Prashanth Krish | Portfolio Yoga

Save Early or Lose Substantially?

An often repeated mantra is that if you don’t start saving early, you end up losing tremendously. You cannot argue with a statement like that , especially when it’s backed by evidence of the difference in returns if you start at 20 or start at 30.

Keeping in mind my skepticism with much of what goes around as “gyan”, I made this kind of sarcastic tweet in reply to one such tweet. Now, just to be clear, I hold Dinesh in high regard for his understanding of Finance and while I did use his tweet as material to push my agenda, it has nothing to do with him perse.

https://twitter.com/Prashanth_Krish/status/1327548992037609472

Kids in the US are burdened by Education Loans they take. The burden is so heavy for some that they would need to keep paying off till retirement. So, why do they even bother? The reason is simple – higher the education, more the remuneration and lower the possibility of being unemployed

https://twitter.com/Prashanth_Krish/status/1327624954192412672

One would rather be employed and paying off debt than unemployed with no debt but no optimism about the future either. While I don’t think that education in itself is everything, it’s a foundation that can help a lot.

Let’s go back to the original tweet. What is seen is the difference in outcomes based on a straight line approach to savings. If you start saving at 20, you are way better off than someone who starts to save at 30 assuming both end at 60. This is not surprising and it’s not just about compounding effects. Person A is saving for 40 years versus Person B who is saving for 30 years. 10 years of savings and the compounding does matter as the chart below shows

There is a very big hidden assumption here. Not only is Person B starting at 30 which is 10 years later than Person A but he is investing the same starting capital. What if rather than invest 10K per month, he is able to invest more?

When he is 30, Person A is investing roughly 16,300 per month (10,000 per month with an increment of 5% per year). If Person B starts his year 30 by investing 31,800 per month (close to double what Person A is investing) which too increments by 5% per year, this is what the chart looks like

Basically, by starting with a higher number, Person B despite starting late is able to catch up to Person A.

But he is investing more, you complain. This is true. My assumption is of course that he has not whiled away his time between the age of 20 to 30 but gathered either diverse experience which helps him earn more or got himself a higher degree which provides a higher salary and hence even with a similar savings rate is able to save on an absolute terms a higher number.

But lets equalize it in a different way – let’s assume that both work for the same period of time – 30 Years. Person A hence retires at 50 while Person B retires at 60. When Person B starts to invest, we assume he will invest the same amount per month that Person A is investing at that point of time and increment 5% per year. Where will they be when they hit 60 years of age?

We are back at Point 1 though slightly better. Person B trails Person A by nearly 50% even though Person A has retired a good 10 years earlier.

But there is another assumption we are overlooking. We are assuming that both of them get similar returns. How much of a higher return should Person B get to catch up with Person A at the age of 60?

The answer to that is 15%. If Person B can get 15% per Annum vs 12% per Annum for Person A, at 60, both of them end with a similar capital.

Here is the interesting thing. Both Person A and Person B can expect 15% from Equities and still end up at the same outcome at the end. The difference though would come from Asset Allocation.

While Person A can have a 60 / 40 Asset Allocation in favor of Equities and reach the number as Person B who is forced to have 100% in Equities. In other words, though both have similar return expectations from Equity, the allocation they need to take will be different.

For Person B to have the same outcome as Person A with the same Asset Allocation, he will need to generate 20.3% from Equities – something that very few have been able to achieve in the long run.

On the other hand, Costs can play a large role in the final outcome. Assume both invest in Large Cap Equity but Person A invests through a Mutual Fund Distributor in a Active Large Cap Fund whereas Person Invests in a Large Cap Index Fund / ETF.

While both of them will hold a similar portfolio {minimum of 80% matching}, Person A is paying a 2% fee vs Person B who will end up paying 0.10%. That is a straight forward gain of 1.90% and actually reduces the requirement for Person B to outperform Person A by that much. To get 15% returns in Equity after fees, Person A has to have a fund that delivers 17% vs Index fund Returns of 15.10%. If you have looked at SPIVA data recently, you shall notice that most Large Cap have it hard beating the Index let alone by that margin on a long term.

