Four Probing Queries About Your Portfolio

Assessing Your Investment Strategy: Four Probing Queries About Your Portfolio

If you have already created your investment portfolio, it is great. However, your job does not end there. Portfolios are dynamic and they need to change with the changing times. The key is to regularly evaluate your portfolio on a number of parameters. How exactly do you do a health check on your portfolio? Broadly, there are four health checks that you can conduct on your portfolio. Here are the four questions you must be able to ask about your portfolio on a regular basis.

1. Does the portfolio reflect the market reality?

This is a question you must constantly ask. You can have a portfolio that is too defensive in a bull market nor can you have a portfolio that is a high beta portfolio in a rangebound market. It is true that you want the portfolio to generate wealth in the long term and not the short term. Even for that, the portfolio must reflect the market realities. 

Let us consider some instances. When the Nifty is quoting at a P/E of 12, your portfolio must be largely long on equities. On the debt side, if you expect bond yields to fall then you must be into long-dated debt, just as you can be in long-dated debt when yields are rising. A good portfolio is one that reflects the market reality.

2. What about a reflection of your risk capacity

At the outset, risk capacity is different from risk appetite. When it comes to your investment portfolio, your risk capacity matters more than your risk appetite. Risk appetite reflects the risk that you are willing to take but risk capacity reflects the amount of risk that you should be actually taking in the market. Let us look at some instances to understand this part. For example, with advancing age, your exposure to equities needs to come down and your exposure to debt must increase. As you approach goal milestones keep shifting from equity towards debt. Similarly, at a young age, your SIPs must reflect a bias towards equities.

3. Portfolio responsiveness to external triggers

Let us understand this point with an example. If your debt portfolio is tilted in favour of long-duration debt, your portfolio becomes too vulnerable in a rising interest rate scenario. Similarly, if your equity portfolio is too focused on rate-sensitive stocks like NBFCs, realty companies and auto companies, then the portfolio is vulnerable to a surge in interest rates. 

On the other hand, if the portfolio is tilted in favour of globally dependent companies like IT, Pharma and oil; then a global slowdown situation is hardly conducive to such a portfolio and you may consider tilting your portfolio more in favour of domestic plays. Similarly, having gold in your portfolio at a time when the dollar is strengthening is also not a very good idea.

4. Are there latent risks in your portfolio?

What do we understand by latent risks? These are risks that are not too obvious, but they can escalate rapidly. One such example, if your equity exposure is too much to a sector that is going through a global downturn. A classic example was digital stocks in the last one year. Also, you must be wary of a portfolio where too many companies are relying on raising their debt in the short-term market and rolling it over. As we have seen in the case of IL&FS and Dewan Housing, such a situation can backfire if interest rates start moving higher. 

Similarly, if your equity portfolio is dominated by companies that are high on leverage or have a huge capital base, then you could be in trouble if the profits start tapering. They are called latent risks since these risks are not immediately evident but you need to scratch the surface to get the gist. More importantly, you must keep a tab on news flows to ensure that these problems do not aggravate; in which case, it is best to think with your feet.
Quite often, this concept of latent risks can be quite subjective. However, when you are planning your portfolio for the next 20 years, it pays to be clear on the worst case scenario.