Prashanth Krish | Portfolio Yoga

The Contrarian Fund Manager – Prashant Jain

Peter Lynch is seen as one of the greatest fund managers even though the period where he managed real public money is of a time frame that is extremely short when one compares him with other great fellow investors.

Prashant Jain has been managing what today is known as HDFC Balanced Advantage Fund (but earlier known by other names) for what very few fund managers have managed historically. 1994 to 2022 is a very long period for an open ended mutual fund manager to be at the reins of any fund. The only person who I can name and one who has a phenomenal track record of his own is Anthony Bolton who managed Fidelity Special Situations fund from December 1979 to December 2007.

If you wish to check out more about Anthony Bolton, do check out his book Investing Against the Tide: Lessons From a Life Running Money

Do note that while he was part of the funds since the start (as Head of Equities), he wasn’t the CIO of the funds themselves until a much later time (2001 for HDFC Top 100, 2003 for HDFC BAF and 2003 for HDFC Flexicap). But since he was involved in the decision making process, I am looking at the complete cycle vs only from when he assumed full control.

Note: While I shall use the current fund names, most of them went through different names and objectives in the past.

How does one assess a fund manager whose timeframe of managing money is greater than what the average age of an investor is today. He started at a time when today’s dominant exchange, the National Stock Exchange, just about commenced operations.

One of the complaints that most investors have with fund managers who manage funds, large or small, is that many of them are just closeted investors. In other words, they try to mimic the Index pretty closely and hence generate returns that are no different from the Index but for which one ends up paying a fee that is multiple times that.

Regardless of whether you are a believer in him or not, one thing that most won’t disagree with is that Prashant was less of a closet indexer even though as the size of his fund grew, it obviously would have placed a limitation on where he could invest.

He was lucky too. His bad bets, even with which he was able to closely generate Index returns, came after he had already made a name for himself. If the path had differed and he had made similar bets in the past when he was not really well known, it’s doubtful we ever would have heard of him.

Breaking down the Performance

Let’s start by looking at the yearly performance of the 3 funds he managed vs the Sensex returns. Do note that while Mutual Fund returns are Total Returns, I am using non Total Returns of Sensex since Total Returns data doesn’t go as long back as the 90’s

1999 (when he was not the fund manager) and 2003 (when he was) were blockbuster years for all their funds. The outperformance above the Index can be better seen in the following chart

The first 10 years sees some massive outperformance, the next 6 decent outperformance and finally the last 12 not so much. Geometric Average outperformance for the periods

HDFC Balanced Advantage Fund (then known as Zurich India Equity Fund but started out as Centurion Quantum ) was able to ride the bull in the Dot com bubble and then get off before it all crumbled down. As a result, it gave an incredibly good Alpha both in the years of the bubble and the years when the market fell. When markets rose once again from the Ashes in 2004, the fund was once again able to maximize.

But in the last 10 years or so, the outperformance is basically gone. Do note that I use non TRI to compare but am also using a Regular plan (where the bulk of the money I assume is invested anyways). While TRI is seen as the right benchmark, there is no way to get TRI Index returns and hence a better benchmark would be a Index Fund for that is the real alternative investors could have invested into.

When we are looking at long term trends, starting points can create substantial bias. One way to eliminate and smoothen out to see how a fund performed vs its peer / benchmark is to compare returns on a rolling scale.

Short term comparisons to me are meaningless since there is a lot of noise and factor of luck in the short term. Anything from 5 years and above starts providing good understanding.

The first few years were incredible Alpha generators. Way better way to look at the excess returns would be by way of this chart

For investors upto 2014, the funds continued to produce Alpha. Post that, it declined with 5 year excess returns getting into negative territory.

One reason that is given for the decline is his bad picks (or rather contrarian picks). But the contrarian side was what saved the funds during the dot com bubble phase. So, in a way it evens out.

How about the AUM growth? We unfortunately don’t have much data. Anand Gupta was kind enough to share data from 2012. Here is the growth of assets in the scheme over the last decade

But does the above picture reflect the real change? No. Remember, markets have gone up since 2012 and that organic growth would have moved the AUM higher even without any inflows. We need to remove the gains in assets which came in because of the markets to get a better understanding of the numbers. Removing the gains the fund made, here is the rebased chart

While HDFC Balanced Advantage shows strong growth, one aspect that is missing here is the impact of merger of other schemes into it. The other two have actually lost AUM though point to point AUM is higher thanks to the market’s growth.

80% of the Assets under Management come through Mutual Fund Distributors and the data seems to suggest that they were either moving away from the funds or dissuading inventors from adding more. Either way, its finally returns that are the key to continued investments by clients with even the famed Seth Klarman facing withdrawals after years of underperformance

Managing other people’s money is tough but what attracts the best of the minds is the financial incentives that accompany this endeavor. Higher the asset one manages, more the Income and in a way this creates an incentive to focus more on asset gathering than generating alpha for clients.

It’s doubly tough to be a contrarian fund manager if one is an employee because the risk to one’s career is multifold. Most funds with a couple of decades of history generally have seen multiple fund managers getting the hot seat and then being removed based purely on performance.

The risk of being contrary is that when things don’t work out the way one anticipates, everyone would pitch into say how stupid one had to be to invest and lose money in a stock that even a man wouldn’t touch.