When we were young, we were taught the concept and Importance of Savings by stories such as the Ant and the Grasshopper. I don’t think we should deny the importance of a disciplined saving from an early age. But is everything lost because you started late though the barriers are higher.

While I do like the message of saving early being good there is nothing to be scared about if you started out late. Finally, it’s not the amount you have at 60 that really matters as much as the quality of life you have lived. The very fact that you are reading this puts you into the 10% of the population and one that is most likely to succeed as well.

Want to Stress Test your Retirement – check out the simple calculator(s) here. Of course, the assumptions build in here are US related, but should give you a chart of how other paths than the one excel plots.

The Impact of Fees on long term Returns

In the days of the old when Stock Broking was carried out in a ring with people shouting at one another, brokerage as a percentage made eminent sense. Buying 100 shares was far easier than buying 10,000 shares for example. A percentage fee made sense since a higher effort was required to buy such huge quantities while at the same time trying to get it for the best possible price for the client.

Once we moved to computerized mode and we did that once NSE came into existence, this should have gone out of favor but it did not. In fact, one of the reasons I became a broker was the attractiveness of the fees. Placing an order for say 100 shares in the new environment took me as much effort as it was for placing an order for 1000 shares but the magnitude to the income was 10x, 100x if you consider a client who wanted to buy 10,000 shares.

Once online brokerages came into being, this should have vanished since now the client himself did all the work and the broker had nothing to contribute regardless of the size of the order and yet it did not. It took Zerodha to shake things up starting in 2010 but even today, that is not the norm.

In the world of investing though, it’s been a percentage fee all the time even though the effort to manage your money of say 10,000 isn’t very different from the effort to manage another person’s investment of 1,00,000. Higher the investment, the more the fee you end up paying in absolute terms even though there is no real difference in the way you are handled vs the smaller guy.

While we have order based brokerage and flat fee advisory, we are yet to come across any fund that charges a fixed fee and why should they anyway. The barrier to entry is high and one that ensures not every Jill can become a fund manager and even if he does, unless he can showcase good performance over a long time, money ain’t going to flow and the high cost structure makes it a non-feasible venture right at the start.

When the mobile revolution started in India, one needed to pay approximately 24 rupees per minute for every incoming and outgoing call. This fell as competition rose and the number of subscribers grew. Today, we are accustomed to pretty much free outgoing and incoming once you have paid a fixed fee.

What the Cable guys used to charge and continue to charge as is the case with say a DTH operator or OTT networks like Amazon Prime or Netflix charge is based not upon how much you use or not use but based simply upon a fixed fee. I may watch them on a 21 inch television or project them on a large screen, watch them for an hour once in a way or watch them continuously for days – the fee is the same.

A few Portfolio Management Service companies offer a zero management fee but charge a percentage on performance. On the face of it, this seems ideal – I make money only if you make money. His fee structure was simple – Zero Management Fee, a 6% hurdle rate and 25% of the profits above it.

This has been copied by many others though with one unique distinction. Most of them aren’t Warren Buffett. In the years he managed the partnership’s, he had not one negative year. This even in years when the S&P 500 had a negative year. In 1966 for example, the Dow closed with a loss of 15.6% while Buffett generated a positive return of 20.4% for his clients. How many such fund managers are around these days anyway.

To encourage equity investing, talking heads regularly talk about how the long term returns for the Indian market is 15% never mind the fact that Sensex was not even there let alone investable during the star period. But overall, the assumption is that you should get around 12% for the investments you make in equity.

The question is not whether you need to pay a fee and given that we don’t really have a choice in terms of Fee only Investment Products vs % fee based Investment Product, such a question adds no value either. But it’s about whether you are getting value for the fee you pay. If a fund performed in line with the markets, should you pay 0.05% or 2%. Depending on your investment capital, this can run into lakhs of Rupees – not something that should be taken lightly or ignored.

A very well known fund manager recently posted his long term track record of 15 years and it’s impressive. If you had invested say a Crore of Rupees with him when he started, the value of the said investment today would have been before fees worth nearly 14.40 Crore. Post a small 2.5% fee levied year after year, this drops to just below 10 Crores. A 30% cut in the profits.

