How to build a winning equity portfolio?

(Article by Team White Oak Capital Management)

India’s equity markets have rallied sharply from their March 2020 lows. Notwithstanding the sharp rise in equity markets over this period (Nifty up by 130%), there have been intermittent bouts of volatility as well. In this context, we have fielded numerous questions from our clients which pivots around the theme of building a resilient portfolio. Some of these questions are as follows: (1) How to ensure my portfolio is safe from any correction in markets? (2) Which sectors to own now given that we are at the beginning of the rate hike cycle? (3) Finally, when do you think a correction is due as I have been waiting on the side-lines to enter the market?

If anything, events over the last two years or so suggest that market timing is a folly. Even if one had a crystal ball to foresee the damage Covid would inflict, it would have been impossible to predict the market implication of such an event. Our fundamental, long-held belief has been that in the short term the direction of equity markets is impossible to predict, hardly any different than a coin flip which has a 50-50 chance of landing a heads or tails.

For a winning portfolio, it is best to maintain a balanced portfolio with an aim to ensure that performance is a function of stock selection capabilities of the team rather than being driven by non-stock specific macro factors such as market timing, sector, currency, or other such factor exposures. On the contrary, a portfolio based on bottom-up stock selection that is well-balanced across cyclicals and non-cyclicals pivoting on varied macro cycles ensures that alpha does not get easily overwhelmed by non-stock specific risk factors over any reasonably medium to long time-period.

A robust stock selection criterion is key for wealth creation. After all, building a portfolio is all about including stocks that can deliver a higher alpha through market cycles.

There are many approaches for stock selection that a fund manager takes depending upon their investment philosophy and goals. At White Oak, our investment philosophy is that outsized returns are earned over time by investing in great businesses at attractive valuations. To be considered great, a business should possess following attributes: (a) superior returns on incremental capital, (b) scalable, (c) well managed in terms of execution and corporate governance. The team also does not rely on traditional multiples such as P/E or P/B as they can be distorted. The focus is instead on economic cash-flow based multiples as derived from the proprietary Opco Finco Framework.

The most exciting part about the Indian markets is the potential to generate alpha and thus the opportunity cost of market timing is also very high. Thus, from a prudent risk management perspective, it is advisable to stay fully invested at all times with a bottom-up approach to investing in great businesses at attractive valuations.