Prashanth Krish | Portfolio Yoga

Are we at a Tipping Point

The big read of the week has to be the “Howard Marks” Memo which these days seems to be the second most read fund manager report after the Oracle of Omaha. In this Memo, Howard warns about the Risks that the market seems to be ignoring as the fear of missing out (FOMO) seems to drive money towards ideas that in general times wouldn’t have been given a second thought.

Last weeek, I ran a Twitter poll asking if it was possible to see 20,000 on Nifty 50 by year 2020.

What probability would you give for Nifty to cross 20,000 by 2020?

— Prashanth (@Prashanth_Krish) July 21, 2017

Quite a few replied saying that they felt the chance was ZERO while the majority of voters felt that the chance was less than 25%.

The results weren’t surprising to me given that in recent times, there has been quite a concern that markets may have over-extended and it was time for a pull back. Yet, given the fact that we don’t know the future, should we write off even the remotest of possibilities?

No one really likes Bear Markets. While Value Investors claim to love Bear Markets as they provide them the opportunity to pick Dollars for Nickels, when the push comes to shove, I do wonder how many will be left standing let alone participate by buying stocks as they become cheap.

Bear markets come in different shapes and forms.

The 2000 Boom and Bust

Who doesn’t know about the Dot Com Bubble these days. December of 1998 was the start of the rally that took Nifty 50, a Index that wasn’t having any heavy weight Infotech Stocks at that time from 817 to a final high of 1818 in the space of just 15 months.

The rally in the Infotech Sector Index took quite a different route with the rally starting two years earlier in December 1996 with the Index floating around the 78 mark. When the peak was finally achieved, the Index was quoting at 9,550.

Similar to the Nasdaq 100 which took more than a decade to break its all time high of 2000, Nifty IT too broke its 2000 high only in 2013.

One thought process of where one should start a new bull rally emphasizes that a new bull rally starts only on breaking the previous all time high. Using that definition, we are still in the Infant stage of the bull rally in Infotech (validity to remain as long as it trades above the 2000 high) and yet IT stocks are a pretty hated lot.

Nifty 50 on the other hand took around 34 months before it broke above the 2000 high and 48 months it was before we were well and truly above that high water mark. Dow Jones Index on the other hand had to wait for 72 months before the 2000 high was broken only for the financial crisis to crater the Index well below even its 2002 low (Nifty 50 on the other hand didn’t really come anywhere close to the lows we saw in 2002).

Its another matter that the stocks of the next rally bore little resemblance to the stocks that mattered in the earlier rally.

The 2004 and 2006 Mini Bear Markets

Markets fell greater than 30% from their peaks in 2004 and 2006, but given the speed of recovery, this mini bear market is less talked about. While the trigger to the 2004 fall was the surprising end to the NDA government in which markets had great hope, the 2006 fall was triggered by global factors.

While both 2000 and 2008 are talked about as the great bear markets, 2004 and 2006 aren’t since the amount of time spent underwater was fairly short. Markets rebounded strongly from the lows and in no time were we back at the earlier peaks.

The Great Crash of 2008

Who needs to be told about the crash of 2008? These days, every time market starts to feel a bit too hot, the fall of 2008 is what comes to top of the mind. Investors who look at valuation seem to worry that every time we close in to the valuation we saw in 2008 prior to the fall, its just a matte of time before we see a repeat of the same.

At its peak, the much derided and yet the quickest way to figure out where the market lies, Nifty 50 PE was testing the highs it saw in 2000. Sensex PE Ratio (both of them being at that time of 4 Quarter Trailing Earnings on Standalone Balance Sheets) was a bit away from its peak of 2000.

Despite the difference in stocks (Nifty 50 has 51 stocks while Sensex has 30) and the weights, both most of the time top out simultaneously most of the times. 2008 was one such instance.

The fall of 2008 has for many who experienced the same has created a phobia of every fall being similar to the one seen in 2008. Seeing your retirement kitty (if invested in the market) fall by 50% or more is nothing some one can forget in a hurry.

For long, Foreign Institutional Investor have been the critical driver behind the rise and fall of markets. Other than for the one instance of 2016 where markets closed positive even as FII’s sold (Calendar year basis), every time, FII’s have sold, markets have dropped and vice versa.

Much has been said about how Mutual Funds are becoming the key driver in markets. But a cursory look at the Quarterly net flow of Equity Mutual Funds doesn’t really show it likewise. We have had similar inflow’s in 2007 for instance as we are having now.

The only difference is in terms of Gross Inflow / Outflows. While the first 6 months of 2007 saw a Gross inflow of 42,903 Crores , in 2017 its 1,24,517 Crores. This would suggest that while there has been a strong move towards Mutual Funds, the churn is pretty high as well.

Breadth Indicators

One way to determine where we are relative to earlier times is to look at a few breadth indicators.

Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

John Templeton

A euphoric market is one when literally everything is flying. At this point of time, you don’t need to do any Analysis but just invest in anything that seems to be moving higher.

While Mid and Small Caps seems to have been in a Euphoric in recent times, the evidence doesn’t easily lend to that buzz. For instance, here is a chart which plots the percentage of stocks that are trading above their 200 day Moving Average.

The above chart contains 2 data points. The top pane plots Nifty along with the 10 day Moving Average of Number of Stocks trading above the 200 day Indicator. The idea of using a 10 day Average is to smooth out the volatility.

The lower pane provides the raw data – % of stocks trading in NSE that are above their 200 day averages.

At 60%, we aren’t really into territory that seems to be risky at the moment. In fact, post 2014 Election Rally, we haven’t seen the Indicator cross 70.

This in my opinion is indicative of the fact that markets aren’t totally over-bought. While one cannot rule out any reactions from current levels, any major bear market of the kind seen in 2000 or 2008 seems to be not on the cards unless there is a Global Meldown in Equity in which case, all bets will be off.

Valuation

The big elephant in the room would be Valuation. Markets are expensive based on PE Ratio regardless of what Index you apply the same upon. The only cheap Indices would be the Infotech and Pharma, but hey, who wants to invest there in the first place.

Above is the Nifty Price Earnings Chart over time with Average and Standard Deviations. A casual observation would be that while markets are expensive, they haven’t reached a point where the odds really aren’t in favor of exposure to equities.

Current market valuation is more expensive than in 2004 prior to the crash, but is the Index the same as what was in 2004? Currently Financial Services account for 35% of the total Index weight. This wasn’t the case in 2004 for instance when the composition of the Index was vastly different.

Only 25 stocks continue to be part of the Index when one compares the Index of 2004 to that of today. In other words, as much as its essential to look at historical data points to get a sense of valuation, ignoring the huge churn and differential weights can change the basic structure of the analysis.

HDFC Bank for example is trading at 30 times its earnings and is closing onto representing nearly 10% of the Index weight. A High PE + High Weight in turn would pull up the overall weight of the Index. Is HDFC Bank cheap or expensive is another story altogether.

The path forward

Wouldn’t it be lovely to have a Almanac which can give us precise turning points of the future (Experts of GANN, a style of Technical Analysis would love to claim they know such dates) so that we can be fully invested when markets are trending higher and be totally in cash when the trend turns to bearish.

While we cannot project the future, one thing that is bound to showcase the future as it happens is the chart. Right now, the market is strongly bullish regardless of what method you apply. At some point markets would start to roll over breaking major supports and trend-lines on the way. That would be a better time to become bearish than try to predict the top based on tools that fit our narratives.

Above chart is as on date. Compare this with similar chart of the previous bull run. See something similar?

Is the chart of 2017 similar to one of 2008 or are we placed similar to 2006 or 2004? Once in a while markets can go up sharply at a 45 Degree Angle. While they mostly end up correcting, not all corrections end up like 2008.

I for one continue to believe that the best way to play would be to follow a Asset Allocation mix that is suitable under current circumstances and one while allows us to reach our goals even if the best laid out plans falls flat.

Small Investors and the Risk of Derivatives

India was introduced to Derivatives in Exchanges in 1999. A lot of water has flown since then in terms of the stocks, their contract sizes among others. What hasn’t much changed is the fact that we were and always have been a cash settled derivative exchange (one of the very few).

India has one of the most myriad of laws, most of which are to protect the weak and the innocent. Derivatives aren’t instruments that are suitable to everyone. Nick Leeson working at Barings Bank at Singapore had a mandate to look out and trade Arbitrage opportunities he spotted on the Nikkei 225.

To cut a long story short (if you are interested, do read Rogue Trader, one hell of a good book), he was able to bring down a 200 year old bank that had survived through thick and thin sitting from his small office in Singapore.

The Parliamentary Standing Committee on Finance in 1999 observed that because of the swift movement of funds and technical complexities involved in derivatives transactions, there is a need to protect small investors who may be lured by the sheer speculative gains by venturing into futures and options.

SEBI’s mandate is to safeguard the small investor from harm (both self inflicted and one inflicted by other participants). Based on the committee report, SEBI decided to keep a threshold limit of Rs.2 Lakhs as minimum contract size.Recently this was raised to Rs.5 Lakhs as minimum.

But like ants get attracted to honey, small investors have got attracted to options. If attraction wasn’t enough, NSE in its wisdom introduced Weekly options in Bank Nifty.

Option Prices depend on 3 factors (more or less). One is “Intrinsic Value”, second is the amount of time left in the Option and third is Volatility.

The longer the period of time left before the option expires, the more expensive the option is (again, this is dependent on a host of other factors including Strike, but lets keep it simple and say for a option at the current level / price).

But as it comes closer and closer to expiry, options can get pretty cheap and on the last day, all bets are off as options can really move (if the underlying moves).

Take for example, the Expiry day of May – 25th May 2017. Here is how much some options moved that day (calculated from the low of the day to the day’s close).

For anyone who was long that day and held till close, it was a jackpot like no other. Any wonder that small investors get lured by option tip sellers showcasing one such instance to showcase how easy its to make money on options.

The other day, I came across the tweet of one Mr.Aftab Khan who got caught with positions which were In the Money at the time of Expiry and was expected to pay Rs.6,25,942/- as Security Transaction Tax. Lot of people believe this is unfair. Petitions have been signed to see to it that option expiry isn’t treated as Exercise (Exercise in reality is when you exchange your option for Shares in American Style Options).

If you are new to Options, do read “Options Exercise, Assignment And Settlement” to understand what this is all about.

So, how did the Trader get into a situation where he has to pay as STT more money than he spent on Options?

The answer to that question comes by calculating his Exposure (Notional Value). The trader bought or held at time of Expiry, 20,960 Call Options of Bank Nifty with Strike Price of 23,900. The average buying price was 1.14 which means he paid a sum of Rs.1.14 * 20,960 = 23,900 to acquire total contracts with a Notional Value of Rs.50,09,44,000 (Fifty Crores).

STT when options are closed via Exercise are charged at a different rate than when closed intra-day and there-in lies the problem. If Options were closed intra-day, the STT charged is only on Premium (used to be Premium + Strike for many years till it was changed in June 2008).

But STT is not a issue given that this is a issue that is known from a very long time with only new investors falling for the trap once in a while. The bigger question is, should small investors even be allowed to take trades that are larger (in Notional Terms) than the Networth of many brokers.

In a Moneylife Article (Link), the issue of Systematic Risk is raised and I agree. Small brokers can be doomed with just one or two such clients. While the client may eventually pay, if he isn’t able to pay immediately, the broker needs to make good and if he fails, he will be suspended and all his monies frozen by the Exchanges.

While its agreeable that STT needs to be changed when there is a financial closure rather than closure via exchange of stock (which can never happen in a Index option), the key to avoiding such heart burns is to ensure that small investors aren’t allowed to trade.

The reason for contract size being Rs.5 Lakh was supposedly to ensure that small clients don’t get trapped and yet, here we are.

In the United States of America, Securities and Exchange Commission (our equivalent of SEBI) has regulations that require that the trader maintains an equity balance of at least $25,000 into their trading account to be allowed to trade Intra-day.

Even in India, a small investor cannot invest in a PMS without he putting up a minimum of Rs.25 Lakhs, cannot invest in a Hedge Fund unless he can puny up a minimum of Rs.1 Crore. The reason is said to be that both these are sophisticated instruments and hence shouldn’t be offered to smaller investors who can lose their hard earned savings. Yet, Derivatives seem no sophisticated enough to ensure a minimum investment / networth requirement for now.

Its time SEBI comes up with similar minimum investment requirements for Derivatives (Rs.10,Lakhs of Equity (Cash or Stock) Balance for example) to ensure that small investors inadvertently don’t get caught.

Of course, there will be the argument that this will just push investors determined to trade in Derivatives into the illegal (Dabba Trading for example). But if some one is intent on doing something against the law, no amount of law can really stop him.

