Prashanth Krish | Portfolio Yoga

Long Term Investing and Trading

Today morning, good friend and guide, Sunil Arora tweeted the following

The only way to make money in the markets is Long term investing. have no doubt about that. I have now completed 31 years in the markets

— Sunil Arora (@moneybloke) June 30, 2015

On the face of it, that statement makes complete sense in every regard. There is tremendous evidence that traders end up losing their capital within a short span of time. In fact, evidence from brokerage points out that 95 to 99 percent of all traders end up either having wiped out their capital or at best generated returns that aren’t commensurate to the amount of time and energy spent on achieving the same. While there is no such static with regard to investors, I wonder how many really thrive – in sense, how many actually are able to generate healthy returns for the efforts put in as compared to what could have been achieved by just buying a Index ETF and sitting on the same. Its tough to measure success / failure for investors due to various reasons including but not limited to fact that there is a lot of Survivor bias and Sunk cost fallacy at work. Investor buys stocks like Koutons (which today we know is bad, but as I pointed out in one of my earlier blog posts was recommended as a fine stock by major brokerage houses) and if he had just sat on it, it would still be on his demat account even though trading has long stopped. If one has caught onto the right stock and sat on it, the returns would be fabulous indeed. But once again,as I wrote in my previous blog post, its the Quantum of profit that becomes important than just percentage since unless the bet was fairly large, even a 100x return can be meaningless in today’s money. The biggest difference between a trader and a investor is the time required to get a feed back. A investor generally has a large amount of time before the feed back is received as to whether his logic was proved right or wrong. A trader on the other hand has a much faster feedback loop with he knowing within a very short span of time how good or bad his decision was. A secondary difference between a trader and a investor is the use of leverage. While a trader loves to leverage his capital in the hope of capitalizing more gains, a long term investor can rarely leverage and hence can invest only as much as his capital would allow him to. The biggest advantage of not using leverage for a investor is that he knows that the only way his capital can go to zero is if all his picks go to zero. A trader on the other hand can get chopped out even though the markets may have moved nowhere. For example, just today, ReformedBroker posted this tweet

If you’ve been buying and selling the S&P 500 this year on every 50-day moving average cross, you’ve traded 27 times pic.twitter.com/HtmpVx6N2l — Downtown Josh Brown (@ReformedBroker) June 30, 2015

If some one had traded every signal with a fixed position size, he would have run out of capital long before we hit this 27 mark. Of course, even a guy who uses position sizing would get killed (not to mention lose his hair trying to stick to his system) if he followed the same blindly.

Then again, if trading was not a feasible way to generate profits, could we see the kind of returns that Dunn Capital Management has generated using purely trend following systems?

While the fund goes through gut wrenching draw-downs that have in some cases gone on for years together, the end result has been one where the program has strongly beaten the markets (as measured by S&P 500). In fact, if you were to search the CTA world, you would find many such examples, though Dunn as far as I can see is the one with the longest track record.

Long term investing does not mean easy money as Sunil tweeted in his tweetstorm

If someone thinks making money is easy in the stock markets, think again. It takes real hard work and then some

— Sunil Arora (@moneybloke) June 30, 2015

Earning a profit higher than what the markets provide (again, as measured by the benchmark) is neither easy nor possible for a large number of investors.

In fact, I strongly believe that majority of the investing population out there neither has the capability nor the band-width required to be a investor / trader and are better off achieving their goals by prudent investing in Mutual Funds / ETF’s.

For every one stock that has given abnormal returns in the long term, I am sure one can easily find 5, if not 10 stocks that seemed to make even more sense at that point as a great investment just to be wiped out in time.

Every market peak has seen hundreds of stocks making the news and every bust has seen most of them wiped out. The few survivors that are left are those that could pass through some of the booms and busts and yet survive. In the 2000 IT boom, at Bangalore Stock Exchange, we had around 50 stocks that got traded. Of them, I wonder if even a dozen survived (forget about thriving since many of them are yet to see their highs of 2000, 15 years later).

