Investing for absolute returns can liberate investors

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In my early days as an investment analyst, I was once pitching a stock to my fund manager boss. Two minutes into the pitch, he asked me “What’s the weight?" I had no idea what he was talking about and so I later asked one of my senior colleagues what he meant. Most institutional investing in India is of the relative return type, which means that every fund is benchmarked against an index and a fund manager’s competence or otherwise is measured by how well he or she performs against the benchmark.

Hence the oft-asked question in investment discussions is the one my boss had asked me. It meant: How large is the stock in the benchmark index? Before becoming a buy-sider, I was an amateur equity investor, and this weight question had never crossed my mind. One bought what one liked and didn’t buy what one didn’t like.

But as I got steeped in the world of institutional investing, the term ‘index weight’ became the centre of many portfolio discussions. When you are incentivized to beat a benchmark, you quickly adapt to this new way of investing. This shift has several implications.

One ends up spending a lot of time analysing heavyweights: i.e., stocks that have a large representation in the index. Those stocks may not be the best money-making ideas, but getting them wrong will impact the fund’s relative performance, your annual bonus and even your career. HDFC Bank, Reliance Industries, ICICI Bank, Infosys and Larsen & Toubro are the five largest stocks in India, accounting for almost a third of the Nifty 100 index by weight, and it’s no surprise that they are some of the best covered stocks by equity research houses.