Prashanth Krish | Portfolio Yoga

Paytm will make investing in Mutual Funds easier, but is it setting up new investors for disappointment

While investing directly in a mutual fund was offered more than 5 years ago, it was a child that no one wanted. Asset Management Companies offered it just to ensure compliance with the rules rather than see it as a way for individual investors to avoid the middle man.

While even today, Mutual Funds are easier to access than say an Exchange Traded Fund, investing in Direct funds wasn’t something that was easy. Yes, we did see new fintech companies come up with a flat fee based subscription, but if you were good with technology, you anyways could have easily bought the same from the mutual fund house website directly.

The first real attempt to reach out to normal mom and pop clients out there was to me enabled by the launch of Zerodha Coin. By providing the ability to buy direct funds through the brokerage interface, it made life much simpler than it was earlier.

Last week, Paytm launched its own offering – Paytm Money which allows anyone with a Paytm account to seamlessly buy mutual funds from its app. With growing usage of smartphones, this can trigger growth like no other.

In fact, Paytm expects to see more than 1.5 Crore investors using its app to invest in mutual funds. Nilesh Shah, managing director, Kotak Asset Management has gone to record to say that he expects Paytm to double the number of investors in a couple of years.

Over the last few years, money has flown into mutual funds like they never had seen earlier. Strong advertising has ensured that even those who may not have been inclined to invest in mutual funds at least have a understanding of what it means.

Ease of buying can always trigger irrationality like no other. The simple way you can buy on Amazon for example means that many of their customers end up buying far more than what they desired to buy or were required to buy in the first place.

Unlike in United States where interest rates are so low that equity makes sense for almost all categories of investors, in India, Interest rates is pretty high and doesn’t really require a massive dose of equity exposure to help you reach your targets.

But Debt funds, especially short term funds where no prediction of the Interest rate cycle needs to be made has always seen fees that are barely there. Mutual Funds are more than happy to sell Equity as the panacea to all ills given that even Direct funds charge on an average 1.5% to manage your money.

The huge inflow of funds in such a short span of time in a market that is not really deep has meant that mutual funds continue to chase the same set of stocks regardless of whether it makes sense or not.

So, we have Tyre companies which historically used to trade at single digit or low double digit valuations now trade twice their historical mean.

We have Fast Moving Consumer Goods companies which can at best growth at a bit higher than GDP + Inflation; selling at valuations that many a stock saw during their peaks in earlier mania’s.

Page Industries, the leader in the premium undergarment segment trade at triple digit valuations even though its unlikely the company can deliver that kind of growth even if everyone is made to buy 2 pairs – one for the morning and one for the evening.

The biggest physical retailer in the world – Walmart for a very long time traded at low valuations below the 20 times earnings. Our biggest listed retailer on the other hand trades at a price to earning ratio greater than 100. While for now, its growth is able to provide some semblance for the valuation, can retailers really grow at 100% or even 60 – 80% as the market expects it to for a long time to come?

Literally everything out there in the market seems expensive and the continuing inflow of funds have meant that they have either stayed expensive till our brains got fried and we joined the herd or have become even more expensive making anyone who used valuation as a measure to justify investing look inept.

The other day, I was at Karvy for some work regarding transfer of securities and happened to overhear the conversation of a couple who had come there to redeem their mutual funds. They seemed unhappy that even though they had been invested for some time, they barely got the returns they expected (or assumed).

The last 10 years has been incredible for funds given the fact that starting point is now closer to the bottom we made in 2008. This seems to suggest that investing for the long run can be very fruitful indeed.

But ten years ago, markets were pricing in more for bankruptcy than for growth. Today, markets are pricing in anticipating that India will grow at record pace. The key reason for such exuberance has to be seen in the light of the fact that while inflow of funds into the markets has shot up big time, the number of investments that are available haven’t.

Abnormally high valuation is clearly not sustainable in the long term. If zero risk debt assets can get you 8% and low risk debt assets can get you close to 10%, the expectation of returns from risky assets such as Equity tends to be much higher and that itself can be a source of disappointment.

Among Large Cap funds, Nifty 100 Total Returns Index has given a return of 12.50% over the last 10 years. The category average return was 11.23%. The last 10 years has been one hell of a bull market in hindsight, will the next 10 years pan out similarly?

The category average return for Ultra Short Duration funds over the last 10 years has been 8%. This means that equities have generated 3.25% more returns which is substantial but one that required a lot of things to come together.

While my recent posts seem bearish in nature, I am not really bearish when it comes to investing with close to 50% of my assets sitting in equity. But my expectations are tempered given the historical experiences I have had.

New investors on the other hand attracted by fancy returns generated by funds in recent past will turn out to be disappointed even though the returns maybe comparable to what should be expected going forward.