The returns are still better than if you had invested in Nifty 50 (Total Returns) , so maybe this is okay or is it. As an investor today, you have no clue as does the manager whether he will provide you with an Alpha say 10 or 20 years away while the only guarantee is the fee you pay.

Much of the personal finance space about savings is dedicated to saving on small things that bring joy to our lives but would barely make a dent when it comes to the long term. There are plenty of stories of how instead of buying a Royal Enfield bike you had invested the same in the stock, you could have afforded a Merc maybe. Of course, most of them don’t use LML Vespa (a fairly nice scooter back in the days as an example) since if you had invested in the shares of LML instead of buying that scooter, your value of the investment today would have been Zero.

From a personal point of view, I think it’s important to save where we can and spend where we must.

So, why do we pay. Are investors really that ignorant about the impact of fees on their final returns?

The reason we pay is not because we are generous but because we expect better returns than the market. In a world or market where data cannot be gathered, this could hold true – we don’t know what we don’t know.

But we are in an interconnected world and data to back the fact that not only does fees eat deeply into long term returns is out there but we have sufficient data to show that very few fund managers after accounting for survival bias are even able to beat their benchmarks.

So, why do we pay? Is it Greed or is there something else. Why do funds that have massively under-performed their benchmarks continue to get new investors to bet that the “Worst may finally be over”. Is it Behavioral?

Our Goals are 20 / 30 years out and fees we pay can have an extra ordinary impact on the final capital we aim to reach but one that is less discussed and even lesser talked about.

One reason passive indexing is picking up so much is not only because they are cheap but also because most funds don’t really provide a differentiation that makes the fee worth paying. A fund that is a closet index has no reason to charge anything more than what a passive fund should and yet most closet funds (and the number of such funds will only go up in time) are happy to charge for the Beta while ignoring the impact it has on the Alpha.

As I finished writing this, I stumbled upon this

https://www.bloomberg.com/opinion/articles/2015-04-30/how-fund-managers-take-a-yearly-cut-of-your-savings

and a even better counter opinion

Why do Investment Firms Charge AUM Fees?

Final Thoughts

Writing for me is a way to clear my own thoughts and if it can help someone else, so much the better. As a trader, we once upon a time used to complain that if not for the brokerage we would have been profitable. I should have become profitable once I became a broker myself for there was no brokerage and yet, magic did not happen. It took me a long time to realize the mistakes and rectify the errors so as to speak. So, apologies if this post comes up as a confused one this is not about providing the right answers but trying to ask the right questions.

Portfolio Yoga Monthly Newsletter – October 2020

{This post is an edited excerpt of the October 2020 letter to our Subscribers}. Hope it adds Value to you.

Let me begin this letter with a heartfelt thank you for trusting us. Every business has three phases – The Start-up Phase, The Growth Phase and the Mature Phase. While each of them are individually important, the Start-up phase basically lays the foundation for whether or not the business shall be able to move onto the next phase.

The first few months are always crucial and thanks to your valuable support, I think we shall come out flying. A larger subscription base is not just a morale booster but also provides the capital to invest for launch of new products and services.

A monthly report for Momentum is not easy to write. After all, we have no reasons to provide as to why certain stocks went up or other stocks went down. There is no narrative to assuage that while the returns are sub-standard compared to what you could have achieved in investments elsewhere, our companies are strong, focussed on growth, management quality is…, blah blah blah. You get the drill.

Rather, through these monthly posts, I shall try to throw light on the overall health of the market using breadth and allied indicators that have historically proved to be of value. Many years ago, one of my job functions was to write a report on the markets. As much as I love writing, I am pretty sure there is no real utility to such posts that I see coming even today. An example of this would be, Nifty seems bullishly inclined and may test 12000 but if it breaks below 11620, we can move down to 10780.

There is nothing wrong with the statement perse – if you were to look at the Nifty 50 chart, you shall see that I have used a Resistance as the target, a Support as a trigger and another support as a point the Index may reach. The problem though is, what is the probability that anything of that sort could happen?