I am all for the long term if you are willing to work hard at identifying opportunities that get presented by the markets and are willing to wait for long time frame to pounce only when a opportunity presents itself. Else, your long term is better off as a investor in Mutual Funds / ETF’s which enable you to more or less achieve what the markets provide without you having to sacrifice personal and family time in an attempt to beat the market and grow your capital.

List of Companies that have got delisted over time is available here (Link). The list of companies that have got delisted either due to Compulsory Action (many a time for not adhering to listing requirements) and due to winding up of the company is fairly large.

Trend following & the Greek Referendum

One of the reasons I am a strong believer in trend following is that I have observed that in all cases where markets were supposed to be caught by surprise by an event that shook the markets, the trend was already down. I have in the past given presentations and talks using examples such as the Kobe earthquake, September 11 attacks, our Election results among others. Every time, the trend was already established in line with the future unfolding.

To that extent, this day’s opening gap down of 1.6% was definitely a surprise since markets seems to have had the least amount of any such anxiety going into Friday’s close. In fact, even the Greece markets seemed to have missed any clues as it closed in the Green on Friday.

The non believers though seem to have been having a field day

So Greece was not priced in?

— zerohedge (@zerohedge) June 29, 2015

So, I decided to see, how often this is the case – the case of the short-term trend being up and markets opening down 1.6% or greater. For the short-term trend filter, I used a 15 day EMA.

Since 1999, we have had just 4 such instances with the last event being on 16th July 2013. And other than the 1999 event day, every other day, we actually closed above the open price though on no occasion did the markets close in positive territory (and that includes today obviously).

The table below showcases the performance of the markets for the next 5 days post such events

Based on historical evidence, t+1 which is tomorrow, seems to have an edge in terms of a positive close. But more interesting is that other than in 1999, the bullish trend of the past seems to have held on with this day being an aberration of some sort and not a deal breaker (given the low number of instances).

Core Competencies

We all have our area of expertise which is where we have spent much of our energies both in terms of education as well in terms of the job we do.

Charlie Munger once said and I quote

“Warren and I only look at industries and companies which we have a core competency in. Every person has to do the same thing. You have a limited amount of time and talent and you have to allocate it smartly.”

As a amateur trader / investor, its normal to jump from one strategy to another in the hope that we find the golden goose. But as we mature, both in terms of age as well as in our ability to understand things better, we concentrate our energies on what works best for us and try to make the best of the situation.

But even the professional gets swayed especially when one’s strategy is going through a tough time. Trend followers for example have’t had that much of returns in recent months even as the rest of the market seems to be having a jolly time. Value investors have doubled / quadrupled their investments while the best we seem to be able to achieve is just hanging on to our capital.

Recently, there has been a spate of discussion on my time line regarding Market Profile, a strategy that has suddenly got the limelight even as many other strategies falter. I personally too got swayed and read a introduction to Market Profile just to get a hang of it.

But does it really make sense to switch gears in the middle? Can a Veterinary Doctor switch to Dental because it seems to make more business sense?

In last one year, we saw a sway of Mid and Small Caps throwing up some crazy returns. But how many investors really have a clue as to what they are buying? How many stocks have some truly great qualities and how many are just the Mom and Pop store that got caught in the Dot Com craze?

I love twitter for the ability to connect with other people and read articles / books which they feel is worth one’s time. But when it comes to trading and results, how realistic are those in the first place? I constantly use the word “Twitter Traders” since I seldom see some one taking losses with most claiming to be making a packet. Since markets, especially derivatives, are places where one cannot win without some one else taking a loss, one wonders as to where are those losers?

Every strategy has its weakness regardless of what their ardent followers may claim, nothing is fool proof. In my own view, over the really long term, the returns of almost all strategies (those with decent expectancy) should be around the same.

So, while 2014 may have been the year for Value Investors, 2015, the year for Mean Reversion traders, 2016 may favor some other methodology. By jumping around, all one will do is miss out on all opportunities since we would never have a domain expertise to know the good from the bad and worse, miss the early juicy part while competing with others for the left overs.

