Why Active Management Is Key Right Now…

The ‘V-shaped’ rally which has followed the 39% plunge of Nifty-50 Index due to the COVID-19 pandemic has made it clear that almost every sector of the Indian economy has varying levels of exposure to this crisis. The modern world has never witnessed an induced recession before in the name of public health like we are experiencing at the moment, with government-mandated shutdowns in effect and social distancing restrictions. Not all industries have been impacted equally by this economic reality. Some have been affected badly whereas others are weathering the storm. Surprisingly, some are actually thriving.

The different levels of impact are actually visible in the Q1 performance numbers. The Nifty 50 finished down -24% for the quarter, but an investor’s participation in the downside had everything to do with exposure: Nifty Bank (-43), Financials (-38%), and Metals (-44%) got clobbered on the way down, while Technology (-18%), Pharma (-6%), and FMCG (-19%) outperformed on a relative basis. A handful of pharmaceutical companies even finished the quarter in positive territory.

After observing the above figures, one can easily conclude that the investors who recognised a shift in consumer consumption and industry trends as a result of the contagion might have churned their portfolios to upgrade their investments with trending industries such as the Consumer Food and the Pharmaceutical Industry. Such active research and management of one’s portfolio can be extremely fruitful in the long run, especially in such volatile times. However, most retail investors do not have the expertise or the resources to conduct industry-wide intensive research or to closely micromanage their portfolios.

Even after determining the industries which might outperform in the foreseeable future in relative terms, the selection of stocks within those industries can be rather challenging for a passive investor. It is necessary to stay invested in leading companies that are experiencing expansion and growth by either launching new products or by gaining uncaptured or their competitor’s market share. These tend to be the stocks that carry quality growth potential. It is best to avoid investing in stocks that move ‘in sympathy’ of these leading companies and have no sustainable growth of their own. Active management ensures that no such laggards are a part of your portfolio.

Another advantage of opting for active management is that your portfolio remains perfectly balanced in terms of allocation and diversification. The proper allocation of stocks is often neglected by retail investors. Although it is advisable to place one’s eggs in different baskets, one must strictly stick to a limited number of quality stocks when it comes to equity investments. Over diversification results in missing out on the opportunity to earn significant returns despite owning a few quality shares as the capital allotted to these stocks will be less. On the other hand, an under diversified portfolio can tamper your risk-reward ratio and might expose you to unreasonable risk. A passive investor who owns the entire stock market or specific sectors via ETFs probably has exposure across the board and owns the good, the bad, and the ugly.

Long-time investors know that a diversified equity portfolio plays an important role when it comes to growth and wealth-building over time. But that does not mean just blindly owning the entire market equally, or simply allocating an equity portfolio perfectly in-line with the Nifty 50's cap-weighted allocations. This results in an over-diversified portfolio full of inferior investments. An active manager can help in determining how much relative exposure should be allocated to each sector based on that sector’s outlook. Additionally, an active manager can go a step further and attempt to examine every single stock available to determine earnings potential, credit risk (very important in the current environment), earnings estimate revisions vs. actual results, valuation, historical dividend payments, and so on. He can work to separate the bad and the ugly from the strong and the good.

Stock market volatility continues apace and is likely to remain elevated for the next few months as the world fights to contain the Covid-19 outbreak. The economic hit will also continue as shutdowns and restrictions on movement persist, with some sectors and industries feeling acute pain while others weather the downturn or even thrive. A passive investment approach in the current environment means owning some or many of the companies that are not likely to do well or may even fail to survive. An active approach to investing – like our MILARS Portfolio Advisory Service – means taking a more analytical approach to owning stocks that can survive the crisis and perhaps even emerge stronger during the recovery. Now seems to be the right time to be an active manager and to upgrade your portfolio.