Prashanth Krish | Portfolio Yoga

The future is Robo

Way back in 2000, while trading had already moved from the pits (or rings as it was called in India) to the VSAT linked trading terminals, we still did not have any stock broker who allowed or offered internet trading to retail clients. Clients either visited the stock broker office or called on the telephone to place orders.

In those time got launched a new venture called 5Paisa.com. At a time when intra-day trading meant paying the broker 0.10% on either side, this site started straight away at 0.05% and what more, offered you the ability to trade directly from your home without the need to call your broker to know the rates or place an order.

While I wasn’t a broker in those times, I was around them most of the time and the feel I got was that this was not going to change anything. After all, clients depended on the broker not just for rates but also advice and handholding.

And for a few years, they seemed to be right as internet trading really did not take off as one would have expected. But they constantly kept the brokers on the toehold and brokerage rates fell from 1.0 to 1.5% (which most brokers charged for delivery) to miniscule percentages and finally today we can buy stocks without paying a Rupee in Brokerage.

But is the old model dead and buried?

Well, even today you can see brokerage offices having clients who sit through the day and place orders. But the business model has changed and the good old days of the past will never come back.

Disruption of existing model is never liked by those who stand to lose. When Uber got launched, the main skepticism was that these new drivers could never match the knowledge of taxi drivers who knew the road map of the city like the back of their hand. How wrong were they?

The Robo Advisory model in the Mutual Fund / ETF space is very new even in US where everyone is still working on which model will finally be able to take hold as an alternative to traditional advisory model.

In India, there are very few firms (though one tweet suggested that number is 30) and most of them will fold up over time since we are at a very early stage of the financial evolution. Things are changing as seen from the continued inflow mutual funds have seen even as performance has flattened or gone negative.

An Advisor will play a role for now since most investors have no clue as to what they want, let alone what they desire. But as they start understanding the nuances, they will move to cheaper models (Direct for instance) unless the advisor is able to provide real valuable advise rather than saying they will hand hold you through good times and bad.

I have not much of contact with distributors but I do wonder how many have really worked on models to select the best possible funds or do they just sell you what is the hottest running fund / highest return fund.

It’s nice to have goals such as Retirement funding / Children’s Education among others, but how many advisors really have the skillset to deliver especially when they are at the mercy of the fund manager who can under-perform for long because he chased the wrong ideas.

While 100% Robo investing may take time, the future for now seems to the way Vanguard is approaching with a mix of Robo Selection + Human contact. With growing pool of mutual funds / ETF’s, it’s imperative that the fund section / risk ascertainment process be outsourced to the algorithm while the advisor focus on providing the client hope when times are bad and perspective when good.

Rejecting Robo altogether in my opinion is akin to throwing out the Baby with the Bathwater.

Start of a New Bull Market?

A Bull market in the markets is one of the best times to be invested as stocks more or less follow the herd (going up) and regardless of when you enter, opportunities are available in one sector or the other.

But getting when a bull market started is easy only in hindsight and never when we are literally at the starting point since we tend to discount the bad news and focus on the charts / positives in the earlier era while focusing on the negatives this time around making us believe that a bull market couldn’t possibly start in this environment.

One of the benefits of being a trend follower is that we do not believe we can predict the market on where the future lies and hence the best we could do is try and be with the larger trend that is in force.

When the bull market started in 2003, there was a real gloom in markets with no one feeling confident of the future, let alone think that we were at the start of one of the greatest bull run we had ever seen. In 2009, people were so shaken by the rapid fall of 2008 that they couldn’t believe that markets could climb so fast so much.

The current scenario cannot be really called the start of a new bull market since the fall we saw in 2015 can be seen more of a reaction to the over expectations that got build up as Modi came to Power, but given the fact that technically we did get into a bear market (what ever definition you used), we now need to focus on whether those bear market signals are well and truly invalidated.

Bull / Bear markets have no clear definitions and so one needs to use multiple such definitions and arrive at a conclusion. So, lets take a look at some of the definitions and where the market is trading currently.

The 20% Rule

One of the simplest rules, it basically says that we enter a bear market when markets drop more than 20% from the peak and enter into a bull phase when we rise 20% from the lows.

Nifty 50 entered the bear market when it dropped 20% from its peak in Jan 2016. While markets final low was another 6.65%, theoretically speaking this bear market was very much a truncated one despite signs of all around gloom and doom.