Building domain expertise is a life long endeavor and honestly it is not worth the time or the effort to try and compete with all. After all, despite the fact that software engineer’s get salaries way above what other jobs pay has not meant that we all have jumped and tried to become software engineers ourselves. So, why should our way of investing / trading in markets be any different?

Food for thought?

Its the Quantum that is Important

Real Estate has given some crazy returns in the last few years and there is not denying that. We can always pick and chose stocks that have maybe given even better returns, but the big question is, are they even comparable.

While there is always the case of stocks like Infosys / Wipro / Motherson Sumi, the net results if one looks at the Index itself is not as promising.

Even taking the most optimistic scenario that is used by most fund managers (investing in 1979), the returns come to some 17%. On the other hand, I know of properties that have (at current market prices) given a return of similar proportion for a much longer time.

But as usual, I am digressing from the subject on hand. On Twitter and elsewhere, I constantly hear about investors making 2x, 4x, 10x their investments in certain stocks.

The returns are fabulous if one were to put it, but the question is, is the return really worthwhile in money terms?

Let me give a example of my own. In 1997, I bought a certain company called Indo Count Industries. It was a penny stock at that point and remained one for a very long time. In fact, when markets collapsed in 2008 / 09, this stock traded at around 2.50.

Things started to change in 2013 and in 2014, this stock galloped 800%. This year, it has already gone up 80%. For me, this stock is near to a 100 bagger. Theoretically speaking, I should actually be able to retire on just this stock alone.

But as usual, there is a caveat. I invested 700 bucks (in 1997) and today while its worth 65,000, the sum is pretty low for thinking of any dream purchases, let alone retiring.

Lets assume instead of buying Indocount I had bought some real estate (of course, I could not get something for 700, so amount of investment would need to be higher) and it became a 100 bagger, I could actually have retired for a comfortable life.

The key difference is the amount of investment that is required / invested when it comes to the stock market vs the investment we do when we enter into real estate.

In Real estate, not only do we invest every Rupee we have got but actually leverage ourselves by taking on loans that magnify our returns.

When it comes to investing though, we rarely invest what we can (our Liquid Networth), let alone investing it all and then adding some leverage on top of it.

The key reason is the lack of conviction. While we are convinced that Real Estate markets shall not drown us, we aren’t so sure when it comes to the stock market.

The reason we aren’t convinced that stocks comes down to the fact that most of the time, we are clueless as to how to analyze companies / investment and even when we are, having either burnt our own hands or seen the destruction suffered by others, we worry too much about what if it goes wrong.

A friend of mine has a couple of crores in investment in real estate while having a couple of lakhs into the market. Even if his investment in the market doubles / quadruples, the returns are literally are literally a drop in the bucket so as to speak when compared to what the returns (a big IF) that are generated if his real estate investment doubles.

Of course, I am not advocating real estate. I strongly believe that while we may not see a crash of the kind we saw in US, the forward returns from Real Estate will be pretty low (and this even before Indexation) for the foreseeable future.

On the other hand, if India grows in the way countries like United States / South Korea / South East Nations / China have grown, there is a lot more to look forward to.

But you will only build wealth if you not only invest significantly but also be willing to stay through it through thick and thin. But that requires a lot of discipline since its not easy to stick to our process when the times are tough.

At PortfolioYoga, we introduced a Asset Allocator model sometime back. We believe that rather than invest everything when the markets are high, it makes sense to have a lower exposure and increase the exposure if market gets cheaper. Else, while returns will be lower than complete exposure shall provide, at the very least, you shall be able to sleep well at night.

Big money, both in markets as elsewhere, is made by those willing to bet it big. That of course does not mean take un-necessary risks. But with the right risk models, you should be able to build your wealth without having to go through the pain of having your investment stuck with no way to exit in a hurry as is the case with asset classes like Real Estate.

