Prashanth Krish | Portfolio Yoga

ETF or Mutual Fund

For years, any investor who wished to invest in the markets without having to do a lot of homework, the easy option was to invest in one of the several mutual funds and sit tight. The basic concept here being that the fund manager has a certain expertise and hence will be able to generate good returns on the pool of money so collected.

While ETF’s have a history of their own, it was not until Vanguard hit the scene in 2001 that is started to become more and more noticed as a instrument of choice given the low cost such funds charged.

Over the years, there has been enough of documented evidence to prove that ETF’s may actually be a better tool to invest compared to a Mutual Fund. Both a Mutual Fund and a ETF provide relative returns – in the sense, returns are measured against a set benchmark. While a Mutual Fund manager tries to beat the market to justify his higher expenses, a ETF manager just needs to ensure that the ETF tracks its benchmark as closely as possible.

Unlike a Mutual Fund, a ETF manager cannot and will not buy outside his benchmark to help generate so called “Alpha”. At best, he may vary the weights but even that is not generally entertained given the fact that discretion can cause havoc with the tracking error.

In India, the ETF Industry is still in its infancy with only Nify Bees having some amount of liquidity. Also, there is widespread questioning about whether the Indian Markets are really suited for ETF’s with fund managers claiming that Indian Markets still provide for opportunities for fund managers to deliver Alpha and that ETF’s aren’t the best tool for investing in India.

Its tough to ignore that view since quite a few funds have delivered returns superior to the ETF / Index. But the question is, did they beat while sticking to the benchmark stocks? In majority of the cases, its not.

While Large Cap funds generally benchmark themselves to Nifty or CNX 100 / BSE 100, its not unusual to find in their portfolio names of stocks that are outside the said Indices. In bull markets, its these stocks that provide them the additional reward though in bear markets, they do have the ability (as shown in the fall of 2008) to drag the fund performance even below its Benchmark returns.

The question that one does come to finally is that if a Investor is able to split his investments between Large Cap ETF’s (Nifty Bees for instance) and ETF’s tracking Indices such as CNX 100 / CNX 500, would he be able to generate better returns.

A list of ETF’s (Equity) listed on the NSE can be found here (Link)

While both Nifty and CNX 100 are represented, its disappointing to see no ETF’s tracking the broader CNX 500 Index. Either way, unless there is more interest in ETF’s its doubtful to see fresh ETF’s being launched.

To decipher whether by dividing our capital, we can generate returns similar to the best mutual funds, I used Nifty Bees for Nifty and the respective Indices, CNX 100 and CNX 500. Since NSE does not provide total return Indices for Indices other than CNX Nifty, I used the general Index.

The key difference is that in all the above tickers I have used, I have not accounted for dividends that get paid. While small, these do have a impact on the overall returns if the same is invested back.

To answer the question as to how much one should invest in Nifty and how much in a CNX 100 / CNX 500 ETF, I drew the following matrix

The returns generated above are CAGR returns (without accounting for Dividends). In case of Mutual Funds, all the selected were Growth Schemes.

Top 10 Mutual Funds are selected based on Category and look back period. So, 18.37% represents the average return of the top funds over the last 3 years. Now, a few may be in the other brackets and a few others may not be. Idea was to select and compare with the best possible (which is known only in hindsight) options.

Even in the above matrix, there are issues when it comes to comparing against ETF’s. For instance, the the top performing fund on the 1 year look back was ICICI Prudential Advisor Series -Very Aggressive Plan (G). Now, the plan is more of a Allocation Model with 80% of its funds being invested in Debt and only 20% in Equity. Its no wonder that even as the broader market showcased negative returns, this generated strong Alpha.

As the above table clearly lays out, investing 60% in CNX Nifty tracking ETF and 40% in CNX 100 tracking Index provides the best return which beats the return of almost all Mutual Funds. And best of all, you do not need a Advisor to guide you since all it requires is a call to your broker and buy the concerned ETF’s in the proportion that one is acceptable with.

And when it comes to the question of how much to invest, do take a look at our Allocation Matrix (Link). All in all, investing is simple, all it requires is a bit of discipline and hard-work of buying and you can be your own fund manager.

The biggest advantage of a ETF over Mutual funds is the fact that you can exit whenever you want without having to worry about paying load (which can be pretty huge) due to the short amount of time spent with the fund. This allows for better allocation as you can move in and move out without the need to wait for the minimum time to elapse.

