Prashanth Krish | Portfolio Yoga

The Asset Allocator dials down Risk, Should you?

The simplest and the best asset allocation matrix is not one that brings the greatest benefits but one that you can stick through the thick and the thin. In popular parlance, a 60:40 split between Equity and Debt is the best split you can ever have. All you need to do is once a year or once in two years adjust for any changes to bring the ratio back to 60:40 and voila, you are all good.

The thought process is that having 60% exposure to equity will add value in the upside while the 40% exposure to Debt will ensure a steady boat that is not rocked by turbulence the way a 100% equity allocation will.

Unfortunately, the 60:40 split suffers from the fact that while exposure of Equity is limited to 60%, its volatility is much higher making it seem more like a 80:20 or even a 90:10 portfolio. As I showcased in the previous post (The Surging Balanced Funds – The Good, Bad and the Ugly), Balance funds which implement the idea of such a split have hurdles that aren’t easily to overlook.

In out and out bull markets, Balance funds massively under-perform the Equity funds (CAGR for last 5 years for the Best Equity fund is 32% while its 20% for the Best Balanced Fund) while in a deep swirling bear market; they aren’t too different from what you could have expected from a Equity fund (Drop from peak in % terms). Hence, while you miss on the upside, you more or less are forced to partake the gifts on the lower end.

I have been on this site posting a split for Equity and Debt based on your Risk Profile / Time Horizon (Greater the time available, more aggressive you can afford to be) for quite some time now. This is a contrarian way of approaching investing with risk constantly being removed as markets creep higher without accompanying growth in the companies that represent the market while adding Risk when rest of the market is panicking.

The contrarian attitude of the model cannot be showcased better than what happened in May 2016. At the end of May, the Model started to cut exposure to Equity. But my own indicators were suggesting that rather than dial down exposure, we should add to it since we seemed to be ready for a bull run in the offing (Start of a New Bull Market?)

Yesterday, the model once again dialed down Risk to the lowest since May 2015 when I started posting the model. Yet, just a couple of week back, my own reading of the market seemed to suggest that we may be in for a Melt up rather than a Meltdown as many were suggesting (Fear of Meltdowns and Power of Meltup’s).

This is bound to be confusing since if a strong move higher is coming, now is the worst time to cut down on risk. As much as its horrible to see portfolio’s decline day on day, it’s even tougher mentally to stay tuned to a lower risk profile when every Tom, Dick and Harry seems to be reaping the rewards of the market.

The way the Asset Allocator has been build is not to try and predict future returns but rather try to remove risk as the same gets build up. Currently, based on the inputs the model uses, its indicating that Risk is at a very high level.

On the other hand, the reality is that markets can remain oversold or overbought for more period of time than what we are prepared for. The question that crops-up is, should be really dial down exposure when there is no sign of turbulence on the horizon.

The way I love to build portfolio is to split it into Permanent or Core Holding and Opportunity based Holding. The permanent holding can be mutual funds (both Equity and ELSS) which you are comfortable holding through the up and down and are not looking at it as savings for any objective that isn’t at least 10 years away.

The Opportunity based Holding on the other hand can be based on either Momentum or Value. For my personal portfolio, I have chosen Momentum while for family portfolio’s I manage; I have tried to create a mix of Value and Momentum.

On the value front, I am loaded up on sectors like Pharma and IT. Yes, these aren’t the sector that are to be touched with a barge pole, but for me, by having a exposure to these sectors I hope to have a lower portfolio risk even though the asset allocation maybe well over what is recommended at the current juncture.

Momentum on the other hand is plain and simple. I stay long in stocks that are showing strong momentum and churn the portfolio once a month to weed out the ones that are showing signs of weakness (real weakness or relative weakness).

While the Risk is way higher, the model has an exit clause which when triggered will allow me to cut exposure from 100 to Zero. The risk then is all about how much damage the portfolio will sustain before risk is dialled down to Zero.

The Asset Allocation model I post is not a recommendation but to be used as a input on the current state of the market. While you may feel confident about the future, remember that the path isn’t as smooth as we think it will be.

The key to the best allocation mix is to think deep about how much of a pain (marked to market loss or draw-down from peak) you can absorb and still sleep well at night. Whatever number you can think of, reduce it by 50% for dream and reality can be way different in how we react to the event.

Personally, my own current asset allocation mix is 40:60 (Equity:Debt) and this is a ratio I am willing to maintain for the foreseeable future. What level you should maintain depends on a host of factors that are unique to you and no automated calculator can come up with a mix that is optimal to you.

The Surging Balanced Funds – The Good, Bad and the Ugly

The choices we make are based on choices that we would rather make but are denied – passively or actively.

Most investors would want nothing better than a simple investment products that can provide them the comfort of long term returns that can match inflation. But there is no simple magic wand that can provide the mental comfort that reality requires.

