Portfolio construction
In this chapter: Concentration vs diversification · Active risk and tracking error
Concentration vs diversification is a continuum. More concentrated portfolios can outperform but with higher volatility. Active risk (tracking error) measures how different the portfolio is from its benchmark — a TE of 4% means the portfolio is meaningfully active. Information Ratio = excess return / TE; >0.5 is good, >1.0 is rare.
Indian PMS portfolios typically run 15-30 stocks vs mutual funds' 50-100+. Tracking error of 5-10% vs NIFTY 500 is common. Concentration limits: SEBI norms cap exposure to a single security (max 10-15% of AUM, varies). Sector concentration: typically 30-40% max in any single sector. Construction approaches: bottom-up (security selection drives allocation), top-down (sector/theme drives security choice), factor-based (e.g., quality + momentum overlay), event-driven (special situations). Each requires different skill sets.
A nuance: factor exposures hidden inside discretionary PMS. A "growth equity" PMS may have a strong momentum tilt without explicitly stating it. Performance during momentum bear markets (e.g., 2018-19, 2022) reveals this. Sophisticated clients use factor-attribution analysis to decompose PMS returns into market beta, factor exposure (size, value, quality, momentum), and stock-picking alpha. Most PMS managers can't explain their returns this granularly — a red flag.