Low RSI and future Returns

Good friend, Nooresh has recorded a presentation where he showcases as to how a low RSI has more or less meant a sharp move on the higher side in the coming days. While his presentation (you can check it out here) provides us with visual evidence, I wanted to see how this would translate if I left out the chart and just used data points from the day RSI went below 30 (14 days of lookback).

Here is the pic of the days and where Nifty ended 5 days, 10 days, 20 days, 40 days and 60 days later.

and here are some stats culled from the above data

As can be seen, while its true that this can turn out to be a great opportunity to buy into the decline, it does not come without some amount of volatility. Most of the negative out there were from bear markets and unfortunately its only very late in the day that we find out that the fall that seemed out of the normal was just the start of a extended phase of bearishness and not exactly “buy on dip”.

In my last blog post I wrote that I do not believe (again, backed by historical data) that markets are cheap (there would always be some stocks that are cheap, but then again, we are looking at the overall markets) but yet cheap enough that some amount of exposure is warranted. The above data to be is inconclusive as to whether this is the final dip before we spring back to new highs or one that is one of the several dips we may see going forward.

As a trader, I am currently long but as a investor, I would wait for further evidence to build (of course, evidences comes with cost of opportunity) before I think that the current markets warrant 100% exposure (current exposure levels based on my Asset Allocation model is max of 50 / 60% for the aggressive investor) .

Blood on the Streets?

Today was a record breaking day in many aspects. The opening gap down for instance, we last saw something bigger way back in 2007. The net change for the day was a 3.5 standard deviation of daily returns, something we last saw in 2008. Not a single Nifty stock ended in positive territory, not even defensive stocks which got hit (though compared to the battering many other stocks got, this was more of a slap on the wrist).

We can slice and dice data in many ways, but what it won’t tell us is whether the fall is a sign of a long term bottom being formed (panic bottoms are generally ones that aren’t easily broken) or this is just the start on what could be a long journey into the dark world of bears.

To being with, lets look at two fundamental based charts. PE charts of Nifty and CNX 500. The key reason for looking at these charts is to understand where are in relation to the past.

Lets first start off with the broader CNX 500 PE chart. While today’s fall has meant it broke down below the 2nd Standard Deviation, the fact is that even today, CNX 500 is very expensive. While there maybe pockets of value, on the whole though, market seem to be on the expensive side and since there is vast amount of evidence that buying a stock when its expensive is as bad as buying a bad stock, its tough to lay out whether we should jump in after today’s fall.

Since the PE ratio also accounts for results of the June quarter, the next trigger can only be in September if companies come up with splendid numbers. But with GDP growth slowing down, its a question as to whether companies can actually match market expectations.

On the other hand, while Nifty going by its PE is not as expensive as CNX 500, its not in the area of cheapness either and this creates a dichotomy in a way. Can mid caps correct without there being a impact on the large caps? While Nifty PE moved below the 1 Standard Deviation thanks to today’s fall, its not exactly in a area of cheapness.

After the Modi victory, markets realigned themselves with the hope that with strong growth, even if a company is over valued in today’s terms, they shall get back to normal by way of better earnings. Unfortunately, anyone who has kept a eye on earnings has been disappointed by the lack of growth in majority of companies.

In bull markets,, all kinds of reasons of why a company is not growing gets accepted without much damage to the price, but once markets starts hitting a trough, every company gets its growth put under a microscope to determine whether there is really stuff out there. We are currently at one such stage.

Today’s fall has created a lot of interest as to whether we are seeing a situation similar to what we saw in 2008. While one can only be sure in hindsight, I am pretty confident and shall stick out my neck to say that this ain’t 2008 repeat. But then again, while we remember 20058 thanks to recency bias, what worries me is whether this is a action replay of what happened in 1997 Asean Crisis.

While Indian markets were not as exposed to the world events in 1997 as it is today, by the time the bottom was made, Sensex was 31% below its 52 Week high. Even accounting for today’s fall, we are just 13.6% from our 52 Week high.

Just like in 1997 when most countries were not sure of what was happening in the Asean countries, similar is the situation today with respect to China. The opaqueness of the situation creates a scare that is larger than what may actually be the true picture.

Sensex hit a 52 week low today and while that may seem damming, its a good thing since historically, the first low after a series of highs has never continued without there being a strong bounce back to scare off even the strongest bears.

While FII’s sold heavily in the market and hence maybe in a way accelerating the decline, purely based on how the Rupee has behaved against the Dollar, I believe that India is still relatively unscathed with depreciation not amounting to much (which in other words suggests that while FII’s maybe selling, they aren’t taking out money from India).