Markets are all about probabilities derived from historical data and one that we try to find a way to position ourselves. If we were to believe that a strong bear market is on the horizon, we reduce our exposures and if we believe that a strong bull market is on the horizon, we would wish to take more exposure.

But probabilities in itself aren’t easy to decipher or even provide the right answers. Let’s take Nate Silver who became a celebrity when he was able to correctly predict the Winner in all 50 States in the US elections of 2012. In the 2008 election, he correctly called 49 out of the 50 and even the miss was by a mere 0.1%. But this happened in 2016

Was Nate absolute wrong? Well, the answer is not so straight forward for he did say Trump had a 28.6% chance of winning. Post the 2012 Election forecast and wins, Nate Silver was featured as a prophet with a Mashable heading reading “Triumph of the Nerds”. Four years later, he was literally burnt at the stake. Nate wrote a series of posts on the issue of being wrong. It’s worth a read (Link).

Getting back to markets, Valuation based models such as the Portfolio Yoga Asset Allocator has had a tough time in recent years. Markets have never been as stretched as they are and yet, they are staying at the elevated levels longer than they have done in history. The question to be asked is – have the model broken or this time it’s different.

In the United States, Value Investing has been taken to the cleaners like never before to the extent that well known fund managers are quitting the game. As Momentum Investors, its easy to make fun of other strategies that are facing tough times, but our own historical data shows the limitations of Momentum and the difficulties we may face in the future. Only in Lake Wobegon is it possible for all the women are strong, all the men are good-looking, and all the children to be above average.

This being the first letter to you as our client, this is not to scare you but to provide you a context and enable you to set the right expectations. We strongly believe that Momentum has better odds of winning than a pure passive strategy, but it’s not 100% and we will have our bad days or months while hopefully not extending to years.

But enough of narrative, let’s focus on what the market is seemingly telling us as we go into the US Elections and one that seems to have registered heightened volatility in recent days.

First of – our Weight of Evidence Indicator. Since this is still a work in progress, we don’t have a write up but suffice to say that it has value even though it doesn’t predict anything.

The Weight of Evidence currently stands at -1 which is more or less a Neutral Stance with average historical performance over the coming 22 days being slightly positive. The odds of a positive close is 60%. Average win was 3.70% while average loss was -3.84%.

Our issues start with the Internals though. On 28th August of this year, Nifty 50 stood at 11,647. The percentage of stocks on that day that were trading above their 200, 50 and 10 day Exponential Moving Averages were 74.50%, 84.70% and 70.75%. Today, Nifty 50 stands at 11,642 and the same scores read at 49.60%, 33.35% and 33.10%. In other words, the market remains flat while stocks have been hammered tremendously.

In April, one of our trading systems based on the above data went bullish. On the 21st of this month, it turned bearish. While we don’t expect a market meltdown like we saw in March of this year, markets are losing momentum. As on date just 43% of stocks that we monitor are bullish. This was 61% on that day in August.

Volume demand exceeds Volume Supply (10 day average to smoothen out the daily noise). This is positive for now and we shall track any negative crossovers which accompanied by market divergence can have negative bearing.

The biggest positive for the markets currently is that all the broader indices are trading well above their 200 day EMA’s. As long as reactions are contained well above the 200 day EMA, we feel that we won’t need to change our strategy of rebalancing once a month. The only other reason this could change is if we see very heavy volatility in the coming days.

There is one change in the Multi Cap Portfolio. We exit ~~Globus Spirits~~ and replace it with ~~Astec Life Sciences~~. The same is also recorded in the Monthly Rebalance Information Sheet.

Finally, Novembers have generally been positive. Hope this November is one such November.

PS: Work on our Large Cap Momentum Portfolio is on track and we expect to release the same in November. In addition, we are also working on a Sector Portfolio which is not Systematic but one we believe holds a great deal of promise. More of it later.

Wish to Subscribe? Check out our Philosophy and the Charge here
https://www.portfolioyoga.com/wp/philosophy-services/

The Path and Reason to become a Fund Manager

The other day I received an email from someone who is currently a student but wishes to pursue a line of work that one day will lead to him becoming a fund manager. While everyone of us have their own reasons as to why to become a fund manager and take the trouble of not only having to manage our own emotions that come tied with the funds but the emotions of others, one uniform reason many choose that route is the leverage, something I touched upon in a short Twitter thread a few days back.

