Ashish Gupta
“If you are not a professional investor, if your goal is not to manage money in such a way so you get a significantly better return than the world, then I believe in extreme diversification.” – Warren Buffett
There are two interpretations one can make from the above words said by Warren Buffett. One, if you are a professional investor managing large funds, diversification won’t help much and two, for the average retail investor out there, owning a concentrated portfolio without the proper research can be a daunting experience. There is always a trade-off: while a concentrated portfolio can produce enormous wealth, the risk of failure is also increased. Stock picking for retail investors is not easy, as it requires not just a lot of research but also patience and conviction to hold on to those ideas. To put things into perspective, the current leader, Reliance Industries, did not generate any returns for almost a decade, from 2009 to 2017 and then went 4X in just 4 years. Similarly, the biggest bank, HDFC Bank, has largely underperformed since COVID when compared to its peers. Let’s look at some of the advantages/disadvantages of each of the two approaches –
1. Diversified portfolios tend to work better in the long run, have lower volatility at the overall portfolio level because one single investment doesn’t have a larger impact on the entire portfolio.
2. In a concentrated portfolio, both risk and reward tend to be on the much higher side. If picked correctly, even 1 or 2 (out of say 5 assets portfolio) turns multibagger, it helps in creating enormous wealth. However, it comes with the risk of underperformance and huge volatility as well.
3. Rebalancing is more often required in diversified portfolios to kick out the losers and underperformers in the portfolio.
If I try to draw parallels from startup investing, I wouldn’t want to put all my eggs in one basket, especially when I am new to this space. According to data from CB Insights’s Global Unicorn List published in April this year, India has the third-largest startup ecosystem globally, with over 60,000 startups, and it is estimated that 90 percent of them are likely to fail within the first five years. This means that 9 out of 10 startups are likely to fail, so if you were to invest in startups, you’d ideally want to invest in many ideas from different sectors. Eventually, a very few of them might turn into multibaggers, the likes of 10/20/30X, which will generate returns on your overall investments. The same is true for stock investing, as the overall goal of having a diversified portfolio that includes non-correlated sets of assets is to diversify the risk associated with investing in financial instruments. Having said that, however, during times of uncertainty and stress, no amount of diversification would help as most assets would go south (except the precious metals, as we had observed recently during the COVID crash and many times before). So for those starting out, it’s good to work with a diversified portfolio, as it will help you stay in the business for a longer run. As you grow in your investing journey, you can choose to move slowly toward concentrated portfolios.
By Volatility Trader and Derivatives Experts, Mr Ashish Gupta.