Helmets are compulsory in Bangalore and yet every other day, there is a news paper article about some death in a accident due to non wearing of a Helmet. Karnataka banned Lottery tickets (which was a large Industry) and had to suffer a blow-back in terms of Revenue. But this has also meant that people who weren’t addicted were saved from losing their savings. But is Lottery really gone? Of course not, especially now with access to online gambling, but most daily wagers aren’t really that versatile.

I have been trading Options on and off since 1999. While its easy to blame Exchanges / SEBI for greed, I believe the real jump up in volumes (from small investors) have come thanks to Discount Brokerages. In the hey days before Discount Broking, I would have paid 50K as Brokerage (one side) for buying so many contracts. These days, you could have bought them all by paying just Rs.20 (A reduction of 99.96%).

Low brokerage is a incentive to trade more. While our Exchanges lack the depth seen in other more mature exchanges, NSE is the Number One among all Exchanges when it comes to Index Options.

SEBI recently released a Discussion paper on Growth and Development of Derivative Markets in India wherein one matter of Discussion is “Taking into account trading of individual investors in derivatives, especially options, is there a need to introduce a product suitability framework in our market”

I can only hope that SEBI ensures that small players are better protected by harming themselves by ensuing that they cannot easily access the Derivative Markets.

Does Investing all at Once makes sense?

It was nearly 10 years ago that I received a big Cheque thanks to selling off a asset that had suddenly appreciated in value much beyond what I had imagined. What I did with that was a kind of turning point (in a bad way) in my life. But this post is not about the stupidity I did, its about whether you can do better when you receive a big cheque that could really change your life.

Assume for instance you sold off a property and now have a sizeable sum of money. What should you do with it and how do you go investing the same?

Once you are in the 30% tax bracket, any investments should be seen in the light of how that post tax return compares to other options available.

Equity Investing is all the rage and if you are looking at wealth generation for the long term (or even for goals that don’t require money for a decade or more), its a good bet. But how should you proceed with the money you received?

Should you for instance just select a few funds (if you are into Mutual Funds) and invest it all or should you drip the money into the same funds over time.

Vanguard in 2015 did a study of whether it makes sense to invest all at once or invest over time (Assumption being that you have the full money available at the start). This was conducted across three markets – United States, Canada and Australia.

The conclusion;

Our analysis indicates that investing immediately has historically provided better portfolio returns on average than temporarily holding cash

The conclusion though isn’t conclusive since only 67% of time does lump sum out-perform sipping the same money over the next 12 months. In 33% of the time, it was better to invest over time rather than invest all at once.

So, how would such a idea fare in the Indian Markets?

For the test, I used Nifty 50 (Spot) data starting from 1990 to date. When money was invested over time, the assumption was this was held in Cash and did not yield any returns. But in reality, this could have been easily invested in funds such as Ultra Short Term Bond funds with monthly withdrawal to feed the equity.

Here are two charts to provide a birds eye view of which option is better.

The above charts plots multiple things. We plot the instances where SIP made sense. This is represented by drawing a Vertical Line – the colors denote the length of the SIP in Question. On the Secondary Axis we have the Sensex PE chart plotted.

The visual represents whether investing in one shot gave a better return than when invested over time (invested over 12 / 24 / 36 / 48 / 60 months). Blank are is when lump sum made absolute sense while lines were when SIP’s of a certain period made sense.

The above chart can also be synthesized in a data table which I present below.

How to read this Table?

The table beside this text represents the % of time lump sum investing beat investing over time. Longer the period of SIP, higher the probability of success using the lump sum mode.

While regardless of market conditions and valuation, investing all at once can make sense if you are looking for a investment period greater than 20 years, as the charts above showcase, looking at Valuations can be advantageous to your financial well being.

The Vanguard Study: Invest now or temporarily hold your cash?

The Future Is Not a Continuation of the Present

Mutual funds are on a roll. With Gross inflow of 23,000 Crores and a Net Inflow of 15,000, collections have been never better for the Industry. One key reason for the growth has been the spectacular returns by few funds in the recent past.

Recently, Economic Times report wrote about 5 funds that doubled within last 3 years (Source). Fintech companies are sprouting up left, right and centre promising to help you achieve your dreams. AMFI has been on a roll in recent times advertising even at high profile events such as the recently concluded Champions Trophy that Mutual Funds are the way to go.