For anyone who entered real estate before it became the hot subject of town, returns have been fairly good even though markets have stagnated in last few years. Those who looked at short historical returns and ventured into real estate though have been a disappointed lot owing to setting themselves to wrong expectations.

More new investors I expect will end up having a disappointing experience in equities unless their expectations are tempered to begin with. But in the never ending race to gather assets, who is really looking to bell the cat.

Do you learn what you seek through Social Media?

The website, http://www.worldometers.info/books/ suggests that a book is published every 12 seconds. Number of books published has shot up phenomenally in recent years thanks to coming of age of self-publishing which has democratized the ability of anyone to be an author plus our own desire to be well read.

Writing a book is a serious work. Even well-known authors who are in the flow don’t churn out more than one per year and many an author has not more than one book to his credit. Yet, with a growing population of readers and writers, writing a book is fast becoming the new calling card.

One step below the book would be the Blog. It’s much more easier to churn out a blog post than a book and with no barriers or cost associated with blogging other than your time, Blogs have taken off since the arrival of Blogspot and WordPress.

Googling for the same gets me the answer – a mind boggling 440 Million blogs and counting. While the number of blogs that are active (at least two posts a month for instance) can cut down the number, we are still speaking about a number that cannot be easily wrapped around our head.

Further down the food chain lie the tweets and facebook posts. These require literally zero effort in producing. It’s no surprise to hear that Facebook users upload 300 million photos per day. Just to give a perspective, if they were all viewed in a slideshow with each picture being given 1 second, it would take you 9.5 years just to completely view of one day’s upload.

8000+ tweets are sent every second. In other words, if you sleep for 8 hours, you are missing out on 23 Crore tweets that went out. How many were worth spending time on versus how many were just passing moments that one wouldn’t remember the next hour, let alone the next day?

While these numbers seem like excess, they have also been the catalyst for greater interaction, even if limited to only on these channels with more people than you could have ever have done if you went through your normal life without internet.

From discovering interesting places to visit, books to read, movies to watch – the possibilities of new things are endless.

“Too much of anything could destroy you, Simon thought. Too much darkness could kill, but too much light could blind.” ― Cassandra Clare, City of Lost Souls

Social media is addictive is a well-known fact. The blame lies in how our brains are modelled when it comes to acting on our needs and desires thanks to a chemical called Dopamine. In a 2017 article titled “How evil is tech?”, the New York Times columnist David Brooks wrote: “Tech companies understand what causes dopamine surges in the brain and they lace their products with ‘hijacking techniques’ that lure us in and create ‘compulsion loops’.

As if these weren’t enough to distract us for most of our waking hours, we have applications like Whatsapp which ensure that you never run out of Good Morning Quotes. At traffic junctions, its normal to observe most drivers utilizing the time on scrolling through their Whatsapp time lines.

The best thing about all these great technologies is that you are never asked to buy anything or at least directly. Thanks to falling prices of mobile and data connectivity, it’s never been cheaper to spent humongous amount of time with no feel of regret.

Early on in my own twitter career, the dopamine kick was given by the increase in number of people who followed me. But as the number of followers went up, that wasn’t enough to give me my kick. Rather, I got the kick by seeing how many liked or replied to my cheeky tweets, most of which I wouldn’t remember the next day forget about others.

For all the amount of time I spend trying to impress the thousands of my followers, my reward other than the regular kicks was the fact that my blog did see a bit more volume than it saw once I deleted my twitter account.

But even my best blog posts, never achieved the kind of viral re-tweeting that a random cheeky thought I posted once in a way. Not surprising that one of the accounts I have seen with the fastest growth in followers is an anonymous account who through the day tweets more or less tongue-in-cheek.

On the other hand, well known people in the area of finance who run real money and who can really be a good wall to bounce of ideas from are barely followed. Why follow someone who requires application of System 2 when its so easy to just use System 1 and move on.

Social media is an interesting way to connect with independent thinkers who otherwise may not be well known, but as Social Media has grown by leaps and bounds, finding those guys is becoming the proverbial needle in the haystack problem.

While twitter itself hasn’t been able to monetize to the extent it wishes to, it has helped create a platform for sellers of shovels to whoever is interested in digging gold. From selling software that can give you easy entry / exits to courses teaching the holy grail of trading, nothing is out of reach for the street smart entrepreneur.

Real learning never happens by accident – its always purposeful application of the mind on the subject at hand. Twitter and Facebook are distractions that sway you away from such thoughts for why bother with the hard work when you can get more excitement by posting a tongue in cheek comment.

The role of Incentives and what it means for your Retirement

There is this famous skin Doctor in Bangalore whose clinic is thronged by patients all-round the year. Being famous generally also means that one gets expensive but it ain’t so here, the Doctor Consultation fees is lower than what any other specialist anywhere shall charge.

