Notice: Function _load_textdomain_just_in_time was called incorrectly. Translation loading for the restrict-user-access domain was triggered too early. This is usually an indicator for some code in the plugin or theme running too early. Translations should be loaded at the init action or later. Please see Debugging in WordPress for more information. (This message was added in version 6.7.0.) in /home1/portfol1/public_html/wp/wp-includes/functions.php on line 6114

Deprecated: preg_split(): Passing null to parameter #3 ($limit) of type int is deprecated in /home1/portfol1/public_html/wp/wp-content/plugins/add-meta-tags/metadata/amt_basic.php on line 118
Asset Allocation | Portfolio Yoga - Part 3

Category: Asset Allocation

Does Investing all at Once makes sense?

It was nearly 10 years ago that I received a big Cheque thanks to selling off a asset that had suddenly appreciated in value much beyond what I had imagined. What I did with that was a kind of turning point (in a bad way) in my life. But this post is not about the stupidity I did, its about whether you can do better when you receive a big cheque that could really change your life.

Assume for instance you sold off a property and now have a sizeable sum of money. What should you do with it and how do you go investing the same?

Once you are in the 30% tax bracket, any investments should be seen in the light of how that post tax return compares to other options available.

Equity Investing is all the rage and if you are looking at wealth generation for the long term (or even for goals that don’t require money for a decade or more), its a good bet. But how should you proceed with the money you received?

Should you for instance just select a few funds (if you are into Mutual Funds) and invest it all or should you drip the money into the same funds over time.

Vanguard in 2015 did a study of whether it makes sense to invest all at once or invest over time (Assumption being that you have the full money available at the start). This was conducted across three markets – United States, Canada and Australia.

The conclusion;

Our analysis indicates that investing immediately has historically provided better portfolio returns on average than temporarily holding cash

The conclusion though isn’t conclusive since only 67% of time does lump sum out-perform sipping the same money over the next 12 months. In 33% of the time, it was better to invest over time rather than invest all at once.

So, how would such a idea fare in the Indian Markets?

For the test, I used Nifty 50 (Spot) data starting from 1990 to date. When money was invested over time, the assumption was this was held in Cash and did not yield any returns. But in reality, this could have been easily invested in funds such as Ultra Short Term Bond funds with monthly withdrawal to feed the equity.

Here are two charts to provide a birds eye view of which option is better.

The above charts plots multiple things. We plot the instances where SIP made sense. This is represented by drawing a Vertical Line – the colors denote the length of the SIP in Question. On the Secondary Axis we have the Sensex PE chart plotted.

The visual represents whether investing in one shot gave a better return than when invested over time (invested over 12 / 24 / 36 / 48 / 60 months). Blank are is when lump sum made absolute sense while lines were when SIP’s of a certain period made sense.

The above chart can also be synthesized in a data table which I present below.

How to read this Table?

The table beside this text represents the % of time lump sum investing beat investing over time. Longer the period of SIP, higher the probability of success using the lump sum mode.

 

While regardless of market conditions and valuation, investing all at once can make sense if you are looking for a investment period greater than 20 years, as the charts above showcase, looking at Valuations can be advantageous to your financial well being.

The Vanguard Study: Invest now or temporarily hold your cash? 

 

The In-active Asset Allocation Model

For a long time now, I have been updating a simple Asset Allocation Model here. This model which has a large weight towards Time and Value is designed primarily for Active Investors who would like to reduce risks when markets look frothy and add to exposure when blood is on the streets.

Most asset allocation models advise one to re-balance once a year or even once every 2 years since every re-balancing results in churn which can turn out to be expensive in the long run. The problem is that longer time differential between allocation re-balancing, higher could be loss of opportunities that present themselves.

For instance, when markets tanked in February it provided for a very small period of time a opportunity to snap up stocks / funds at a extremely undervalued (relatively) level. This kind of alacrity is what results in Alpha over the long run.

But the above model may not be suitable for someone who is starting of today and is saving for the very long term, for example Retirement. The aggressive model is currently at  30 : 70 in favor of debt and while this in a way signifies that there is Risk of a draw-down / lower returns going forward, this may not be a big issue for a investor who has saved very little, but wants to deploy small amounts regularly over time.

The United States is where one has seen all kinds of financial innovation and its there that the idea laid out below comes from.

Lets take the case of Dilip who is 25 years old, works for a private company and wants to save for retirement. Historically the easiest and the most efficient way to save on taxes while also saving for Retirement was through Employee Provident Fund. Even today, for most employees, that is the biggest savings kitty since the concept is kind of forced on them and most don’t see reasons to disturb the growing nest.

In the early 1990’s, Donald Luskin and Larry Tint[2] of Wells Fargo Investment Advisors invented what is known as “Target Dated Funds”. Target Dated Funds use the same Funds as anyone else but offer a glide path that reduces exposure to equities as the end date approaches.