But having said all that, I continue to believe that there is no reason to be aggressively long in this market. My own Assset Allocation meter suggests just 55% exposure to equities. As a saying goes, while the early bird gets the worm, the second rat gets the cheese. Regardless of today’s fall, I continue to believe that Risk Reward wise, we aren’t in a stage where markets are a blind buy.

Yes, Analysts may talk about how selective stocks / sectors are performing better, but unless you believe that you can identify them in advance, the best thing to do will be stay on the sidelines with cash ready to deploy.

They say, Patience is a virtue and for a investor, its important to be aligned correctly since the short term (1 – 3 year) returns are dictated by when you enter. At today’s PE, the 1 year forward growth is still an average 5% but at 19, this moves to 11% which given the circumstances will be a very good return if that gets achieved.

The following table should provide you with perspective on what to expect (based on historical averages) if you were to buy at X times earnings on Nifty

To conclude, if your allocation to equities is below 50%, now is the time to enhance upto a max of 60%. If you are already there, it could be profitable to wait for the dust to settle before diving in.

Real Estate vs Equities

Writing in Valueresearchonline, Aarati Krishnan says “Equity funds often do beat real estate, but it is all about behaviour and perception of investors”. I am not sure as to how many investors agree with that, but that is not the point.

In that article she correctly points out that while investors in Real Estate not only are willing to put in a bigger lumpsum but also keep paying EMI’s which are way bigger than what most equity fund SIP’s are. The affect of leverage also adds to the returns (especially since until recently, there was hardly any fall in prices).

But how correct is one to compare investing in real estate vs investing in mutual funds (equities). I for one believe that there are quite a few.

To start with, for most, investing in real estate means owning their own shelter. Of course, there are people who buy second / third or even fourth home, but for majority, one barely is able to see through one.

When one buys a home, he buys not with the intention that this shall provide him the money required for Retirement or for his Daughter’s Wedding or her Education. He buys for the simple reason that he believes that buying his own home not only is a viable and wonderful investment (that shall keep appreciating) but also a sign of prosperity and sign of success.

While in the older times, people waited till they nearly got to retirement age before many actually bought / constructed his house, over time, people have become more faster in acquiring a house regardless of whether he requires one immediately or not. After all, what is the whole point in waiting when its so easy to get loans and with prices that keep increasing, it seemed that waiting was a losing proposition.

The bigger question that the article raises is that if one made the same kind of investment in equities, one could have got similar / better return. But there is a catch and even the Author seems to agree with it when she says “people seldom take loans to make equity-fund investments (it’s not a great idea anyway)”

Much of the investment that goes into real estate is by way of Loans which can compound the returns even more. While the author does say “its not a great idea to invest on borrowed money”, its actually tough if you really wanted to do it since no banks will lend money for investing in stocks and shares. Also, unless you believe that the return from the investment is way higher than the interest cost, it makes no sense.

In fact, the very reason a lot of small investors are attracted to stock futures and options lies in its ability to provide massive returns if one is right for what is assumed to be a small risk.

Since unlike real estate, the very idea of investing in Equities is to achieve a goal, its actually important that you have a plan since there is no guarantee that markets will be where you would want them to be when the time comes to withdraw.

The draw-downs in Real Estate does not matter since the investment is not with the aim to reaching a specific goal. On the other hand, when you are investing in Equities with the understanding that this shall help in reaching one’s goals, its equally important to be able to time the market (on a broad level) since otherwise you may start at the worst point (to invest) and need the money in the best time (to invest).

While most advisors and fund managers harp upon SIP (Systematic Investment Plan), if you are investing for a Goal, do take into account that a plan of how you exit is also as important. After all, our needs will not match with market cycles and hence one needs to plan the same.

Its hence imperative that you have a proper asset allocation with multiple plans of action on how you shall deal with various stages of market and how they shall align with your goals. After all, what is the point in saving if it cannot come to use when one really requires the same.

Why Equity Funds Don’t Beat Real Estate

The proof of the pudding is in the eating

The proof of the pudding is in the eating is a age old adage which is said to mean that you can only judge the quality of something after you have tried, used, or experienced it.

In the financial industry, one key thought process is the concept of “Skin in the Game”. If I were to advise you to buy a certain product, the least I am expected to do is risking something of my own in the same product.

Mint today reported that Kotak Mahindra mutual fund staff told to invest in-house. The concept in itself is not new with the same being practiced in US for quite a while (see pic below) while PPFAS was one of the first to explictly showcase the skin in the game concept out here in India.

