Prashanth Krish | Portfolio Yoga

Not a Clue!

Trend following is a methodology with a simple concept. Keeps (Buy) stocks that are going up, Exit (Sell) stocks that are going down. The tendency to sell winners too early and ride losers too long is referred to as the ‘disposition effect’.

But, why despite tons of evidence do we continue to do the same mistake? The reason I feel that we do what we do is because of pure Hope and Fear.

When a stock where we are long goes down, we “Hope” that it will come back to where we bought and hence it makes sense to wait. Those with a extra appetite for risk go on to average in the hope of getting their average price down and hence profit earlier itself.

When a stock goes up, we are more times than ever riddled with fear. We fear that the profit we are seeing may soon be washed away when market trends higher. After all, having seen that markets are cyclic, we tend to fear that a upcoming fall may wipe away all our profits. As the idiom goes, “1 bird in the hand is worth 2 in the bush”. Its nice to know that there maybe even more profit going forward, but since there is also a risk of losing the current profit, better to exit than wait is the thought.

The key reason for the above attitude by most investors is that they do not have a clue as to why they have bought the stock in the first place. Most of the time, it was based on a recommendation by some friend / television pundit or the broker. So, when it goes up, one is willing to take a profit as early as possible let the profit slip out of hand.

But the same attitude is not followed in loss since it pains once to take a loss. While its one thing to see a notional loss, once its booked, its becomes permanent. Hence, the best way to avoid the pain is by hoping that it will come back some day and wait it out.

In many of my blog posts, I have emphasized on having a plan, a strategy, a thought process before one enters into a investment / trade. Without it, you will never be able to judge whether the carbon your holding in your hand is Coal or Diamond.

My thought on Net Neutrality

Over the last couple of days, I have come across a intense debate as to both the validity and the morality of Airtel to charge for calls made using 2G / 3G Networks (using apps like Skype, Viber and the like).

I would suggest you go through the following links first

Medianama

Niti Central

Personally, me & my family has been using VOIP a lot over the years though we use it using a DSL connection (Airtel) rather than a 3G (you cannot get streaming video on 2G, forget about using Skype). I pay Airtel money for providing me with a certain speed. While I would have loved not to have a FUP limit, I have been required to live with it since no Internet provider seems to provide genuine unlimited downloads (at the speed I am hooked for).

Tomorrow if Airtel says that they will charge separately for downloads (Torrents), VOIP (Skype / Google Talk), I will be immensely pissed. But for now, thankfully it does not see to be on the cards.

TRAI chairman has said that while its wrong from the angle of Net Neutrality, what Airtel is doing is perfectly legal based on current laws. Now, if the law is a ass, it makes no sense to penalize Airtel for using it to the maximum. After all, companies in US who like to showcase that they are highly patriotic do use whatever legal means available to ensure that they do not have to pay tax (especially on overseas income).

Lets try to compare the Airtel situation with say the Restaurant business. Any and every restaurant has a board that says “Outside food is not allowed”. Once you enter a restaurant, one is required to order from the restaurant itself and not take outside food.

For instance, how would Coffee Day feel if you sit inside a Coffee day cafe and then order Coffee from the nearby Shanti Sagar (where the price of Coffee is at least 5 times cheaper than Coffee Day). But go to a canteen and this distinction does not apply.

At our office, we have a canteen where we are allowed to use the infrastructure to eat eatables from outside (home or elsewhere). Tables are kept clean and if we do not order anything, we do not pay anything. Theoretically, we use the facilities for free while the cost of keeping it up (Clean Tables, Drinking water, Washbasins, Rest rooms) are all paid in one way or the other by some one. But nothing comes for free for there is always a catch.

Here, it’s possible because the canteen is not run as a restaurant. In most cases, the rent is highly subsidized, given for free or even paid to make it viable. If any canteen has to pay the market rent, I doubt anyone would want to put up one in the first place since there are always limitations on how many folks would come to eat (and pay). And they would definitely ensure that outside food (home made or not), is strictly not allowed inside.

