How To Evaluate Your Portfolio When A Corporate Shock Hits

The Securities and Exchange Board of India (Sebi) alleged in a June 3 order that Rajesh Exports had engaged in financial misrepresentation to the tune of more than Rs 15 lakh crore.

Within hours, the Bengaluru-headquartered multinational gold retailer's shares dropped sharply. Then, it began to be pointed out that LIC had been maintaining a share of around 11% in the company for a few years. It was one of the nearly-2-lakh investors who had a stake in the company, whose shares were reported to have fallen more than 80% over the last five years.

In its aftermath, it becomes prudent for investors in general to evaluate their portfolios to understand their exposure to such corporate shocks, and educate themselves on how to emerge from the after-effects if they have been impacted.

What to do?

Evaluating portfolio exposure to companies involved in corporate governance failures or scams requires a shift from chasing returns to implementing rigorous structural safeguards.

One of the first steps should be to identify the "concentration risk" in your portfolio. The most immediate danger of a corporate scam is not the scam itself, but how much of your total net worth it represents.

A generally prudent idea, if you hold direct equity, would be to ensure that no single company occupies more than a small "satellite" portion of your portfolio. This limits the impact of a total loss on your overall financial health.

Such situations also make the case for the use of or the shift to mutual funds (MFs). One of the primary reasons to use MFs is that they provide professional oversight. A single stock going to zero in a well-diversified fund (like a Nifty 50 index fund) has a negligible impact on your life.

Another step would be to check for portfolio overlap. A common mistake Indian investors make is owning too many MFs, which creates a false sense of security. However, if five different "active" funds all hold the same high-risk stock, you are heavily concentrated in that risk without realising it.

Use a portfolio X-ray tool to check for overlap. Consolidate your portfolio into 2-3 high-conviction funds, like one large-cap index and one mid-cap fund. This should make it significantly easier to track exactly which companies you are indirectly owning.

Other steps

Besides the aforementioned steps, try to monitor behaviour gaps in your portfolio, and try to pinpoint red flags as well.

Corporate governance issues often manifest as extreme price volatility before a scam is fully uncovered. Therefore, avoid "bottom fishing". When a stock crashes due to misgovernance rumours, the instinct of many retail investors is to buy the "sale". However, in the case of scams, a crash is often a trap, not a sale.

For MF investors, a sudden, unexplained drop in a fund's Net Asset Value (NAV) relative to its peers can be an early warning sign of exposure to toxic paper or failing companies. This is one very prominent red flag, and can be tracked using various tools.

Another strategy to avoid the pitfall is to implement strategic diversification. This means that you should look beyond the Indian market to shield yourself against domestic corporate or regulatory shocks.

If all your investments are in Indian companies, you are exposed to a single country's regulatory and corporate risks. That is where you take the route of international hedging.

This may entail allocating a portion of your wealth to international ETFs or US-denominated assets, which should provide a buffer. When domestic companies fail, or the rupee weakens, these global assets can preserve your purchasing power.

And this step is especially important, given how the rupee has depreciated against the dollar over the past year, and especially so in the past few months.

About the Author

Handa Uncle is an AI-powered Personal CFO focused on simplifying finance, investing, taxation, and wealth-building concepts through practical and easy-to-understand insights.