31 Oct, 2021

Diamonds are forever; bluechip stocks, not so much

Here’s a nice piece of trivia. How many of 2020’s top 10 largest stocks by market cap were also in the top 10 in 2015?  The answer is six. For 2010, the gure drops to ve. If we look at 2009, the figure is just three – Reliance, Bharti Airtel and TCS. On average, within the Nifty 50, about seven companies get churned every year if we count both companies moving out of the index and those entering the index every year.

This constant movement of companies means that ‘buy bluechips and forget’ is not an efficient strategy. Today’s bluechips are not tomorrow’s bluechips. Large companies decline and others take their place. In this piece, we backtest the returns of buying and just holding bluechip stocks.

We took portfolios of the 10 largest companies in different years (2005, 2007 and 2019) and saw what happened if you held them for 10 years (till 2015, 2017 and 2019). The results are not promising. Instead, buying and holding an index fund turns out to be both cost and tax efcient. What if you had weighted this 10 stock portfolio by market cap: the results are a slightly lower return at 14%. However, this parity is a matter of chance.

Let’s shift ahead by a few years to 2007. This would be the Indian stock market on the eve of the great recession and at the end of the great bull market of 2003-07.

The index was dominated by commodity and resource companies, most of whom were state-owned, a result of a long infra boom. Hence, in addition to ONGC and NTPC, mineral giants such as Metals and Minerals Trading Corp. (MMTC) and National Mineral Development Corp. (NMDC) were present in the top 10. DLF had entered the top 10 list and so had Bharat Heavy Electricals Ltd (Bhel). These companies did spectacularly badly over the next 10 years. MMTC lost 95% of its value, while NMDC lost 76% of its value. Bhel lost 73% of its value. An equal weighted portfolio of the top 10 stocks would have delivered -4% and a market cap weighted one would have given -3% compared to 5.2% on the Nifty.

Let’s move ahead another two years to 2009. The great recession had set in and the market was only just beginning to bottom out. DLF and ICICI Bank had dropped out of the top 10 list due to the drubbing they endured along with other real estate stocks and banks. Instead, software exporters like Infosys and TCS had entered the top 10 list. Buying this list of top 10 stocks in equal weight would have also been a bad idea. The great PSU behemoths continued to decline over the following decade with ONGC and NTPC delivered -36% and -39% in absolute terms.

If you had market weighted them, assigning higher weights to the larger stocks, you would have gotten roughly the same return as an equal weighted portfolio of the top would charge an expense ratio, investors in it would save on tax as well as face lower costs under certain heads, such as brokerage.

“Some companies do well and others don’t. The market rewards the performers and punishes the non-performers and this drives a churn in indices. Simply buying a portfolio of bluechips and holding it is not enough. Manually rebalancing this portfolio every year is also very costly. You would have to buy and sell a certain number of stocks every year. This would involve paying brokerage, STT and capital gains taxes on the gains you end up booking. This entire process happens inside an index fund at a far lower cost and with far more tax efciency. You do not pay tax until you redeem your units in the fund, ” said Anish Teli, managing partner, QED Capital Advisors LLP.

Leave a Reply

Your email address will not be published. Required fields are marked *