When companies like Airtel bid for the spectrum, they are doing so in the hope of en-cashing on the usage. Of course, who knew how breakthroughs in technology would put a lid on many of their hopes. SMS used to be a big thing till the time we saw the arrival of Whatsapp. If much of Voice (especially non local) gets off the grid, the whole point of paying so much for the spectrum makes little sense.

Its all nice to say that we are in a age of disruptive economics. But no one would want to sit around while others burn their business literally to the ground. Every battle will be fought tooth and nail and this is no different.

Yesterday I was reading about Microsoft approaching the government to enable it to launch Wireless internet using what they call “Dynamic Spectrum and TV White Spaces”. If that is successful, that will change the whole game. Who knows, where go from there

I am all for Net Neutrality, but what we need is laws to ensure that. Without a supporting law, bashing a company for its policy takes us nowhere. While Airtel has been the fist to kick this off, it would be just a matter of time before other telecom operators replicate the same.

Blood on the Street

The low risk opportunity arises when the herd is full of fear and hence valuations are cheap. Of course, the fear based opportunities for the market as a whole do not happen regularly nor is it possible to wait endless for it. But while entire market may not be available for cheap, impact of news can mean that some sectors are available cheap even when the rest of the market is expensive.

Before I continue, the following quotes from legends is a apt read;

“The time to buy is when there’s blood in the streets.” – Baron Rothschild

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffett

In the current market, while good stocks are becoming expensive (some crazily expensive), there is a sector that is not only cheap but becoming cheaper by the day. The sector I am talking about is the Exploration & Production of Crude Oil. In India, the major listed companies in that sector are

1. Oil And Natural Gas Corporation
2. Cairn India Ltd
3. Oil India Ltd
4. Aban Offshore Ltd
5. Selan Exploration Technology Ltd

Of the above, I would straightaway exclude ONGC and Oil India due to my personal dislike of Public Sector Units. Aban gets excluded since its

1. A company that is into leasing drills rather than being direct oil producer
2. Its debt is pretty high and its debt is nearly 5 times its current market capitalization. High leverage companies are the first to go bust when the climate changes and Aban seems to carry that risk.

That leaves two companies that are into crude oil production and carry zero debt on their books. The falling price of crude is guaranteed to have a direct impact on the profits and hence its no wonder that the stock prices are way down from their all time highs.

But the question to be asked is,

i) At what price would one start to find it valuable given the fact that both these companies will continue to earn profits (though lower) and with no debts to pay off, everything is going to do straight to the bottom line.

ii) While we are said to have seen a decline in consumption, with no other viable energy sources, its doubful that Crude shall go out of fashion.

Yesterday, I was reading a report that said Russia is likely to consider cutting back on production since with prices on a free fall, the probability of many fields ever being able to make money will be low to zero. In fact, one of the reasons Saudi is said to be not intervening is that it wants to bankrupt Shale Oil producers since they have a higher cost of production and hence cannot continue to keep producing even when it seems non viable.

In fact we have already seen bond yields of small shale oil firms jump up on anticipation that many will not be able to repay back the bonds when it comes for redemption.

The historical chart of Crude suggests lengthy bear markets and shallower bull markets. If that pattern holds true in future as well, the current fall is just the start of a long bear market and wherein opportunities will be many.

Purely based on charts, I see no reason to try and catch the falling knife. Instead, I would rather wait for a entry based on say a cross above the 200 day EMA. While that would take place well above the lows we would have seen, it would provide one with a low risk entry with exit (in case it does not work as expected) being pretty close.

For now though, its a wait and watch since the jury is still out as to how long this bear phase shall last. There is no reason to rush through and pick the dip since if as the historical chart shows anything, it is that there will be plenty of time before this is over.

Exception to the rule

Today I read a tweet by a person who claimed that he was posting his ledger just to showcase to those who believed that “Day traders loose” that its indeed possible to make good money trading purely on intra-day scale. While I have not met him, I do take his word on faith and assume that he is indeed pretty successful in trading the markets on pure intra-day basis. And there is this friend of mine who has build a fortune (by his standards, not Fortune’s) by just being street mark and networking with the right folks.

In November of this year, a 4 year kid fell 230 feet and survived (Link). Lots of people make money in Casino’s as well despite the known fact that “the house always wins”. And this without having to do card counting.

