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Is Higher Risk necessary for Higher Returns in Equity investments?

Punit Jain | 03 Nov, 2014  | Follow Author | Add to my Favourites 
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What is Risk?


Risk defined by Investopedia is “The chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment”.


One of the rules that are commonly believed is that ‘higher risk needs to be taken in order to earn higher returns’. This is intuitively obvious - the entrepreneur invests in a new business knowing that there is a probability of failure. The Venture Capitalist invests in a portfolio of businesses knowing that some may give him 30X returns and others may fail.


But lets review this in the context of Equity Investments.


Asset Classes 


In investing, this risk-return rule is true across asset classes. The following graphic Fig 1 illustrates the Risk and Return rankings across different asset classes. 



1. Here we can see that Cash is the safest asset.

2. FDs come next, as they are of fixed duration and fixed returns, guaranteed by a Bank.

3. Next come Debt, Bonds, and Endowment Life insurance. Insurance of course is a very high gestation investment product.

4. Debt and Bond MFs are products packaged by the Mutual Fund industry into Units.

5. Gold and Gold ETFs are another investment option.

6. Real estate may come next. It of course varies by location, and commercial/ residence.

7. Equity ETFs and Equity MFs 

8. Direct equity is the final high risk investment product.

Note that these are strictly the author’s personal views and may vary under different circumstances. The graphic Fig 1 is only a conceptual map, and indicates relative values.


Risk in Equity


Direct Equity as an asset class has two types of Risk:


1. Systemic risk is applicable across all sectors. A significant political event, for example, could affect your entire equity portfolio. It is virtually impossible to protect yourself against this type of risk.


2. Unsystematic risk is sometimes referred to as "specific risk". This kind of risk affects a few of the assets. An example is news of a sudden strike by employees, that can only affect a specific stock. Diversification is the only way to protect yourself from unsystematic risk.


Even equity can be split into equity classes, where the risk profiles are different, See Fig 2. Speaking in general, Large Caps are most stable, and have lower risk, next are Mid-caps and next Small caps.





The Risk-Return Relationship


However, once we look at individual stocks for investing, higher risk may not give higher returns.


1. The high performing firms in the stock exchange over longer periods are those that are more predictable in terms of growth, costs, investments, new projects and brand strength.


• Example – HDFC Bank over the period of 2009-13 has given fairly predictable 30% YoY growth in profits. As a result investors gave it a superior valuation and it became the bank with the highest market capitalization, even though it was smaller than peers on other parameters.


2. Sharp swings for a firm from profit to loss and the reverse too are not seen positively, especially if these happen unexpectedly.


3. The ability of growth companies to execute on new initiatives is very important. Such firms need to launch in new markets, create new products or set up new manufacturing plants. Here the track record of such firms in these initiatives is important.


4. Monopolies are seen as very positive situations for firms.

•  Example – ITC has for several decades dominated the Indian cigarette industry with 75-80% market share. This is a profitable and steady growth industry and so the ITC share has performed well in the past 10-15 years.


5. Typically the fundamentals based approach to the stock market involves projecting financials for a company over 1-3 years, assigning target prices and identifying high potential investments.


6. Warren Buffet has taken predictability to the extreme by investing in a bunch of consumer companies (Coca Cola, Procter & Gamble, Kraft Foods, Wal Mart, etc.) where these products are strong brands that are daily consumption habits and so growth is quite predictable over decades rather than years.


The Role of the Equity Researcher


It is the task of an equity researcher to identify, prioritize and assess the risks associated with a firm. Thus a good equity researcher is actually able to lower the ‘specific risk’ of making an investment, identify potential situations of a company’s future and increase the chance of profitable investments. 


JainMatrix Investments approach to Investing


 1. The JainMatrix Investments approach to investing is to start with a top down approach to first identify the attractive sectors that are likely to outperform the next 1-3 year perspective.

2. Next we drill down to the company level to analyse the fundamentals of firms and identify outstanding Large, Mid and Small cap firms. This research is published periodically.

3. These firms are further crystallised into two portfolios. By aligning the portfolios with their risk appetites, we help investors invest better.


Large Cap Model Portfolio

- The objective of the LCMP is to outperform the Sensex and Nifty by 5-10%.


- It consists of 7 large cap shares which are the current or future leaders from attractive sectors of the Indian economy.


- This is a lower risk portfolio.


Mid and Small Cap Portfolio

- The objective of the MSCMP is to outperform the Mid and Small Cap indices by large margins.


It consists of 7 mid and small cap firms that are emerging out-performers from identified 3-5 high potential sectors.


- This is a higher risk portfolio.

- The performance of these portfolios over the last 20-21 months has been excellent – visit to find out more.


Disclosures and Disclaimers

- This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation.

- This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security.

- The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same.

-  Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein.

-  Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor.

- JM has been providing equity research and portfolio advisory services commercially since Nov 2012.

- Any questions should be directed to Punit Jain, the Director of JainMatrix Investments at [email protected]

Also see:

JainMatrix Investments ( is a firm started by Punit Jain that offers Equity Research and Portfolio Advisory Services.

About Punit Jain

The author is a SEBI-registed Research Analyst (SEBI Registration No. INH200002747), and has a firm called JainMatrix Investments ( which offers an Investment Advisory Service. He can be contacted at [email protected]

For more information please write in to [email protected]

Disclaimer: The author has taken due care and caution to compile and analyse the data. The opinions expressed above are only the views of the author, and not a recommendation to buy or sell. Neither the author nor accept any liability whatsoever arising from the use of any of the above contents.

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