Craving Alpha

The “Annual Reset” Concept in Portfolio Management

Portfolio Management

Has been a fairly new concept, in theory, however, we believe it has been in existence since the inception of equity rather since the inception of investing. While probably back in the day it must’ve been more about asset allocation, today we have professional firms offering “Portfolio Management Services” (PMS) focussing on selective industries, assets and even as capital allocation within businesses.

But, What does it mean today?

As a definition, “Portfolio Management, is the practice of designing an optimal capital allocation schedule within a focussed group of assets in order to grow the collective value of an investment in a favourable risk/return trade-off”. While, technically implies that each portfolio is designed individually to account for the Risk/Return Tradeoff for each portfolio instead, for the sake of convenience professionally managed firms have started offering thematic or model-based portfolios for the investors to choose from. Probably replacing the idea of “Asset Selection” and “Security Selection” with “Theme Selection” or “Manager Selection”.

The Flaw in the Design

Since the inception of PMS and Fund Management, rather the “newer design” has a few flaws, namely:

  1. The Presentation: Most presentations are a function of “the probability of something in the past working out in the future”.
    Would you want to invest in chance? By design, as the corpus of investment goes up most investment strategies become less effective- saturating as the investor base increases.
  2. Liquidity: A major problem with portfolios investing in stocks. Probably a strategy investing in smaller companies for higher returns would either fail to work with higher capital or eventually would fail to liquidate those stock in profits. While most large-cap investing strategies would have no problem of liquidity, statistically very few “large-cap” strategies “post costs and commission” would fail to consistently beat the index.
  3. Emotional Bias: Like any investor/investment even fund managers risk being emotionally attached to investments which may cloud their judgement.

The “Annual Reset” Concept

Given the above flaws, no single portfolio is a perpetual long-term investment. Like in equity investing even portfolios/funds would need to be churned, managers and themes alike. Our research team in the quest of being able to create a worry-free portfolio realised what we needed to achieve was:

  1. A Factor-Based Hybrid model that would liquidate each year (annually reset) itself to buy into a fresh new portfolio, so that each investor has similar returns over a longer time horizon.
  2. With super low churn and a reset post “Long term Capital Gains” eligibility, we were able to drastically reduce cost and increase the reinvestment growth.
  3. Reducing the stock universe to the top 100 stocks by market capitalisation on the date of “RESET” we were able to reduce issues with liquidity.

Does it work?

While we are very proud to put on record it does work, we are not sure the reader of this post would be interested in the returns we could generate.

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