Does your portfolio have concentration risk?

Concentration risk is the potential for a particular investment or a few stocks to threaten the health of an investment portfolio. Concentration risk, especially in the index, has been a topic of much debate for the past two years. Large-cap indices have not only outperformed handsomely, the outperformance has been driven by the largest stocks. As the chart below shows, the S&P BSE Smallcap index is still ~35% below all-time highs made in early 2018, while the BSE Sensex is only ~15% below all-time-highs made early this year.

Within the large-cap index, it has been the largest stocks that have driven the returns. For example, Reliance Industries has handily outpaced the index in the past five years, despite being the largest constituent in the index.

Similar concentration risk trends have been seen globally. The most famous example is that of Microsoft, Apple, Amazon, Google and Facebook, the five largest US companies, which constitute 15% of the US market capitalization. They have led the US stock markets higher while the broader indices have struggled. If we look at recent data, post-2000 then indeed the largest companies now constitute a higher portion of the index that ever before. But longer-term data available for the US markets suggest that the largest 5 companies have historically averaged 17% of US market capitalization, with market capitalization share reaching as high as 25% over multiple decades pre-1970.

The problem is more acute for our indices as they have fewer constituents – S&P 500 and Nasdaq  100 have 500 and 100 stock constituents compared to 30 and 50 for BSE Sensex and Nifty 50. That exacerbates concentration in our indices. The largest five companies in the BSE Sensex (RIL, HDFC Bank, HDFC, Infosys, ICICI) now constitute 49% of the index. and they constitute 41% of Nifty 50. A prudent risk manager would advise keeping the concentration of any one stock to be under 5% unless you are explicitly taking a concentrated bet, even then a 10% allocation to a single stock shows signs of high concentration.

So, what is an index investor to do?

First, realize that this concentration can continue to increase in the near term. Second, realize that the problem is more acute for Indian indices because they are less diversified. What we would recommend is that if you have only invested in BSE Sensex and Nifty 50 then this is the right time to look at Nifty Next 50 and add it to your mix. You can also look at equal weight Nifty 50 index that caps each constituent to be only 2% of the index to specifically avoid such concentration risk. Both the equal weight Nifty 50 index and Nifty Next 50 index are part of our recommended portfolio. 

In our ongoing series #KuveraQuickTakes, Neelabh, our COO & Co-Founder, continues the conversation with Pratik, Head – Passive funds, Motilal Oswal to answer several questions you need to know about investing in passive funds.

Taxpayers will now have time until July 31, 2020, to complete their tax-saving exercise for the financial year 2019-20. The deadline for filing income tax returns for FY 2018-19 has also been extended by a month till July 31, 2020.  The central government had earlier extended these deadlines to June 30, 2020. Visit our ELSS Help Center to learn everything you need to know to save taxes while investing in Mutual Funds. You can find ELSS funds on Kuvera here.

SEBI has introduced a framework for transactions in defaulted debt securities. The move is aimed at creating  liquidity for securities that would otherwise be rendered illiquid in case of a default. The regulator has asked exchanges, depositories and debenture trustees to put in place necessary systems and infrastructure for implementation of this framework by June 29. The new guidelines would be enforced from July 1.

UTI AMC has received SEBI approval for an IPO. Existing shareholders of the fund house are looking to sell 3.90 crore shares in the issue. The IPO could help raise about Rs 3,500 crore for the country’s seventh-largest mutual fund house. UTI will become the third Indian mutual fund company to go public after Nippon Life Asset Management and HDFC Mutual Fund.

Movers & Shakers

1/ HDFC Mutual Fund has appointed Vikash Agarwal as the co-fund manager for HDFC Floating Rate Debt Fund and HDFC Money Market Fund with effect from 01 July 2020.

2/ Edelweiss Mutual Fund has appointed Radhika Gupta, Chief Executive Officer and a key person of Edelweiss Asset Management Limited as a Managing Director on the Board of Edelweiss Asset Management Limited, with effect from 01 July 2020.

3/ Nippon India Mutual Fund has announced that Hardik Shah ceases to be a fund manager of the AMC with effect from 29 June 2020. The fund house has changed fund management responsibilities for the relevant schemes.

Quote of the week:

 

And still, after all this time,

the Sun has never said to the Earth,

‘You owe me.’

Look what happens with a love like that.

It lights up the sky.

: Hafiz, 14th-century Persian poet

 

Interested in how we think about the markets?

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