And finally, Markets have been exceptionally bullish come hell or high water. With the Real Estate sector seeing reducing interest thanks to both slowing of growth as well as prices reaching way out of reality, this move to Equities is not surprising.

While the Industry is growing strongly, that hasn’t really translated into better options for Investors. With SEBI mandating a 50 Crore Networth for starting a fund, the barrier to entry is pretty high. This has translated into funds having nothing to worry. Most funds seem happy to charge as much as the regulator allows them to.

Funds with 50 Crore in Assets charges the same as one that manages 10,000 Crores. But if a fund can deliver 30% return post the charges, why complain say the naysayers.

I am not a skeptic of investing in equity or even of the fact that “Active Management” is better than passive, especially in a country such as our’s where there are just too many opportunities that big firms cannot easily take advantage of (Liquidity concerns for example).

Having said that, Active Investing not just requires one to be pro-active in markets but also have a strong philosophy which one uses to invest and the ability to stick to it come rain or shine. Since majority of us aren’t as clued it as professionals, it makes ample sense to give the money to some one who has both the time and the inclination.

A recently released advertisement by Motilal Oswal makes this amply clear

While Momentum seems a bad word to use in the world of Mutual Funds, the fact of the matter is that money chases performance. Better the performance, stronger is the growth in its Assets under Management. Larger the assets, more the Income – there couldn’t be a better incentive for everyone concerned, except of course the fund investors.

When money chases stocks, it results in abnormal valuations but as Chuck Prince once said,

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.

Couple of months back, Parag Parikh Mutual Fund provided this table to give a context to how sharply have valuations gone in a short period of time.

Some of these companies were maybe trading at valuations below what it should have commanded, but overall, the valuation of today seems to suggest that India is Shining with astounding growth opportunities.

Couple of days back, I posted this chart outling returns provided by Mutual Funds for the period between 2008 to 2016. By using 2008, I was literally asking for trouble – after-all, I couldn’t have chosen a worse starting period. The objective of the exercise was not to show that Mutual Funds were bad but give a view point that just because one professes long term doesn’t mean long term results have to be great regardless of when one made a entry.

These funds are the best among all funds that were open in 2007 (December 31) and were still active on 31st December 2016.

The list is dominated by funds that targeted Mid and Small Cap stocks where much of the action is these days.

So much money has been chasing performance that DSP BlackRock in February 2017 decided to suspend fresh transactions in Micro Cap Fund.

Nifty Mid Cap 100 Price Earnings ratio today is trading at a value higher than what it traded at its peak in 2008.

In Technical Analysis, when one uses a Oscillator, one is forewarned that just because a stock reaches a over-bought territory doesn’t make it a sell candidate.,

In fact, the first sign of over-bought could be a contra-buy for much of the crowd is yet to pile on to the instrument. Its not the first staw that broke the camel’s back but the last straw.

Similarly, higher valuations alone doesn’t mean a sell. But if your Networth is overly exposed to equities (Direct / In-Direct), it makes ample sense to trim a bit of the profits rather than let all of it run.

When investors pile into performing funds without understanding the context of those returns, they are looking for trouble and disappointment. From its peak in 2000 to its peak in 2008 (8 years), Reliance Growth Fund gave a return of 5000%.

Along with Reliance Vision Fund, these were the funds with the maximum collection of assets (HDFC Top 200 being one of the other funds with similar returns during those times). But the returns over the next 8 years has been nothing similar.

Of course, Markets haven’t gone up so much you may argue and you are right. But, the question is, what is the expectation of the client who made those investments in the year 2007 / 2008? Were they expecting 4.79% return (Reliance Vision Fund) or 6.52% (Reliance Growth Fund) 8.42% (HDFC Top 200 Fund).

Couple of days back, I sat and went through more than a Dozen websites that hawk Mutual Funds. While most claim their thought process is different and hence will make a difference, when it came to advise, it was Equity all the way.

This regardless of whether I put in a time frame of 5 or 30 years. One site advised a Asset Allocation of 85:15 for my retirement. Nothing wrong except that it also gave out a 18% CAGR over the whole period. I have no clue whether 18% is low or high since we have no clue about the future inflation (other than just to guess), but by giving out a number that is way high compared to any other investment at the current juncture, its setting a very high expectation in me.