Fear is the starting point for many a investment but once you over-come that, you have Greed that shall let you take decisions that you wouldn’t have taken just a few years ago.

I love movies and some movie dialogues have such a impact that it never bores me to watch it again and again. One such which in the context of his post would be from one of my all time favorite movies – V for Vendetta

I was reminded of this speech when thinking of why there has been a swell of money that is flowing into Balanced Funds. While I can understand Equity Inflows and Debt Inflows, why the sudden surge into Balanced is a question that has been not answered.

For long, Fixed Deposits in Banks / NBFC’s (for those who were willing to take a bit more risk for a bit more reward) were the key places to invest. Stock markets have been there for Decades and we even had a Quasi Mutual Fund that invested in Equity but gave returns and volatility similar to Debt for Decades [US-64 scheme of Unit Trust of India].

With Interest rates on Deposits falling to low’s not seen in a long time, investors are caught between the Devil and the Deep sea. Rising costs, which seem to have very little correlation with the inflation numbers released by the government.

Debt funds make sense for those who are paying taxes on their Interest, but for those who don’t, there is little to differ in returns. This squeeze kind of forces investors who won’t want to take risks to start taking risks many are unprepared for.

Enter, Hybrid Mutual Funds aka Balanced Funds

Balanced funds themselves have been here for long and yet for a long time it was like the unwanted child. Equity lovers didn’t love that it held Debt and those looking at Debt did not want the volatility that came with the Equity exposure of Balanced.

Balanced is a wrong way to define the current genre of funds in the first place. When we use the word balanced, the thought is that its equally weighted towards Debt and Equity. But look at the portfolio of any Balanced Fund and you shall see that most have a Equity Exposure of 70% while Debt and Cash completes the rest.

The reason for that peculiar spread comes down to the Tax advantage gained from having equity at minimum of 65% which makes the fund qualify as a Equity fund. This means, Zero Tax on Long Term Gains and no Dividend Distribution Tax on Dividends.

If a fund had a ratio of 50 : 50, it would be qualified as a Debt fund wherein Short Term gains (Sale within 3 years of Acquisition) is added to one’s Income and hence treated similar to a Fixed Deposit. Post 3 years, it gets a little better since you qualify for Long Term wherein Tax is levied at 20% with Indexation benefits.

To this, add the fact that Debt funds have very little commission payable to advisers versus Balanced where the commission is similar to Equity Funds. Added to this potent mix are funds which are willing to pay Regular Dividends making it seems like there is little or no risk in going for Balanced versus Debt Funds.

With markets on a roll, all the above factors have meant a strong inflow into Balanced Funds. The chart below plots monthly inflow into Balanced Funds (in Rupees Crore).

Balanced funds are good in terms of the investor getting a bit of exposure to Debt along with Equity. But the sale narrative is that these are good funds and comparable to Fixed Deposits with the additional advantage of higher returns thanks to Equity exposure.

“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffett

The disadvantage of Balanced funds comes to the fore if and when the markets crack. While we may or may not see a fall similar to the one seen in 2008, its important to see how the funds held up during the 2008 crisis with a much lower Asset Under Management to get a better understanding of the Risks that a Investor is assuming.

Look at the draw-downs from the peak they had suffered by October 2008. 50% seems par for the course at a time when Nifty was down 60%. So much so for calling themselves Balanced. More importantly, at the end of 2007, Balanced Funds together had assets under management of just 20K Crores versus nearly 190K for Equity.

Today, Balanced funds account for 135K Crores versus 588K Crores in Equity Funds. The ratio has gone from close to 10% to 23%. This growth is good if the investor is looking at risk and returns that are closer to equity funds. But if the investor is looking at this as a Regular Income Scheme, will he be in for a surprise.

A new category of Balanced Funds that have hit the market lately are Dynamic Balanced Funds or Asset Allocation Funds. These funds too hold more than 65% in Equities to qualify as Equity funds but differ in Net Exposure to Equity by holding Short positions (using Futures) thus reducing their Exposure from long positions. In other words, these are comparable to Long-Short funds.

Take the Motilal Oswal Focussed Dynamic Fund for example. Their Long Exposure in stocks is equal to 79.50% as of September 2017. But using Short Futures, they are able to set off 34.75% of the above exposure giving them a Net exposure of just 44.75%.

But since shorts require margins which are kept in Cash, their exposure to Debt comes to just 10%. While the advantage is that the fund can based on its MOVI index (created using a amalgamation of Nifty Price to Earnings Ratio, Nifty Book Value and Nifty 50 Dividend Yield) add or decrease exposure to markets, its low Debt exposure means that any gains will need to accrue from markets.

Balanced funds are good if you want to divest yourself of the responsibility to allocate assets between Debt and Equities to the fund. But if you ratio doesn’t match the ratio used by the fund, you shall end up having a unhappy experience even though the fund would have performed as it should have.

