Case 072Buy-side portfolio judgementWarm up

A fund wants a Rs 150 crore position in Sahvira Microfinance, which trades Rs 8 crore a day. Buying at 20% of daily volume, how many days does it take to build, and what does that mean for sizing?

The situation

You run research for a Rs 5,000 crore equity fund. Your work on Sahvira Microfinance is strong and the portfolio manager wants a Rs 150 crore position, 3% of the fund. Sahvira has a market value of Rs 2,400 crore, 40% of it in free float, and its shares trade about Rs 8 crore a day.

The desk will not trade more than 20% of a stock's daily volume, because beyond that the fund becomes the price. The fund's risk rule says any position must be sellable within 20 trading days. Microfinance stocks have a history of sharp sell-offs when collection rates slip, and in those weeks volume tends to dry up.

Your task

Work out how long the position takes to build and to exit, and recommend a size to the portfolio manager with the reason.

Quick check

At 20% of Rs 8 crore a day, how long does Rs 150 crore take to buy?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

About 94 trading days to build, and the same or worse to exit, so Rs 150 crore is too big for this stock. At Rs 1.6 crore a day, the fund's 20-day exit rule caps the position at about Rs 32 crore, 0.6% of the fund, and nearer Rs 16 crore if you plan for volume halving in a sell-off. Conviction sets the direction; liquidity sets the size.

Step 1Why can a fund not just buy what it wants?

Think of buying all the mangoes at a small village market. If you buy every crate the moment it arrives, the seller notices and the price jumps; so you buy a few crates a day and the job takes weeks. A fund in a thinly traded stock is that buyer: it can take only a slice of each day's trading without becoming the price, so the size of the position sets how long it takes to get in and, more importantly, out. At 20% of Rs 8 crore, the fund buys Rs 1.6 crore a day.

Rs 150 crore at Rs 1.6 crore a day is 93.75 trading days, about 94, or 4.5 months. During those months the price moves, so the average cost is not today's price, and if the thesis gets out to other investors while you are still buying, you pay up for the last part.

Days to trade a Sahvira position at 20% of daily volume050100150200Rs 0Rs 40Rs 80Rs 120Rs 160Position size, Rs croredaysFund rule: exit within 20 daysRs 150 crore: 94 daysat normal volumeRs 32 croreIf volume halves in a sell-off,Rs 150 crore takes 188 days
At 20% of Sahvira's daily volume a Rs 150 crore position takes about 94 trading days, 188 if volume halves in a sell-off, while the fund's 20-day exit rule allows only about Rs 32 crore at normal volume.
Step 2Why does the exit matter more than the entry?

You choose when to buy. You rarely choose when to sell: the moment you need out is usually when collection rates have slipped and every other holder wants out too. In a sell-off volume dries up, so the exit takes longer than the entry, exactly when speed matters most. If Sahvira's volume halves to Rs 4 crore, the fund can sell only Rs 0.8 crore a day and Rs 150 crore takes 188 trading days, most of a year, while the price keeps falling.

There is an ownership problem too. Rs 150 crore is 6.25% of Sahvira and 15.6% of its free float. Holdings above certain thresholds trigger disclosure under the takeover and insider rules; confirm the current thresholds before sizing near them. And a holder of a sixth of the float is the market in that stock.

Step 3So what size do you recommend?
The same idea at three sizes, set by how fast you can get outConviction sizeRs 150 crore, 3.0% of fund94 days to exit, 188 in a sell-offLiquidity sizeRs 32 crore, 0.64% of fund20 days to exit, 40 in a sell-offStress sizeRs 16 crore, 0.32% of fund20 days to exit even in a sell-off
The same Sahvira idea is a Rs 150 crore position on conviction, about Rs 32 crore under the fund's 20-day exit rule at normal volume, and about Rs 16 crore if the rule must hold when volume halves.

Apply the fund's rule: 20 days at Rs 1.6 crore is Rs 32 crore, 0.64% of the fund. If the rule has to hold in a sell-off, the cap is Rs 16 crore. Recommend about Rs 30 crore, built over about 19 trading days, and tell the portfolio manager plainly that the stock cannot carry a 3% weight. If the conviction is about microfinance as a sector, a larger, more liquid lender can carry the rest of the exposure. Say the limit: daily volume changes, and if Sahvira joins a major index its volume could rise and the cap with it.

SizeRs crore% of fundDays to exit, normalDays to exit, volume halved
Conviction1503.0%94188
Liquidity rule320.64%2040
Stress rule160.32%1020
Trading 20% of Sahvira's Rs 8 crore daily volume, only positions of about Rs 16 to Rs 32 crore meet the fund's 20-day exit rule; the Rs 150 crore conviction size would take 94 to 188 days to sell.

Where candidates lose it

The arithmetic trap is dividing Rs 150 crore by the full Rs 8 crore of daily volume and answering 19 days. The fund cannot buy every share that trades; at 20% participation the answer is five times longer.

The judgement trap is stopping at the entry. Interviewers want to hear that the exit is the binding constraint, because it arrives in a sell-off when volume has dried up.

What the interviewer asks next

  • How would your answer change if Sahvira were added to a large index fund's benchmark next quarter?
  • The portfolio manager insists on 3%. How would you build it with the least market impact?
  • What other measures of liquidity would you look at besides average daily value traded?

Company names and figures are illustrative.