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Opinion | Every market cycle gives an opportunity to transform your portfolio

Rebuild the portfolio which you want to own without being burdened by past mistakes

Portfolios are seldom static. We routinely tend to make changes when we find that our stock ideas have reached maturity in investment performance. The need to sell is often thrust on us by the market when valuations become unsustainable. But our choice of stocks plays a critical role in decision making. Also, the method and style of investing determines the frequency of portfolio churn. Long-term investing depends on how the portfolio is constructed.

Much as we would like to hold stocks for the long term, there almost always comes a point in a stock’s holding period when it is compelling to sell. Even the best businesses can reach a point where selling is much better than holding. When portfolios perform very well and several stocks deliver their all-time best investment performance, we may need to sell those stocks. Investors who bet on themes tend to hold more than one stock in the same theme. When a theme plays out to maturity, the need to sell only becomes acute.

That is why stock selection plays a critical role in determining portfolio dynamics. Mobility is a function of the stock selection strategy and the stock’s liquidity, and higher liquidity is a prerequisite for churning portfolios. While bull markets give us the freedom to churn more, often, we may need to show restraint for long phases of time before becoming decisive about selling over a short phase. The ease of selling must be used sensibly and correctly to reap full benefits.

The past two years have seen higher churn in our portfolios as many of us rode the long bull market in several companies from 2009 to 2018. This 10-year cycle was extremely rewarding, especially for those who showed patience, selected stocks which did well over an extended period of time, and sold them when the markets started valuing their very distant future.

This resulted in a lot of selling in every portfolio. Your portfolio of 2014 would look very different from your present portfolio. Everybody habitually builds portfolios from the sale proceeds of the earlier portfolio. But remember that the risk of building a weaker “new" portfolio is always real. The new resulting portfolio may often be structurally weaker than the older one, stock selection may be very ordinary, and its quality may be lower. These symptoms are typical of portfolios built during the bull markets when everything is expensive, prices seem to be running away, and competitive intensity to buy stocks is very high.

When markets come off the highs, and this happens suddenly and sharply, then our view of the newly constructed portfolio tends to change very quickly. What looked like a good portfolio around a market peak tends to look rather ordinary after a 25-30% correction. When we look around, we feel that there were much better stocks that are now trading at far more attractive valuations than the ones we own.

The difficult part begins at this juncture as we may not have much cash to buy into these new ideas. This brings us to a rather difficult decision stage. But here’s what we can do. We first need to reassemble all our ideas—existing stock holdings and newer stocks that we find attractive. The next step is to build a fresh portfolio on paper as if we are building a new portfolio ground up. That portfolio must be compared to the existing one. This will give an idea of what we own and what we wish to own. Thereon, it is fairly straightforward. We need to gradually rebuild the portfolio which we want to own without being burdened by past mistakes.

Every market cycle gives investors an opportunity to transform their portfolio. The opportunity is too good to miss but the window of time to do this is maybe narrow. So what are you waiting for?

Shyam Sekhar is chief ideator and founder, iThought

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