When Nifty crossed above 8190, it also meant a rise of 20% from its bottom hence invalidating the bear market and suggesting the start of a new bull market.

2. The 200 DMA / EMA Rule

Markets are in a Bear Phase when below the 200 days average is one of the better known ones. While the first break below the 200 DMA happened in March 2015, it was never a smooth ride with the many chops. Even recently, one saw plenty of chops till it broke out.

3. The 13 by 34 Weekly Rule

While moving average crossovers are well know, many a well known technical analysts use this to determine the trend of the market. Once again, this comes with a fair bit of risks (Whips).

4. The Ned Davis Rule

The Ned Davis rule of a a bull market requires two things to happen. A Bull Market requires a 30% rise in the Dow Jones Industrial Average after 50 calendar days or a 13% rise after 155 calendar day.

While Nifty 50 is up greater than 13% from its low, its still just 60+ days from the low. Another 10% rise too could trigger this rule though by that time, Nifty 50 will be closer to 9000 (8872 to be specific).

5. RSI on Weekly

Now, this is not really a rule of Bull Markets, but when RSI on the weekly moves above 60, it showcases strong underlying momentum and one that can carry. Here is a Nifty chart with previous Buy / Sell signals (Arrows)

And finally, my own Trend Indicator went into Strongly bullish mode a week ago.

Only in hindsight can we really know whether this would be a great time to enter or not, but at the moment, my money is on being bullish rather than try to predict whether this will whip and the down-turn will continue. Remember the saying

“the early bird catches the worm but the second mouse gets the cheese”

No Risk = No Gains

Does Golden Cross Work

Friend, Nooresh Merani uploaded a video (Youtube Link) where in he literally questions using Golden Cross as a trading / investing tool. While I see loads of skeptics who believe Technical Analysis is Bullshit, I found it disappointing that Nooresh does this since he is a expert in Technical Analysis and runs courses and sells newsletters based on application of Technical Analysis on markets.

Unlike say Elliot or Market Profile, strategies like Moving Average Crossover do not require one’s reading of the charts to decide whether its a Buy or Sell. The strategies that can be tested are generally Binary in nature with clear cut logic behind Buy & Sell which cannot be disputed.

His main reasons for not believing is due to

Huge Lag between time when market hit a low or high and the Signal
Whipsaws which eat away a huge chunk of capital

Both indeed are true. Moving Average systems lag and you can never catch the bottom or the top. But as investor, are you looking to buy at bottom / sell at top or looking to maximize the amount of time you can spend in market when conditions are favorable and out of market when its not.

Lags can be removed by using a smaller multiple for crossover, but that in turn means more trades and hence more slippage / transaction cost and taxes. For example, if you were to test the smallest MA cross (3 by 5) on Nifty 50 since 1990, you will get 405 trades (Long only). On the other hand, for a similar time frame, using a higher multiple like the Golden Cross (50 by 200) would have given you just 14 trades.

A simple Buy & Hold from say 15th September 1993 (on Nifty) would have given you 7330 points. On the other hand, if you used a MA Cross such as the Golden Cross, you will have ended up with 6600 points. In other words, it will not be beating the Buy & Hold returns.

But while we are exposed to markets 100% of the time when we do a Buy & Hold, we aren’t when we use a system such as the Golden Cross. In fact, we are in the market for only 60% of the time. In other words, for 40% of the time, your capital can earn at the very least Liquid Bees earnings as it awaits the arrival of the next signal.

But the biggest advantage is that when markets go down like they did in 2000 or in 2008, you shall be sitting pretty in cash. So, while a Buy & Hold investor can reap a bit more, he will also have to endure a lot more pain. How much pain? Well, let this chart show you the same in picture format

The chart above plots the draw-down the equity curve would have faced when you just bought and held (Blue) vs using the Golden Cross (Red).

As you can see, while the Blue lines test the 50% (loss of half the maximum capital reached) multiple times, with a simple system such as the Golden Cross, you are able to avoid the risks with draw-down barely moving above 20%.

The comfort it provides to be sitting in cash when everyone is neck deep in losses and wondering if the world will shut down tomorrow is hard to describe.

Yes, a moving average system may not be the best tool if you are a active trader willing to take big risks and spending time on the screen. For all others though, this provides the simplest way to participate in bull markets as and when they come.

Below is list of all trades that you would have taken if you had used this system (a few theoretically since Nifty did not exist until 1996).

