• Mayank Mehraa CFA, FRM

Diversification- Friend or Foe

Updated: Dec 7, 2018


Well, the buzz on the street has always supported that diversification is the best friend of any value investor, but being as stubborn as we are we attempt to break down the myth for you to decide your self.

So what is Diversification?

Not to bore you with the definitions, but basically Diversification implies adding on stocks of various companies because people believe that not all stocks would fail together.

You know the “Not to put all your eggs in the same basket” logic.

But is that actually the smartest thing an investor can do.

To quote our own admiration Warren Buffet, “Diversification is for the dumb investors”

-Excerpt from Berkshire Hathway Shareholder’s Annual Letter 1994.

But lets shed some light on exactly why would the worlds richest investor have to say such a thing.

Statistically speaking a well diversified portfolio will truly be able to remove most of the Unsystematic Risk and obviously if any one stock fails you would barely feel an impact.

Now why

We honestly believe if you’re an investor and you need to have every company in your portfolio then I’m sure you’re better off investing in Index ETFs, I mean the NIFTY wouldn’t fail right?

We’ve seen Blue chips fail, Mutual Funds fail, companies managing mutual funds fail and also economies fail.

So, nothing is to big to fail and thus even an extremely diversified portfolio might just fail too.

We believe if investments should be made then its better to do so as though you were to own that business.

Successful flagship Investments

  • Rakesh Jhunjhunwala in Titan

  • Radha Kishan Damani in VST

  • Ramesh Damani in CMC

  • Basant Maheshwari in Page Industries

  • Warren Buffet has quite a list but to mention Coca Cola

None of these people would have been half as big with a diversified portfolio.

While we could use this as a marketting presentation and ask you to invest in out Legacy Growth x Value 10 a portfolio of 10 stocks which we believe will grow into business legacies lasting for generations, we actually want this post to be more educational in nature.

We can trace diversification’s craze to that of discounted brokerages and transaction charges, a diversified portfolio would generally always ensure your brokers stay rich and wealthy. Now to add the concept of Churning Decay.

When you try to diversify even more selling portions of profit making investments trying to buy new companies or even worst averaging a loss making investment, none of which is advisable.

If you buy a stock and it shoots up, but you haven’t bought enough- you’re similar to a driver whose happy having a day’s fuel in his tank when the fuel price shoots up…

A generation of disruptions

We dont see the current startup generation of disruptions in industries as a major cause of worry because we’re fairly certain that most of our companies would either be ancilaries to newer generation startups or might just pave the way to one.

If you’re business moves and changes with time to keep on creating alpha there won’t be any economic sense for any other business to grow there.

To conclude on a lighter note

We don't mean any offence to any person's investment style, but with this post we simply try to debate the myth of diversification, for clarity in context we believe a diversified portfolio is one with investments in over 50 companies.

In 1999 Nifty was priced roughly at 900/ unit and 19 years later today its priced at 11500 /unit, to put it in prospect this translates to an absolute return of 1178% or 11.78 times but an annualised return of 14.45% per annum (dividends not accounted for).

Believe it or not very few portfolios have given that kind of performance consistently across that time frame, not to mention we have discounted major events like

  • The 1999 Dotcom bubble

  • The 2001 Ketan Parekh crash (CSE)

  • Satyam Defaulting

  • The Credit Contagion of 2007

  • 9/11 Twin Towers attack

  • 26/11 Mumbai attacks

  • Along with Greece, Cyprus economies burst, The Brexit and the very recent Chinese Sell off

Still gave a 14.45% CAGR + whatever returns one might have made from the dividends of Index companies.

To conclude, we strongly believe if you wish to invest for Stock Market Exposure buy the ETFs and if you want an ownership of business invest the ones you'd wish you owned or hire an advisor whose professional at doing exactly that ;)

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