 stocks from the NSE500 pack on an average outperformed the underlying index every year. The NSE500 index delivered a cumulative return of 703 per cent during this 16 years.

“Even if an investor had picked the 90th best stock (and not the top 10 or top 20 performers of the period), she would have managed to beat the benchmark hands down with 5,600 per cent return,” Arora said.

An investment in the 60th best performing stock would have delivered a whopping 29,137 per cent return. In short, even if one is able to spot 120 of the top 500 stocks, instead of the top 20, they can alone deliver huge alpha to investors.

Yet not many fund managers with concentrated portfolios delivered that 60th or 90th best return during that period.

“By definition, if there are 100 guys with concentrated portfolios, some would do well, others won’t. The only tradeoff is whether you want to make the extreme bets or slightly-controlled bets,” Arora said.

Arora said some of Buffett's concentrated holdings, in fact, hurt Berkshire's portfolio returns. Coca-Cola’s 12.26 per cent annual return during 1998-2020, Wells Cargo (1999-2020) 11.57 per cent and American Express (1996-2020) 10.08 per cent were among a few examples, Arora said.

Thus, going by Buffett's famous quote – An investor should act as though he had a lifetime decision card with just twenty punches on it – ‘buy & forget’ does not work in the real world, Arora said.

He cited a July 2010 paper "Overconfidence, Under-Reaction, and Warren Buffett’s Investments" by John S Hughes, Jing Liu & Mingshan Zhang, whose findings based on 13f filings by Berkshire Hathaway during 1980- 2006 suggested that the median stock holding period of Buffett’s Berkshire Hathaway was just one year.

Berkshire held just 20 per cent of stocks for more than two years while 30 per cent were sold within six months.

Arora questioned whether holding stocks for a very long time is logical. “What is the possibility that 20 best stocks chosen by a portfolio manager last year are the same 20 stocks that he would recommend for this year,” he asked.

“Will it work in the PMS or fund management industry that instead of suggesting an investor to invest in a stock based on current price and fundamentals, one has tell investors about the best long-term stocks he chose last year,” he asked.

Arora says starting price does matter in investing. He noted that for 53 years, shares of US-based Standard Oil outperformed IBM despite the latter being superior in earnings per share and other fundamental parameters, all because of the starting point.

He said in 2000-2005, Infosys had an earnings growth of 44.5 per cent per annum and yet the stock did not return much. The same Infosys in another phase saw earnings grow just 10 per cent per annum, yet the stock price more than doubled.

Arora said concentrated portfolios generally lead to missing a large part of returns in the early phase when the initial discovery of the stock and acceptance by the market give high returns. Besides, a fund manager might be concentrated, but clients anyway end up buying a number of 'concentrated funds', says he.

Analysts say one should buy companies with 'good managements'.

But what defines good managements and by when would one know if a management is good?

“Does a strong parentage mean a good company? If so, if one is positive on Tata Group's TCS, should one equally be positive on Tata Motors,” he asked.

“Show me a single company that delivers high performance and where one would always find something positive to say about the person in charge,” Arora said.

He said the Halo Effect can often distort one’s opinion about a company and the management, when a stock is performing well.

Citing the example of Cisco, he said Fortune in May 2000 ran an article with a headline “Is John Chambers the world’s best CEO?”. This was when the Cisco stock was trading at $80 level. By May 2001, when the scrip had fallen to $15 a dollar, the same Fortune ran an article “Cisco Fractures its Own Fairy Tale”.

Arora also talked about some of the famous stock market books including In Search of Excellence by Tom Peters & Robert Waterman. Out of the ‘31 excellent companies’ the book identified, 18 underperformed the S&P500 index 10 years after the study (1980-1989).

He said Built to Last: Successful Habits of Visionary Companies by Jim Collins & Jerry Poras had a similar story after 10 years. Out of the 16 ‘excellent’ companies identified in the book, 10 underperformed the S&P500 index. Collins wrote another book Good To Great: Why Some Companies Make the Leap...And Others Don't, a decade later. Not even a single company was common in the two books!

Arora said a sweet spot for initial investment horizon is one to three years, and if the company continues to do well, there is absolutely no reason to not hold the same stock for another one to three years.

Arora said he owned HDFC Bank for 25 years, but was not a long-term investor in it. “I held it as it did well. It is different from saying the bank is doing badly for three years and there is a management fight at the top. If it does well, I will hold, if it does not, I won't. There is no such concept as long term. If it was, you need not look at your portfolio every month," Arora said.

Arora said even the longer-term winners themselves do not know about their calibre.

Just because the management is running the company well does not mean it knows the company will be a long-term success story.

“Bill Gates, whose Microsoft was once the second most-valued company in the world, had only $15 billion invested in Microsoft shares out of his $125 billion worth,” Arora said, adding that a reasonable amount of Steve Jobs' wealth, when he died, was not in Apple, but in Walt Disney.

Arora said no one knows everything beyond a point.

On Buffett's saying that diversification makes little sense for those who know what they are doing, he said: “One does not know he is ignorant till something unexpected happens.”

He questioned the basis on which one would have chosen Nestle India (up 131 times in 25 years) over HUL (59 times) or Colgate (23 times) 25 years ago, or for that matter RIL (up 207 times) over the 25-year-old favourites like Grasim (up 28 times), ACC (up 15 times) or Ambuja (up 23 times).

“Do not look for what to buy, but start with what not to buy,” Arora said. He said Coca-Cola might not be Buffett’s biggest conviction, but technology, as he said, is not for him.

There is real value in being able to differentiate between good and bad, and not so much between good and good, he said.

Arora said a good portfolio needs to have two kinds of stocks: The ones that offer high confidence of reasonable returns and the ones that offer reasonable confidence in high returns.

Arora says long-term should be looked upon as a series of short terms. “Holding a stock at any valuation is not advisable,” he said.