Wednesday, March 23, 2016

How To Construct A High-Risk Portfolio

 Courtesy : Investopedia

A lot of investment advice centers on producing as much return as possible for as little risk as possible. But what about the other side of the coin? What about embracing the possibilities of risk and actively seeking to build a high-risk investment portfolio? Such a portfolio could hold considerable promise for market-beating returns, but investors need to keep a few ideas in mind when approaching this type of investment portfolio.



Why Seek Risk?

The linkage between risk and reward is not always perfect or predictable, but there is a time-tested correlation between risk and reward. If investors want higher returns, they have to be willing to take on higher risk. Said differently, though, if an investor can accept higher risk, he or she can also potentially realize considerably higher returns.

A low-risk/high-return portfolio is more often about fantasy (or fraud) than reality. Moreover, not all risk is bad for an individual investor. The key, then, is taking on the right risks. After all, risk only becomes problematic if, or when, an investor is wrong. There are also different ideas of risk; holding an all-cash portfolio is actually quite risky if that cash is being eroded by inflation. 

Large institutions cannot afford the risks that go with low liquidity, but that threshold is much lower for an individual. Even a small fund may be unable to invest in a $20 stock that trades 50,000 shares a day, but there is no reason that an individual investor cannot take on that liquidity risk. Likewise, many institutional investors cannot invest in low-priced stocks, pink sheet/bulletin board stocks or stocks in certain industries (particularly for certain ethical funds), but individuals have no such statutory restrictions.

It is also important to understand another key detail of "high-risk" portfolios – volatility is NOT risk. True, many academics and market participants do use volatility as a proxy for risk (beta, for instance), but in many respects volatility is a poor analog to risk. Risk, as most investors would define it, is either the probability of loss or the probability of an asset (or collection of assets) providing less than the expected return. 
Some stocks can go through wild up and down swings, but still produce handsome rewards for investors. In other cases some stocks just quietly and steadily fade into oblivion. In many respects, then, volatility is like the turbulence experienced on a plane ride, whereas risk is the actual chance of crashing.

Seek Out Smart Risk / Not All Risk Is the Same

One of the most important concepts in building a high-risk portfolio is that not all risk is the same. A close corollary is that investors should only seek out the smart risks, the risks they get compensated for taking. For instance, investing in the equity of bankrupt companies almost never pays off; yes the stocks trade for pennies and the companies often survive, but the bankruptcy process almost always completely wipes out equity investors and there is not enough wiggle room in that "almost" to validate the risk.

Investors should also guard against laziness and complacency. High-risk investing demands responsiveness and attention to detail. So while building a portfolio without thorough due diligence and then ignoring it is certainly high-risk investing, it is not a kind of risk that will earn extra rewards.


Types of High-Risk Portfolios

Concentrated


It is possible to create a high-risk portfolio without really changing investment styles. Heavily investing in a single sector/industry can certainly amp up risk and increase return potential. Investors who over weighted into technology stocks during the late 1990s (and got out in time) did quite well, as well as investors who successfully play cyclical commodity runs.

Perhaps it goes without saying, but this strategy is predicated on really understanding an industry well and having a good sense of the industry's place in the business cycle. Likewise, it is important to have a good sense of market psychology and moods; over weighting an unpopular sector is not likely to boost returns.  

Momentum investing - is another option for a high-risk portfolio. The basic idea of momentum investing is to invest in stocks already showing strong price action. The risk from this strategy is often due to the above-average valuations that popular stocks carry, but expensive popular stocks can often trade up to "very expensive" or "extremely expensive" before fading.
Momentum investing requires strong sell discipline (using tight stop-losses when momentum fades, for instance). Investors can also look to diversify across sectors to lower absolute risk, but a general market decline will hit a momentum portfolio hard unless an investor is nimble enough to go short. 

Penny Stocks

Most financial information sites go to great lengths to dissuade investors from investing in penny stocks, highlighting the prevalence of fraud, corruption, and hype as well as the overall illiquidity of these stocks.

While those are valid issues, some times the enormous risks of this investment type do pay off. Penny stock investing requires exceptional commitment to due diligence, and diversification can help reduce the risks.

Emerging Ideas

Risk-seeking investors can also take a page from venture capital and look to invest in emerging technology companies. At their best, these companies can give investors something close to a "ground floor" opportunity in new technologies and products. Once again diversification matters, as investors have to be patient and willing to accept a low "batting average", as most emerging technology companies fail. Investors should also focus on companies that have capital and/or access to capital on good terms as many of these companies are pre-revenue and torrid cash-burners.



Bottom LineInvestors with the financial capacity to take on risk should not shy away from it. Over time, intelligent and disciplined risk-seeking behavior can produce substantially above-average returns. The key, though, is "intelligent" and "disciplined"; investors must seek out the risks that can earn them better returns and strictly avoid (or minimize) those risks that do not add any money to their pocket.