But there is a catch – you need to buy the ointment he prescribes at the Chemist shop next door. The chemist dispenses the prescription which can be split into two parts. One is the actual ointment, an as I have experienced, this is not one easily available elsewhere. Second is a cold cream which is manufactured by a very famous multi-level marketing company.

You buy both and go back to clinic where the Doctor’s assistant mixes the same, labels it and then goes onto provide you with the next appointment date. While the Doctor fees is generally small, the charge for the ointment is extravagant – especially the cold cream.

You by now would have clearly guessed how the Doctor can afford the small fee and yet earn big. Is this Illegal? Of course, not. He doesn’t really compel you to buy at the chemist next door but I have tried and failed at sourcing the ointment elsewhere, so where else would you really go.

Second, once you accept this as part of the fees, you are okay for your main criteria here is not about paying money but getting rid of the disease that afflicts you.

Is this ethically or morally wrong?

What about if the Doctor charged a much bigger amount as his fee but then recommending medicine that is more affordable and not limited to that one store. Would that change the dynamics for his patients?

Or, what if he charges a low fee but prescribes high cost medicine and gets compensated not by the Chemist but by the Pharmaceutical company by way of tickets to seminars in distant countries or just a direct cut from the sales of the said medicine. Would that make any difference?

Let’s move the discussion to the world of Finance

Stock Brokers for long have chased their clients in an attempt to get them to trade more – higher the trading, more the brokerage. This is of course not in the best interest of the client, but targets have to be met, incentives have to be lapped up – so who is really counting.

While brokerage rates have fallen, even today many a stock broker dealer (the guy who places the order on your behalf) is determined not by how faultlessly he handles the transactions but how much brokerage he can generate.

Don’t we all have an Aunty or Uncle who after becoming a LIC agent would pressurize one to buy a policy which while actually not serving our real needs would help the Aunty or Uncle meet his targets and collect his cut of the cake.

Introduction of Unit Linked Policies took this to an extreme and while the trend has reduced a bit thanks to curbing of how much the agency can pay as commission, the highest and the worst form of financial misspelling still lies in the Insurance Field.

In an attempt to incentivize its distributors to sell its funds, Mutual Funds offer two kinds of payments – Upfront Commission and Trailing Commission

Upfront Comission is paid for any funds received – be they lumpsum or SIP. They range from 1.5% at the higher end to 0.25% at lower end with the Median upfront commission being 0.65%.

Trailing Commission is the commission paid on the value of your investment. This is to incentivize the seller for helping the client stay with the fund. It’s also a kind of ransom paid to ensure that the seller doesn’t take his clients money out at the end of the first year to only re-invest & hence obtain the upfront commission. This commission ranges from 0.75% to 0.25% with the median working out to around 0.50%.

Debt funds, a category of funds that invest only in Debt products with return comparable to Bonds on the other hand has way lower incentives. The incentives themselves depend on the product with Liquid funds which are favoured by corporates getting the least amount while Gilt and other longer duration products commanding a higher fee in recognition of the skills it takes to sell those.

“Show me the incentive and I will show you the outcome.” – Charlie Munger

Incentives aren’t just limited to the ones above. After all, when people complain that Tata Workshops don’t distinguish between the Taxi driver who is driving a Tata Indica and the owner of Tata Safari, Star Distributors cannot be satisfied with financial incentives alone.

A large mutual fund house for example takes its Star Distributors to Omaha to attend the annual pilgrimage that is the Berkshire Hathway Annual General Meeting. While the meeting itself is in recent years broadcasted live, there is a world of difference in attending it live versus attending it from the comfort of your room. Attending at the comfort of your own doesn’t give you the bragging rights compared to what you get when you attend it live.

It’s ironical that they are sent on a trip to Omaha given Warren Buffett’s own views when it comes to Investing. Speaking to CNBC, he said

“Consistently buy an S&P 500 low-cost index fund. I think it’s the thing that makes the most sense practically all of the time.”

How many advisors, whether they visit Omaha or not will dish out this advise to their clients? While its true that in the recent past, active funds have beaten the passive indices, with new changes, do you really think that they will continue to beat forever.

SBI ETF Nifty 50 is the largest fund out there thanks to it being the fund of choice for the Employees Provident Fund Organisation (EPFO). It is also the cheapest fund around and the one with the lowest tracking error.

Over a 3 year look-back, this fund is the 12^th best fund of 68 funds. Most of the 10 above this, the 11^th fund is its cousin – SBI ETF Sensex, we have only Axis Bluechip fund with almost all others ebing passive ETF’s.

Going further, I believe this trend will accelerate with more and more ETF’s and Index funds being in the top decile.

But ETF’s and Index funds have a problem – they are no one’s baby. So, regardless of the returns, barely any advisor will recommend the same to his clients. Over a 10 year period, the best performing large cap fund is Reliance ETF Junior Bees. Its AUM – a measly 515 Crores.