By early 2009, the current best fund – DSP BlackRock Micro Cap Fund – had gone down 75% from its peak of 2008. In other words, if the value of your investment had reached 1 Lakh in Jan 2008, by March 2009 this was down to 25,000. It requires a really strong mentality to not just hold but buy into the same (which is what SIP is all about).

Job losses was less heard of even during the peak of the financial crisis in 2008. Currently, we hear of Job Losses even as markets scale new highs. The next crash will not be similar to 2008 or even the less talked about and less known 2000 crash.

Its time you set the agenda rather than follow the agenda of some one who is more interested in how much he gains versus the risk he is exposing you to.

The In-active Asset Allocation Model

For a long time now, I have been updating a simple Asset Allocation Model here. This model which has a large weight towards Time and Value is designed primarily for Active Investors who would like to reduce risks when markets look frothy and add to exposure when blood is on the streets.

Most asset allocation models advise one to re-balance once a year or even once every 2 years since every re-balancing results in churn which can turn out to be expensive in the long run. The problem is that longer time differential between allocation re-balancing, higher could be loss of opportunities that present themselves.

For instance, when markets tanked in February it provided for a very small period of time a opportunity to snap up stocks / funds at a extremely undervalued (relatively) level. This kind of alacrity is what results in Alpha over the long run.

But the above model may not be suitable for someone who is starting of today and is saving for the very long term, for example Retirement. The aggressive model is currently at 30 : 70 in favor of debt and while this in a way signifies that there is Risk of a draw-down / lower returns going forward, this may not be a big issue for a investor who has saved very little, but wants to deploy small amounts regularly over time.

The United States is where one has seen all kinds of financial innovation and its there that the idea laid out below comes from.

Lets take the case of Dilip who is 25 years old, works for a private company and wants to save for retirement. Historically the easiest and the most efficient way to save on taxes while also saving for Retirement was through Employee Provident Fund. Even today, for most employees, that is the biggest savings kitty since the concept is kind of forced on them and most don’t see reasons to disturb the growing nest.

In the early 1990’s, Donald Luskin and Larry Tint[2] of Wells Fargo Investment Advisors invented what is known as “Target Dated Funds”. Target Dated Funds use the same Funds as anyone else but offer a glide path that reduces exposure to equities as the end date approaches.

Today, fund houses from Blackrock to Vanguard offer Target Date Fund with maturity extending to the year 2060. The further the time period, higher is the equity portion of the allocation matrix.

Here is the split between Debt and Equity for various end dates in funds managed by Vanguard

As can be seen, as the year of Retirement gets closer, the allocation to equity as percentage of total portfolio falls significantly. This tapering of equity exposure lowers the risk for the investor who is close to retiring and looking at the fund to be part of his annuity scheme.

Investors in India are yet to see funds like above being launched and hence there is no automatic way to save with a variable asset allocation that is linked not to markets as most Balanced / Hybrid funds available today are, but instead linked to one’s own target year.

But creating such a fund for one’s own purpose is very easy. All you need to do is select a couple of mutual funds (1 Large Cap, 1 Mid Cap and 1 Small Cap) and a Debt Fund (either Ultra Short Term Fund if Retirement is close by or Gilt funds if Retirement is far away).

What would be the choice of funds for someone like Dilip?

Given that he has a minimum of 35 years before he retires, his asset allocation mix would replicate the 2055 fund. 90% of his savings should go towards equity fund while the rest 10% can be allocated to debt funds.

Gilt or Ultra Short Term Funds

The choice of which fund to invest primarily lies with whether we believe interest rates will harden from hereon, in which case Ultra Short Term funds make sense or interest rates will soften further. In case of the later, Gilt funds allow one to lock up on the interest rate that is currently available.

Since Dilip is looking to save for the long term with a very small allocation to Debt, Gilt funds make sense for him given that Interest Rates are generally hiked when economy turns better and if happens, thanks to his 90% exposure to equity, loss (notional) in Gilt funds will be more than made up.

Mutual Funds or ETF’s

For the Equity Exposure, long term readers would know that I am a strong proponent of ETF’s and yet there is ample data to showcase that even though ETF’s make a whole lot of sense in US, its not the same out here. Indian markets continue to provide opportunities for Alpha though given the time frame we are looking at, its undeniable that the sky will be as clear in 2050 as its today.