In his most recent memo, Howard Marks talks about taking the path not taken. But the example he uses is of the one guy who took a non beaten path and emerged victorious. Those who take a path that is contrarian by nature and don’t succeed are those we never hear about. Remember, Abraham Wald and the Missing Bullet Holes

India hasn’t had a fund manager managing public equities for the length of time Prashant Jain has been at the helm. Nilesh Shah, CEO, Kotak Mahindra Mutual Fund compared him to Don Bradman of our times.

If you look at his outperformance generated by the funds he was part of in the first ten years, he did have an average that no fund manager of today can match. But if you were to look at his recent ten year outperformance, it would be hard not to see him as Kohli, an incredibly talented batsmen but who currently has been out of form for a long time.

Outperforming the markets today is way tougher than it was two decades back as information arbitrages have dwindled down. Everyone has the same information as the next guy. Stray too far from the herd like what a few managers have tried and you shall be pilloried. This even if you actually end up being right. Only time this works is if you are right and the rest of the world is wrong in which case there will be some grudging acknowledgement. But even there, there are big ‘if’s”. And if they fail while trying to be different and generating excess returns? Remember Santhosh Kamath?

Overall, I would say Prashant will pass off as one of the great fund managers in India. While we can quibble on his value add over the last few years, the fact also remains that at no point of time was his portfolio seen as untouchable by other fund managers. Getting timing right with major trends is enormously tough and there is no shame in getting it wrong as long as his clients get a decent return.

Finally I am reminded of the famous dialogue in the movie Ratatouille

Some reading sources:

2001 article on Zurich India Equity Fund

2010 article on Prashant Jain in Forbes

Investing Style and Perspectives

For #Fintwit India , the favorite whipping boy for a while has been Momentum. While its usual to get whipped when one is on the losing side, this time around even winning doesn’t seem to matter for the guys who follow this methodology are being whipped for paying taxes on their profits.

Most of the persons on the other side follow Value Investing even though there are as many divisions on what exactly constitutes value. Is buying Reliance Communications when it is below a Rupee constitute buying a crap company or a Cigar butt investing?

Its hurting to see a strategy that one believes in ridiculed and more so by guys who seem to confuse between systematic momentum and random buying but calling it momentum.

But the more I interact with people on the other side of the fence, the more I appreciate what they are trying to achieve. It’s not something I may do though there is always a itch to try and identify a stock well before the market as a whole does.

Size is a limiting factor for Momentum. Most fund managers on the other hand are managing money on a size that is 100 or even 1000 times more than what an optimal AUM for momentum would be. There is just no way that even if they somehow were to become believers in momentum can execute the same without slippage killing them.

Almost all great investors one can name can be bracketed as Value investors – it could be deep Value or Growth at Reasonable Valuations or any of the other nuances they may wish to identify with but the approach they take is one where the Valuation of the business takes a predominant role.

All intelligent investing is value investing says Charlie but what is “intelligent investing” anyways. Last year, I bought Tata Elxsi as one of my portfolio stocks. I continue to hold the stock which is up 200% from where I bought. If given no context on how I bought the stock, does it merit being an intelligent investment? Afterall, as Charlie says, all good investing is value investing.

The objective of all styles of investing comes down to managing Risk. Value investing does that by way of buying securities where the buyer sees a margin of safety. A momentum investor on the other hand limits his risk by cutting down on stocks that lose out on momentum.

We have been doing things that are contrary; the things that people tell us won’t work from the beginning. In fact, the only way to get ahead is to find errors in conventional wisdom
Larry Ellison

One of the biggest reasons for why a lot of investors fail is peer pressure. Pressure to do things like the winners do even though they lack the resources that are available to the big guys. Coat tailing is rampant but given our lack of understanding on the reasons and more importantly portfolio construction of the investor we wish to coat tail, our returns will almost surely be worse than the person we are attempting to copy.

Peer pressure of doing things similarly is not limited to investing either. The other day, I, with a friend of mine, visited a famous dosa hotel in Bangalore. If one were to try and list the most famous dosa hotels in Bangalore, this would come Second or Third. The first is so famous that the waiting time these days can be as much as an hour.

One of the trademarks of the most famous dosa hotels is the way the dosa is carried by the server as he comes to serve the customers. Multiple dosas are piled up on one another making it in itself something of a curious sight of its own.

The dosa hotel I went to never had this kind of serving. Dosa’s were brought mostly in a tray and served to the customers. But this time I could see a difference. The server brought in about half a dozen or more dosas piling it one top of the other. But he was when he reached the table next to us clearly uncomfortable and afraid of spilling it all. He asked the customers themselves to reach out and take out the dosas slowly and only when it was reduced to a couple was he more comfortable.

My friend commented on this about how despite being well known, even the hotel was getting driven by peer pressure of doing something that they weren’t in reality comfortable just to make it more similar to the more famous hotel.

Thinking about it made me wonder as to how much of this was related to investing. First we have this benchmark that we wish to beat. Then of course, there are always other guys whose returns we wish to beat.

The pressure of a friend being able to generate a higher return most of the time forces the others to take more risks that they are comfortable with in the first place for what if one’s returns are lower – it would make one look bad or worse.