31 comments :

  1. Sir, there are rumors that you gave the sale call for SKM egg. Have you sold your shares and quitted SKM egg. Please clarify sir. There is big panic in the group.

    ReplyDelete
    Replies
    1. I could not understand What do you mean by group ?

      I never given any call secretly or personally to any one or a specific group . I already shared my opinion about 1-2 months back both in blog ( as reply to a comment) and in MMB openly.Nothing more to add at this juncture.

      Delete
  2. Sir what you would like to update for your old likes i.e. subex, pioneer embroideries, NCL, Sintex, IDFC bank etc.

    ReplyDelete
    Replies
    1. On business side Subex is improving but excess supply from FCCB converted shares limiting its stock price's upward journey.

      Pioneer is expected to turn around in future.

      After doubled from suggested price NCL corrected sharply , keep an eye on the trend of cement price movement and take a call based on it.

      Not strictly tracking Sintex.

      IDFC bank is expected to grow but need patience.

      Delete
  3. Sir you mentioned In MMB, Ramky is better one From Infra Sector.Can I Enter At CMP

    ReplyDelete
    Replies
    1. It is an already suggested stock at much higher level.Thereafter all infra companies faced lot of challenges in past few years.Still I have hope in it, but enter only at a rate you are comfortable.

      Delete
  4. Sir why do you think such a reputed promoter group is failing to arrange working capital? What is way forward ?will patience bear fruit?we value ur suggestion

    ReplyDelete
    Replies
    1. About which company you are talking ?

      Delete
  5. Sir ABFRL not performing well with market if any reason. Please your view

    ReplyDelete
    Replies
    1. I think you are talking about the stock price and not about the business.In that case it may be due to some supply on account of selling by someone who got shares on scheme of arrangement.

      Delete
  6. VP, Export of table eggs from Tuticorin port is being done by SKM Egg products Ltd or SKM Universal Marketing Ltd? Is there a requirement of export licence for exporting eggs?

    ReplyDelete
    Replies
    1. Only business of listed company is egg powder and table eggs not coming under it.

      Delete
    2. Liquid eggs too. Though quantity in meagre, about 1.7 Cr this quarter so far

      Delete
  7. Dear sir thanq very much for continuation of our blog we need your support and encouragement for long term investment

    ReplyDelete
  8. Sir I personally interacted with SKM officials CFO and CS. They are very positive on Japan business and Russia business. Also they have got a new client domestic where they are done with quality audit test and expecting business from this qtr. They are planning for expansion this year in organic and inorganic ways. My buying price avg is at 160 with 30% portfolio. Your suggestion is very weighted sir. please suggest

    ReplyDelete
    Replies
    1. I never mentioned that its promoter quality is bad or something like that but just mentioned there may be some challenges in business in short to medium term because of reasons even beyond the control of management .It never means SKM is a bad company and one should not touch it. I am also praying for the improvement of their business and we all know how much they tried to bring back the company from near collapse.Because of a possible soft demand from export side and unexpected increase in raw material cost I am expecting few soft quarters and made such a suggestion after considering the tax advantage ( capital gain tax) factor also since it is the last month of this FY.

      I am happy to be proven wrong and always value the efforts of all genuine promoters who are trying their level best for the benefits of company and its share holders.

      Delete
  9. Hi Sir,
    What are your views on FCEL for long term investment?

    ReplyDelete
  10. Sir Thanks for your guidance in building high risk portfolios.

    ReplyDelete
  11. Dear Sir give your view in deccan gold

    ReplyDelete
    Replies
    1. I can't understand the secret of making optimistic announcement on one side and reducing promoter stake on the other side .Hence no comments.

      Delete
  12. Sir, your views on Tanla Solutions? Can one enter at CMP

    ReplyDelete
  13. sir god bless you for your selfless service to stock market community. sir can u suggest any oil gas stocks for long term investment
    thank you again.

    ReplyDelete
    Replies
    1. We have only limited choice in this space.

      Delete
  14. Sir i beg ur pardon i was so much obsessed with price performance that forgot to mention the name of the stock .it is Il&fs eng .is it the fall in crude that is hurting the capital power of bin ladin .please illuminate

    ReplyDelete
  15. When you refer to promoters reducing stake in Deccan gold, it might be because of the rights issue!!!!!! Just thought I'd clarify because I don't want the stock to go down for wrong reasons because people on the blog seem to be blindly interpreting your statements. Please post this so people have a better idea.

    Thanks.

    Pavan Mathani

    ReplyDelete
  16. Dear VP sir,
    Kindly give your views on Krebs biochem.. Is both their units operational?? When it could turn profitable!

    ReplyDelete
  17. Sir what are criteria u see finding stocks. Market Capitalization how much and what??

    ReplyDelete

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