Exposure by Category:

How much of the portfolio should be comprised of Large Cap Funds?

Lets first look at the performance of various indices.

Starting from 2004, we can observe that the best performance has been delivered by Nifty Midcap 100 Index. Worst performance is by Nifty 50. But this picture suffers the starting point bias, what if we started at the peak of 2008?

Suddenly, Nifty 50 doesn’t look so bad and Nifty Mid Cap isn’t a winner, let alone by a distance as could be seen in the first chart.

Based on a simplistic idea of adjusting total returns by the risk (measured in terms of Standard Deviation of Monthly Returns), I came up with the following allocation matrix.

Remember, this is more of a Guide than a Advise. The thought process is to participate without risking great damage when the correction finally shall set in.

Instrument of Choice

Large Cap:

ETF: Nifty Bees

Mutual Fund: Quantum Long Term Equity Fund

Nifty Next 50:

ETF: SBI ETF Nifty Next 50 Fund

Index Fund: ICICI Prudential Nifty Next 50 Index Fund

Nifty Midcap 100:

ETF: Motilal Oswal MOSt Shares M100 ETF Fund

Nifty Smallcap 100:

No ETF’s exist for the Small Cap 100 Index. Neither do we have any Index Fund.

Mutual Funds: Sundaram S.M.I.L.E. Fund, Franklin India Smaller Companies Fund & L&T Midcap Fund are the current best among the crop based on 10 year returns.

Ultra Short Fund:

On a 10 year look-back, Birla Sun Life Savings Fund, ICICI Prudential Flexible Income Plan & UTI Treasury Advantage Fund – Institutional Plan are the best in business.

Do note, much of the Analysis is based on historical data. The future may not be exactly similar and funds that are leaders today may make for laggards tomorrow. But given that historical data is all we have, I believe one needs to make the max of it using principles that have proven historically.

Hope that if nothing else, this post provides you food for thought on how to save for Retirement or for any other time based goal you may want to save for.

The ethics conundrum

Many moons ago, I was offered to be taken as a partner in a company which was started and continued to be run by someone I admired. Given the timing (personally for me), it was indeed a very tempting offer. Then again, I also knew how he treated clients (and their monies) and as much as it would have been profitable, I thanked him for the offer but declined to be part of it.

Years ago, an Industrialist bought an Airplane for his personal usage using funds from a listed company. Unfortunately for him, shareholders objected and the company was a US listed one. The kind Industrialist simply transferred the asset to his listed company in India.

This post was inspired by an Investment Adviser who tweeted and I quote

The biggest co in India grew by corrupt ways. Also, created Huge shareholdr wealth & many millionaires.

There is nothing wrong with the above statement for investors who invested with the company in its early years got some pretty good returns. But then again, so goes for investors in companies like “Infosys” among others which prospered without the need to cheat the government the way the big company is rumored to have.

But what is overlooked is that this is a case of Selection and Survivor Bias. A steel company some time back tried to bribe its Banker to have its way. But not all things go as planned and the stock plunged more than 90% from the peak.

Over the years, hundreds of thousands of companies have vanished with investors monies. Some would have had genuine business difficulties, some just bad luck and quite a few I am sure were there to take advantage of the cluelessness of investors and claw as much money as possible.

It’s here that the philosophy of investing you follow becomes so important. If you are an investor who looks at numbers and willing to bet sizeable sums on companies you like, would you really want to partner yourself with a cheat. Today, he is cheating others, tomorrow could be your turn.

Momentum traders like me on the other hand rarely bother to check the background of the promoters. If the stock is going up, it’s a Buy. If it’s falling, better get out for there are always better options available elsewhere. In that sense, we are blind and may be willing to be shareholders (for however short a period of time) of companies that seem to have crooked managements.

But I am digressing. Great Companies with honest management can have mediocre returns while Lousy companies with dishonest managements can give great returns. While on the long term, there is a very strong correlation between ethics and returns, on the short term, no one gives a damm about it, especially when the markets are running like crazy.

Raymond is in the news for its corporate (mis) governance. But this is a stock that recently broke above its high of 2005. Breakouts are good and one that comes after 12 years could easily work wonders. But if it doesn’t, there is always an exit plan that hopefully ensures that we get out and not become a lifelong investor in the stock. But if your allocation is no more than 4%, should you give a damm about whether the promoter is a chor or not for finally you are measured not in the kind of companies you invested but the return you generated on your investment.