We believe this is a very welcome move. While it may not mean that Kotak funds will move to the top of the bracket, at the very least, one hopes that pressure from employees will have some impact and ensure that their funds are not bottom scrapers in their respective segment (Kotak’s funds fall mid way in terms of 5 year performance)

Performance of Kotak funds (data from mutualfundsindia.com);

And the Greek Votes No

So, against what the markets in my opinion seemed to have expected, the Greeks have overwhelmingly voted No to accepting the deal that was offered by the European Union. Of course, since its very much doubtful that most voters had a clue about what the offer meant and what accepting or rejecting the offer will bring, it came down to who was able to convince them better and in that aspect, the Greek Prime Minister had his way.

Over the last 3 days, I have read a lot of reports on Greece and yet find it difficult to come to a conclusion as to whether they had a better future going with the recommendations of the European Union or they will have a better future risking the future (based on what a lot of top ECB folks are saying) and tie themselves with whatever plan Alexis Tsipras has in his mind.

Everyone who seems to have supported a No vote seems to indicate that since there is no way the Greece can payoff the debts and some amount of debt write off is necessary. A nation is unlike any other business where ff the compang unable to earn as much as necessary, the lenders will take action including pushing the company into bankruptcy and closure to ensure they get whatever they can get.

A nation on the other hand cannot be disbanded and sold off piece meal because the lenders were not paid their dues back. Greece is not the first country nor will it be the last to default on its obligations. In this 21st Century itself, we saw Argentina default on its debt and despite it passing 14 long years, is unable to access the International markets even today.

Russia defaulted on its debt in 1998 while in 1982, Mexico said that it would not be able to pay its debt triggering a full blown Latin American crisis.

One of the ways to get out of the sticky situation is by allowing its currency to depreciate and hence make Imports expensive and Exports cheaper. Unfortunately for Greece, even this option is ruled out for now since being in the Euro, it has no currency on its own to make that kind of transition,

One of the interesting things I learnt while reading about the Greece situation is that, this is not the first time Greece has gone into default. In the modern era itself, Greece has defaulted on its loans in 1826, 1843, 1860, 1894 and 1932. Its as if the country has never been able to be on the right side of the law.

There has been a lot of hand wringing by Analysts about the Greek tragedy and how it affects the commoner. Most seem happy to blame the creditors for all the pain and since Germany leads the list of creditors, its the one that commands the most hate.

But the big question is, What next for Greece and how will that impact the markets.

As of now, the SGX Nifty is down as are the futures of Dow, Dax and FTSE. Markets are disappointed since a Yes vote would have meant at the very worst kicking the can further down the road. With a No vote, none is sure as to how the European region will react.

A No vote we were told will mean a Greek Exit from the Euro. Since the agreement which facilitated the Greece (as well as other country entries) in itself does not have a exit clause, Greece cannot be kicked out but will have to go on its own.

Banks in Greece has been closes this last week since once the referendum was declared, ECB decided to stop its Emergency liquidity as well. If ECB does not open its purse, Banks will remain closed for the foreseeable future. Going back to their old currency, the Greek Dramcha was spoken about though that would literally mean that all the savings of everyone who still holds it in Banks will more or less get wiped out.

Greece will be able to start a new life with its own currency, but the pain of changeover can be huge. After all, if everyone loses all their savings (more or less), its very difficult to kick start the economy. Yes, tourism may boom since Greece becomes way cheaper for the rest of the world, but these things take time and time is something they don’t have the luxury off.

As traders / investors, all we can do is follow our rules and hope for the best since there is little impact on our markets / country directly. If this goes into a full blown European Crisis, we shall be impacted as well. The question hence becomes as to how well can the ECB ring fence the Greece crisis from affecting other weak countries in its region such as Spain / Portugal / Italy among others.

On Friday, before the markets closes, I tweeted that I was Long since I believed market know best. Depending on how big a opening gap down we see, I shall have my moment of truth and reckoning. But I continue to believe that markets will not be unduly ruffled since this was a out come that was expected as well (even though probability may have been lower).

This coming week will more or less provide us a glimpse of how this situation will evolve and the path forward. While the sword may still hang over the neck, I doubt markets to be unduly shaken off unless it starts affecting other as well.

καλή τύχη

Get busy living, or get busy dying

Once I read Kiran’s wonderful post, I knew there was a post that I could write on things I felt he overlooked. Tougher was getting the title though 🙂

First of all, I would suggest you go ahead and read Kiran’s post if you have not done. There is a lot of things I actually agree with him (Link).

I am a strong believer and I believe even wrote in a previous post of mine that since we do not know the end date, there is no point in saving to the point of not having a great life. Yes, the children, grand children maybe happy, but were you happy while you saved every penny and invested in the best possible way to achieve the best possible return is my question.