The pressure of wanting to get rich and rich fast is what attracts most people to derivatives, even those who know that in the long run (which may not be that long in the first place), most derivative traders have blown up their capital many times over. Yet, the attraction of what seems like an easy endeavor from the outside makes one keep trying before most quit – some when they aren’t too behind in the game while many when they are thrown out once and for all. No one really quits when it is working for who does that.

Momentum Investing is fascinating for clients for it seems to suggest that there is a possibility of making a great deal of money, more than what you could do otherwise if you just stick with the system. How hard it is to make the changes once a week or a month says the newbie.

But there is no free money, not in Momentum, not in Value or in Quality. Whatever the additional returns that a strategy makes can most of the time be drilled down to higher risks that were taken and one that got paid.

It’s been five years since I started investing by way of systematic momentum, 15 if I count the number of years I have been a follower of systems (trading and not investing in the past). I think I have a better understanding of the strategy today vs 5 years back. But the real deal is only once I complete 20 years for then I shall surely know whether I did the right thing by following a strategy that is anathema to most but one I believed shall work out well.

It’s tough to be contrarian, but if one wishes to have results different from the herd, one needs to embrace it and accept that one’s path may not all the time be accepted by the peers whose respect we wish to have.

Value vs Quality vs Momentum

I got introduced to Technical Analysis by way of an accident during the time of the Dot Com bubble and I fell in love with it. I loved it for both the simplicity and the fact that the answers were binary in nature with very little between.

Pure Technical Analysis though is as discretionary as with any other strategy. Buy if the stock doesn’t break below 100 but if it breaks 100, expect the stock to go down to 80. Good Luck trying to invest or trade based on such analysis.

Loving the method is not enough, one needs to be a constant cheerleader for how else will the world know that my method is the best. The ability to spread the word during the early part of this century wasn’t easy – no Twitter or Whatsapp or Telegram. So, I did what I could do – started a Yahoo group and given that I still believed myself to be more of an investor than a Trader named it Technical-Investor.

While I may or may not have learnt anything from the group, I did make quite a few friends for life. In a way, my scribbles on the group were also responsible for my first real job when I got a job with Dr. C.K. Narayan. This was kind of a midwife to me for enabling me to meet “Captain Hindsight”, someone who has influenced me and continues to do so .

Technical Analysis for me still is the bedrock for understanding markets. If prices move based on Demand and Supply, it can be only gauged by data.

A reason for me sticking with it is also because of the fact that I was barely able to forecast my own businesses let alone dream of being able to forecast the business run by others.

Not for lack of trying though. I have read most of Buffett’s writing as well as have books written by many well known authors on Value Investing. While I understand the rationale, I doubt my ability to muster enough courage to bet on companies based on the understanding.

Quality is something I have grown to like with a lot of credit for it owed to Saurabh Mukherjea. While most analysts try to showcase quality by way of narrative, SM to me was the first to backtest a simple idea and showcase its ability to generate above market returns for any investor willing to invest for the long run.

To me Value, Quality and Momentum are many sides of the same coin. One cannot exist without the other. In fact, I was recently said that my returns suggested that my portfolio was more of Quality stocks and less of Momentum even though my selection criteria has nothing to do with fundamental aspects of the stock itself

Thanks to @rajanraju26, Attribution Analysis (via Factors) of my personal Momentum Portfolio (last 3 year returns) pic.twitter.com/l4JAPf5tkj
— Prashanth (@Prashanth_Krish) June 27, 2022

Financial Advisors tell you that the risk you should take should not disturb your sleep. In many ways, the method you follow is something that you can sleep with. Every strategy has its positives and negatives. I have in the past tried to showcase the negatives of Momentum Investing for example. Same risk exits for Value / Quality or any other strategy that exits.

There are no free lunches anywhere.

Regulations with respect to Research and Investment Advise

Outside of finance, there are few fields where there are so many intermediaries who try to provide solutions for every aspect of one’s finances be it personal finance or corporate finance.

In the United States, you have Mutual Funds, Registered Investment Advisors and Broker Dealers who perform activities with regard to providing advice to clients with respect to investments in the financial markets.

India has a much fragmented ecosystem with Mutual Funds, Portfolio Management Companies, Registered Investment Advisors, Research Analyst and Mutual fund distributors performing the same functions.

While only Mutual Funds are Product sellers in the US, here PMS can also be categorized as product sellers with the rest being service providers.

A couple of days back, SEBI through its settlement order seems to have suggested that Research Analysts cannot offer Model Portfolios. In a way, this order unless challenged and changed would mean that a Research Analyst can at best offer Buy / Sell on stocks but not provide the client any information on how much to risk.

If one were to look at any sell side research, the reports are what SEBI seems to believe is the way for a Research Analyst to act. While even Sell side these days showcase Model Portfolios, the majority of Sell side is basically about providing a Buy / Sell call on a single company with a detailed report to back up their viewpoint.

The issue though is that a big sell side organization can have a Buy on as many as 100+ securities. There is no way someone can follow this up and build a portfolio of stocks whose aim is to ultimately get returns better than the benchmarks.

So, who is an investment advisor?