Food for thought, eh?

Of Labels and Stereotypes

Like it or not, we are all labelled one way or the other – from the Religion we profess to the Country in which we happen to be born among many others. For South Indians, anyone born in the North is a Bihari regardless of whether he is from Bihar or from Rajasthan. In the inverse, anyone south of the Vindyas is regarded as a Madarassi once again overlooking the vastness of the land that is there.

In Investments, we are believers in labels. We can either be Value Investors / Momentum Traders depending on which way the wind is blowing though there are guys (including me) who are die-hard fans of one style versus the other and would rather defend to death our ideology than just be open to whatever works.

Whatever Works. Isn’t that the key?

Chris Gayle you may claim has no style when you compare him to say Rahul Dravid. But in the format of 20-20, the key wasn’t whether he had style or not. It was whether he delivered. Its as simple as that.

In the Universe of Mutual Funds, funds are labelled according to their Portfolio into either Large Cap / Multi-Cap / Mid Cap and the Small Cap Universe. But these labels aren’t permanent for as the portfolio changes shape, so do the labels.

Quantum Long Term fund for example was long labelled as a Multi Cap fund but now is seen and categorized as a Large Cap fund. The fund is currently the best performing fund among Large Caps with a 10 year return of 14.63%. But what if the fund was not labelled and was compared with every other fund with a 10 year track record. Would it still be the leader?

14.63% Compounded Growth over 10 years is no small return and yet it would be placed in the 18th position among all funds (Excluding Sector Funds). Wait a minute you would say, aren’t we ignoring the Risk of these funds verus the lower risk of Quantum?

Thankfully we don’t need to speculate for we have data. For this exercise, I select 2 other funds. The first is IDFC Premier Equity Fund which is the best fund among all Equity Funds over the last 10 years. The second fund is ICICI Prudential Value Discovery Fund, the best fund among “MultiCap” funds of the last 10 years.

Since a picture says a thousand words, here is a chart showcasing the draw-downs suffered by these funds against one another.

Absent labels, could you really identify which fund is a Large Cap Fund, which one is a Mid Cap fund and which one is a Multi Cap one?

When shit hits the fan so as to speak, there isn’t much difference between a good mid cap stock and a great large cap one. Every starts to behave like a small cap and the above chart is just showcasing how close they are when it comes to risks taken.

Now, lets look at the cumulative returns (2006 to date) generated by these funds,

At no point of time has IDFC been even challenged in terms of leadership in returns. Quantum and ICICI were competing with each other before ICICI took off in the “Modi Magic” bull market with Quantum constrained to play catch up.

If I were to have not given you knowledge of the fund names or the labels they carry, which one would you go out and invest today?

Parag Parikh Mutual Fund was launched as a kind of Value Fund. But since fund research houses don’t have a label for Value, its closeted with other Multi Cap fund. The fund is really unique in many ways. For instance its well known exposure to stocks listed in US to the extent that its biggest holding is Alphabet Inc (Google).

Recent portfolio also shows its into Arbitrage (Futures versus Cash) with nearly 8% of the portfolio being totally hedged. It also has around 16% of its AUM in cash.

Since the fund has been launched only in 2013, we really don’t have a track record long enough to compare with other funds. But fact of the matter is that while the span maybe short, its performance hasn’t been great even in that short spell.

With a 3 year CAGR return of 15.66%, its return is half the Category Leader, Motilal Oswal MOSt Focused Multicap 35 Fund. But when it comes to draw-downs, the difference is not too big to suggest that the Multicap 35 fund is taking way higher risk than this fund which could account for the difference in returns.

2 Funds. Which one would you Buy? pic.twitter.com/qwRxYT8xft

— Prashanth (@Prashanth_Krish) May 21, 2017

Without the label of being a “Value Fund” , would you be a investor in the fund? To help you make a better call, here is what Warren Buffett said recently about this funds largest holding

Buffett said he had failed to see Alphabet’s growth potential, despite being a user of the online search giant.

One’s man’s trash is another man’s treasure goes a saying. But if all you have is data from the past, shouldn’t that be the only criteria to judge a fund / investment.

Adios!

The 2000 Boom and Bust

The 2004 and 2006 Mini Bear Markets

The Great Crash of 2008

Breadth Indicators

Valuation

The path forward

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