If you are going through a Advisor route, its his responsibility to ensure that your Net allocation to Equity and Debt matches your needs and risk taking abilities. Asset Allocation is much easier and cheaper if you can model it outside.

Investment objectives and Risks of both Equity funds and Debt funds are clear – WYSIWYG , with Balanced though, its neither here nor there.

Fear of Meltdowns and Power of Meltup’s

Yesterday, 19th October 2017 marks the 30th Anniversary of the greatest crash seen in US Markets when the Dow tumbled 22.6% (close to close). Unlike 2008 though, this barely had a impact on the real economy which continued to remained buoyant.

There is once again fear that maybe we are on the edge of something similar – a meltdown of market though unlike in 1987, its unlikely to be a one day affair. While 2008 still evokes strong memory, a risk of 2008 is even lower given that the financial markets aren’t stretched and all the fears of a looming Credit Card Bust / Housing Loan Bust / Municipal Bond Bust dragging down the markets once again seem to have disappeared from the investors and markets mind.

These days, even threats of wiping out America by Kim Jong-un is seen little more than empty threats and are compared to the Boy who cried Wolf once too many times. The smoothness of the rise wherein markets haven’t seen a substantial fall for quite some time is un-nerving for many but then again, a key factor that is also driving markets is the Fear of Missing Out.

While the markets recovered from the 1987 crash by just a year, the psychological impact takes much more time. As markets continue to climb the wall of disbelief, fear turns to envy and finally greed overcomes fear. The final leg of such a rise can be called a “Melt Up“.

Prior to the the final top of March 2000, Nasdaq had doubled from the starting point of 2600 seen in October 1999. Our own Nifty 50 saw a screaming rise of 50% (4000 to 6000) between mid August of 2007 to mid January of 2008. But Melt-up’s needn’t be the end of a bull market as one experienced in early 1986 in the Nikkei 225 (a case of False Positive). On the other hand, Dow in early 2008 barely showed any signals of a Melt-down.

Currently markets are expensive though not as expensive as we had seen in 2008 or 2000. Combined with the fact that FII’s are continuous sellers while the retail is lapping it up (Direct or Indirect barely makes a difference since Retail is always seen as Weak Hands) makes one wonder how long this rally can last.

The period between 1980 to 2000 was one of the greatest for a investor in the United States stock markets. Dow rose more than 10 times in the intervening period while many a stock delivered much much more. But that one event of 1987 raised fear so much that investors were caught flat footed and missed a substantial part of the rally. They did enter in force towards the end just to see entire portfolio’s, most of which were tech heavy, being wiped out in just a year and more.

Participation increased tremendously with share of households who had a stake in the markets climbing from 19% in 1983 to 49% in 1999. While it differs from state to state, it seems that the number hasn’t moved much from there since 1999

There are certain similarities between Indian markets of today and the US of the early 80’s chief among which is the huge rise in investing by retail folks. Mutual funds lapped up the monies as a falling interest rate and rising markets provided confirmation that the only place to invest was in the stock markets.

This has been one of the key reasons for the strong push upwards in both the prices of stocks as well as the valuations they command. Yet, we aren’t at a stage where there is a possibility of a Melt-down, a Melt-up on the other hand cannot be easily ruled out.

Melt-up’s and Melt-down’s some time have a trigger – for instance our own case of Melt-up in 2007 was triggered by the US Fed action of cutting Fed Rates by 0.50%. Or take the case of Nifty closing the day barely seconds post opening in May 2009 in the back-drop of Congress winning more seats than what the markets anticipated.

On the other side we have Melt-downs such as the fall we saw when NDA lost the 2004 election or the fall we saw in late January 2008 when in the space of just a few days, markets went from 6300 to 5200 (at the low’s).

Both Melt-up and Melt-downs generally do not happen without some iota of signalling. While we focus on 19th October 1987 as the day when the bottom gave way in the US Markets, markets were already hobbling in the day’s prior. Same was the case when the final result of the 2004 Elections came in, the markets had already started to discount NDA coming back and all it needed was a last push – something a statement from Sitaram Yechury achieved.

What next for the markets has been a million dollar question for market participants with stories of how investors are breaking fixed deposits in Banks to invest in markets. But the reality (based on data) is something else. Yes, there has been a huge interest in Mutual Funds in recent past but all the money hasn’t gone into equity alone.

Between January and September of this year, Equity Mutual Funds have seen a inflow of 86K Crores while Balanced funds have seen a inflow of 60K Crores. With most Balanced funds having a portfolio with Net Equity Exposure closer to 50%, this can provide a cushion if and when market tanks. On the other hand, this also showcases that even distributors who sell majority of the funds aren’t really comfortable at the current stage of the market and would rather push their clients to lower risk / lower reward funds than what they did in normal times.

On twitter, Experts have been foretelling doom for quite some time and yet markets continue to defy gravity. High valuations can be a factor that leads to a fall but is generally not the trigger. Markets are at all time highs and yet there is perceptible bearishness in the commentary.

