My colleague Satish Joshi, our CTO, is a solid writer, and he sent me his post in the second week of May this year. I am reproducing parts of his post to set the context for this week’s investor post. He wrote:

“On May 9th, 2024, the Sensex tanked more than 1000 points.

A friend of mine pointed out that the Sensex had gone back to the same level it was at in January 2024, and therefore, all the gains that investors had made in the last four months had been wiped out!

He was using that fact to argue that (a) those who did nothing in the last four months were worse off now compared to where they were in January 2024, and (b) therefore, you cannot be a passive investor; you must watch the market and capitalize on the opportunities that market ups and downs create.

I thought I should test his arguments with real data. When I tested his argument (with my own data) about investors being worse off today than they were in January, the data clearly showed this was not true.

The results were eye-opening.

The day after the crash of May 9, my own portfolio was up 4.4% compared to its value on 29^th December 2023. And before you ask, let me clarify that I have not made any new investments or changed anything in my portfolio during these four months. As a matter of fact, I had redeemed some amount to pay for a 2-week vacation in Spain which I took in April. So, if anything my portfolio has gained a bit more value than the 4.4%. Therefore, this claim is certainly wrong, at least for some of us lazy bums!”

How could this be possible if the index was flat?

Here are a few reasons why…

Your Portfolio is Not the Index

First and foremost, your portfolio is not a mirror of the index.

Most indices, like the Nifty 50 or the S&P 500, are weighted averages of the prices of a selected group of stocks. These indices provide a broad measure of market performance, but they don’t reflect the active decision-making process that occurs within actively managed funds.

Actively managed funds are built on the expertise of fund managers who strategically choose investments based on a variety of factors, such as economic conditions, company fundamentals, and market trends. As a result, the performance of your actively managed funds can significantly differ from that of the index.

For example, large-cap indices like the Nifty 50 are dominated by a few heavyweights such as Reliance Industries, HDFC Bank, and TCS. If these companies perform well or poorly, they can have an outsized impact on the index. However, your portfolio might be more diversified or focused on different sectors. As a result, the performance of your portfolio can deviate significantly from the index.

There are many technical concepts to understand but I know I will digress from the essence of this post. So, let’s just understand this fact here – Your Portfolio is not the Index.

Sectoral Rotation: The Dynamic Nature of Market Leadership

Another critical factor to consider is sectoral rotation. Different sectors of the economy perform well at different times due to various macroeconomic factors, including interest rates, economic growth, technological advancements, and regulatory changes.

For instance, there might be a period when banking stocks outperform due to rising interest rates, while IT companies could become the new market leaders as economic conditions shift. This constant rotation of market leaders means that even if the index remains flat, different sectors—and therefore different parts of your portfolio—could be performing quite differently.

Sectoral rotation means that the winners in the market keep changing. Today’s top-performing sector might be tomorrow’s laggard. This constant rotation can lead to significant differences between index performance and actively managed portfolios, depending on the sectoral exposure and timing of the manager’s decisions.

**The key point here is the stock market goes up because some companies and sectors will lead the market higher. Then they fall. This does not mean the stock market falls. Instead, some other companies and sectors take the stock market higher.

The Core Point: Your Portfolio’s Performance is Unique

It’s crucial to remember that your portfolio’s performance is unique to your investment strategy and the specific stocks, sectors, and assets you’re invested in. Just because the index is at a certain level doesn’t mean your portfolio will mirror that performance.

Here are a few reasons why your portfolio might perform differently from the index:

1. Diversification: If your portfolio is diversified across various sectors, geographies, and asset classes, it’s likely to show different performance characteristics than a single index, which may be concentrated in certain sectors.
2. Stock Selection: Even within the same sector, different companies can perform very differently. Your portfolio might hold stocks of companies that have better growth prospects or financial health compared to others in the index.
3. Dividends and Income Streams: The index reflects price movements, but it doesn’t account for dividends and other income streams that your portfolio might generate. Dividend-paying stocks or interest-bearing bonds can contribute to your overall returns, independent of the index’s movements.
4. Thoughtful Rebalancing: While the index remains static, your portfolio might benefit from strategic rebalancing. This allows you to Sell High and Buy Low in a disciplined manner. But there are tax consequences for doing so. Therefore, be very thoughtful about rebalancing.

Focus on Your Financial Goals

The key takeaway is that the performance of your portfolio is influenced by a multitude of factors, many of which are independent of the index. The index provides a useful benchmark, but it’s not the definitive measure of your financial success.

Understanding the reasons behind the difference between your portfolio and the index can help you make more informed investment decisions and set realistic expectations.

Your portfolio is a unique reflection of your financial journey, and its success should be measured by how well it helps you achieve your personal objectives, not by how closely it tracks the index. 

Remember, the winners in the market are always rotating. Today it might be banks, tomorrow it could be IT companies, and next week it might be something else entirely. Time and again, new leaders emerge to take the market higher. The key is to stay patient, and behave well, by focusing on your long-term financial goals.