Today, fund houses from Blackrock to Vanguard offer Target Date Fund with maturity extending to the year 2060. The further the time period, higher is the equity portion of the allocation matrix.

Here is the split between Debt and Equity for various end dates in funds managed by Vanguard

As can be seen, as the year of Retirement gets closer, the allocation to equity as percentage of total portfolio falls significantly. This tapering of equity exposure lowers the risk for the investor who is close to retiring and looking at the fund to be part of his annuity scheme.

Investors in India are yet to see funds like above being launched and hence there is no automatic way to save with a variable asset allocation that is linked not to markets as most Balanced / Hybrid funds available today are, but instead linked to one’s own target year.

But creating such a fund for one’s own purpose is very easy. All you need to do is select a couple of mutual funds (1 Large Cap, 1 Mid Cap and 1 Small Cap) and a Debt Fund (either Ultra Short Term Fund if Retirement is close by or Gilt funds if Retirement is far away).

What would be the choice of funds for someone like Dilip?

Given that he has a minimum of 35 years before he retires, his asset allocation mix would replicate the 2055 fund. 90% of his savings should go towards equity fund while the rest 10% can be allocated to debt funds.

Gilt or Ultra Short Term Funds

The choice of which fund to invest primarily lies with whether we believe interest rates will harden from hereon, in which case Ultra Short Term funds make sense or interest rates will soften further. In case of the later, Gilt funds allow one to lock up on the interest rate that is currently available.

Since Dilip is looking to save for the long term with a very small allocation to Debt, Gilt funds make sense for him given that Interest Rates are generally hiked when economy turns better and if happens, thanks to his 90% exposure to equity, loss (notional) in Gilt funds will be more than made up.

Mutual Funds or ETF’s

For the Equity Exposure, long term readers would know that I am a strong proponent of ETF’s and yet there is ample data to showcase that even though ETF’s make a whole lot of sense in US, its not the same out here. Indian markets continue to provide opportunities for Alpha though given the time frame we are looking at, its undeniable that the sky will be as clear in 2050 as its today.

Exposure by Category:

How much of the portfolio should be comprised of Large Cap Funds?

Lets first look at the performance of various indices.

Starting from 2004, we can observe that the best performance has been delivered by Nifty Midcap 100 Index. Worst performance is by Nifty 50. But this picture suffers the starting point bias, what if we started at the peak of 2008?

Suddenly, Nifty 50 doesn’t look so bad and Nifty Mid Cap isn’t a winner, let alone by a distance as could be seen in the first chart.

Based on a simplistic idea of adjusting total returns by the risk (measured in terms of Standard Deviation of Monthly Returns), I came up with the following allocation matrix.

Remember, this is more of a Guide than a Advise. The thought process is to participate without risking great damage when the correction finally shall set in.

Instrument of Choice

Large Cap:

ETF: Nifty Bees

Mutual Fund: Quantum Long Term Equity Fund

Nifty Next 50:

ETF: SBI ETF Nifty Next 50 Fund

Index Fund: ICICI Prudential Nifty Next 50 Index Fund

Nifty Midcap 100:

ETF: Motilal Oswal MOSt Shares M100 ETF Fund

Nifty Smallcap 100:

No ETF’s exist for the Small Cap 100 Index. Neither do we have any Index Fund.

Mutual Funds: Sundaram S.M.I.L.E. Fund, Franklin India Smaller Companies Fund & L&T Midcap Fund are the current best among the crop based on 10 year returns.

Ultra Short Fund:

On a 10 year look-back, Birla Sun Life Savings Fund, ICICI Prudential Flexible Income Plan & UTI Treasury Advantage Fund – Institutional Plan are the best in business.

Do note, much of the Analysis is based on historical data. The future may not be exactly similar and funds that are leaders today may make for laggards tomorrow. But given that historical data is all we have, I believe one needs to make the max of it using principles that have proven historically.

Hope that if nothing else, this post provides you food for thought on how to save for Retirement or for any other time based goal you may want to save for.

IPO’s,do they really add value to your Portfolio?

Twitter is a great way to share view points but given that one has limited number of characters within which to express one’s opinion, the opinion can be misconstructed to mean something other than what it was supposed to mean in the first place.

I made a comment on how major brokerages were recommending the DMart issue not because it was supposedly a great business to own but because it’s cheaper than other listed peers which is really a pathetic argument IMO.

Here is a comparative valuation chart of all listed companies in the Retail space (Data Courtesy: http://www.moneyworks4me.com/)

But even leaving aside the Valuation concern, the question here is does it make sense to apply for IPO’s in general.