While I have participated in both the 2000 rally and bust as well as the rally leading to the 2008 bust, I fail to recall the widespread skepticism I am seeing right now when the markets were peaking out then. One reason for the Skepticism could be the fact that direct investors haven’t reaped rewards as easily as they did in 2000 or 2008. In 2000, Information Techonlogy stocks was what attracted most and man, did they generate returns. Only those invested in old economy stocks were feeling left off.

The rally leading to the peak of 2008 was much more broader than the one in 2000. 8 out of 10 stocks were in strong up-trends. While Infrastructure and Real Estate were key drivers, almost every other sector was a participant in the rally that seemed to herald the start of a new era.

Friends of mine who I know as perma-bears turned to bulls unable to overcome the overall sentiment that overtook the markets. When the fall came, perma bears friends such as those suffered more burns than even perma bulls for unlike the bulls, they entered too late in the game and waited too long before cutting out their positions when the market turned for real.

One reason for the current skepticism is that this has not been a market where majority of the stocks in the market is on a uptrend. Just a week ago, more than 50% of the stocks were not even trading above their 200 day EMA, let alone be making new 52 week / all time highs.

A Whatsapp message doing the rounds credits much of the recent rise to just 2 stocks – Reliance and HDFC Bank. The story spun is that, if only these two stocks hadn’t moved so much, markets would have been negative rather than closing once again at a all time high. Sentiments are negative even though on the surface people claim to be optimistic.

Investors of today are said to be of a different breed than those of the yesteryear’s. While in US, they are moving lock, stock and barrel to cheap ETF’s and Index funds over expensive Mutual Funds, in India, the flow is said to be from Real Estate and Gold to Equity.

As much as I would love to believe that narrative, I wonder if human behavior can really change in such a short period of time. Have we suddenly grown immune to the basic desires that drive us – Greed and Fear?

Bull markets, be they in Stocks or markets in general are accompanied by good stories. Stories of how GST will make Logistics companies valuable beyond imagination drove stock prices of any company associated with the logistics business and yet by the time GST actually was implemented, most stocks are in strong bear trends [Blue Dart is down 48% from its peak, All Cargo is down 26% from its peak, GATI is down 48% from its peak, Snowman is down 63% from its peak among other notable stocks].

Look at the newspapers and you see barely any good news on the horizon let alone India Shining stories. Complications in implementation of GST is seen as dragging down growth, the demonetization coming undone has driven a spike through growth, Modi is seen as becoming defensive. And yet, we have a market at a all time high and a strong Rupee (despite the substantial withdrawal of FII money from markets). Not the things you would tend to hear during the final phase of bull market that has been for more than 3 years now.

To me, these indicate that there maybe a possibility of a melt-up rather than a melt-down which is being anticipated by most. I just don’t see the factors that would be reason enough for a melt-down in the coming days. That said, as I have written in the past, finally it all boils down to your asset allocation mix and how comfortable are you to hold the same even if market cracks say 20% from here.

I believe that I have enough dry powder to take advantage of any such fall while at the same time not risking as much that I shall be one of the sellers as the markets cracks big time rather than being the buyer.

Illusion of Safety

At the Mall I frequent to, a guard uses a hand held device to screen me – front and back. Neither he knows nor I as to what he expects. Beeping is considered normal since Belts / Pens and variety of things cause the same sound. But a illusion is created that once you are inside, you are safe.

Seat Belts and Helmets are compulsory in most cities across India and the world. But do they really make a difference or are they providing a incentive for people to risk more?

In his book, Risk, John Adams tries to showcase as how humans are comfortable with a certain level of risk and if there are new safety mechanisms introduced to reduce that risk, we take higher risk that shall match our earlier risk profile we were comfortable with.

The Risk Thermostat

A model originally devised by Gerald Wilde in 1976, and modified by Adams (1985, 1988). The model postulates that

everyone has a propensity to take risks
this propensity varies from one individual to another
this propensity is influenced by the potential rewards of risk-taking
perceptions of risk are influenced by experience of accident losses—one’s own and others’
individual risk-taking decisions represent a balancing act in which perceptions of risk are weighed against propensity to take risk
accident losses are, by definition, a consequence of taking risks; the more risks an individual takes, the greater, on average, will be both the rewards and losses he or she incurs.

The above chart showcases how we take risks and balance the same based on Rewards & Risk. Unfortunately what it doesn’t show is that Accidents which help one understand “Perceived Danger” isn’t just a stroll in the Park. When they happen, depending on the intensity can set back financial plans of years.

A part of our earnings are saved and where we save is based on multiple factors including future returns. While real estate has always been a place for investing big (dumping all savings plus taking a load of loans), it was only in the years from 2004/05 to 2012/03 that things went crazy.

Doubling of prices became a norm and investments that became 10x in under 10 years a reality. Yet, here we are with prices going nowhere (not yet South other than a few panic driven sales) and lot of projects stuck without being completed.

