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Blinkered Vision

People rush blindly into stock market investing, chasing a chimera

Over the last year, practically every sector has had its moment in the sun, some longer than the others. Banking and FMCG may be hot now, but auto, technology, energy and of course, infrastructure - everything has been the right thing to own at one point or another. This 'rotational leadership', as the talking heads have deemed it, is nothing but momentum chasing, in slightly respectable garb.

This approach doesn't help the investor in any way. Inevitably, the best part of any story is quickly over and most momentum chasers are perpetually a little late to the party. However, when I look at the stocks held by such investors, the real problem is generally not that they believe in the latest story, but that they believe only in that story and that story alone, to the exclusion of everything else.

The main problem is not that what we are doing is wrong, but that it has no safety net. The value of diversity is completely lost in this approach. Diversity is supposed to be the first principle of portfolio construction. This is almost too basic to be explained, but the point of investing in more than one stock is that they should be dissimilar so that when one goes out of favour, there should be some others that aren't so much out of favour. The stocks you own are not random bits and pieces you collect at various times, but form a portfolio, whether you think of them like that are not. Each one of your holdings has a relation with another.

What this means in practice is that when the broker's salesman (relationship manager, as they are called nowadays) calls with the latest tips (research inputs, as they are referred to currently), you should be able to tell him firmly that no, you are not interested in yet another technology stock, no matter how hot, because 40 per cent of your equity investments are already in technology companies. Surprisingly, few investors manage to think in this fashion. The result of ignoring diversity is that you are inevitably setting yourself up for a sharp disappointment whenever the current cycle ends. When last year's crash happened, lots of people lost a lot of money, but by far the worst hit were those who had portfolios that were almost all realty- and infrastructure-related stocks.

The practice of diversity is not rocket science. Anyone who invests can immediately see what needs to be done. But that's not the point. Diversity is difficult to practice because it's difficult to maintain the discipline needed for it. When the going is good, then diversity inevitably makes your returns less exciting than they could have been. When a sector is hot, then it’s much more fun to be 100 per cent in that sector than to keep 40 per cent of your holdings in something else because that will lower your returns.

You may be able to understand that the logic is impeccable, but like so much else in investing, the problem is not in understanding, but in controlling and modifying your own emotions and behaviour.