If you were to look up the meaning as per US Laws, its;

“Investment adviser” means any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities

Sell Side Research which is freely provided to investors in theory should not come under Investment Advisor since he doesn’t directly receive any compensation for the fees even though the firm may indirectly benefit from getting more business from clients who wish to have access to their research team.

On the other hand, any one suggesting someone to buy a stock, mutual fund, PMS or any other financial asset where the person who recommends is compensated in one way or the other can be seen as Investment advisor.

But let’s back to the core issue – Model Portfolios

The basic idea of providing a Model Portfolio is simple – an investor has a sum of money he wishes to invest. The advisor provides a set of stocks where the said sum of money can be invested. If you think deeply, this is the same that happens when you buy a Mutual Fund or invest in an PMS.

The amount you invest is “theoretically” invested in a set of stocks. While we may not know in advance the stocks and the proportion that is invested in Active funds, we can approximately guess as to how our investment will be invested. This works best for the vast majority of investors for it makes things simple.

When you buy a fund today, you have no choice on what stocks will be invested. If you don’t want to have say the Reliance group or the Adani group, you have very little choice in that matter.

When you hire an advisor and he recommends a portfolio of stocks, there is no compulsion into investing into all that. Let’s assume the advisor recommends buying Mc Dowell but you don’t want to buy into “Sin” stocks. You can easily overcome that by just not executing a trade in McDowell.

The right certification to recommend a portfolio we are told today is that of an Registered Investment Advisor (RIA). But there is a problem. The reason a Registered Analyst (RA) is not allowed to provide a Model Portfolio is because an RA doesn’t do any Risk Profiling of the client and the same portfolios are offered to clients about whose Risk taking ability the advisor seemingly has no clue.

But the way Model Portfolios are built and sold have little understanding of the intention of why SEBI framed such and such a law.

Assume I were to take a Risk Profile questionnaire and the output is that my risk profile is Conservative, should I be able to buy a Small Cap Portfolio? If I can buy, what is the point of taking the Risk Profiling questionnaire anyways.

Is the Investor is Naïve

Thanks to information arbitrage, the retail investor for long has been naïve and have many a time been taken for a ride by unscrupulous dealers. The objective of SEBI was to ensure that the small investor got a fair deal and in many ways they have been able to get that right.

Since SEBI came into the picture, stock markets have become safer and better managed. While we even today have a broker default or two, the numbers are a rounding off error when one compares the number of brokers who used to default in the past.

But this heightened surveillance has also meant a more concentration of market share. So while a broker defaulted a couple of decades earlier did not cause risks to millions of investors, the same cannot be said today.

The way rules are getting framed, I wonder if the only way a small investor can be saved is by killing them beforehand.

If you are active on Social Media, it’s tough to not have read an article or a book by one of the guys who work at Ritholtz Wealth Management. But for all their talk on how investors should act and behave, if you are an investor whose investment is less than a $1 Million, they have no interest in providing you with their service.

All investors require a certain degree of handholding. But if the advisor community is shrinked, there are only so many capable players who remain in the game. Will they wish to have small investors who demand as much time and attention as large investors as part of their clientele?

Once upon a time, India had more than 25 stock exchanges and thousands of stock brokers. Onerous regulations combined with changes in technology has meant that 90% of them have stopped being in existence. While there is a good side to it, the negative is lack of support for anyone who is not tech savvy.

Brokerage rates for investors have fallen to Zero but someone has to pay and this has meant that brokers today try to have more traders as part of their fraternity than investors. Having seen enough people lose in trading, I don’t see how this can end well to the vast majority.

As India grows, the percentage of people who wish to be associated with the capital markets shall grow. What we need is regulations that ensure that the advisor community shall grow to meet the needs and this doesn’t have to stop at just having more Mutual Fund Distributors.

Wish SEBI comes with clear regulations with respect to what and what not a Research Advisor can provide his client with for no small advisor wants to have a Sword of Damocles hanging over their head by way of massive financial penalty. Better not to do business than take that chance.

What to make of the Markets

As with any other beginner, when I started off in the market, I was a Bull. I saw friends short stocks but never got enthused. Long stocks are good in bull markets but bull markets end and when it did and we went into one of the longest bear markets I have experienced (2000 to 2003), I migrated to a trader. Retrospectively with more data today vs then, this was one hell of a bad move.

It took me nearly 15 years to migrate back again – back to the camp of the bull and it has been a good time. So good that I find myself looking at things only from a bullish angle. But we have had a decade of astonishing rise – both in the markets as well as in the size of the central banks that have helped the economy remain afloat during the tough conditions.

This post is trying to, as Charlie says, invert the idea and think about whether I could be wrong.

Markets can go through long periods of nothingness – we have seen that in the Indian markets themselves as they rolled around with no real returns other than a few spurts from 1992 to 2000. In fact, even in 2000, if you were not a participant in the Infotech sector, making money was pretty hard.

We have seen the same in the United States, recently between 2000 and 2010 and previously in the 70’s decade. Does investing, Buy and Hold, Value, Momentum really work during those times?

Data is scarce which means that backtesting is tough (at least in the Indian context, data for the US is available but expensive for theoretical understanding). Compared to the 90’s, Information is not scarce as it was during those times, so the easy opportunities that were found by many great investors will not be as easily found today.

