The secret of portfolio management in Nepalese capital market; know how defensive investment strategy could yield sound return in long term (Part 1)

-Krishna Khatiwada

A portfolio management plays an important role in the stock market. Many people throws a lot of money for managing their Portfolio. In this article, we will discuss how effectively a laymen investor can manage stock portfolio with ease.

The stock selection in portfolio differ from an investor to investor, some investor have larger risk appetite so he/she invest majority of the capital in an emerging company while other have low risk taking capability so he/she chooses to invest in well-established company.

We will discuss about the types of investors according to the bible of value investing “The intelligent investor” written by the father of value investment, Benjamin Graham. He said that there are two types of investors.

1. Enterprising investors: They can give quality time in the market and invest majority of the capital in growing company. We will discuss about the enterprising investor in detail in the next part of portfolio management.

2. Defensive investors: They are the one who doesn’t have enough time to dedicate to the market, so he casts index funds and blue chips stocks in his/her portfolio.
Benjamin Graham frequently urges that beating stock market consistently for the long period is very tough, so he suggests investors to move with an index funds but in this article we will consider an investment in stocks only.

Defensive Investor: Defensive investor majorly thinks about preserving his fund by diversifying his capital and minimizing the risk.  Defensive investor grows capital gradually and he/she doesn’t alter the chosen stocks until and unless something truly awful happens. Defensive investor choose stocks based on some requirement which can differ from investor to investor but he/she would choose majorly the well-established company of the respective sector than the growing one. The said investor will diversify capital in such a fashion that the most stable stocks will get the highest percentage of capital.   
Which type of portfolio is appropriately suited at this time for the defensive investor?
To understand this first, let us look at the chart below
The comparative performance of individual sub-indices with the NEPSE index in the last 5 years is shown below.

In the last five years, the most trending sectors are the development bank (black) and the insurance sector (green).  The two sectors which are moving in the range of NEPSE index (light blue) are banking sector (red) and finance sector (dark green). The most stable sector is an “other” sector (purple line, other sector is dominated by the NTC stocks). The shortest line in the chart shows the micro-finance sub-index. In last two years, micro-finance is the most trending sector.
A defensive investor in Nepal should diversify in at least 20 stocks and assign the capital appropriately. Here, an investor can keep the majority of the capital like 35-40% in NTC stocks; around 15-20% in the commercial bank and around 10% in each of the remaining sectors. Do not invest majority of the capital in the stocks of unregulated sectors because the financial shenanigans are more likely to intrude there.
The chosen stock should have the highest paid up and reserve & surplus, the high paid-up capital will ensure that the company has enough “interest-free capital” to support in the poor days and the large reserve & surplus will ensure that the firm is generating a sharp profit year after year. To choose stocks we require to perform in-depth research by looking at other financial, management of the company and current market movement however, in this article we are concentrating entirely on the companies with highest shareholders equity (paid-up capital plus reserve & surplus). We assumed, we were investing like a defensive investor from the year 2070.

We have imagined we had invested a total of Rs 5 lakhs 50 thousand in 14 stocks from different sectors 

As shown in the table below, we choose an Agriculture Dev Bank, Nepal Investment Bank and Nabil Bank from the commercial bank sectors; from development bank sector we choose Kailash Bikas Bank and Jyoti Bikas Bank; from micro-finance sector we choose Nirdhan and Swabalambha Laghubitta; from the finance sector we choose Janaki Finance and ICFC finance; from hydro-power sector we choose Chilime and Butwal hydropower; from the insurance sector we choose Nepal life insurance and Rastriya Beema from the non-life insurance and we choose Nepal Doorsaanchar Company from others sector. Note that we have selected stocks on the basis of highest “sum total of Paid up and reserve & surplus” from the Q4 result of 2069/2070.

Here, NTC will be defensive stock, which will remain stable during the high volatility period and save investors from a serious loss in bad times. So in NTC, we have invested around 36.36% (Rs 2 lakhs) of total capital. After NTC, the next stable sector is Commercial Bank so we have invested 18.18% (Rs 1 lakhs) in three commercial bank's stocks as per their shareholder equity, ADBL got Rs 50000 and other two banks got Rs 25000 each.
Remaining sectors got 9.9% each and for individual stock Rs, 25000 allotted.

In an above virtual investment, NTC and commercial bank sector had grown by CAGR of 10.34% and 20.01%. The most profitable sectors were the Micro-finance sector with around 75% CAGR and development bank sector with around 33% CAGR. The sector which had underperformed was the hydro-power sector with around 4.5% CAGR.  In our investment, the best performer was Nirdhan Laghubitta with 79% CAGR and least performer was Butwal Power with 0.79% CAGR.
By investing in 14 different sectors, our investment has grown with 25.635 CAGR to Rs 20.20 lakhs from 6.45 lakhs (initial investment plus right share investment). In the period of last five years, our investment had increased by 3 times and this is an amazing return for the lay investor. In above investment, we choose stock on the simple logic but we stick with our investment plan which many investors failed to achieve.

At 2070, we didn’t knew that the insurance, development bank and micro-finance sector will outperform the market and outperforming sector of 2018 can underperformed in upcoming years. Thus, to stay safe from these uncertainty of stock market we should diversify our investment in all available sector. Maybe in the next 5-10 years, the other new sector could outperform the market and that out-performing sector can be a hydropower sector too.
We have chosen stocks with highest Paid-up capital and reserve & surplus from the Q3 report of from 2074/2075 from different sectors and the list is given below.

(Investor should look for management, profitability and some important financials of the company like P/E, Free cash flow per share, Price/Book value etc. along with shareholders equity before selecting a stock)

Graham's stock selection criteria for the defensive investor

1. Consistently dividend paying record for at least last 10 years.
2. EPS had been increased by at least 4/3 times every year in past.
3. P/E ratio should not exceed 15 times and P/B ratio should not exceeds 1.5 times.

Defensive investor should allocate different amount for different stocks and should invest majority of investment capital in stable stocks. Defensive investor can consider investing in mutual funds, debenture, bonds etc. Benjamin Graham in “an intelligent investor” suggest that the defensive investor should invest the majority of capital in secure funds rather than on the stock.
We will discuss about the enterprising investor and their stock selection in Nepalese Stock market in part two of Portfolio management.