Common Thread among all Great Investors

Have a very strong conviction to a process you believe in. It may be Value or Growth, Concentrated or Diversified, Top Down or Bottoms up. The choice is yours, but choose one
— Prashanth (@Prashanth_Krish) October 24, 2020

When we talk about Leverage, we always think of Derivatives for that is how the majority of investors perceive and are able to access. A secondary way is margin trading and finally leverage by way of personal loans and commitments.

Most traders go bust – the odds of long term success is incredibly hard. This is more with traders whose capital is too small to start with and hence are forced to take higher leverage to make it work. A single losing streak of trades is enough to destroy them even if the strategy they are following has a long term positive expectancy.

A few, just about go on making money and losing money with little to show overall for the efforts and time spent. Success is always so close and yet so far for these folks – it’s like the Carrot and Donkey. Always visible just across the horizon, but unable to reach. Yours truly belonged in this camp for a really long time.

Then there are the Unicorn’s, the true blue real deals (and not just Twitter Screenshots). They are incredibly successful (the money of the losers have to go somewhere) and barely wish to be seen. Even with these folks, it’s normal to see some of them just burn out from the day to day pressure that trading forces upon oneself.

How rare are these folks? Well, Nitin Kamath of Zerodha had this to say about Successful Option Traders.

The number of people I know who have traded options profitably for over 10 years = People I know who have started and run a business successfully (adjusted for tougher entry barrier to start a business) for > 10years. Approximately 1 in 10000 or 0.01%. 1/2 https://t.co/dz4LGrTLRo https://t.co/6UR4wtzzQ2
— Nithin Kamath (@Nithin0dha) July 11, 2020

Which reminds me of this scene from the movie, The Mask

While it’s not Luck that takes you from being no one to being someone, Luck is a very important catalyst that you cannot do with. For starters, assume you are both lucky and not lucky. Even the most successful traders have seen very hard times including bankruptcies but have been able to overcome them all.

Leverage as implemented using Derivatives is a double edged sword. You make it good when things are going your way but can end up losing a substantial part of your capital. With the odds of success being as it is, it’s not surprising to see thousands of books, hundreds of seminars and talks and a variety of tools that promise that you can become a better trader. But the truth is that it’s more profitable to sell dreams aka shovels to enterprising traders than become a trader oneself.

The people who made the real money in America's gold rush were those selling the shovels, picks and pails.
— Jim O'Shaughnessy (@jposhaughnessy) July 5, 2020

So, how to get leverage without running the risk of personal bankruptcy if things go south? One way is to become a fund manager. Of course, becoming a fund manager is neither a simple process or a cheap one these days, but who said it’s easy.

Let’s take the case of one Mr. Warren Buffett. We all know his story of how he started earning money delivering newspapers and invested the same. As much a success he was in other ventures such as PinBall machine operator, his big bet on Geico where he invested 65% of his wealth in 1951 among others. He was incredibly talented as well as lucky in many ways. But that was not what provided him the foundation that led him to become one of the richest men in the world.

Between 1949 to 1956, his net worth (Income from Salary / Business) grew at a phenomenal rate of 70% per Annum. But what transformed a substantial (for those times) sum of money to being a Millionaire and later a Billionaire was his partnerships.

In 1956, Buffett started his first of the many partnerships he would have over the coming years. He himself invested $100 while raising 1,05,000 from family and friends (as he has said himself, he had won the Ovarian lottery). To give a context, in 1956 the average income of all families was estimated at $4,800.

Forget for a moment that he had another 100,000 of his own money (but not invested in the partnership). The partnership had no Management Fee but charged a Performance Fee of 25% of the returns above 6%.

Before we get any further, the most important factor to note is that he out-performed the markets massively. Today such out-performance is as rare as an Oasis in the Sahara Desert. Just look at the table below. Literally zero years of negative performance and only in the last year was performance in single digits.