What would trigger such a long term range bound market?

When a bubble bursts, markets first go into a bear market and depending on how the economy manages to hold up can go into long sideways action. We saw this in the US post the bust of the Dot com, Japan is still yet to come out of the bust it saw in 1980, much of Europe (exceptions being Germany and a couple of others) have never risen above the heights they saw in either 2008 or even 2000.

The CAC Index of France was able to break above its high of 2000 only this year. The FTSE of the UK is just above its high of 2000. IBEX of Spain is closer to the 2008 lows among others. Not surprisingly when we talk about International Investing, we focus only on the US and even there much focus is on the Nasdaq for that has generated returns like no other Index has in the past decade and more.

China has been a growth story for the last few decades but if you were an investor in the Shanghai Index, it’s been a literal no growth Index for more than 15 years now. HangSeng is pretty close to the high it saw in 2000.

India along with the US have been the most expensive markets. Russia was the cheapest. But does an expensive market mean we are in a bubble?

The biggest bubble most point out is the Federal Reserve Balance Sheet.

The Federal Balance sheet first ballooned up post the financial crisis of 2008, remained elevated for nearly a decade before rocketing up when Covid hit. But if you were to look at the chart closely, you shall see that it was not the Fed’s Balance sheet that brought about the 2008 crash or even the 2000 crash (data not available on the Fred website).

What brought about both the bubbles is an extended period of low interest rates. But inflation did not spike either of the time. This time around, while we have no bubble (housing prices have shot up in the US but not to bubble territory) in any public markets. Private markets are in a bubble depending on how you look at the valuations there but there won’t be any panic selling, just panic shutting shops when the firms burn through their capital.

Are Indian Markets Expensive?

Expensive Markets are always at a high risk of a crash when expectations of future earnings shift down drastically. Here is the monthly chart of Sensex trailing four quarters price to earnings ratio. While we aren’t cheap, we aren’t anywhere close to the high’s as well. Of course, if future expectations of earnings go down for whatever reason, even this may seem expensive.

Gone up too much and hence markets needs to fall

I keep hearing this and in a way, there is an element of truth there. When markets go up too much, too fast, it seldom has been able to stay at the higher end for long with the subsequent correction being easily to the extent of 20% to 30%. We have seen this in the past – the 2003 rally was followed by the crash in 2004 (narrative being the fall of the NDA govt) though by the end of the year, markets were positive for the year.

The last year the Index had a negative year was 2015, so with 2022 being the seventh year of a bull market, is a deep correction due?

Even internationally save for Japan where Index went closed in positive for 12 year culminating in the peak of 1989, Indices rarely sport seven or more consecutive years of positive close. Currently one of the Index that is positive for the year which is its 11th consecutive year is the S&P MERVAL Index, Argentina’s flagship index. Not sure we would want to mimic their economic performance though.

One reason for the inability to sustain a long period of continued growth comes from the fact that markets are mirrors of the economy and an economy that sees strong growth will generally be over heated to the extent that some cool off is required before the next phase can take off. Japan is an example of what can happen when Central Banks don’t pull in the plug when the economy starts to get overextended.

But if we are to look at India’s growth, or the debt of the Corporate Sector or even the Debt of the government, we don’t seem to be at a stage where excess money supply has chased growth making things expensive for everyone. We saw that in the 2003 to 2008 boom.

Given that Corporate earnings are good, most Twitter Analysts have veered to Macro to forecast doom and gloom.

Macroeconomics is tough. Professional Economists have got it wrong so many times that Paul Samuelson joked years ago, “Economists have predicted nine of the last five recessions. Even when they get it right, the claims are muddied somewhat by how early many would have given such a call.

Take this opening para from the book, The Economists Hour

In 2016, Warren Buffett had this to say on Economists

“I don’t pay any attention to what economists say, frankly,” Buffett said two years ago. “Well, think about it. You have all these economists with 160 IQs that spend their life studying it, can you name me one super-wealthy economist that’s ever made money out of securities? No.”
“If you look at the whole history of [economists], they don’t make a lot of money buying and selling stocks, but people who buy and sell stocks listen to them. I have a little trouble with that,”

But can we dismiss economics as modern day voodoo? As investors, does it really matter a lot?

I believe it does matter. When we study markets, much of our focus other than the local markets is on the US markets. There has been so much inflow of funds into the US from Mutual funds here that they have exhausted the RBI limit on the max allowed.

But this attraction in itself is very new. Motilal launched their Nasdaq 100 ETF way back in 2011 but only in the last couple of years did the assets under management really take off.

First, let’s take a look at why Inflation was on the boil in US (even before the Russia Ukraine crisis sent prices of commodities sharply upwards)

Across two presidencies, Congress approved an unprecedented $5.8 trillion in relief spending that included new interventions such as forgivable loans, direct payments and an expanded child tax credit that was deposited into people’s bank accounts monthly.

The Federal Reserve Balance sheet was 3.8 Trillion USD before Covid crisi hit and the Balance sheet was expanded.

Here is an interesting data point. The Central Banks for most part are behind the curve, they then start aggressively tightening and from being behind they end up being ahead which in multiple cases have resulted in a recession. The way out of recession, to again aggressively go back behind the curve.