Mean Reversion is a concept that many don’t understand but holds itself true almost everywhere you go. Gold had a fabulous few years and while we continue to buy, the price is going anywhere but up. Its been 5 years and we are still 15% away from the price we saw in 2012.

Gold tripled in price between 2007 – 2012 but for anyone investing in 2012 expecting similar returns, he surely would be sorely disappointed.

With Gold and Real Estate not delivering returns, the only other logical choice of investments have been the stock market. Where gold left off, Equities have picked up from there.

Last five years have been very good for market and I am not speaking about India alone. Almost every other country is on a unprecedented bull run. Mutual funds have seen good times, but this time around, the rush is crazy for even fund managers to wonder if it makes sense to keep investing or better to close funds for fresh investments.

Since Modi came to power, Retail investors have plunged in big time investing their savings in Equity and Debt Mutual Funds (70% in Equity Funds, 24% in Debt, 4% in Balanced funds, 1.5% in ETF’s and 0.5% in Fund of Funds).

This in-turn has driven up valuations big time though thanks to timely changes by the Index Management committee’s, we still aren’t at 2008 highs not to mention 2000 peaks.

There is optimism in the air and why not – equities have been delivering returns even though underlying companies aren’t really able to deliver on Analyst expectations. And the best part is that despite all the hype, we aren’t even close to bubble territory kind of move.

Mergers and Acquisitions start hitting peaks as Optimism grows irrationally and yet we are still at a stage where one hears about more companies cutting down dead wood than buying new forests. Bubbles need easy money for Promoters to do stupid things.

These days, with Public Sector Banks reeling under Non Performing Assets, they are lucky if they aren’t being squeezed out. Those caught with loans more than what they can afford are trying to unload assets as quickly as they can.

Reliance Energy wanting to sell its Crown Jewel, JP Associates selling off its Cement Plants or they wishing to sell their prime jewel, the Yamunna Expressway, Tata’s literally giving away part of their Telecom business for Free – these aren’t the things you hear if there is a lot of unbridled optimism in the Air.

When a asset class becomes too expensive, the immediate thought is that the only way it could go is for a Crash to happen and in a way, the stock market has been a excellent candidate. Every-time we got over-valued, we have crashed and the next time won’t be any different.

Yet, not all mean reversion happens by way of price crash. Time correction is another way for markets to decompress valuations till they reach the mean (or rather mean meets the price).

When Gold reached its peak in 2012, a investor who got in at the lower end in 2003 was looking at a impressive CAGR return of 24.5%. Today, the same investor if he held to the asset has a CAGR of 9.80% – a okay kind of returns.

Assume gold stays around same place or makes a all time high 5 years from now. A investor who bought and held for the 15 years (remember, buying was at bottom) would be seeing a CAGR of 7.60%. These days, Banks give out as much and that return without a iota of Risk.

Markets have had a wonderful run in the past few years – the future though is uncertain (as it is all the time). Valuations are expensive yet we aren’t close to bubble territory. Foreign Institutional selling is being easily absorbed. We saw that in late 2007 as well, but Mutual fund investments were never so strong at that point of time.

Time based corrections remove the panic but depress the returns. If you are planning your life based on the past returns, maybe its time for you to take a quick rain check. Its never too late to keep some powder dry for no matter how good you think you are, you don’t want to be in a place like Tata Tele found itself.

The illusion of safety in Mutual Funds can make one take risks higher than what he ideally should. Keep track of your Allocation and stay away from exposure that you cannot digest in the next fall – whenever it comes.

Retirement Worries

How much do you need to Retire in Peace? The quintessential question has really no clear answers with answers varying based on their own biases and beliefs.

On the web, a simple search for “How much to Retire filetype:xls” give you hajaar excel files where you need to put in a few numbers and voila, you have a ready-made number that you need to save to get there.

While Excel files are a good place to start, they at the max are dependent on who has framed the question and what he believes in. Some excel files for example ask very few questions and then provide you data on how much you will spend in Retirement while others request detailed queries which you need to answer before a number is flashed.

Someone I know from Twitter and who has built the later style of Excel Sheet had this to answer for my question on why so many queries

“The sheet is complex. Deliberately so. Most investors want piece meal answers and product names without considering asset allocation and its variation. So I would like to focus on that. It is not for everyone”

Some time back I downloaded from the web around two dozen such calculators and tried it out to see the results on what I shall need for my own retirement. Most numbers are close and not surprisingly so.

The other day I had tweeted about a live webinar on Retirement Savings. I myself attended the same though didn’t follow up on calculating what I need. Someone who I have met once mailed me a couple of days back and I quote (with permission of the sender)

“Thank you for sharing the details of the webinar. But after watching it I’m a bit afraid. The gentleman in the webinar says 4 crores of capital is required if I want 50K monthly after retiring. I want your frank opinion – is this really legitimate? or is it some sort or market gimmick from him?”

I wasn’t surprised he was worried. Very few of us are able to earn / save 4 Crores by the time of Retirement. The reason for the big figure lies in the way most Retirement Calculators are build.

The three Key questions that most Excel sheets require your answer are

Your Current Expenditure (Yearly)
Inflation (Estimate until you Retire)
Years to Retire
Life Estimate (End Date)
Inflation (Estimate post Retirement)
Return on Investment (both Pre and Post)

Once you gather all the info, Excel – the greatest invention ever, comes to your aid.

Type in FV(Current Spend, Current Inflation Estimate, 0, Years to Retire) and you shall quickly find out how much you will be spending at the time of Retirement.

Do a similar Query using the output (Expenditure at Retirement, Inflation post Retirement, 0, End date in Yrs) and voila, you suddenly now know how much you will be spending at the death bed.

It’s my humble view that if you can project inflation for the next 50 years, I am sure that you should be considered for the post of RBI Governor for he himself has no clue of what Inflation would be over the next 1 year let alone next 30 / 40 years.

But since we know and if we feed that information to Excel, we immediately know how much we will spend at what year and reverse engineering that, we can easily find out how much to save by the time we retire.

For example, if you today are spending 25K per month and have 20 years to Retire, at the time of Retirement you will be spending 80K per month and by the time you die (95 Years), you will be spending 6.16 Lakhs per month.

Man, Life is so easy once you have figured out all these info for all you now need to do (for majority of folks) is Save, Save and Save with the hope that you shall reach the magical number that Excel has given out.

Most calculators go the Linear Equation way since it’s pretty simple to come up with a number that seems to sound round about right. We are after-all a growing economy and will continue to grow for decades (something very few countries have actually been able to achieve) and hence these numbers should be right, Right?

The fault in these numbers lies in the fact that they are for proving ready-made solution. The reality though is that each one of us will have a different path and one that will lead to a different requirement.

Expenses grow over time and that is true. What is false is that you will continue to spend as much money (Inflation adjusted) even after touching your 70’s and 80’s as you did in the 40’s. The biggest expenditure at those times is Medical for no matter how much you like eating out now, your body will say No to eating out and having the simple pleasures of Life at your own home.

Current Expenditures in that sense have very little to do with Future Expenditures.

Real Estate investment (even for self) is currently a nice mocking subject. SIP better than EMI goes a famous saying. But at 60’s and 70’s, do you really want to move houses because the landlord wants you out every few years.

Yes, Renting is cheaper option these days given the atrocious cost of property. Unlike markets though, corrections in India have been far and few (last most remember is the 1995 price crash). Property prices I am told are crashing left, right and center and yet I find very little evidence to the same. Yes, there have been instances where owing to difficulties; people have disposed off properties at prices lower than what one believed in. But that is nothing more than a panic and one unlike stock markets rarely result in capitulations.

The famous crash in United States of housing in 2007 was due to a variety of factors most of which aren’t even applicable to countries such as India.

The biggest advantage of owning your own house shows up in the Security you shall have in the post-retirement years. Regardless of anything else, the least of your worries shall be getting kicked out of the house due to inability to make the required rent.

A financial calculator doesn’t differentiate between costs that cannot be avoided and costs that can be avoided. Every cost you have now is assumed to remain and keep growing in the years to come.

10 years back, I barely spent any money on Telecom and Internet. Today, it’s a big number. Tomorrow, who knows – it may actually decline rather than increase for disruption is always in the air.

Retirement Calculators also try to include expenses you may need for Children’s Education / Marriage among others. Once again, the thought process is simple. If it costs 60 Lakhs today to do a MS in USA, how much will you need to save so that your child can do when he comes of age.

Once again, we overlook what technology can aid up in. MOOC wasn’t even an acronym few years back, today more and more colleges are looking at it as a way to limit the costs of students who are overburdened by student loans while at the same time being able to deliver quality education.

The biggest complaint of MOOC today is that the students miss out on the Networking / Learning from co-students as also ability to make friends. While the complaint is real enough, by the time your children come of age, we may have found a better solution. Most importantly, this assumes that the child really wants to do a MS in USA instead of something else.

The bigger your requirement is, the more you need to save. While savings are always good than spending, too much of savings always comes at the cost of quality of living. Do you really want to compromise on every small pleasure, read expenditure, today just because a excel sheet says so?

A friend of mine spends an excessively obscene sum of money on vacations (he loves travelling). Yes, he can save more by cutting down on that expense. But at retirement, no matter how big the savings are, his body itself would disallow the free nature of vacations, something he can now do now.

On the other hand, at other places he is as miser as you can be with very little spent on un-necessary items such as Gadgets / Mobiles and Vehicles. In a way, his way of life is Quid Pro Quo.

Today more than ever, we have people and tech that can help up plan our retirement. Whether you plan it yourself or take the help of someone else, question every number and every assumption.

There is nothing like one single number that can solve all your worries, so the key is to make sure you are in the wide band with the best case scenario being of lowest probable expenses and worst case scenario of maximum expenses. The reality would lie somewhere in the middle as always.

To Hedge or Not

When markets crack and they do crack all the time, it doesn’t really matter whether your portfolio is made of high quality stocks or low quality, your portfolio will take a hit. The only difference would be in percentage with high quality portfolio’s tumbling way less than low quality portfolios.

Derivatives were introduced to enable long term investors to take a hedge against short term corrections using options. But using options as a tool to protect portfolio from falls such as one we saw on Friday doesn’t come cheap.

Nifty 50 closed at 9965 on Friday. If one wanted to take a hedge, the best way would be to buy a At-The-Money (ATM) Put Option. A Put option, for those who don’t trade Derivatives, makes money when market falls. With October Futures traeding well above the 10K mark, the ATM option to buy would be the 10,000 Put.

Nifty 50 contract size is 75 and with the strike price at 10,000, this means a exposure of 7.5 Lakhs. In other words, if you have a portfolio that is totally correlated to Nifty 50, buying one contract of Nifty 50 should be enough for every 7.5 Lakhs of Portfolio Value.

But portfolios are rarely correlated to Nifty 50. While last week saw Indices dipping by 1.2%, the Median fall witnessed among Large Cap Funds (Direct) was 1.47% with the worst performer being Taurus Starshare Fund which fell 2.72%.

Nifty Midcap 100 Freefloat Index and Nifty Small Cap 100 Freefloat Index fell by 2.9% each. I would assume most investor portfolio’s fell by as much or more. This suggests that buying 1 Lot of Nifty 50 Put may not be actually enough to protect the downside.

The Nifty 50 10,000 Put of October closed at 135. One unit hence shall cost Rs.10,125. In other words, the cost of Insurance for a month will cost 1.35%. Not bad but then again, one needs to remember that most portfolio’s require more than 1 lot for every 7.5 lakhs of portfolio. At 2 lots, the cost now doubles to 2.70% – an amount that will disappear if Nifty closes anywhere above 10,000 on October 26, 2017

A better way to Hedge?

The risk of hedging using options is that by the time the market falls eventually, you may have run out of patience to keep buying puts and seeing them expire worthless.

A simpler and better way is to reduce exposure by way of Asset Allocation. While we all want to maximize when markets are going up, its tough to bear the pain when markets turn the other. This also means that when markets drop, you have cash to deploy rather than be part of the herd that pained by the enormity of the fall is waiting to just off load at any price.

Markets have changed dramatically since 2008. Any one looking into the past and hoping to invest when markets fall like they did in 2008 has been waiting for a very long time even as markets have gone one way up.

The chart above depicts draw-down from 52 wee highs that were seen in Nifty from 1995 to 2008. While we have more deeper corrections pre-2000 than post-2000, we did see some regular deep cuts. From 2003 – 2008, Indices rose 500% though we did have two cuts of 30% or more.

The same chart but now showing the 2009 – 2017 time frame. Not a single reaction of 30%, forget more. Comparing and Contrasting the two charts suggests that what earlier was 30% is now 20%, what was then 20%, now more of 10% and what was 10% now more of 5%.

Of course, this is no suggestion that we may not see a 50% or higher fall in the coming years – there is nothing like never again. But while probability of a fall of 50% or more is low, that is not the case when market tanks 10% or 20% from the peak.

We saw a 10% fall towards the end of 2016, a year which began with markets continuing to drop and finally bottom out 25% below the peak of 2015.

You asset allocation should take into account, the kind of loss you are willing to suffer if market crack 10% and yet have allocation that you can add more at that point as at the point when markets down 20% and later at 30%. I am using round figures though you are free to use any number you feel is place where you should start investing more.

The final objective needs to be that you are at the maximum exposure you are comfortable at the worst possible time. The negative of this strategy is that you will never be at the maximum for most of the times and that is okay if you understand the thought process is more about enabling you to stay through the journey.

To get a better understanding, here is a table that lists the draw-down in Nifty (from 52 Week Highs) using the Percentile method

What the above two data charts point out is the probability of market draw-downs > 40% from Year high of 52 Highs is pretty slim. Yes, we have had instances of market falling 50% or more, but as the above data shows, the amount of time markets spend there is less than 1%. This Analysis was conducted using data from 1990 to 2017. In 27 years, markets spent less than 14 week below such levels.

Waiting for the proverbial shoe to fall generally means that investors add more risk to their portfolio’s when they should actually be reducing and when that results in disappointment, reduce risk when one needs to add.

Reducing draw-down comes with a reduction in returns but what use are returns of the future if we cannot live through a draw-down? Food for thought?

Value, Momentum and The Risks of Coat-Tailing

Fame is a double edge sword. While everyone wants to become famous, being famous brings its own set of scrutiny and limitations. Take the recent controversy regarding twitter handles followed by Prime Minister Modi. As an Individual, he is entirely at his own liberty to choose whom he wishes to follow and who he doesn’t.

But being the Constitutional head of a Government means that every action he makes is scrutinized, every statement read carefully and every action thoroughly analysed. So, when he follows twitter handles, that is as close to endorsement as you can get on social media (and this is evident as many who he follows have that as a Bio input).

Virat Kohli, the Indian Cricket Captain recently opined that he shall stop endorsing soft drink giant and fairness products because of their association with junk food and racism. That action will cost him a lot of money, but when one is looked up my millions of youngsters, it’s important that one’s action is in line with the broader social agenda.

Of course, Kohli isn’t the first sportsmen nor will be the last to take a stand that in-line with the image he wishes to project to his followers. The rise of Social Media brings its own challenges – people who otherwise would have remained Anonymous have now huge followings with their tweets being critical input for their followers.

And this brings us to the controversy that we saw thanks to a Whatsapp message I received about a tweet by Porinju Veliyath who runs Equity Intelligence India Ltd, SEBI Regd Portfolio Manager. By his own words, he is a Value Investor who tries to dig into companies that are ignored by the analysts due to its size.

Lack of data stop me from making a longer term analysis, but based on whatever data is available at SEBI, he has done pretty well for his clients. Better returns means that he is followed by investors hoping to get some ideas of what stocks to Buy. Not surprisingly, his follower numbers on Twitter have shot up and are now close to 400K mark.

On April 21, 2016 he tweeted about Eastern Threads with the disclosure that he was invested.

Eastern Treads @ 95 | A case study – Many Indian Micro-Caps r getting tranformed, going professional, I’m invested:https://t.co/cmV46MFY23

— Porinju Veliyath (@porinju) April 21, 2016

If one were to look at the Annual Report of Eastern Threads, he was invested for more than a Year though based on twitter’s limited search ability this was the first time he tweeted out the stock.

The difference between Momentum Investors (myself included) and Value Investors comes down to time frame of holding. Value Investors are willing to hold onto companies they believe in for years and even decades. Momentum Investors on other hand are much more fickle, we are willing to stay with a company as long as the stock price is rising, once the rise stops, we are happy to part-company.

Markets move in cycles and this means that it’s rare for any momentum investor to hold for years let alone decades. So, it was indeed surprising to see that Porinju divested his personal stake completely within 30 days of the tweet. (Annual Report provides the dates of Sale)

Here is another interesting data point. This one relates to Nirvikara Paper Mills where Porinju bought a stake enough to trigger interest in the stock by those who follow (RJ Blog wrote on the same here and here). While he continues to hold a stake as on 30^th June 2017, the second post coincided with his sale at a price the stock hasn’t yet seen till date.

Coat Tailing is a concept that originated in the United States with one of the biggest follower of the strategy being Mohnish Pabrai. In 2008, Gerald S. Martin & John Puthenpurackal wrote a paper titled “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway” wherein they showcased that copying Berkshire Hathway from his filings earns significant Alpha. Those who buy into stocks that are recommended (Direct or Indirect) by well-known investors are following the same strategy even though many may not actually know much about the Risks and Rewards of it.

As a momentum follower, I would love trading Porinju picks and the mood in the current market is all about, Buy First – Ask Questions Later. We buy a stock not a business and this means that focus in only on the price of the stock rather than how the underlying business itself is performing.

Porinju has not violated any legal rules. But when one is famous enough that just mentioning a stock will push it to upper circuit, moral and ethical behaviour comes under scrutiny too.

Based on returns he has generated in his PMS, he has generated tremendous cash and goodwill of his clients. But becoming a client of him isn’t possible for everyone given that the minimum capital comes to 50 Lakhs. This means many a follower wishes that he can generate better returns by following what he invests into.

Most replies to his tweet where he sarcastically thanked me and another friend who tweeted more info about it was that no one was compelling anyone to follow / buy stocks he talks about. This is very much true – Caveat Emptor is something that goes without saying. But blaming the victim is always easy.

People who have attained fame and are widely followed which to me means that their actions have to be inline not just with the legal rules but with ethical and moral values that he stands for. When I entered the market, I didn’t come with a MBA or an ability to analyse stocks. The only way to learn – follow the big guys. Same holds true for most newbie’s who enter the market today. Very few start by first preparing themselves – acquiring requisite degrees / experience for investing isn’t a full time activity for many but a way to scale up one’s own savings.

Fame as I said earlier brings it’s own set of requirements that go beyond what one may need to follow. As Spiderman learnt, With Great Power comes Great Responsibility. Large Investors have a greater responsibility to the public than what the law requires.

Caesar’s wife must be above suspicion.

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Enter, Hybrid Mutual Funds aka Balanced Funds

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The Risk Thermostat

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A better way to Hedge?

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