Trading with the Longer Trend

One of the often quoted things is that one should always trade with the higher trend. So, if the higher trend is bullish, it makes sense to avoid shorts and take only longs and vice versa. As much as the advise seems great theoretically, its only after testing can we really be sure whether such a strategy really makes economic sense.

The biggest draw-back so as to say when it comes to trend following is the streak of losses that one sees. This generally takes place when the markets are undecided on where next to go and oscillates between a high and low point.

With the current trend among traders being “Market Profile”, this area is also seen as bracket area where both the bulls and bears are in control of their respective zones and defend the same. So, when markets go to the upper range, bears become pro-active as they short the market with the anticipation of a pull back to the lower zone where bulls are willing to take charge.

For a trend follower though, such back and fro movements are killers as they get repeatedly stopped out while the market in itself would have not moved anywhere. Or even worse, we get caught in counter trend trades, even as the larger trend in itself is relatively undisturbed.

For example, take a look at the chart below. Its of CNX Nifty (Spot) with Arrows being the Buy & Sell signals generated based on a simple 3 * 5 Moving Average Crossover

Specifically concentrate on the marked area – the markets were well and truly bearish, yet, our buy signals got triggered a lot of times before the final Buy actually resulted in a good profitable move

What would happen you may wonder if I were to add another longer term Moving Average to figure out whether the trend is Up or Down and act based only upon that.

Since we are looking at the whole situation objectively, we will need to not just randomly pick up a Moving Average which shall tell us whether the trend is up or down but find that number by analyzing all possible options.

One way to do that would be simply optimize the parameter at hand. Of course, we shall then fall into fitting the curve, but since the idea is to see whether our logic is right or not, we will not worry about it for the moment.

So, on top of the 3 by 5 Moving average crossover, I tested for what variable would be the best fit (one for the Bullish trade and one for the bearish). After testing through nearly 35,000 options, the best among the lot seemed to suggest using 150 day MA for our bullish objectives and 200 day MA for our bearish objectives.

Before we go ahead and see the results based on this, lets first see the results of the standalone system.

The test was carried out on EOD CNX Nifty (Spot), No commissions were included and all trades were taken on the closing price of the same day. No compounding of Positions was allowed.

As you can see, while the long trades are extremely profitable, even shorts end up in profit territory despite the fact that markets as a whole has moved up by around 6500 points in the interim.

Now, lets apply our filter of going long only if Signal has come with Close > Moving Average of 150 periods and going short only if Close is < Moving Average of 200 days.

Because of the additional filter, this system will not be a Reversal system anymore (i.e., Long exit is also Short entry & Short exit is also the trigger for Long)

Results are as follows;

So, what are the key differences between them.

First is the fact that having a filter reduces Net Profits. While a simple Crossover provides us with 10,363 Nifty Points, the Filter reduces this to 8,181, a reduction of 21%.

The Number of trades is lower for the Filter compared to the plain vanilla approach. While the plain vanilla approach has 504 trades, the filter reduces this to 232, an incredible reduction if one were to say. This reduction also means that we are not always exposed to the markets as in case of plain vanilla.

While the plain vanilla crossover approach requires us to be in the trade all the time, in this case, that requirement is no more present. The filter version is in the market for 2117 days vs the normal which is in the market for 4333 – again a huge difference.

And finally, lets look at the most important factor – draw-down. System draw-down for the plain vanilla was 15.62% vs 8.63%.

All in all, having a filter will help in having a smoother returns but has the opportunity cost of missing trades (ones where the market trend is changing from Bull to Bear and vice versa).

Its all finally about give and take. If you are happy with a lower return (point wise), you can smoothen your equity curve. But if you are happy & are able to take in volatility, plain villa offers you a higher profit ratio.

Permanent loss of Capital

One of the often quoted reason to invest in the stock market is that they have delivered XX% returns since 1979. This of course is bullshit given the fact that Sensex did not even exist in 1979, let alone a retail investor have the avenue to invest in its constituents.