Want to learn more about his Partnership Days? Do check out this book (Link)

From 1957 when he started with his first partnership and later added more on the way to 1969 when he liquidated the same, he grew his Networth from a mere 100 thousand Dollars to 25 Million Dollars.

Would he have been able to grow his wealth and one that was later invested into Berkshire Hathaway if not for his managing other funds? Assuming the same 100,000 was invested in the same way he did for the Partnerships and recorded the same returns, in 1969, he would have been worth nearly 2.9 Million. That is huge but is 90% below where he eventually ended up with.

Okay, so we know that the path to Riches lies in being a Fund Manager, what is the path?

First – A strong Education. Today, nothing less than an MBA with a CFA. The foundation this gives can shave away years of learning on the ground.

Second: Okay, you are done with the Education – what next. Can I become a Fund Manager now?

Well, not so fast. As Yogi Berra says

In theory, theory and practice are the same.
In practice, they are not.

In the MBA class you may for instance learn about the fact that markets are efficient only to come to the real world and see that it’s really not so efficient after all. But the theory from ability to learn about businesses to knowledge about how to read and decipher the complex financial statements will come in handy for the rest of your life.

The common path for many is to join a fund house as a Research Analyst and work one’s way upwards till either he or she becomes a fund manager. While this takes more time that what you may be prepared for, it’s important to have lived through one complete cycle before you get the confidence of managing others people’s money in bad times you may encounter later since you have already passed through the Agni Pareeksha.

Research is categorized as Buy Side Research and Sell Side Research. If you were to join a PMS firm or a Mutual Fund house as a Research Analyst, you are basically a Buy Side Research and one that is the more coveted of the two.

Joining a Brokerage house on the other hand would make you a Sell Side Research. Basically, your Research is not for the firm to buy stocks on its own books but to sell to their clients.

A Sell Side Research report is for instance never complete without a price target. After all, when you ask someone else to buy a stock, they also wish to know at what price to sell. In the buy side, while it’s nice to have a broad target, that is never the focus.

While today we have PMS / Advisory firms from all over the country, I believe that if you really wish to grow in this field a stint in Mumbai will give an impetus to your career that is not possible in most other cities. It’s similar to the fact that if you want to grow in the technology sector, especially in the product side, you are better off in Bangalore than anywhere else even though today we have a lot of product firms outside Bangalore. Once again, the advantages the ecosystem offers can cut down the learning curve substantially.

Most Analysts do not rise to become a fund manager for various reasons. One reason that you can avoid is to become an expert on one particular industry or segment. As much as it’s nice to have a very deep insight into a single industry, do note that most successful fund managers tend to be multidisciplinary.

Finally, keep a public time stamped track record of your investments. Unless you have become a very famous Analyst, when the time comes to ask for money from others, this can help convince them that you are not just one of theory but also have practiced what you preach for years.

The biggest thing I have liked about the Industry is that even if you are not extremely successful or even as successful as some of your peers, the learning this industry provides is unmatched elsewhere. Make your goal one to constantly learn and evolve and who knows what doors open when.

End Note:

Sometime back, I started a Free Slack Group to discuss markets and strategies with like minded investors. If you are interested, Join here

Of Stories, Trends and Megatrends

I grew up on a diet of reading about Successful Entrepreneurs. I was young and naive at that time (and old and naive these days) and the one common thing I saw among these successful Entrepreneurs was that they all started off from a Garage. I always wanted to be my own boss and would you believe, my Grandmother even had a Garage. All I required was to start a business and voila

30 years later, having floundered in 3 businesses I started or co-started off with and with a bit more understanding than I had in my youth, I now know that the secret ingredient behind those successful fellows was not having a Garage.

Yet, in the world of investing, we read about the traits of Successful Investors, try to distill it to a few common pieces of wisdom and believe that if we copy that, we shall be Successful too.

Success has many fathers, Failure is an orphan is a wonderful saying and one that has had profound impact on people and nations. Who doesn’t love a Success story – be it in the Movies or in life. Our optimism is boosted by reading about other’s success and one we hope we can enumerate in our own life as well. But if only life was that simple.