From the book,. The Great Crash 1929 by John Kenneth Galbriath

Speculation on a large scale requires a pervasive sense of confidence and optimism and conviction that ordinary people were meant to be rich. People must also have faith in the good intentions and even in the benevolence of others, for it is by the agency of others that they will get rich.
In 1929 Professor Dice observed, The Common folks believe in their leaders. We no longer look upon the leaders of the Industry as glorified crooks. Have we not heard their voices on the radio? Are we not familiar with their thoughts, ambitions and ideals as they expressed them to us almost as a man talks to a friend? Such a feeling of trust is essential for a boom. When people are cautious, questioning, misanthropic, suspicious or mean they are immune to speculative enthusiasms.

In late 2007, things in India were going so well that any doubts of a crash were not even considered as possible. Yes, there was some issue with the housing market in the United States but its impact was seen as being limited to the US. Decoupling was a word that CNBC commentators started to use to claim why Indian markets were continuing to rise even as the US markets had started to react.

The last time I remember such enthusiasm was in the Dot Com bubble and for a short period in 2004 when India was supposedly shining.

Markets have seen a significant rise in the last 18 months. That combined with low interest rates and high inflation seem to suggest that the future will be tougher. Question though is how tough and how steep a fall should we anticipate from here.

The Federal Reserve has started to hike rates. The last couple of days’ fall in the stock markets can be directly linked to the hike. But as Powell seems to suggest, they will not go all out hiking Interest rates to the extent of pushing the economy into a deep recession.

While we have seen deep corrections in the past, its tough if not impossible to predict normal corrections where there is no bubble visible. Even when bubbles had been visible, for example the housing bubble, timing was the key and it’s doubtful to have been able to time ot a T.

My personal view for now continues to be bullish. I see no reason to jump out. Breadth has started to decay but is still well within the historical range. The icing on the cake will be if Oil starts to come down.

Roundup of Five Years of Momentum Investing

While everyone wants to take the road not taken, safety lies in the road everyone takes. Fund managers would rather be called out as closet managers than be criticized or worse fired for striking a new road which unfortunately did not lead to expected returns.

Momentum has been around for a long time if you were to consider evidence from the world of Technical Analysis and yet other than in recent times, there was no real interest in pushing this as a way of investing.

In most parts of the world, Momentum Investing is seen as buying stocks where one is looking at Momentum in Earnings. In India, much of Momentum Investing is basically betting randomly on stocks that are going up. While both strategies have their positives and negatives, the one that got me interested was more with respect to price based momentum but where rules are defined.

The biggest advantage of quantitative momentum lies in the simplicity – both in the approach as well as in execution. While the original rule has been slightly tweaked, the strategy that was worked out 5 years back is still working fine as a fiddle.

With the rebalancing being monthly, what this means is a lot less stress. While shorter rebalance periods have their advantages, one that really showed its worth in the month of March 2020, the trade off is a lot more churn and impact costs that add up over time.

Evaluating a Strategy

At the beginning of 2018, a fund manager who was practicing a strategy that was not inline with what most investors believe was having a gala time. His 5 year CAGR was a mind blowing 43%. A 40% return will have you owning the entire stock market in ~60 years (Link)

It’s been 4 more years since then and the calculations seem to suggest that the high of 2017 is yet to be broken. The 9 year CAGR is now 20% – not bad but only if one had invested in 2013. An investor from 2017 would be barely breaking even.

So, what is a reasonable time to evaluate a strategy that goes against the grain of thought? Meb Faber says it should be a minimum of 10, better 20.

9. A reasonable time frame to evaluate a manager or strategy is 10, maybe 20 years.
— Meb Faber (@MebFaber) March 19, 2019

Or take this view expressed by Jim O’Shaughnessy in his Masterclass book, What works on Wall Street

Short Periods are Valueless

Consider the “Soaring Sixties.” The go-go growth managers of the era switched stocks so fast they were called gunslingers. Performance was the name of the game, and buying stocks with outstanding earnings growth was the way to get it.
In hindsight, look at how misleading a five-year period can be. Between December 31, 1963 and December 31, 1968, $10,000 invested in a portfolio that annually bought the 50 stocks in the Compustat database with the best one-year earnings-per-share percentage gains soared to almost $35,000 in value, a compound return of more than 28 percent per year. That more than doubled the S&P 500’s 10.16 percent annual return, which saw $10,000 grow to just over $16,000. Unfortunately, the strategy didn’t fare so well over the next five years. It went on to lose over half its value between 1968 and 1973, compared to a gain of 2 percent for the S&P 500.
More recently, the mania of the late 1990s provided yet another exam- ple of people extrapolating shorter term results well into the future. Here, it wasn’t “gunslingers” pouring money into just the stocks with the highest gain in earnings, but rather new-era disciples pouring money into Internet compa- nies that in many instances had little more than a PowerPoint presentation and a naïve belief that they were going to revolutionize the economy. In both cases, things ended very badly.

The oldest Momentum ETF in the USA is Invesco DWA Momentum ETF which started off in March 2007. The performance though has been severely disappointing with the fund being beaten by its chosen benchmark literally every year in the last 10 years

iShares which launched its own Momentum ETF in 2013 has done slightly better but still underperforms Russell 1000 Growth since Inception.

