There are various reasons why there could be a loss in your portfolio. You may have held on for too long to a set of stocks without triggering a stop loss. Alternatively, a sudden crash in the market may have reduced your portfolio value by nearly 25%. Then there could be very specific announcements like a repo rate hike which may have substantially reduced the value of your rate sensitive portfolio. The question is what you should do when your portfolio is sitting on losses. Here is how you can approach your loss making portfolio in a very methodical and systematic manner.

Sell weakness and reallocate to strength: This is a common problem we may face in managing the portfolio. For example, if the RBI turns hawkish then it could change the outlook for rate sensitive stocks like banking, NBFCs and realty companies. Alternative PSU banks could have become unattractive due to rising NPAs and inherent bond losses. Quite often, commodities like aluminium, zinc and copper go into long-term down cycles. Under these circumstances, it makes sense to switch out of these vulnerable stocks and invest the money into stocks that are showing better prospects. That may involve booking a loss but that will be worthwhile in the long term interest of your portfolio.

Monetize your portfolio for tax harvesting: This is an interesting method of handling portfolio losses. If your portfolio is down by 25%, as was normal in 2008 and 2011, you can book the short term losses. Once these losses are booked, they become actual losses in your books. These losses can either be set-off against other short term capital gains or they can be carried forward for a period of 8 assessment years. Writing off such losses or carrying forward such losses can give you a tax shield to the extent of your peak tax rate. Here is how your decision tree will look…

Restructure your portfolio in favour of beneficiaries and defensives: This is a slightly more active strategy wherein you actually shift to stocks that are less vulnerable to the core macro or sector level shifts. For example, when the commodity cycle starts weakening then most manufacturers of steel, aluminium, zinc etc are likely to be negatively impacted. But automobiles and construction companies that use these inputs are likely to benefit. You can churn accordingly. Alternatively, you can shift to defensives like FMCG or Pharma which are not exactly vulnerable to commodity cycles.

Use futures to replicate your loss making portfolio: This is a slightly more aggressive strategy and you need to undertake this strategy only if you are fully conscious of the risks. When you convert an equity position into an equivalent futures position then your margin will be around 30%, hypothetically. Even if you provide another 20% for MTM losses, you are still freeing up 50% of your portfolio value. There are a few basic rules to apply here. You must apply this strategy on stocks that you believe have limited downside. You must not apply this strategy to stocks that are in a structural downturn as the bounce may take a very long time.

Apply covered call strategies to reduce your cost of holding: This is an interesting strategy to reduce your cost of holding when a stock gets into a tight range. Again, this strategy should be applied strictly only to stocks that are not into a structural downturn. Also, this strategy will work more at a stock specific level rather than at a portfolio level. In a covered call, you hold on to the cash market position but keep selling higher call options that will expire worthless so that the premium can reduce your cost of holding. Assume that you bought SBI at Rs.280 but it is now down to Rs.260. Let us also assume that the 280 call is available each month beginning in the range of Rs.2.50-3.50…

Strategy

January

February

March

April

May

June

280 Call Sold

2.50

2.90

2.60

2.80

2.60

2.50

Closed at

Expired

3.30

0.50

1.10

Expired

Expired

Profit / Loss

+2.50

-0.40

+2.10

+1.70

2.60

2.50

Total Profit / Loss from the Covered Call

Rs.11.00

As can be seen in the above table, the investor made expiry profits in 3 months, booked smaller profits in 2 months and took a loss in 1 month. This profit of Rs.11 over 6 months has reduced the cost of holding SBI from 280 to Rs.269, thus reducing the MTM losses. Of course this strategy works more on a stock specific basis and hence is more effective for small portfolios. There is no downside protection in this strategy, so you must design accordingly! This may sound very complex or esoteric to you but actually it is not. With some bare minimum practice you can make it big for sure.