How they handle risk

Most stock market investors focus more on their returns than risk. But three seasoned investors tell Aarati Krishnan why controlling risk is more important

Never bet on big events

Venkatesan Seshadri (Venkat) is an IT professional with a successful 30-year career in Manufacturing and IT. His investing success, Venkat says, is mainly due to the fact that he is a truly long-term investor. For him, ‘long-term’ doesn’t mean just five years or 10, which is what most Indians believe the term means, but even a few decades! Venkat reels off a number of stocks that he has held for over three decades — Parke Davis, Rasoi, for instance. . Owning stocks for that long has ensured that blips in their value after many years of gains don’t worry him.

So, how does he manage risk? One, Venkat doesn’t chase popular options like gold or real estate for ‘safety.’ “I have insignificant investments in gold. My only piece of property investment is where I live. In my net worth today, my real estate portion would be only 15 per cent, including a small exposure to a real estate fund. But I peg my equity exposure to just 50 per cent of my portfolio. I have good exposure to debt — tax-free bonds, fixed maturity plans and accrual funds.”

Two, he doesn’t get carried away by events. “I don’t look at events such as the Budget or China crash as triggers to buy stocks. ROE, ROCE, debt-equity and other ratios matter more. I have a close handle on market PE. I usually look to switch to equity if the market PE is below 18.” Given the amount of due diligence required on each stock, he restricts his portfolio to a few stocks.

Three, most (80 per cent) of his equity allocation is to giant and large-cap stocks, only the last 10-15 per cent is in mid- or small-caps. The mid-/small-cap portion is invested entirely in mutual funds. But doesn’t that lead to missed multi-baggers?

Venkat laughs. “Successful investing is more about risk than reward. I like to apply the risk management strategies of Manufacturing and IT to investing. If you look at the IS0 13000 definition of risk — it is the effect of uncertainty on your objectives. So, you should not have over-confidence that your predictions will come good. I consciously avoid stocks that hinge on a big event. For instance, people may buy logistics stocks betting on the GST Bill being passed, but what if it isn’t? ” Two, He also ensures margin of safety on every buy. He does an estimate of fair value and buys a stock 20-30 per cent below it.

Venkat looks to hold a business “forever” when he buys it. Seventy per cent of his portfolio, by value, is over 10 years old. But there are stocks and sectors that can drop off the radar over the long term, so how does he manage them?

He has a system for that too. If a stock drops 30-40 per cent, that is a cue to re-assess the investment case. “Investing is more about risk management than reward management. Some people believe if you manage the rewards, the risks will go away. That’s what lands you in trouble,” he wraps up.

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Know your limits

An M-Tech in Computer Science from IIT-Bombay, the soft-spoken Rajesh Ganesh is quite the risk-taker by conventional standards. He is an investor in mid- and small-cap stocks and a keen options trader.

Rajesh had some unpleasant encounters with risk in the early part of his investing career. As a fundamental investor, he lost money in mid-caps in 2006. Once, his short futures trades backfired when the market soared suddenly. That’s when Rajesh put his analytical skills to work and zeroed in on options trading as the strategy that would best suit his temperament, in 2009. He has since enjoyed an over 60 per cent success rate with his trades.

“When you buy options, you already know the worst-case scenario in terms of how much you can lose. The outlay is limited. There is tremendous potential on the upside. I learnt that in the markets, Black swan events, which are supposed to be one-off, can happen quite often.”

His found that both fundamental and technical investors who follow widely used tools are often “trapped” by unexpected market moves. He uses open interest and implied volatility data to do option trades that run counter to the general trend.

Given that 80-90 per cent of options expire worthless, how does he make money? He limits the capital he deploys in trading. “If I have ₹10 lakh to invest, I park only 10-15 per cent of that in my trading account. The remaining portion earns interest in a fixed deposit. Of that again, I am careful not to bet more than 3 per cent (₹30,000) on a single trade.” He is disciplined on stop losses too. “If I buy an option for, say, ₹32, I would have a stop loss at ₹16 and set my return target at ₹64”.

While Rajesh has a regular job at an IT firm, he doesn’t treat his winnings as easy money and spend them. He also has some of his long-term portfolio dedicated to mid-cap stocks where he hopes to unearth multi-baggers. “I only park money that I don’t need in this portfolio. It is about one-third of my equity positions.”

Rajesh believes that it is the investor’s behaviour rather than his ‘system’ that leads to winning or losing. He has worked hard at identifying what he calls ‘limiting behaviour’ – like making bigger bets to recoup your losses.

“I had hastily liquidated my long-term holdings in the market crash of 2006. I learnt that it is essential to stay invested through market corrections in India; it is such a high potential economy. Many people look at equity investing as gambling. But markets offer you an opportunity to pit yourself against the brightest and most brilliant minds. It is all about overcoming mental challenges. If you do that, you can handle risk,” he says.

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Don’t carry over trades

Bharadwaj G is a civil engineer by profession and has a strategy that is at the other end of the spectrum from Venkat. A day trader in equities, he doesn’t hold any position for more than a few seconds or minutes at a time.

Using a technique called scalping, he makes money by making 15-20 high-value trades that capitalise on minuscule moves in the most liquid stocks in the market.

“I track the Nifty support and resistance for the day and try to gauge big sectoral trends. I then make big bets from small intra-minute moves on stocks that I choose.”

As his bets hinge on market direction for the day, how does he manage risk? “I never hold positions overnight, as that leads to losing control over trades. If the US market crashes, you can lose big time.” Bharadwaj says he owes his recent success with day-trading to of many years of experimentation.

“I have learnt it the hard way. My total capital was wiped out four to five times and it took me four to five years to arrive at this strategy, which I have followed for the last seven to eight years.”

“High leverage and the low brokerage offered by new brokers, helps me earn up to ₹1 lakh per day by way of day-trading. But I make sure that funds in my trading account never exceed ₹2 lakh. The profits I earn do not enter the equity market in any form. They go into fixed income and real estate.”

How is his risk-return trade-off? “My highest profit per day has been ₹1 lakh, but my biggest loss has been ₹20,000.”

But Bharadwaj qualifies that in his initial days, he had as many loss days as profit days.

Does he tune into the news flow to gauge market direction? No, news which has come out has often been discounted in the price, he says.

“I don’t read any paper or even track Twitter. I only believe in live charts.”

He has just one message for anyone planning to trade.

“You cannot hold down a day job and be successful at trading. In every bull cycle, there are many fringe players who come into the market, and do trading. They lose money and then exit for good. Unless you can devote your full attention to trading from 9 am to 3 pm, you should not trade,” he says.

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