One of the most successful investors of all time is Warren Buffett. While he himself has not authored a single book, on Amazon you can find over a 1000 books where the authors have tried to dig deeper into his philosophy and what it would take for a small investor to be able to be as successful, I doubt how many books talk about the fact that he had advantages a present day investor doesn’t possess.

For a long time, common stocks were perceived to be much riskier than bonds, the investors required that the income from common stocks must be greater than that from bonds. The guy who challenged that thesis was Graham. But old beliefs don’t go away easily and for a long time, investors like Buffett had an advantage that most others lacked.

Today, there is little of any informational advantage you can have over your peers. Today, everyone wants to buy good quality companies, having strong cash flows, a business that is easy to understand and one that is available with Margin of Safety. Basically, everyone wants to live in Lake Wobegon.

In 2016, Saurabh Mukhejea came out with his book – The Unusual Billionaires which provided a good hypothesis and back-test of the Coffee Can strategy. I was impressed enough to invest a portion of my brother’s funds into one such portfolio. The key here is to wait for 10 years – some have been good winners, some haven’t, but the portfolio as a whole has done better than the benchmark I could have invested.

The table below lists the Stocks I purchased, their Price to Earnings at that time and the same today plus the Change in Stock Value.

What is immediately evident is that most of my wins have been massively helped by positive price to earnings ratio revaluation while the losers were because of contraction of PE. While the portfolio has been better than the benchmark, that was because of differential weighting. An equal weight would have underperformed.

Today, the stocks that qualify for Coffee Can have an even higher Price to Earnings Ratio. What if Price to Earnings decrease even as the companies continue growing. Would the strategy still hold water?

What I am trying to suggest here is that there is a huge tailwind if you are able to pick up stocks or a strategy before they become famous. Once a strategy becomes famous, the money that chases it more or less dampens future returns.

A new theme I keep hearing about how Investors can do better is by catching “Megatrends”. It’s not a new word or theme though – John Naisbitt in 1982 first wrote a book titled Megatrends where he tried to outline how to “identify and ride a large trend”.

How nice it would be to know the sector or industry that shall flourish over the next decade or decades and benefit by betting on the same. But is identifying a Megatrend the same as being able to profit from it?

The Internet has changed the lives of Billions and heralded a new way of life for most of us. But identifying this trend was one thing and being able to bet on it quite another. The other day, Devesh asked me if I could recollect some of the stocks that were listed during the heydays of the Dot com bull market. While Bangalore Stock Exchange alone had 50+ stocks listed, so much time has passed that it is not easy to recall. But those I could find, it’s amazing how few of them have even survived to this day, lets not even talk about returns.

https://twitter.com/Prashanth_Krish/status/1319195735393382401

It’s nice if you can spot a megatrend before others do, but it’s not really necessary to be a better investor. In fact, it may actually be harmful. In 2013 – 14, one theme that made all the news was Logistics. With a new BJP government in play, focus on GST and growing eCommerce was supposed to change the companies. Stocks did play it out for a bit. But even if you had identified them early and held till date, your returns would be inferior to someone who identified no such trend but invested in Nifty 50.

We love stories and while they can make for a good movie, stories have a huge appeal as investors for we are not just investing our money but also investing emotions. This makes it a double edged sword, something Investors need to aware of.

Launch of Portfolio Yoga Advisory Services

We at Portfolio Yoga Capital Advisors are excited to announce the launch of our Premium Portfolio Advisory Services.

Investing in stocks directly has its share of risks and one which is very different from what you would experience when investing with a fund. We hope to help you in the path of becoming a successful do it yourself investor by providing not just a portfolio but also the education on how to approach portfolio construction.

We are a strong believer in evidence based investing and our portfolios are built based on deep research carried out by academics and one which shows the persistency of alpha.

We have outlined our Process and the Fee we intend to charge here. Do check it out

Protected: Philosophy & Services

Our Large Cap Momentum Portfolio is available on Smallcase.

Hoping for your good wishes even if you choose not to be a client of us.