I know plenty of long term investors who have not been able to out-perform a simple Buy & Hold returns of Nifty and even worse, many have fallen by the way side having lost a major part of the money in stocks that today are no longer even available for trading.

Vastu / Astrology are seen as bunkum, but I can show you guys whose careers have changed because of a change in the direction of the door. And there are enough people who strongly believe that homeopathy can cure a lot of diseases.

The single thread between all of them is that they are all exceptions to the rule. If no one ever made money (in short term if not over years) trading on intra-day scale, people would never try to do such stuff. And if no one won in a casino, they would have to shutter for lack of clients.

But exception to the rule does not mean that its easy for others as well. If day trading was really easy, I would doubt anyone would want to work anywhere else when you can literally make mind-boggling returns on capital (Day trading requiring very little capital is the biggest attraction).

If access to news / information ensured a success in markets, the richest folks would be those who have the first access (think of people working at Newspapers, Television studios).

If all our problems can be solved by simply changing the direction of the door, well, you should have seen that happen long back and by now we would be living in a state of Nirvana.

Beating the market is very tough and very few people are able to do that consistently year after year. There is no magic wand that can let you make tons of money without you having some amount of expertise. And the guys who have achieved that success, its not due to luck but more due to hard work and persistence. If you were to read about Sachin Tendulkar or Tiger Woods, the common thread between these guys were the fact that they were not only in the right place at the right time but also that they put efforts more than what others did and as Robert Frost would say, that made all the difference.

Meb Faber Timing Model on CNX Nifty

For a trader, its essential that any strategy he uses needs to at least in historical testing beat Buy & Hold returns (and since we assume a lot in our back-tests, higher the returns compared to B&H, the better). After all, the argument here is simple. If you spend time and effort in markets, the least you should be expected of doing is beating the guy on the street who may have just bought nifty bees and went into deep sleep.

Then again, that may not entirely essential to a investor whose idea is to get a return better than other asset classes and if one comes with lower risks, the better.

The biggest advantage of Buy & Hold on Nifty Bees is its simplicity. You buy it and you can forget all about it. X years later, your returns shall closely mimic the returns of the Index (some variations shall exist due to tracking error).

The biggest disadvantage is that when Index falls big, your investment gets hurt too. For example, a guy who invested into Nifty Bees 2006 would have seen his returns being absolutely zero if he had checked in late 2008 / early 2009. A FD on the other hand would have paid him much higher returns without a iota of risk.

The best way to beat the markets one is told is to buy good companies and hold on (forever). But here too, it comes down all to when you enter. Let me give a example. I doubt you shall be able to say that buying Warren Buffett’s Berkshire Hathaway is a stupid strategy.

This is what I tweeted a couple of days back

An investment into Berkshire Hathway ($BRK-A) at close of 1998 as of today would have yielded a CAGR of 7.66%.

I do not know whether a CAGR return of 7.66% for Americans is huge, but the fact that you could have bought a Treasury Bond (30 Year) which was yielding 5% returns at the same time (End 1998) says that the results aren’t way out of whack with the expectations that could have been made. But I am digressing from the agenda.

Beating the markets on long term is tough. The survivors we see today hide the huge lot of fund managers who have literally disappeared. And beating the markets without having similar draw-down is even more tough. Even the best managers go through tough draw-downs that can send a chill down any investors spine.

Meb Faber some time back talked about a simple strategy. Rather than repeat what he has to say, I would recommend you to head over and take a look – http://mebfaber.com/timing-model/

I tested this strategy on Nifty (using Nifty Total Returns Index to ensure that we account for Dividends which get missed when one uses only Spot Nifty). The results are outlined here;

Test Period: June 1999 till date (December 2014)

Total Raw Returns: 9162 Points (higher than CNX Nifty since it includes Dividends).
System Returns: 8288 Points.

Raw Draw-down: 48.81%
System Draw-down: 26.71%

Raw Holding Period: 173 Months
System Holding Period: 131 Months

Raw Number of Trades: 1
System Number of Trades: 12 (last one being Long from November 2013)

Buy Price & Sell Price = Opening price of the next bar (1st trading day of next month). No Transaction / Slippage charges used.