In the United States, this problem has been taken care of my Fee based financial advisors and wealth management firms who have succeeded in breaking the taboo of investing in simple and plain products. In India, you have better luck finding a needle in the haystack than finding a financial advisor who is fee based.

Fiduciary Duty: A legal obligation of one party to act in the best interest of another.

Fiduciary duty of an Investment adviser is similar in thought to the Hippocratic oath that requires a physician to uphold ethical standards. Keeping the objective of the client above oneself is the key trait of the Fiduciary duty.

Time and again, data has shown that Investors exit and enter markets at the worst possible moments. While one cannot time entry to perfection, when one exits in a panic, the reason is not just about loss of money but loss of confidence.

Mutual funds today are being pushed as the answer to all ills with all kinds of numbers floating around on what to expect. Rather than temper expectations which also leads to a better informed client, very long term historical numbers are used to suggest that one can expect to become rich by investing a very small sum today.

The primary reason for disappointment comes from unable to reach or beat estimations that one figured would be reached. When a product is sold with expectations of high returns, any deviation will result in the product being blamed rather than the message.

Recently I saw an advertisement from a fund distributor that saving just Rs.3000 per month could make one a Crorepati in 30 years assuming growth of 12% per year. There is nothing wrong perse with the above statement.

But what is missing and critical is the value of that 1 Crore, 30 years later. Can you buy what is worth 1 Crore today for the same price 30 years later?

In the US, over a 20 year period (1996 – 2016), tution cost went up by 200% even as general inflation itself went up by 55%. Quality education in India is becoming expensive by the day and given our inability to finance, we are ending up with students passing out of colleges without much of the knowledge and experience required by the Industry.

Tution cost for a two year post graduate degree from the Indian Institute of Management currently stands at 22 Lakhs. Add to this cost of living, cost of books, transport among others and we are quickly looking at somewhere in the 30 Lakh benchmark. Even assuming it grows at 6% per year, 30 years later, you shall be looking at something in the range of 1.75 Crores.

In the above advertisement, 12% return is the post expense return. What this actually means is that a regular fund has to generate 14.5% returns to get you 12% returns. Direct fund requires generating 13.5% returns while the ETF needs to generate just 12.10% returns to meet your 12% requirement.

What if instead, we assume that all funds can generate just 12% returns before expense. Assuming you were saving 3000 per month, what would you end up in the 3 different examples?

Even though the savings and the market returns were the same, the difference in returns is staggering. This is the act of “Compounding”. Returns and Fees both compound – one adds a positive flavour to your returns, another negative.

I am a strong believer in Active Investing and while Active Mutual Funds have had an exciting time, the days of strong out-performance vs the benchmark is more or less gone. The culprit may not be the rules as much as their own growth in assets which limits flexibility on what you can buy.

But that doesn’t stop funds from accumulating more and more for higher the AUM, higher the Income for everyone who is in the food chain.

Well, I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther – Charlie Munger

At the Intelligent Fanatics website, a case study was recently posted on the site with a lot of real life examples of how human behaviour was moulded by the wrong kind of incentives. From selling more loans to get meet the incentive plan (sell less than 80% of goal & you had no incentives awarded) to classifying orphan children as mentally disabled since the subsidy by the government was $1.25 per day for an orphan versus $2.75 per day for psychiatric patients.

If my reward to sell a particular fund was a free trip to Omaha, would I really be concerned about whether the fund suited the client or not?

If you are saving for retirement which is 20 / 30 years away, the savings from fee alone can make a huge difference. Remember, at 6% inflation, a Crore wouldn’t go a long way 30 years from now – you will need at least 30 Crores to make the nest count.

Market performance is not something you can control, on the other hand the cost you pay to achieve market returns is very much in your control. The question is, Will you Act?

An Experiment in de-addiction – Deactivating from Twitter

Addiction is what we all suffer from, some from addiction to narcotics, some to alcohol, some to couch surfing. These days, many of us are addicted to social media as it exploded in usage. Facebook is able to get a 500 Billion Dollar Valuation not because it sells something exotic but because it has been able to capture the time and imagination of millions.

“Time flies, whether you’re wasting it or not” wrote Crystal woods and its true then as its now. It’s said on an average, people spent around 50 minutes on facebook each day. An hour a day spent watching countless videos and photographs of people known and unknown.

I have always believed that I am a product of Social Media. I got into Social Media when it was not FB or Twitter that dominated timelines but forums where you spent time reading views of others and arguing the pro’s and con’s.

It was also a period of substantial learning for even though less than 5% of users actually wrote back, those 5% spent significant amount of time to buttress their views and opinions and one that couldn’t be easily challenged.

