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Building Wealth by Moderating Expectations | Portfolio Yoga

Building Wealth by Moderating Expectations

I recently stumbled upon a PMS that takes in their clients based on reference from people they already know. In a world where PMS managers are happy to give up as much as 100% of their first year fees in an attempt to get a client, this to me was astonishing. 

As I read more about them and also interacted with someone who knows them better, I understood that the reason lay in wanting to be sure the client understood and was aligned with their thought process.

When Warren Buffett started out forming his Partnership’s, he partnered with folks who I assume he knew enough. Even his reluctance to split his stock which recently exceeded the maximum digits Nasdaq system allowed comes from wanting to have shareholders who are  interested in long-term plays, who have extended investment horizons

Advisory is a tough field. Most advisors end up losing 50% or more of their clients every year and to just stay where you are one needs to keep adding more clients. Of course, like equity one has lumpy years like the one we are seeing today where the growth becomes lumpy and huge but they in my opinion are more one off. 

The reason is simple – most clients start out with the wrong expectations and when the expectations aren’t met, the thought is that it’s the failing of the advisor. In a way, the advisor has failed too because he / she was unable to provide a perspective on what to expect. 

Once in a while I get a call from a prospective client who wishes to sign up but isn’t really sure. The noise around Momentum in the last few months has meant that there is this assumption or unstated fact that you are missing out on something if you aren’t invested in a Momentum portfolio.

Nothing could be further from the truth and yet this silliness keeps going on everytime we have a good time with a strategy. ContrarianEPS had written this tweet a few years back 

Between 2018 to Mid 2020 (for almost everyone), there wasn’t much interest in Momentum even though the number of advisors continued to climb higher. The key reason for the lack of interest was the continued underperformance of the strategy vs the broader index – Nifty 50 / Sensex.

This changed in 2020 not because the strategy was bound to do well after such a long period of underperformance but basically because the market as a whole took off. Between April 1 2020 to March 31 2021, we had 460 stocks that doubled, 157 stocks that tripled, 72 stocks that quadrupled and the list goes on. This list of course is constrained to only NSE listed stock. BSE has a much bigger number. A 100% or more on a portfolio based on such data doesn’t really appear out of the world.

In his book, A Random Walk Down Wall Street, Burton Malkiel wrote “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts. Well, last year, you could have just used a dart and come out as well as most of us Momentum Investors.

Since the Federal Reserve started its quantitative easing in 2008, life has never been better. Yes, there was 2011 and then again there was 2020 but every fall has made it seem like all it requires to be successful is stay invested and voila you get paid for the risk you haven’t taken.

While I am not a fan of looking at backtests in isolation, backtests provide a perspective that is not available elsewhere. From the kind of draw-down you should expect to how the strategy behaves in different environments, everything is out there for analysis. Yet, the focus generally comes down to Returns.

Momentum being a factor of the market cannot outperform the market itself. What happens post years like 2008 for example is hardly discussed or debated. The assumption for most part is that Momentum will escape some amount of damage by going into cash early.

While limiting drawdowns is nice, the question is how long it would take for real gains to accrue. My own back-test shows a CAGR return of 7% for the period from 1st January 2008 to 3st December 2013. That is 5 years during which the 30 stock portfolio bought and sold approximately 210 stocks. 

Most Indices did not even generate positive returns for the same period and in that sense Momentum definitely outperformed. If I fine tune the strategy, I may even get a higher number but I would be cheating no one but myself.

Value, Quality or Momentum are all good factors to be invested into. But real wealth is mostly accumulated through either Inheritance or Income from Salary / Business. Returns start making sense only after a long period of time. 

There was this quote that went around some time back 

Buffett made 95% of his wealth after the age of 65.

The statement is true though it ignores that by age of 65, he was really really Wealthy. That base and the continued high returns allowed him to grow his wealth even further. Without that base, he would have been one of the many fund managers who came and went.

Direct Investing can lead to better returns than what the market delivers but there is a trade off. First, there is a risk that you shall have a worse return too and second it requires a commitment in terms of time for both understanding as well as learning. 

Being prepared for the second is the key to success in markets for time is the greatest inhibitor to investment success. As I was writing this, a substack that came into my inbox had this data

“over $8 billion of leveraged collateral was liquidated from more than 775,000 traders by decentralized and centralized lenders”

This from the crypto markets which saw huge swings in the last few days. Basically nearly 8 Lakh trader accounts got liquidated because the accounts weren’t prepared to handle the volatility (and one which was not really out of the world for this has happened way too often in the world of Crypto). For many of these traders, it doesn’t matter if Bitcoin goes back to 100K, they don’t stand to gain anything.

From Mutual Funds to Advisory, the behavioral gap is well known and yet is the biggest stumbling block for most investors. The key reason to me is not because investors wish to chase returns (some do) but more so because the reality is different from the expectation they were sold into.

As Rudyard Kipling wrote, If you can keep your head when all about you are losing theirs, success in markets is guaranteed. Else we become the collateral damage that is counted in number and not names.

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