But the big issue with directly using above data is that you cannot buy Nifty Total Return Index. Instead, what if one uses Nifty Bees. Nifty Bees has a tracking error (bit outdated data) of around 0.20% and a cost of 0.50%. Compared to other options available, this is the best.

In my search on that issue, stumbled upon Kiran’s blog where he has provided some stats on the same out here

All in all, I think for some one who wants to invest directly into market (some Mutual funds have outperformed strongly, but too much of Survivor bias makes comparing them apples to oranges) and yet not get caught when markets drop like a hot potato, this simple strategy is worth a look.

Howard Marks critique of Technical Analysis

Technical Analysis is a nice punching bowl for most seasoned analysts and fund managers. Howard Marks in his book, “The Most Important Thing” suggests that its not a worthwhile strategy in not more than 300 words.

I myself despite being a follower of Technical Analysis for quite some time do not take at face value all the bull shit that goes by its name. Switch on any television channel and you shall be saturated with calls based on so called “Predictive Technical Analysis” with most analysts trying to predict where the markets / stocks may go from here on the short term.

And almost everyone who comes on TV espousing technical analysis is either working for a firm or runs his own tip providing company. When was the last time you saw a person who used Technical Analysis but was managing a fund?

What this has meant is that even Quantitative analysts (an area from which we derive a lot) look upon Technical Analysis as some sort of vodoo science fit to be ignored. But is there really any value in Technical Analysis or are we blindly following a belief that is not worthwhile?

Its a question that has been asked several times by several eminent folks and the answer I have found is that while there is merit in some forms of technical analysis, it does not mean that all the non-sense that is peddled in its name has value.

To me, any logic that is based on some sort of mathematics and can be created using a system has value. This is because by using a systematic logical process, one is able to over-ride our inherent difficulty that comes to pass as several biases showcase.

The very fact that there are hundreds of successful CTA’s who use one or the other form of Technical Analysis (Trendfollowing based) again tells me that the science is not Vodoo as many seem to think it is.

Do take a look at the performance numbers of a few of such folks here (Link) and tell me how could they achieve those returns if the market is random in nature.

Coming back to the book I am reading, Howard Mark says and I quote

Another form of relying on past stock price movements to tell you something is so- called momentum investing. It, too, exists in contravention of the random walk hypothesis. I’m unlikely to do it justice. But as I see it, investors who practice this approach operate under the assumption
that they can tell when something that has been rising will continue to rise.

Momentum investing might enable you to participate in a bull market that continues upward, but I see a lot of drawbacks. One is based on economist Herb Stein’s wry observation that “if something cannot go on forever, it will stop.” What happens to momentum investors then? How will this approach help them sell in time to avoid a decline? And what will it have them do in falling markets?

I am yet to read his latest book, but I do hope that he has in the mean time seen the evidence that has come out to showcase the fact that momentum trading has some value to it. (Link for a search).

And as to getting out when the bull market stops? Is it not as simple as just using the reverse analogy of the buy to get out. Should not be too hard, ain’t it?

Like any other form of investing, Technical Analysis is not easy too. The ease at which it captures trends seems great in hind-sight, but without putting the effort required to understand and apply the same, the ability to do that in real time is pretty low.

Technical Analysis like any other form of Analysis asks for thinking out of the box. Just like the probability of gains is low that you shall gain just because a stock is cheap, so is with most known ways of using Technical Analysis to identify entry / exit points.

So, ignore the pundits on TV and put some work to understand the nature of the markets and how you can apply a theory that enables you to capture as much of it as possible without having to take the risks that come with a pure Buy & Hope strategy.

Random thoughts on a volatile market day

We are all familiar with Notional Loss and Permanent Loss but what about Opportunity Loss (Cost). Compared to the other two, this is not painful since Ignorance is Bliss. But then again, while the other two losses are something that has occurred due to action, opportunity cost is one which takes place due to inaction.

For Investors, the cost of opportunity is not being able to en-cash the gains in their portfolio. Warren Buffet says that he loves to hold stocks to infinity (speaking in a literal sense). But how plausible it is for a ordinary investor who has invested his money not to make wealth for the next generation but to achieve certain targets in his own lifetime.

