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The 'ANTI-PORTFOLIO' You Can Be Proud Of!

The Best Investment Options are Often the Ones You Don’t Make

Seasoned investors often look at their anti-portfolio and assess the investments they declined, which later blossomed into successful companies. Investors honour investments they missed, and say “If only...…!”. But which investors take the time to honour the investments they missed and say, “PHEW!!!! So glad we bypassed that train-wreck!”

Elimination is a highly underappreciated technique in an investment journey that aims to deliver benchmark-beating returns. Avoiding big losers can increase your odds of winning.

Buying stocks primarily based on reported earnings is fraught with risks. Often, a closer analysis reveals that the profits may be unsustainable, overstated or imaginary. Such investments can destroy value for equity holders. Avoiding even a few accidents can protect your investment capital over the long term.

Elimination of such “red flag” companies is an integral part of the design of DSP’s quantitative analysis. To objectively and quantitatively eliminate the “potential thorn in the side”, we use a combination of metrics. These metrics use information extracted from an investee company’s balance sheet, P&L, and cash flow statement. Disclosures regarding related-party transactions, proxy voting, ESG (Environmental, Social and Governance) data, credit ratings and stock market prices are also assessed to identify “red flags”.

Let’s take a look at how we build an ideal anti-portfolio using forensic categories and metrics that can help you in your elimination process. It is difficult to have only a few metrics and capture many “red flags”. Our framework classifies these metrics into six broad categories. The warning signals may come from many sources, and each case may be different or unique. Our approach is to have a 360-degree perspective, with a host of metrics, which have a higher chance of successful elimination. What are these metrics? They are:

  • Earnings Quality: Ratios that validate the authenticity and sustainability of earnings numbers presented in the financial statements
  • Diversion of Funds: Metrics that indicate higher a probability of diversion of funds from the firm’s core business to other businesses
  • Working Capital: Metrics that signify poor cash conversion and rising liquidity risk 
  • Credit: Metrics that signify weakening credit profile and high solvency risk
  • Governance: Metrics that signify risk due to poor governance standards
  • Weak Business Fundamentals: Metrics that signify underperformance in the core business relative to peers. An inherently weak business can cause all the above issues.

What do we do once we have all these metrics? Thresholds for each ratio/metric are determined using a combination of art (judgment) and science (percentile scores). If a potential investee company breaches the defined threshold, we mark it with a a “red flag” on that metric.

Each company gets an overall score based on the total number of “red flags”. We convert this to a percentile score. The percentile score is 100% for the company with maximum “red flags” and 0% for the company with no “red flags”. Remember, our idea is elimination.

We ran a screen and then, we tested our theory! Most investors don’t  focus on what NOT to buy, so we checked if the “red flag” companies actually underperformed the universe (S&P BSE 200 TRI). 

We conducted tests where we applied the frameworks going back in time for a 10-year period. We created a portfolio representing 20 companies with maximum “red flags” in each year. We also created a portfolio separately, representing companies with minimum “red flags”, a.k.a “clean companies” in each year. The portfolios were equal weighted for all 20 companies. 

And the results were clear:  Focus on building an anti-portfolio that YOU’RE PROUD TO BOAST!

Results of Back test
CAGR Returns Volatility Max.
Bottom 20 Red flag companies -7.30% 29.00% -76.10%
Top 20 Clean companies 15.70% 15.00% -26.80%
S&P BSE 200 TRI 8.60% 17.00% -37.80%


*Returns from Sep 2009 to June 2020, Source: Internal, FactSet, Capitaline. Capitaline.  Past performance may or may not sustain in the future and should not be used as a basis for comparison with other investments. These figures pertain to the performance of the index and do not, in any manner, indicate the returns/performance of any scheme of DSP Mutual Fund. It is not possible to invest directly in an index.


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