The arrival of Twitter and Facebook has though demolished such forums for who has the time and inclination to write a 500 word email when you could just post a funny though in 140 characters.

Warren Buffett did not become what he is by reading quotes of Graham but we seem to have come to the conclusion that the way to Nirvana is by reading quotes of the great people while moving in the opposite direction in our own way.

I have been on Twitter for nearly 9.5 years and during this time, have tweeted out more than 56 thousand tweets. For all the time I have spent, I have been able to accumulate a total of 17 thousands followers.

I am without doubt an addict to twitter but once in a while I have always thought as to how much of value it has added to me compared to the amount of time I have spent on reading, replying, re-tweeting the hundreds and thousands of tweets that keep rolling off my twitter stream every single day.

Reading books has always been a hobby of mine from school days and yet somewhere I lost that commitment. Thanks to arrival of Amazon and its patented one click ordering, I have been able to get back to reading.

But reading is tough, it requires one to put aside other thoughts that may try to occupy the mind and focus intensively on the book on hand. Addition to Twitter makes that near impossible for there is always the thought that lurks in the back of the mind even when I am in the midst of the reading – has anyone tweeted to me, am I missing out on any interesting tweet among many others.

My table and book shelf is loaded with books, some of which can really help achieve what I wish to achieve only if I can put in the time required. Addiction to Twitter makes that nearly impossible for the mind is too timid to resist the attraction to reading things that one can relate to or not.

Speaking of reading, I am currently in the middle of Cal Newport’s Deep Work. This is a phenomenal book that explores the impact of new age technologies and how they impact our ability to do what we are else capable of.

People are remembered and honored for what they achieved in their real life and twitter can be real damaging even to those who aren’t as much addicted as some of us. Have a doubt, well just ask Elon Musk.

In the past, I had tried half measures to get rid of twitter’s ability to take-over my time like no other but half measures always fail. It’s taken a long time but as I now understand, the first thing to accept is to accept that one is addicted. Treatment can and shall follow later.

It’s a matter of great pleasure that I am followed by many people who have achieved a lot in their real life. Yet, if at all I wish to get anywhere close to where I want to reach, I need to work smarter and better and this cannot be achieved by being on Twitter 24 * 7.

So, as an experiment, I shall de-activate twitter tonight. Twitter TOS suggests that I will then have 30 days to restore my account. If being out proves too hard, count on it for me to come back. On the other hand, if I can survive the 30 days and be able to accomplish things I want, well, this will be permanent.

“I’ll live the focused life, because it’s the best kind there is.” – Winifred Gallagher

Fee always makes a difference to the outcome. Stop following the Herd

Till the establishment of the National Stock Exchange, anyone who wanted to buy shares approached brokers of the Regional Stock Exchanges who either bought the shares on their own exchange if it was traded or bought it on another exchange on which the stock got traded.

There were two kinds of fees that brokers levied. One was the brokerage which was anywhere between 3 to 5 percent of the transaction amount depending upon whether the stock was traded at the exchange where the broker was a member or on another exchange.

Of course, this was the known fees that were paid by the client. The unknown fees were that of the difference in price between where the share was originally bought or sold and the price reported to the client.

It was not a surprise that Regional exchange membership commanded mind-boggling prices. Most exchanges gave out a limited number of membership cards. The scarcity of the membership card combined with the opportunity to make a bundle meant that come rain or shine, prices of the membership card barely went down.

To compensate for the high fees, each member was allowed to bring in a few more authorized assistants into the trading ring. Even at exchanges where volumes weren’t really great, the price for becoming an authorized assistant wasn’t cheap.

Time and Tide wait for none and so it has been for the stock brokers. First came SEBI which restricted maximum charge that a broker could levy at 2.5%. Establishment of the National Stock Exchange was the real deal breaker when it came to membership prices. Operating on basis of Deposits only, NSE literally pulled the rug from under the feet of other stock exchanges.

Brokerage rates have been on a downward trend since then though establishment of Zerodha in 2010 with its per trade brokerage at first and later going in for free brokerage for delivery trades. Incidentally, the US seems to be catching the same bug with JP Morgan following the lead of Robinhood in offering free brokerage.

The key reason for falling brokerage was not because of the SEBI law which still held brokers could charge 2.5% but because National Stock Exchange removed once and for all the arbitrage held by brokers. Since becoming a broker was now easy and much of the deposit was refundable. Demand and Supply leveled the playing field once and for all.

Few days back, all hell broke through when Morning Star released its Morning Star Global Fund Investor Experience Report 2017.

India has a very good score in many aspects. 100% of mutual funds in India revealed their portfolio’s on a monthly basis, something that no other country in the list comes close. Indian Mutual funds also have the lowest time lag from end of month to release of portfolio holding details at 11 days. The worst is Hong Kong at 113 days.