Being a systematic trader, for me the biggest advantage of systems that can be tested and validated is that I can risk big. After all, only way to win big is to bet big and for betting big, you need to be sure the odds are in your favor (not in every trade, but overall).

The current Golden Cross may whip and hit the trader / investor with losses. But, that is the way trend following works. You lose 6 out of 10 trades, but the 4 you win more than make up for the losses. If you are searching for a holy grail, you won’t find it in Systematic Strategies at the very least.

Using Open Interest To Find Bull/Bear Signals

In markets, its the dream of every trader to find a anomaly that can be juiced out day in and day out. Big traders / funds keep trying to find such inefficiencies that they can exploit to their advantage. Those inefficiencies are never heard in the public domain since if everyone knows about it, its sure to be arbitraged away.

One such anomaly is about how using change in price and open interest, you can predict the short term (next bar at the very least) move in the ticker concerned. In fact, Investopedia has a page with the same title as this post explaining the rules of the same.

In fact, I myself have been guilty of believing the same to be true even though my systems do not use either Volume or Open Interest to detect trend change signals. Today, a Tip Seller said the same when queried saying that today’s move was short covering and hence he foresaw continuation of the trend. Being long, I am happy to accept and agree with any logic that matches my position, but I commented that short covering was not a viable trend continuation signal (If you read the Investopedia link, it says and I quote “a declining open interest in a rising market is Bearish”.

The thing I keep learning from Tweeples is that while its okay to attack Journos (questioning their integrity), attack fund managers (ridiculing their picks, returns), don’t you dare attack Tip Sellers. In no time was I questioned about my intentions though I had not even linked / tagged to the original message.

Anyways, being a believer in data than hearsay, I decided to test whether the logic really had predictable value. The table below shows the results from Nifty (since it started).

The results were a surprise even to me since they indicated that regardless of what happened in Price or Open Interest. When Nifty closes +ve, irrespective of change in OI, the next day, you have a 55% probability of markets closing in positive zone. The same is 52% when Nifty closes in Negative Zone.

Given the fact that 52.68% of days are positive, the above stats say that the predictive value of such information is equivalent to what you can get by tossing a coin. And hey, you don’t need to pay thousands to someone to get that odds.

Conflict of Advise

We generally do not like being told what to do, especially in areas where we believe we know better than most other guys and definitely know better than the Charlie with the attitude who thinks he can advise me on how I can invest better.

In my own extended family, most of those I know pretty closely have done way better than many mostly thanks to investing in their own house at a pretty early stage of their career even though at those times, I am sure none had a clue that the investment would yield such enormous returns (Potential since most still live in the same house anyways).

But if you are active on Twitter for instance, you would have heard about how stupid it is to invest in real estate with such low rental yields. Sophisticated guys would then plot American Real Estate prices to show how prices there are (adjusted for Inflation) at Zero returns after 100 years.

Just now, I was hearing to a financial advisor saying that Goals are important than beating some Index. Feels right, isn’t it? But how logical that statement really is, is the bigger question and one that is tougher to answer.

Most advisors advise against investing in fixed deposits showcasing historical data that shows how equities have given higher returns vs. debt. While that overlooks the fact that, equities provide a higher return since you are taking a higher risk, we still come down to measuring returns against another instrument to justify investing in one asset class over the other.

Websites that offer you some kind of planning (Retirement / Child’s Education among other normal major goals) offer a matrix where you invest X, you assume you will get Y% and if done for Z amount of time, you are well and truly home.

The assumption used to calculate is based on historical growth rates which may or may not replicate. It’s one thing to have faith that our goals will be achieved if we save and invest and yet another thing to assume that between now and 10 / 20 / 30 years later, we shall still be able to do the same things we are doing right now.

When designing trading systems, one key area to focus is “path dependence” of the system which enables it to finally reach its final number. Traders who believe the path of the past will repeat similarly in future as well generally get sorely disappointed and are most likely to drop the system even though its behavior is well within limits of what could have happened in the past.

Any financial advisor who promises to you that your goals will be fulfilled is fooling with you since none knows how the future will unfold. At best, all of us can make educated guesses about probability of one being able to achieve our goals which generally start off from a low base and as time goes by and we continue to march forward on our journey gets higher and higher till we see it being accomplished.

“Life is a journey, not a destination”, so said Ralph Waldo Emerson. While long term goals are important, not knowing how the future will unfold, its way better to have much shorter term goals that are easier to accomplish and at the same time make life more enjoyable.