And then there is the tales of how investing just 10K in 19xx would have turned into Crores of Rupees today. Just today, on Whatsapp I received the following message

Motherson Sumi announces :- 1:2 Bonus on 10th June’15
See Wealth Creation of Motherson Sumi :-
Motherson came out with IPO at 25 INR per share in April-1993
Only 2500 INR of investment on 100 shares.

The Company’s Bonus History and Multiplication of Shares as follows :-

1997-98: Bonus 1:2 – 100 shares became 150 shares
2000-01: Bonus 1:2 – 150 shares became 225 shares
2002-03: Split into Rs.5 paid up – 225 shares became 450 shares
2003-04: Split into Rs.1 paid up – 450 shares became 2250 shares
2004-05: Bonus 1:2 – 2250 shares became 3375 shares
2007-08: Bonus 1:2 – 3375 shares became 5062 shares
2012-13: Bonus 1:2 – 5062 shares became 7593 shares
2013-14: Bonus 1:2 – 7593 shares became 11389 shares

So, 100 shares became 11,389 shares.

Current market value of 11,389 shares=
11,389 shares*Rs.489(Current Value)=55,69,221 INR

So, Total Value of Rs.2500 invested in IPO including cumulative dividend is Rs. 56,71,602 as at 10th June, 2015.

Thus, 2268 times increase in Investment Value in 22 years!!!

Patience is bitter, but its fruit is sweet

The compounding is really amazing but what the message does not say is that this is Selection Bias at best. While Motherson Sumi survived and thrived, there are thousands of IPO’s which came in the same era and which are not even listed on date.

If you had invested 10,000 Rupees (which in 1993 represented maybe a couple of months salary for any mid level employee) into every IPO that came out in 1993, I can assure you that your returns today, adjusted for inflation would be measly at best and disastrous at worst.

That does not mean, no one has invested and held on to great shares. There would be quite a few such folks who would be sitting on tremendous returns realized from those investments. But the reason for them to hold would be far away from any fundamental or technical arena.

These days, I find many a folk advising one to invest directly in the markets despite the fact that the probability of a investor really outperforming the market on a long time frame is in the low single digits. We are told to invest in blue-chips, but how many blue-chips remain blue-chips over a period of time?

Yesterday, I finished reading a book written in the aftermath of the 2000 bubble. Its amazing how easy it was then (as it seems to be even now) to manipulate the small investor / trader to buy stocks that are touted as the next big thing.

While 2000 was purely a Infotech led bubble, the 2008 bubble was much broader and hence I wondered as to how many stocks have survived over the last 7 and a half years and what has been the return between then and now.

The results as shown in the tables below is literally devastating. Many of the stocks which traded in the high 100’s and even above 1000 are now more or less trading or were de-listed at pennies.

Take for example a stock like Koutons Retail. The stock which came out with its Indial Public Offering in September 2007 was over subscribed by 45 times when it offered its shares for sale at 415 Rupees (Link).

With markets in full flow, almost all major brokerage houses / newspaper recommended investing in the same.

Koutons Retail: Invest (BusinessLine Review)

An investment with a one-year perspective can be considered in the initial public offer (IPO) of Koutons Retail India (KRIL). KRIL is a player in the menswear segment with a network of stores mainly in northern and western India. The offer proceeds will help the company expand its retail network.

The price band of Rs 370-Rs 415 values the company at 33-36 times its 2006-07 earnings per share, on an expanded equity base.

KRIL’s premium pricing appears to factor in higher growth rates compared to domestic apparel majors such as Raymond, Zodiac Clothing and Kewal Kiran Clothing. The latter trade at price-earnings multiples of 15-20 based on trailing earnings.

However, KRIL’s performance over the last couple of years and its proposed expansion plans provide some justification for the higher growth expectation.

The expensive valuation for the offer, however, does not provide a margin of safety in the event of disappointing performance. This makes it suitable only for investors with a high risk appetite.

While the huge over subscription would have meant limited allocation, investors who did get a small piece of the cake were left happy with the stock moving higher. In fact, so good seemed this stock that even as rest of the markets were getting slapped in early 2008, Koutons made a new high in late February (by which time, Nifty was down 17% from its peak).