The key reason for the anger lay in the section of Fee and Expenses. India saw a drop from its previous standing to now be part of the Below Average category. While Fees are indeed higher compared to other countries, Front Load not being present should have added value for they too are a part of the Expense Ratio, at least for the First year of investment.

Its thanks to SEBI in large part that today we are able to enjoy a low brokerage structure that is absent in most other countries. But it’s the same SEBI that seems to be the hurdle when it comes to opening up of the financial sector for competition.

While RBI restricts Banking Licenses making it nearly impossible to compete with existing banks, SEBI by way of minimum capital requirement has made it tough for competition to emerge.

In 2014, SEBI raised the Networth required to become a Mutual Fund from 10 Crores to 50 Crores. In one step, SEBI killed the competition that could have come up with interesting and new products. Over the last few years, we have actually seen a decline in the number of fund houses as small and non-viable firms looked for an exit.

Take for example, the United States where anyone can set up a Mutual Fund with Setup costs typically between $75,000 to $100,000. At the higher end, this is more or less 2x the Per Capita Income (PPP).

Indians are flocking to mutual funds like never before. The key reason is not just the strong advertising that showcases the advantages but the fact that the alternative asset classes was not delivering the goods.

Interest rates had fallen and with it being taxed at bracket levels, Fixed Deposits was not seen as appetizing. Real Estate which long had been and continues to draw investors hit a wall as after years of galloping returns, prices have more or less flattened.

During these times, Equity markets rose like a phoenix and rewarded those who were invested handsomely.

But asset classes don’t always move in a single direction. Equity markets have been going up like there is no tomorrow (these days, its mostly limited to large cap), the earnings which are not rising in the same breadth means that sooner or later, this rally too will fizzle out.

While bear markets are part and parcel of any stock market, paying excess fee can mean that your own returns are sub-optimal even though you may have had the knowledge that many others don’t when it comes to investing in equity.

With no new fund houses on the anvil, active funds in India have the upper hand. But that doesn’t mean that one has to pay through the nose for there are many a simple alternatives – Exchange Traded Funds (ETF’s) and Index funds which while not promoted can in the long term provide you similar returns thanks to their lower fee structure.

While an investor who is clueless about the world of finance may be easy to be misled, why are you, a person who knows better following the herd?

Paying for the Right Advise

The fact that Fees eat up returns is well known and yet there persists an idea that somehow Indian funds are different and that even though they are charging a bomb to manage money, all is well. This undying spirit is being broken as with new regulations, Active funds will find it difficult to beat the indices without doing things differently which in turn can expose them to short term under-performances that don’t easily go well with investors and advisors alike.

We pay fees in many ways – some like in case of doctors and lawyers directly and some like mutual funds indirectly. But pay we must to grease the system on which it runs for there is nothing like a free lunch. This blog may seem free but by spending valuable time which could have been spent elsewhere you are making a payment to me.

Save More, Spend Less is an age old adage that will never get old. The only sure path to savings is by spending less. Spending less doesn’t just mean about cutting down on non-essential spending but also scrutinizing spend in case where it’s not directly visible.

Selling fixed deposits of Banks will not yield you any commission, but Selling Fixed deposits of private companies yields a nice little commission. The reason is not far to seek – Fixed Deposit at Banks doesn’t need selling – it’s a pull product. Since Fixed Deposits at a private company aren’t in the same risk bucket as Banks, they need to be sold – they can be seen as Push Products. Without the guy to push, you on your own may not be willing to park your excess money even though the interest rate looks attractive.

In the world of Equity Investing, Direct Investing is more of a pull product. Stock Brokers have strict regulations when it comes to advertising and with they being nothing more than a conduit to invest in the stock markets, rare are those who actually go out and advertise.

But when it comes to Indirect Investing, the product now becomes a push product. It doesn’t matter how good the product is, if there is no one to push it, the product may soon become irrelevant. Exchange Traded Funds are disliked for the simple fact that no one gets paid to sell and hence if one were to ignore the investment of the Pension funds, the total asset under management is less than what Mutual Funds as a whole gather every month these days.

While much of the world is moving towards paying for advise, our inability to overcome the hurdle of having to pay separately for advise leads us to paying a much bigger fee for advise that may actually be not worth paying for.

Over the last few years, we have seen a mushrooming of fintech companies {so called because they combine finance with technology} who provide an ability for investors to buy into mutual funds.

Recommending funds isn’t as tough as it’s made out to be. Select the top fund houses, select their top schemes and you are more or less done with the shortlist of funds available for investment. Final addition would be to maybe mix and match different market styles so that one has exposure to Large, Mid and Small Cap.

The bigger problem and one that is worth paying money for is Allocation – how much should you invest in Equity and how much in Debt. The percentage should be based on your risk profile, your requirements and finally your ability to stay with it during the bad times.

The best allocation would be one that has the lowest risk and yet meets our goals without one having to sweat it out. If only life was as simple as tweeting or blogging.

Harry Max Markowitz won the Nobel Prize in Economic Sciences for his work in modern portfolio theory, studying the effects of asset risk, return, correlation and diversification on probable investment portfolio returns.

While the theory is cool, it’s practically impossible to come up with the optimal portfolio alloction given the constraints of having to know literally the impossible. So much so, when asked about his own portfolio allocation, Markowitz is supposed to have replied

I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.”

Knowledge of complex mathematical numbers in itself is meaningless if we are unable to control our emotions and no matter how strong we feel we are, we all panic if we have positions that are higher than what is comforting.

Few days back, Josh Brown of the Reformed Broker fame had an interesting blog on “What People will Pay for”. I urge you to read that.

Josh is the CEO of Ritholtz Wealth Management and the stuff they do is not trying to pick the best mutual fund or ETF out there. Compared to India, they have a plethora of options out there, so the focus for them is fees.

At the lower end, they charge as much as the distributor of the mutual fund gets here – just that rather than just pointing at the right fund, they are willing to stick their neck out and provide an asset allocation plan that is suitable for the customer.

10 years back, markets at the current time were on the way down, a month from now, they were spiraling out of control before they finally bottomed one fine day in October. By the current time in 2008, Nifty 50 was down 32% from the peak.

The best fund from that point to today was DSP BlackRock Small Cap Fund which over the last 10 years has given a compounded return of 20.36%. But how many advisors would have advised to buy such a fund and more importantly, advise you to invest enough to make a difference to your Net worth?

If I filter for all funds that today have more than 1000 Crores in Assets ignoring all sector / thematic / ETF’s and Index funds, the Median return drops to 14.40%. Asset weighted return comes in at 15.20%.

Nifty 50 Total Returns for the same period comes to 11%. Choosing other major indices could have given higher returns, but the point as I wish to make is not about returns.

A couple of weeks ago, I ran a poll on how often investors measured the growth of their net worth. Given my inclination to tweet slyly and sarcastically, I wonder if that had an impact for the majority claimed to do it on a daily basis. Literally none of them said Never.

But honestly, do you know how much your net worth – liquid that is – grew in 2017 or has grown in this year? While we measure every other thing to the second decimal, it’s surprising to me that most don’t bother with the growth of their net worth.

Growth in liquid net worth is directly dependent on the split between equity and debt. It doesn’t matter if you have the best mutual funds out there if they constitute just 10% of the total net worth for the end result will be worse than someone who has invested 50% in Nifty (which as per data above is close to 45% lower).

Advisors are dime a dozen – but how many are willing to sit with you, talk through your fears, your goals, your savings and the devise the asset allocation that suits you and the plan you need to follow to get to the goals you have in mind?

Asset Allocations can either be dynamic or static. For long, at this site I have been publishing an Asset Allocation Mix that one could reference as a guide to how much to be invested in the markets. That is a form of Dynamic Asset Allocation.

On the other hand, Harry Markowitz follows what can be seen as a Static Asset Allocation. Both have their advantages and disadvantages and its important to understand what suits your style of investing, your risk temperament before deciding on one or the other.

This is what you need to pay an advisor for. This knowledge is neither cheap nor easy to obtain for it requires one to really understand the ultimate requirement of the client and how best he can be served.

No one knows which will be the best fund with 10 year returns in 2028, but with a good asset allocation plan, you can sleep well in the knowledge that come 2028, you have a certain probability of meeting your goals if returns are as per one envisaged based on data of the past.

Now, that advise is worth a fee.

Investing for Long Term is not possible without building Conviction

When it comes to financial advise, everyone knows what is best for others even though one may not be qualified to handle their own money let alone other people’s money. From Fund Managers to your corner uncle who sells Mutual Funds, everyone believes that investing in real estate is a waste. Gold bugs believe that the doom is just around the corner and if you don’t hold gold and that too in Physical, you are doomed.

Insurance agents believe that investing in Insurance is not a hedge against something (Life / Health, etc) but a way to save money. Then again, if I am paid 20% of what you invest, I don’t think I would be complaining about it either.

On the equity side, we have fund managers who believe in different philosophies and refuse to accept that there is more than one way to skin the cat. So, while some vouch by value, some others vouch by quality. Some believe investing in small cap stocks is the way forward while others believe that you are better off with only large cap stocks.

For a long time now, Gold and Real Estate have been the chief investment products for a large majority of Indians. While it’s easy to decry and laugh at their stupidity in investing in assets, the fact remains that financial advisors generally do not have a clue as to why they do what they do.

Let’s take Real Estate for instance. I recently heard about a person who took a house on rent for a monthly rental that is 6 figures. I was wonder stuck as to why anyone would pay that kind of money till it dawned or rather was educated that despite the high rent, the annual rental was less than 1% of the property’s current worth. Add taxes and the real rental is a pittance on the current value of the asset.