The biggest issue of not knowing our end date is that we end up saving more than we require or worse, using up all our savings even before we meet our maker. While in the first case, the kids (or to whomsoever our assets go) will be more than happy, in the case of the latter, we find ourselves living out our last days in a way that we never hoped we would.

Kiran is right in pointing out that we need to make up our capital and be able to start spending when our health is still in the prime. After all, when we reach a stage when its difficult to climb up a staircase, would be want to endeavor walking through Paris at night?

Kiran’s scorn seems to be reserved for those who are happy with achieving 18% returns (CAGR) and says that if one needs to achieve, he needs to at the very least double that.

The problem is not the 18% either since evidences in US has shown that normal investors have generally performed even poorer than what the market has returned. So, when Kiran talks about 18% (which is what Mutual fund managers claim India’s market has returned over the long term), its something that a lot of folks in the market have trouble reaching in the very first place.

He, of course points out that achieving 35%-40% CAGR is not easy. Let me quote his own words

There is a lot of hard work, there is a lot of luck and there is a lot of position sizing science involved before you make that million dollars.

The thing about hard work is that, markets do not work on hard work alone. You could have done all your homework and finally decided to risk your money in a stock that then went ahead and got embroiled in a scam that no one had a clue about in the first place

A wonderful book with regard to Luck is Michael Mauboussin’s “The Success Equation”. In that book, he has the following picture

As shown in the above picture, stock markets come in a place where luck plays a great deal of role compared to say games like Chess and Athletics. In other words, without Luck, you maybe at the right stock at the wrong time.

But coming to his verdict that one needs to generate 35% – 40% CAGR over 15 years to be able to do whatever one wants to do before one gets too old to be able to do that, I decided to check what Investor model (among the great investors) should I follow for achieving a return of similar nature.

Here is a list of top US fund manager and their returns

Since the long term returns (dividend reinvested) for S&P 500 comes to 9%, anyone who has delivered above 26% and over 15 – 20 years would fit our profile. The only guy who seems to fit is the Hedge fund manager Joel Greenblatt whose book “The Little Book that Beats the Market ” has attained cult status. Other than Greenblatt, Soros and Buffett have in their initial years achieved similar high returns though with passage of more time and more assets under their belt, their net returns do not come above the 26% barrier.

Its not that 35% is not possible. Its possible and I am sure guys like Kiran and many others have achieved even higher returns. The question though is, are they the outlier’s in terms of the ability to not only understand companies way better than what most of us do, but also devote the kind of time and attention that is required to achieve those results.

Investing in mutual funds systematically can maybe achieve a number closer to that, but even that requires

1. A deep bear market so that you can invest a lot more when the markets are cheap AND

2. Your ability to keep investing even as the market tanks and the world seems to be coming closer to a Apocalypse.

While a bear market can make asset prices cheaper, it also means that there is plenty of risk to our bread and butter (unless one is a Government employee or knows his company needs him more than vice versa). What use are cheap assets, if one’s own future is unsecure.

As a trader, I target 100% return? But its one thing to target / aim and quite another to achieve. My own testing has indicated that the draw-down one sees in one’s investment is 2X the long term return. So, if I am aiming for a 40% return, I should also be prepared in the worst case scenario to see my equity portfolio go down 80%. More importantly, I should even during the worst time not move away from my process.

Its all easy to be said while tweeting and blogging, but when our real money is going down the drain, the first thing to go out of the window is our discipline and method.

In my opinion, there are no easy way out to most of the things that trouble our little minds. But as Kiran concludes, enjoy the process of investing without worrying too much about whether the outcome will be enough to satisfy our and the future generation or not.

After all, if you are were to study history, for thousands of years, life was so uncertain that nothing other than what could be ported out at a moments notice was not valuable. So, Real Estate was never valuable in the way it is now though Gold had its predominant role due to the ability to run away with it.

As much as the Greece episode has given many investors a ability to buy some stocks cheap, do give a though to those who have their life savings stuck with no idea what will be the final outcome. Same goes to the citizens of countries like Venezuela, Zimbabwe & Argentina. We on the other hand are way better off and hopefully will remain so for a long period to come.

P.S: The title of this post is from a wonderful film called Shawshank Redemption.

Perhaps the best way to sum up the key to life is wisdom from the movie Shawshank Redemption when Andy Dufresne said to his fellow inmate Red: “Life comes down to a simple choice: You’re either busy living or busy dying.” It isn’t just a quote from a movie, its advice for all of us.

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