AQR Large Cap Momentum Fund has underperformed the same benchmark since inception though last year the fund did slightly better vs the Index.

On the other hand, the recently launched UTI Momentum 30 Index Fund has more than comfortably beaten Nifty 200 (which is a good benchmark to compare against).

Does this mean that Momentum works better in India than in the US?

Corey Hoffstein had this to say on why Momentum in US has lost its Mojo in recent times

At any given time, approximately 31% of our portfolio is allocated to a basket of high momentum U.S. equities. Within the context of the broader portfolio design, this sleeve seeks to generate alpha, particularly during bull markets. Unfortunately, since early 2021, it has dramatically underperformed the S&P 500
What makes momentum distinctive, as a factor, is that it is a chameleon. If quality stocks are doing well, it may buy quality. If expensive, junky stocks are doing well, it will buy expensive, junky stocks. If the stocks of companies who have CEOs that have red hair are doing particularly well, it may buy those stocks, no questions asked.

Momentum in India too will face the same issues at some point of time in the future. It’s a feature of momentum and not a bug.

While it’s too early to call, the fact remains that while Indices may showcase strong returns, the ability to replicate it without transmission costs (read as tracking error) is not yet fully tested. Recently Nifty Alpha 50 had included stocks that on the day of rebalance were frozen in upper circuit limiting the ability of the ETF’s that track it to buy the same. Misses such as these will overtime widen the difference between Index and the ETF.

Here is the yearly divergence in percentage terms of Nifty 200 Momentum 30 Index vs Nifty 50. While 2021 was an outlier, the Index has performed massively better over time with few exceptions.

Lets go a step further and add Nifty Small Cap 100 Index Returns (again, the difference and not the absolute returns).

Given that the philosophy and even the strategy is pretty similar, it’s doubtful that Indian stocks are better acclimatized with respect to Momentum vs in markets such as the US. What we are seeing especially in the case of UTI Momentum 30 fund for example could be a case of one off years that happened to be the first year of its existence too.

In almost all strategies, Size is a constraint and this can be a real killer for almost all strategies. From Warren Buffett to Peter Lynch, their Alpha deteriorated once the AUM started to go beyond a certain size.

Compared to Value strategies which have a low level of churn and hence higher allocations can be done over time, the same is not true for Momentum since the holding period can be quite short and one would want to enter and exit without either delay or moving the prices due to our own actions.

Take for instance a stock that has a daily trading value of 1 Crore (Shared traded multiplied by the Price) on any specific day. If one is a Momentum Investor, it’s unlikely that you can buy or sell anymore than 10 Lakhs at maximum without distorting the price.

So, how many stocks will fit the bill. Do note that the data is of current and current volumes as I shall show later on are much higher than what they used to be.

Assume you have a 20 Stock Portfolio with equal weights. So, at 1 Crore Capital, you will buy 5 Lakhs of a stock. If you want to buy no more than 1% of a stock’s daily volume (note that the delivered volumes are actually much lower), you have just 753 stocks to choose from. If you are willing to stretch that and buy say 10% of a stocks volume, this expands to 1373 stocks out of the total stocks of approximately 1800.

While Individual Investors have small capital, this doesn’t seem to be an issue. But if money is being managed, this can and is definitely an issue. The higher the AUM, the lower the number of stocks that are available.

This was an issue that was addressed even by Warren Buffet. His quote,

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
Warren Buffett

Of course, you can buy a greater quantity of a particular stock but as Bill Hwang experienced, at trading in large volumes on a given day – at percentages of more than 10% to 15% of the daily trading volume of a specific issuer – would create upward pressure on the share price and often result in the share price increasing.

The problem accelerates when it comes to selling for it works in reverse. You can always say, I shall sell over a period of time but remember, Momentum stocks are sold when they have lost Momentum. This means that the stock that one is exiting is generally weaker in the short term and a strong pressure of selling can topple it more than what it would have done without that gust of selling.

This is a problem that confounds not just Momentum players. ARK through its multiple ETFs has managed to accumulate a large percentage of equity of stocks that got pushed up because of their own buying. Now that money is on the way out and the only way to raise funds is to sell the same stocks for otherwise they will become too big a percentage of the portfolio, the same are now toppling back at double speed.

Advisories are able to get around this issue by just counting the model portfolio returns. Question though is, how much are the clients making? Given how many low liquid stocks make it to the portfolio and orders placed at market, my own guess is that it’s big enough to make a dent. In bull markets, these things are easy to ignore but can markets be bullish forever?

Smallcase recently changed the way it calculates returns and portfolio returns showcased suddenly saw a big spike down. One small case I tracked fell 25% in a day. But one wonders, is even that number a reality?

Slippage is an invisible killer. It doesn’t show up on your contract note but can damage more than Taxes and Fees put together.

Performance Data

On my personal account, I have been trading using Momentum for the last 5 years. What started as an experiment is now the whole and sole manager of my equity exposure. The figures, tables and charts below are based upon that data.

Monthly Returns

I have been posting personal monthly returns on Twitter since August 2019. The idea of posting came from the way CTA’s in the US post their monthly returns. A major reasoning though is to showcase that Systematic Momentum can deliver the goods. While we lack the narratives that accompany other strategies, the final arbiter being returns, I hope that a long term performance record inspires others

Rolling CAGR

In India, Motilal Oswal made famous the 10x in Years. To achieve this, one needs to compound on an average at 24% per year. Right now, we seem to be on the right path though who knows how the next 5 years shall pan out.

Drawdown from Peak – for the Momentum Portfolio vs Nifty 500

Drawdown in the years between 2018 to 2020 had been much higher than the drawdown that has been seen hence. My own expectation is that we should see a divergence once again in the future.

Equity Curve

While the strategy seems to beat Nifty 500 by a fair distance, there have been funds that have in the same period delivered pretty excellent returns but there is always the question of whether (1) Could we identify them beforehand and (2) how much could we allocate to such a fund.

Point to Pont Returns of the best Mutual Funds (Excludes Sector & Thematic Funds. Direct Schemes)

As I have written in one of the past annual letters, my objective is to be in the top quartile if not the top. For now it seems to be accomplished thanks to the huge pushup given by small cap stocks since the Covid Crash. In fact, the returns for the Momentum Fund could have been easily obtained by just buying and holding a Small Cap Index Fund post the Corona Crash.

While much of the Alpha for Do it yourself Momentum I believe comes from exposure to small caps, the advantage of Momentum strategy is that when the small cap starts to break the trend, we scale down the positions as well. The chart below shows the exposure to Large Cap, Mid Cap and Small Cap at end of every quarter

As you can notice, exposure to small caps was just 21% at the time of the Corona Crash. This shot up to 77% in the second quarter of 2021 and has been falling steadily since then.

Exposure to small caps did increase volatility by a slight margin. Since the start, Volatility for the strategy is 15% vs 12% for Nifty 50 and 11.50% for Nifty 500

Unlike fundamental portfolios, the holding period of Momentum portfolio tends to be on the lower side. The median holding period came to around 3 months.

During the 5 years, have traded around 275+ stocks of which just 120 stocks had a profitable exit. In fact, the combined profit for the strategy (booked profits) came from just 22 stocks.

The biggest worry for investors is high churn. Momentum is a high churn strategy but as the table below shows, churn is pretty consistent other than for a few exceptions

One new test that started in 2021 was with buying a portfolio of Nano Cap stocks using Momentum. One year and bit more down the lane, the results aren’t something really outstanding given the amount of risk involved. But results being decent means that its worth studying.

Overall, for the amount of efforts required, the returns are more than decent and wile it maybe years before one can be sure that we made our money not due to luck, the trend seems to be good for now. Until next year..Adios.

Worst Rank Held – Return Variations

In Momentum strategies, one of the ways to reduce churn is to implement a worst rank held strategy. Let’s assume that the strategy picks the top 30 stocks. In the coming month if one of the stocks that is currently part of the portfolio (previous month being ranked in the top 30) is now ranked 31? Should you remove the stock and replace it with a stock that is currently in the top 30?

Stocks are ranked based not just on their own behavior but also the behavior of others. What this means is that even a stock that is doing good can get deranked if another stock does slightly better than this.

One way to avoid such unnecessary churn is to implement a worst rank held feature. Instead of throwing out a stock that is ranked 31, we can by having a feature such as worst rank held, decide to hold the stock until the rank falls below say 60 (or any other rank that you may be comfortable with).

The biggest advantage of having this is the reduction in churn. But nothing comes free and there are always trade-offs. For example, when you retain a stock that is currently ranked say 50, you are also not selecting a stock that could be ranked in the top 10.

As the chart below shows, top winners outperform the next set of winners who outperform the set below them and so on and so forth

So, when we choose to retain a stock that is currently placed at rank 35 for instance, are we in a way dragging down our own returns?

We decided to test it out and see for ourselves.

First, the equity curves plotted against each other.

The No Worst Rank held beats others comprehensively. But lets dig a bit further

The broad statistics

CAGR is best when there is no worst rank held and goes down as we increase the ranks til which a stock is allowed to continue.

But look at 60th rank as the cut off. While the CAGR is lower than for no worst rank, there are large improvements on every other score.

Median holding goes up from 2 months to 4 months, number of trades reduces by 36% and we get to ride on to one of the biggest trades (for those curious, its Eicher Motors – bought in Feb 2012, sold in December 2015).

Rather than a running score, how about looking at rolling 3 year returns to smoothen out the edges?

Once again, not having the worst rank comes on top.

Every decision has trade offs. More action can lead to a slightly higher return though the invisible costs can reduce some of the outperformance. This is the same issue when we look at rebalancing on a weekly mode vs on a monthly.

While the worst rank held has value, using it blindly can lead to trouble. Understanding what the objective of the methodology is and being willing to be flexible is a way to go.

Breaking down the Performance

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But let’s back to the core issue – Model Portfolios

Is the Investor is Naïve

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Are Indian Markets Expensive?

Gone up too much and hence markets needs to fall

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Evaluating a Strategy

Performance Data

Monthly Returns

Rolling CAGR

Drawdown from Peak – for the Momentum Portfolio vs Nifty 500

Equity Curve

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The broad statistics

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