On one hand, that looks stupid, but one also has to admire the conviction of holding onto the asset in a period when there is neither a capital gain nor rental yields. Which of course, brings the question back to market?

Since 1981, Apple has delivered a compounded return of 18% till date. But that kind of return comes with its own pain points. Below is the draw-down from its peak the stock has seen over time.

While draw-downs are one thing, the real killer is the time a stock spends in the draw-down. For instance, Apple hit a new all-time high in 1991, a high that wasn’t crossed till mid 1999 during the Infotech boom.

We have similar examples out here in India as well, from Hindustan Lever to Reliance Industries which have spent lots of time post hitting of a new high before the stock could go back to another new high.

What does it all point to?

For me, it just showcases that investing is not a simple affair where buying a good company can provide you great results. Good strategy can survive but only if you also understand the risk of the strategy in the first place.

Thanks to the enormous weight of FAANG stocks in S&P 500, Value Strategy has been an under-performer in US for a very long time. But should one even compare with S&P 500 if one is trading a strategy that is widely different to the underlying Index?

Would you race a dog and a horse and declare one to be the winner since both have similar body shapes and four legs.

In the world of factor investing, one of the major factors is the “Size Factor”. Size factor is calculated by taking the average return of small cap stocks and subtracting the average return of large cap stocks.

From 1927 through 2015, the US size premium was 3.3%. In other words, if you held a small cap portfolio from 1927, your return would have been higher by 3.3% compared to someone held a large cap portfolio in the same period.

Of course, the very fact that they out-perform doesn’t meant they do it all the time. In the same period of time, the probability of your portfolio under-performing a large cap portfolio after 10 years of being invested was to the tune of 23%.

Since 2013, markets had a tremendous run, more so for the small cap than large cap stocks. While the data showcases an outperformance of just around 3% per year, in this case, we had something like a 3x returns.

This was very well known not to stretch to infinity and beyond though every time it seemed like the rally would end it sprung a surprise. In February I wrote in my post, The Rout – What Now? And I quote

“By the time, the bear market got over, a lot of stocks had seen draw-downs from peak of 35 – 55%, a huge difference from the current falls of between 15 – 25%.”

Among stocks that trade on the National Stock Exchange, around 36% of stocks have fallen greater than 50% from their peaks, another 42% have fallen between 35% and 50%. In other words, nearly 80% of the market is now down from their peaks by more than 25%.

But as I tweeted out the other day, this way of looking at markets has issues. When a stock has risen from say 100 to 1000 and falls to 500, it has suffered a 50% draw-down yet is up 400% from the starting point. A case of Glass being half empty of half full.

Valuation is a better way to look at where markets are compared to where they started from. It’s been nearly 5 years since this rally started and one way to figure out whether markets are cheap or not is by looking at valuations.

The rally from 2013 happened due to two reasons – Reasonable valuation and Trigger of a shift in power from Congress to BJP which was till recently seen as the center of right party. The 2018 fall that has started has started with similar reasons – Unreasonable valuations and Trigger of a shift in power from BJP to who knows whom.

To add to worries we have the US Fed hiking interest rates and swapping up liquidity from the markets. Even here in India, growth of M3 as % of GDP has slumped sharply.

So, let’s move back to our original thesis – why do investors prefer Gold / Real Estate over Equity even though they are not fools to know that it won’t go up in a straight line? Why are they able to stay the course when it comes to Real Estate and Gold while the same person behaves differently when it comes to financial assets like Equity.

The answer in my opinion lies in conviction – they believe they understand better about Real Estate and Gold. This conviction didn’t come from seeing advertisements but from either experience of self and close friends.

AMFI has been funding big time advertising the merits of Mutual Funds under the “Mutual Fund Sahi Hai” campaign and I would give it a lot of credit for the shift we have seen in recent times. But what really helped the campaign was not just that the other asset classes were showing weakness even as equity was delivering.

At best, to me this is borrowed conviction and one that is not easy to sustain if the market undergoes a long and painful correction. At Capitalmind we recently wrote about Insurance and one chart was deeply troubling – more than 50% of the policies closed out by the end of the 5^th year.

Once again, massively misselling means that while its easy to get people in, sustaining them is pretty tough. Would equity mutual funds turn out to be any different?

My guess is as good as yours though I believe that the only people who shall stay is who aren’t swayed by the advertisements but have understood the importance of having equity in their asset allocation matrix.

Finding the edge that works for you is not an easy task and one that can years and decades. But once conviction is build, its easier to deal with stuff like draw-downs and volatility. Till that time, one keeps jumping from one queue to another since one’s queue always seems to be not moving.

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What does it all point to?

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