A portfolio of IT stocks would have skyrocketed in value when the 2000 IT boom happened. Once it burst, the portfolio could have never recovered even though its been 14 long years. Even a Index (which has the advantage of being able to jettison weak stocks and add new stocks instead) like the Nasdaq Composite has not been able to conquer its 2000 peak. If you consider the impact of Inflation, the break-even cost will be even higher.

A portfolio which was heavy on Infrastructure / Energy would have seen it soaring in value in the years between 2005 – 2007 (in India). But how long before they come back to their highs (and will many of them even survive in the interim).

Some stocks though have never bothered to look back too much. But the question that you need to ask yourself is, how likely do you think that your portfolio consists of such stocks and hopefully everything bought at prices which are not tested when the larger trend reverses?

Some Small caps move onto Mid Caps and later on become Large Caps. The question though is, what is the % of stocks that advance such. On the other hand, what is the % of stock that move the other way round.

Index stocks are seen as the bluest of the blue-chips. But 20 yeas later, how many companies have survived and thrived. If you had bought (for equal amounts / stock) all Sensex stocks in 1994 and looked at your portfolio today, the CAGR gains you would have seen is somewhere around 12% (Of the 30 stocks, 29 are in existence with Philips India being the only company that got de-listed).

If you were to think that maybe investing in Mutual Funds would have given you a better return, think again. While you would have gained handsomely if you had invested in Kothari Templeton Prima Plus, your investment (adjusted for Inflation) would have wiped out if you had instead invested in CRB Mutual Fund (and both were launched in the same year, 1994).

Ask any stock broker / Analyst and he shall be happy to share the huge gains that could have been made by investing right and sitting tight. Heck, as the list below compiled by friend Girish showcases, your returns would beat the hell out of any other asset classes

Of the list, I have been into a couple of stocks. But then again, like any other investor, I have not held to-date and missed a pretty nice opportunity. But then again, I do hold a couple of stocks which have given me 100x returns (UTI Bank / Indocount), but since my quantity of purchase is small, even though the percentage returns seems awesome, the amount is pretty meager. A lakh of Rupees 10 years back is not the same 10 Lakhs now.

In fact, its not about identifying a 100x opportunity but ability to buy it big is the key to making wealth in markets. But how many have the confidence to buy a stock and invest say 10 / 20 or even 30% of their networth into it?

Recently I was reading a tweet by a Mutual Fund manager where he professed as to how investors would have made handsome returns by investing in markets and as an example showcased how Sensex has grown to 27,000 from 100 in 1979. What he forgets is that 100 was the base price and secondly, there was no way to invest into Sensex / Nifty till 2002 when Benchmark Nifty Bees came into the picture. So, when people talk about the long term returns of market, do take with a few kilo of Salt.

Over the last few days, Russian Markets have literally imploded. Things have come to such a pass that one is hearing that people are buying iPhones to hedge their currency risk. What is the probability that we may get hit with something similar and what is the plan of action if that does indeed happen. How hedged is one’s portfolio to international moves that we may have no control.

Without a plan, most of us move with the herd making it easy for the hunters to cull us. But how many have financial plans in the first place. Today youngsters take loans which they repay for most of their lives to buy asset such as Land / Appartments. While that has worked well in last 15 / 20 / 30 years, what is the probability of it working in the next 30 years?

We are happy to see advent of Flipkart / Uber / Zerodha among other disruptive companies. But what if the next disruption makes us jobless with our domain expertise not worth the price we deem its worth. What is the plan of action?

Writing this blog is a way for me to express my inner thoughts and if its boring, I apologize. But think deep, do we have a plan to achieve our goals if the Plan A bombs. How many have a Plan B or even a Plan C to take care of us when shit hits the fan?

A couple of interesting recent reads that may have influenced some of the thoughts above;

On the Shortness of Life

How Adam Smith Can Change Your Life: An Unexpected Guide to Human Nature and Happiness

Hand to Mouth: Living in Bootstrap America

Do check out the books above. Deeply inspiring to say the least. Made me think of what Warren Buffet calls the Ovarian Lottery and how lucky we are (regardless of the challenges we face).

This has been one hell of random writing. Thanks for reading. Hope its worth your time

sayonara 🙂

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