Monday, September 5, 2016

Can an Investor Simply Pick the Top Held Stocks from a Mutual Fund Portfolio?

A portfolio is not merely a list of names of companies. If it were so, then fund managers will not be such a well paid lot.
There are three vital ingredients that need careful consideration before inclusion to a portfolio:
  1. Justification behind inclusion of the names of the candidates themselves.
  2. The fair price that can be paid to purchase the particular share.
  3. Regular monitoring the performance and need to take necessary action.

Let us examine the three elements in detail.
The constituents of the portfolio:
I do not agree with the view that the top held companies of a mutual fund are naturally good names that merit inclusion in a portfolio. Generally fund managers included the market leaders in the industry segment (based on too general criteria like turnover, market share and market capitalisation) in the portfolio irrespective of the real balance sheet strength. Let me give you an example. Please see the three picture below:

We can see that even though NTPC ranks number one in turnover and market capitalisation it is a laggard in EBT%, Current Ratio, Quick Ratio and Dividend Yield Similarly, Reliance Infrastructure’s EBT% is too low and unacceptable. Hence both these companies do not merit inclusion in a good portfolio, but I have no doubt that both will appear in the portfolios of many mutual funds. On the other hand SJVN Ltd., though small and ranking lowest in terms of turnover and market capitalisation is a brilliant performer in all parameters and rightfully occupies a pride of place in our ‘Portfolio 2K15’.
Price at which an Investment can be made:
Secondly we cannot simply include the top held shares of mutual fund in our portfolio because we do not know at what price the mutual fund had made the investment and what is the prevailing price today. In the year 2009, Infosys Ltd. share price was in the range of Rs.280, today its price is Rs.1031.85. Perhaps the mutual bund had acquired a major chunk of its holding in 2009 and it does not make sense to buy the scrip today at Rs.103.85, without deeper analysis, does it?
A value investor writes next to the name of the selected candidates the price beyond which the share shall not be purchased. For example, even though SJVN Ltd., is a great company, worth including in our portfolio, it cannot be bought at a price over Rs.34 a piece (10 times the EPS of 3.4).
Regular monitoring the performance:
Generally if a good company is included in the portfolio, you should be able to simply forget about it for ten years. Having said this, companies can make grave mistakes and jeopardize the interests of investors. Therefore one needs to continuously monitor and ensure the shares are worth holding even after making the investment. When this is the case for shares selected by us after careful evaluation, how can we merely include companies selected by a third party, howsoever reputed a mutual fund that institution could be?
In summary, it is not advisable to include in our portfolio top held shares from the portfolio of a mutual fund. Every inclusion purchase shall be made based on a fresh evaluation taking guidance from points highlighted above.