Vedanta – Valuations and more…

Unless you have been sleeping under a rock, you know the story of Vendanta that has been splashed all over in recent days. Promoter wishes to buy the company back from its public shareholders. He proposes a price he thinks is a fair price to start discussions with, the biggest shareholder baulks and says the price he is willing to part with is multiple times that, others bid at various prices including a few at 1000 times the offer price. Offer fails – end of story.

The biggest non promoter holder of the shares who had once stymied a similar offer from the promoters came out publicly with his Valuation that was 3.7 times the floor price offered by the Promoter and 2.5 times the current market price. By making this number public, he essentially made it clear what he thought about the company and where he shall part company at.

On Twitter, a controversy has erupted over Mutual Funds that tendered at lower prices than what the biggest Institution had placed. How dare they sell the jewels at a price lower than what the other guy felt it was worth at. Mutual Funds chor hai resonated.

Warren Buffett says that he Invests for the Long Term. But that doesn’t mean he won’t sell when he finds an opportunity good enough to warrant such a sell. Our guy on the other hand is the Baap of Warren Buffett when it comes to Long Term holding. He is willing to bear any amount of pain as he holds stocks for periods longer than anyone else – sometimes even outlasting the promoters.

The biggest advantage of his pool of money that he uses to buy these stocks and hold them forever is that he really doesn’t have to sell just because a client comes calling and asks for his money back. While the source of the monies are its clients, because it’s an Insurance company and not a Mutual Fund, the whole business model of investing is different. The profits and the losses of the investments don’t flow completely to the unit holders.

Mutual Funds on the other hand buy stocks with money from their clients and all the profits and the losses are directly attributed to the hands of the investor. What this means is that the thought process of a fund manager who manages a fund dependent on the public continuing to remain invested differs from someone whose capital is more or less permanent.

Warren Buffett can afford to do what he does because he manages no money for the public in the way Mutual Funds do. This means that he can afford to play the really long game since the only option for his investors who hold shares of his company is to either continue to be an investor or sell the stock to another public shareholder. The cash flows of Buffett is immune to this.

Mutual Funds on the other hand have to provide an exit for their unit holders and if a large portion of them wish to exit, the fund manager has no other option but to sell even good companies at whatever price the market thinks it’s worth even if the fund manager himself thinks the companies are worth a lot more.

Markets are efficient in the long run but inefficient in the short term. This is why active investment strategies work. We buy stocks when we feel they are available at a price which is lower than what we believe the company is worth and sell when we feel they are well above what we think it worth. Whether we make a profit or not though is dependent not on our calculation but if the market thinks similarly too.

The other day, I calculated the weighted average price at which Vedanta exchanged hands since 2005. The number came to Rs.190 even though the range the stock has traversed in the said period is between a high of 495 and a low of 28.

Let’s assume our Mutual Funds guys have acquired the shares at the same price. The current market price is 120 which means their investors are underwater and if an investor exits the fund – he is indirectly booking a loss in Vedanta. Assume all the unit holders of a fund want to exit – the Mutual Fund manager has no option other than selling the stock he owns at whatever price the market asks for it regardless of what he believes the company is really worth.

So, the fund has a buy price of 190, current market price is 120 and the promoters wish to buy back at 90 and a guy with permanent capital who plays a way different game than yours says its worth 320. What price should the fund manager tender the shares?

From the fund manager’s perspective, any price higher than 120 which is where he can sell his current stock at is a “Profit”. The reason I say Profit is because for the fund manager, a 160 Rupee buyback (if it goes through) is worth more than a 320 he thinks the company is worth at but one that may never see the light of the day.

A friend of mine who tried to take advantage of the arbitrage he felt was on offer had an interesting view – the promoter was no different from a value investor – he was just trying to exercise his ability to buy the stock cheap than what it was worth and he better than anyone knows what is worth since he has inside knowledge as also control of the company’s future path.

Vedanta may be worth even more than 320. A blog post sometime back speculated that it’s worth north of 500. The issue though is not what we think a company is worth but what the market thinks it’s worth. Remember, when the time comes to Sell, it doesn’t matter what you think it should be valued at, you shall sell at what the buyer thinks it worth.

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