Saurabh Mukherjea suggests 2 tools to cut risk in your equity portfolio

“If you aren't thinking about owning a stock for 10 years, don't even think about owning it for 10 minutes.” - Warren Buffett

If you are one of the followers of Buffett's methodology of buying and holding stocks for the long term without disturbing the silent but magical power of compounding, then you might be in for a lot of pain in the short term. Sometimes the stock price might suffer due to macro factors like war, inflation, recession or rising interest rates, and on other occasions it might be due to corporate governance issues in the company or an incumbent threatening to upset the market leader's dominance.

Dalal Street's favourite stock picker Saurabh Mukherjea says there are two key risks before a long-term investor - the risk from short term fluctuations in stock prices (i.e. noise) and the risk of underperformance due to investments in sub-standard companies.


The Rs 11,000 crore fund manager says there are two tools that can help investors generate materially higher returns with less noise in the long run.

1) The first tool that Mukherjea, who runs PMS firm Marcellus, says can help investors mitigate volatility is to increase the investment horizon from 1 year to 3 years as the longer the investment horizon, the lower the noise.

"Narratives and expectations are the sources of risk that lead to short term fluctuations in share prices. These risks are not related to the long term fundamentals of a business. This is so because price movements in the short term are mostly a function of the market’s perceptions of the business in question. Such perceptions also reflect the market’s tendency to extrapolate short term performance (good or bad) many years into the future," Team Mukherjea said in a note to investors.

Giving the example of Asian Paints, he said the stock delivered zero absolute return during the 18-month period from July 2010 to December 2011 amid concerns around the impact of massive input cost inflation on profit margins and shortage of a key raw material. But over the 12-month period post December 2011, the stock delivered absolute returns of 70 per cent.

2) The second trick from Mukherjea's playbook is to increase the average rate of compounding by focusing on high quality companies. "The higher the expected rate of long term compounding of share prices, the lower will be the potential drawdown even if the investors are extremely unlucky with timing their entry and exits," says the star investor and author of bestselling books like 'Coffee Can Investing' and 'Unusual Billionaires'.

As a result of a high median (or expected) return, the absolute returns for Mukherjea said his consistent compounder stocks are likely to have a lower downside and higher upside vis-à-vis an average ‘high quality’ portfolio (constructed basis RoCE>15 per cent and revenue growth>10 per cent) as well as the Nifty50 index.

Using a cricketing analogy, the star money manager said if an ordinary gully cricketer plays one delivery from Jasprit Bumrah, there is a reasonable chance that he could snick it for a boundary (this is ‘noise’). "If, on the other hand, the gully cricketer plays five overs from Bumrah then it is almost inevitable that he will be clean bowled (this is the ‘signal’). The more deliveries played – or in investing, the longer the time period considered – the more likely that the ‘signal’ will overshadow the ‘noise’."

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)