Each one’s opinion (including mine) is not just based on how we see the world but also the experiences one has had (especially negative ones). Add to that complexity of the fact that advisors look out for their own interest as well (after all, nothing much comes for Free, Right?)

A lot of things are honestly outside our control, so all you can do is control the things that remain in your control (Income and Expenses). Rest is left to market forces and Luck.

Further Reading: The high cost of high expected returns

Past Performance and Future Expectations

All Mutual Funds carry a disclaimer saying

“Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s)”

Yet, in real life everyone including Mutual Funds want you to see the past performance and while they don’t claim anything, the message sent across is that there is correlation between past and the future and that given the great performance of the fund manager in the past, you can assume similar performance in the future as well.

When I recently tweeted about why I wasn’t comfortable with Nifty Quality 30 Index (despite me liking the idea in itself), one of the questions that I was asked was, you should not look at past performance to judge the future. Yes, past has no relation to the future and yet, every adviser and every rating agent looks at the past returns to come up with a list of Top funds to invest into.

If past performance really didn’t matter, we should have seen a more uniform spread of Assets under Management across various fund houses which is not true and hence showcases that we are really driven by the past performance even if we know that there is no way to know for sure whether the future will be as good as the past.

When the future performance is not in line with the past,we get disappointed and search for excuses as to why the fund manager could not replicate the performance of the past. Let me give a real life example.

HDFC Top 200 fund is one of the biggest single funds in the Mutual Fund industry. While investors continue to believe in the fund manager, there has been more than a murmur of voices as its performance. But is the peformance really so bad?

If you take a look at the fund performance over last 5 years, you shall see that it has performed inline with Nifty Total Return Index. So, why the angst and the disappointments that seem to have surrounded the fund?

The answer lies in how it performed over the 5 years previous to that. Rather than talk numbers, let me provide you with a chart where I have divided the data into two equal parts (10 year data) and re-based everything to zero to provide you with a clearer perspective

The first five year (2006 – 2011) was pretty good for the fund as it outperformed significantly against Nifty generating tremendous Alpha. The next 5 years, returns are all in line with its Beta and therein lies the difference.

When investors look at the past and invest, they are essentially hoping that the fund manager will provide similar performance in future and any deviations on the lower side is not taken kindly.

Futher Reading: A paper on why you should not buy funds that have recently out-performed

To really generate Alpha using Mutual Funds (even as they decline in over all terms), you need to be the few who identify and invest with him early and exit when he starts to become a house hold name and that is really a tall ask to say the least.

A free trip to Goa

Unlike new age media sites which use click bait article headings such as the one above to enhance their page views (and hence garner more advertising revenue), this is no click bait article though it on the surface would seem as such.

Instead, if you are a Mutual Fund investor (Large Cap), you are theoretically gifting away a fully paid vacation to Goa for every Million Rupees you have invested. And if you are a big investor, you are gifting away a trip to Maldives every year and if you by any chance or a Very High HNI, you are just giving away a paid vacation to Monte Carlo.

Now, as a reader of many financial sites, you very well know that there is no free lunch and wondering what the catch here is. The thing is, there is no Catch. What I am calculating is simply the difference between the charges of most mutual fund and Nifty Bees.

I see the smirk on your face as you think, but then – I am missing the fact that MF’s out perform ETF’s and whatever savings I achieve will not compensate for that loss.

Indian Mutual Funds have indeed been (on a long term) out-performing Index by a margin (Alpha). But this out-performance has been on a steady decline over the years. The key reason for Alpha was that in earlier years, with a smaller capital to manage, stocks had a good time buying quality stocks that weren’t identified by others and then held on to it as both earnings and its Price Earnings got re-rated.

But with more and more money chasing the limited number of stocks, its tougher to beat the herd if you don’t innovate in how and where you invest. But as the recent episode with a large mutual fund manager showed, buying what is cheap and not liked by others may sound interesting on paper, but if it doesn’t work out as panned, investors are in for a long period of under-performance.

I don’t know how the future will unfold, I don’t know which funds will do great and which funds won’t but what I do know is that as we go forward, bigger the fund, tougher it will find to out perform and here no matter how big a ETF grows to be, it will continue to give me more or less what the Index has delivered.

If I can get a free trip every year just from the savings, why bother about the nitty gritties of constantly tracking the fund and the fund manager and switching from one fund to another in the hope that he will deliver what the former couldn’t.

Share this:

Share this:

Share this:

Share this:

Share this:

Share this:

Share this: