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Unleashing Antifragile Powers: The Power of Population Explosion in Your Portfolio
In my previous posts in the fragility series which can be found here Fragility Series, we have explored the four fundamental pillars of fragility which an investor needs to be aware of to eliminate fragility in their portfolio:
Pillar 1 - Avoid investing in Fragile Companies
Pillar 2 - Avoid investing in Overvalued Companies
Pillar 3 - Avoid investing in Companies having Management with fragile mindset
Pillar 4 - Avoiding Shorter timeframes
By diligently implementing the above pillars, we can reduce the severity of adverse events and allow favorable news to substantially enhance our portfolio. I have also provided a consolidated checklist encompassing all these pillars, aimed at guiding investors towards effectively eliminating investment fragility.
However, it's essential to understand that 'robust' is not the true opposite of 'fragile.' The real opposite of fragility is 'antifragility.' We have previously explored this concept in the post titled "How to build an Antifragile Portfolio." While the four pillars mainly focus on eliminating fragility and reducing downside risk, we must now shift our focus to transforming our portfolio into an antifragile one. In other words, how can we create a portfolio that not only withstands adverse events but also capitalizes on positive events with unlimited upside potential? This will be the focus of our forthcoming posts in the Fragility Series.
Antifragility entails surviving adverse events and minimizing their impacts, enabling us to take advantage of positive events with non-linear impacts and unlimited upside potential. To achieve this, we must harness certain "Antifragile Powers" that will enhance the impact of positive events and make our returns non-linear. We acquire these “Antifragile Powers” only if we remove fragility from our investments which we can do by following the four pillars of fragility. In this post, we will delve into one such power - the Power of Population Explosion.
Mother Nature maintains a delicate balance between populations of various organisms, exemplified by the symbiotic relationship between zebras and lions on the African savannah. The abundance of vegetation supports a thriving zebra population, which, in turn, attracts the vigilant attention of the lion population that benefits from the availability of prey. This cycle of life depends on the existence of both species, each playing a crucial role in maintaining ecological equilibrium.
Similarly, the world of finance emphasizes the importance of diversification in an equity portfolio. Just as the population of zebras and lions are interlinked, acting as checkpoints for each other's populations, we too rebalance our portfolios regularly to ensure proper diversification and avoid concentration risk. For example, if a stock starts appreciating and starts contributing a significant share of our portfolio, we try to exit a portion of the same and invest in other stocks to avoid concentration risk.
Even SEBI has stipulated a Risk capping of maximum allocation of 10% in a particular stock for mutual funds. When HDFC and HDFC Bank merged, few mutual funds had to exit a portion of their allocation towards HDFC twins to comply with the 10% allocation. 40 equity mutual funds have more than 10% in HDFC twins - The Economic Times (indiatimes.com)
However, imposing too many restrictions on portfolio allocation can hinder our upside potential. By regular rebalancing and restricting maximum capping in a single stock in a portfolio to say 10%, aren't we limiting our upside potential? This works against the concept of Antifragility. Remember Antifragility means having as limited restrictions as possible for Upside Potential when positive events occur. By capping % allocation in the portfolio for a single stock, we are not letting positive events do their work.
Power of Population Explosion
While following the four pillars of Fragility helps reduce the impact of adverse events, enhancing the impact of positive events requires us to leverage the Power of Population Explosion unlike Mother Nature which tries to control Population of various organisms. This means removing the restrictions we place on upside potential and allowing our winners to grow substantially within our portfolio. By doing so, we can maximize our returns when positive events occur.
To illustrate, let's consider an example: If we invest in ten stocks with equal 10% allocation in our portfolio, there is no guarantee that positive events will occur evenly across all ten stocks. What if all ten positive events happen in a single stock, and the others experience none? By strictly adhering to rebalancing practices, we might unintentionally limit our upside potential.
In the initial 5 years of my investing journey, I earned FD like returns of 7% per year or so as there were no major positive events in any of my portfolio stocks. However, things changed drastically in the 6th year when one particular stock became 10 bagger and started contributing 80% of my portfolio!! I let this stock grow till 10 bagger and then exited a portion of the same to diversify into other stocks. This enabled me to earn higher than market returns subsequently. If I had exited/rebalanced when it reached 10% or 15% of portfolio allocation, then I would have restricted the upside potential of positive events happening in this particular stock.
Legendary investors like Rakesh Jhunjhunwala and Radhakishan Damani have experienced remarkable wealth creation by unleashing the Power of Population Explosion. Allowing their winners to grow significantly within their portfolios contributed to their outstanding success. Late Rakesh Jhunjhunwala bought 6 Crore shares of Titan at Rs 3 each in 2002-2003 i.e. a Rs 18 Crs investment. The share price of Titan has since become ~1000X. While he exited partially during the years, he (i.e. now his wife) continues to still hold ~4.5 Cores shares of Titan which is still contributing 40% of his wealth. Titan is a significant contributor towards his wealth creation journey. Similarly Avenue Supermarts (DMart) significantly contributed towards the wealth creation journey of Radhakishan Damani.
Power of Population Explosion is “Acquired”
The concept of not putting all our eggs in one basket is often emphasized in investment advice, promoting the idea of diversification. This strategy aims to mitigate risks associated with fragile investments, much like delicate eggs. However, what if each of our investments were more akin to rubber balls—resilient and even antifragile? In that case, we could confidently place all these rubber balls in one basket without fear. In other words, we could embrace concentration risk if our individual investments lacked fragility and exhibited robustness or antifragility.
By diligently following the four pillars of fragility, we "acquire" the Power of Population Explosion, which grants us the ability to take on concentration risk. This means that we can allow certain investments to grow significantly within our portfolio, maximizing their potential when positive events occur.
However, failing to utilize this acquired power of population explosion would limit our returns. Similarly, there are other Antifragile Powers that we "acquire" by removing fragility from our investments. In my subsequent posts, I will explore these various "Antifragile Powers" that will enable positive events to thrive in our portfolio.
To unleash the true potential of positive events, we must tap into these Antifragile Powers and cultivate an antifragile portfolio. By removing fragility from our investments and acquiring these powers, we can create a resilient investment strategy that thrives on the opportunities presented by positive events.
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