diamonds are Forever; Bluechip Stocks, Not So Much

This constant movement of companies means that ‘buy bluechips and forget’ is not an efficient strategy. Today’s bluechip is not tomorrow’s bluechip. Big companies decline and others take their place. In this piece, we test the return of buying and holding only the bluechip shares.

We took the portfolios of the 10 largest companies over different years (2005, 2007 and 2019) and saw what happened if you held them for 10 years (2015, 2017 and 2019). The results are not promising. Instead, buying and holding an index fund proves to be both cost and tax efficient.

In the first test period, we look at the structure of the Indian stock market in 2004. Buying the top 10 stocks in 2004 and holding them for the next 10 years would have yielded a 15% compound annual growth rate return equivalent to that of the Nifty. (CAGR). What if you had this 10 stock portfolio weighted by market cap? The result is a slightly lower return at 14%. However, this similarity is a matter of coincidence.

Let’s go back a few years to 2007. This would be the Indian stock market on the eve of the Great Recession and the end of the great bull market of 2003-07.

The index was dominated by commodity and resource companies, most of which were state-owned, a result of the prolonged infra boom. Hence, apart from ONGC and NTPC, mineral giants like Metals and Minerals Trading Corporation (MMTC) and National Mineral Development Corporation (NMDC) were present in the top 10. DLF had entered the top 10 list and so was Bharat Heavy Electricals Limited (BHEL). These companies performed well over the next 10 years. MMTC lost 95% of its value, while NMDC lost 76% of its value. BHEL lost 73% of its value. A similarly weighted portfolio of top 10 stocks would have given -4% and a market cap weighted would have given -3% compared to 5.2% on the Nifty.

Let’s move on to 2009 for another two years. The big recession had arrived and the market was just starting to move down. DLF and ICICI Bank were left out of the top 10 list as they suffered losses along with other real estate stocks and banks. Instead, software exporters like Infosys and TCS had entered the top 10 list. It would also be a bad idea to buy this list of top 10 stocks in equal weight. The great PSUs continued to decline over the next decade with ONGC and NTPC – -36% and -39% as absolutes.

If you would have marketed the larger stocks giving them a higher weighting, you would have got the same return as a similarly weighted portfolio of the top 10 stocks, which is 5% CAGR over the next 10 years. In comparison Nifty 50 gave 10% return.

Experts recommend buying and holding index funds instead. While such a fund will charge expense ratio, investors will be able to save tax as well as face lower costs under certain heads like brokerage.

“Some companies do well and others don’t. The market rewards performers and penalizes non-performers and this leads to churn in the indices. Just buying a portfolio of bluechips and holding it is not enough. Every year Rebalancing this portfolio manually is also very expensive. You have to buy and sell a certain number of stocks every year. This will involve paying brokerage, STT and capital gains tax on the gains you make at the end of the booking The entire process takes place inside an index fund at a much lower cost and with far greater tax efficiency. As long as you don’t redeem your units in the fund, you can’t redeem your units, said Anish Teli, managing partner, QED Capital Advisors LLP. do not pay tax.