The slide started from then as markets tumbled even further and even Koutons caught onto the fever. But Brokerage houses were not one to be moved by this volatility as they continued to recommend the stock even as it went down the rabbit hole.

Some of the few brokerage reports I could find can be downloaded here (Koutons Research Reports). Since their publication, the stock had gone just one way – down the rabbit hole so as to say, but while I could find Buy Reports, I found Zero sell reports. The reports though seem to completely stop in 2011 with the stock having breached the 100 mark as well.

Yesterday, I tweeted the complete list of winners and losers. For those interested, here is the spreadsheet with the same data for you to check any company you would like to. (Link) Do note, that most of these prices are adjusted for Splits / Bonus and hence the actual closing prices may have been different for a few stocks. Add to that, some stocks which got delisted / merged and where the earlier ticker bore no resemblance may pop up, apologies for that.

Also, this list is only of those stocks that are listed on NSE. (Link).

To summarize, Direct Investing while seeming to be way more attractive than investing via a Mutual fund can be very expensive in terms of your ability to meet your goals as also enable your savings to grow if you are not able to choose the right stocks. But what are the right stocks becomes the bigger question when stocks supposedly great end up on the mat.

If the mutual fund universe were to be scanned using a database of Survivorbias free returns, I believe you shall find that even there, many investments would have given partly gains. But the key difference is that the percentage of such funds are lower than what we can find in stocks. Also most funds which tripped where sector focused funds which anyway’s carry a much larger risk than a diversified fund.

Direct investing is very risky unless you are prepared to do all the hard work required. Direct investing in funds these days costs just around 1.25 – 1.75% and I strongly believe that this is a small price to pay for the ability to at the very least keep up with the market. ETF’s are another route, but unless we have a more broad based ETF markets (Mid Cap / Small Cap / Sectors), it will remain a fringe industry (though one that has proved based on performance to be better than most Mutual Funds in US where there is both depth and variety)

Selection Bias in Mutual Fund

When we are told that Mutual Funds beat Benchmark & hence generate Alpha, we are given the list of funds that have achieved that landmark. What we aren’t shown is the list of funds that have under-performed (who wants to highlight losers anyway) as also how 2 similar funds managed by a single fund house can have returns that are hugely diversionary

The rationale for this post comes from this tweet by Manoj Nagpal (tweet). The fact that despite trading under the same fund house (and hence similar philosophy), the returns are dramatically different

Here are the returns and comparison to the benchmark via ValueResearchOnline

(Link to above Fund)

And here is the table for the Second fund

(Link to the above Fund)

So, what is the difference in the funds that could be the reason for such a wide parity. The difference comes in who is managing the funds.

Fund-1 is managed by Star fund manager Kenneth Andrade while Fund -3 (the Second fund above) is managed by Ankur Arora & Meenakshi Dawar.

In a way, the whole Alpha of the fund seems to be credited to the one guy and not exactly because of fund philosophy or any other nonsense that is generally seen as key factors and that brings us to another question as to what does one do when the key player quits (as is being rumored in case of Kenneth) or unfortunately dies as in case of Parag Parikh.

In case of Parag, my own rationale (which seemed to be different from what most other financial advisors were saying) was that it made a lot of sense to exit the fund for now and wait to see how the fund performs in the future.

Kenneth Andrade, Prashant Jain are among the few widely known fund managers who have been drivers of not just their funds but also have made it possible for people to experience what long term compounding can achieve.

There is a huge amount of literature out there since Internationally, a star fund manager leaving for fresh pastures happens all the time. Here are a few of them

Star fund manager quits – what should investors do? (The Telegraph)

Should You Sell a Fund When the Star Manager Leaves? (Morningstar)

Don’t jump ship after star managers quit (FT)

Reach for the stars? (SquareSpace)

While the jury is still out there, I believe in that one should look at safety first and in that, it makes a lot more sense to exit a fund when the Star Manager quits rather than hoping the the next one in line is as good as the former. After all, its our money at risk.

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