I am not a fan of IPO’s in general and the worst IPO’s are those that come at the peak of a market rally. With markets already hot, even normal companies get extra ordinary valuations, great companies get whatever they ask for.

The objective of every merchant banker / investment manager is to try and maximise returns for the selling shareholder while also ensuing something is left on the table for the allotee as well.

In recent times, most IPO’s have opened higher than the price at which they were sold which seems like a great opportunity for a investor. But it’s not as if every investor gets allotted the number of shares he applies for.

In case of DMart, investors will be lucky if they can get a single lot (50 shares). This means that unless you are a very small investor, even a 50% pop will barely register on your total portfolio (If your Equity Portfolio is worth 25lakhs, a 50% pop will mean a profit of 7,500 Rupees {that is assuming you are lucky enough to get a allocation} which is 0.3% of your portfolio).

One historical example that has been used suggest that even paying a high price to earnings is worthwhile is by using the example of Walmart. Like Sam Watson used a different strategy that set aside Walmart from rest of the competition, so has DMart. But will it be able to replicate its own success of its Initial years is something only time will tell.

The Key difference is that unlike the time when Walmart started up, the playbook to success in retail is way different. As a investor, it definitely makes sense to apply to the IPO. If you are a small investor, opening pop can provide for juicy returns where as if you are a large investor, at worst this could be a tracking position.

Ultimately though, your returns are less driven by IPO’s such as these and more by how much of your net worth you allocate to a particular asset class, the kind of returns you are able to generate in that asset class and the asset allocation model you follow.

The Asset Allocator has changed

Equity Markets move in cycles is we all know. But if only we knew when the markets will top and when they shall bottom, life would be so much simpler.

Since we don’t have that information, all we can do is use a bit of mathematics to try and figure out how and where to add exposure to markets and vice versa.

Who doesn’t love to buy when markets crash or sell when it tops at multiple year high valuations. Then again, much of this is not only hindsight in nature but the bigger issue is the amount of time available to take that decision. Market stays at Market Tops or Market Bottoms for very short period of time.

Based on earlier tops, one of the easiest prediction people made was about market topping in 2016 (1992 Top + 8 years = 2000 Top, 2000 Top + 8 years = 2008 top. Hence, 2008 Top + 8 = Market Tops in 2016).

Rather than hoping to Buy everything at the bottoms and Sell everything at the Peaks, we need to granulate to ensure that we don’t end up with too low a exposure when time is ripe for buying or have too much invested when markets are near the peak.

Portfolio Yoga Asset Allocator has been up there since the start of the site. Its time for a revamp and this is what we have done today.

While the basic philosophy stays the same, we have tried to granulate the entries and exists to ensure that we don’t stay too long in the party. On the other hand, when market falls big time, this allocator is more nimble to be able to capture at least a part of it.

Mutual Funds or ETF

The topic is something I have written about earlier but given the nature of the market, it keeps propping up as one or the other side unearths what seems to be new evidence which show why one is better than the other. In the United States, its more or less settled that Active funds cannot beat simple ETF’s and this is not just limited to Mutual funds as the bet by Warren Buffett is showcasing.

Ravi Dasika, Co-Founder, Tavaga.com wrote a post on Medium trying to show why the viewpoint of Sharad Singh, Founder and CEO of Invezta.com wherein it was claimed that 95% of all funds beat ETF’s was simply and absolutely wrong. Before we go any further, a word on these two sites. Tavaga.com is a site founded to provide investors a way to build portfolio’s using simple ETF’s while Invezta.com is a site that provides investors with the ability to invest in Mutual Funds Direct (other sites such as FundsIndia for example are sites that provide avenue to invest via Regular schemes which are more expensive ,0.5% to 1.25% approx depending on fund.)

In other words, they offer their customers a choice that is pretty much opposite (Passive vs Active) and even while the total pie of investments that is coming into the equity markets is pretty high, like in the United States, at some point we shall see some sort of cannibalization.

Given the background, lets explore what Sharad Singh wrote at Business Today in his post More than 90% active mutual funds beat the indices. There is still time for ETFs. I would suggest you read the article though the conclusion (as would be evident from the headline itself) was that ETF’s were inferior to active Mutual Funds.

To make a case for Active, Sharad combined ETF’s and Index funds on one side and all Mutual funds on the other. While Index funds are supposedly passive and theoretically should move like the Index, it rarely does so thanks to Tracking Errors that dominate. Either way, Sharad takes a total of 17 ETF’s. I on the other hand could find a total of 24 funds (18 Index, 6 ETF’s) with a minimum track record of 5 years.

Here is the list with returns

As the data evidently shows, ETF’s handsomely beat Index Funds some of which can be attributed to fees (IDBI Nifty Index fund for example charges 1.74% as its Expense) while others maybe due to the churn needed to continually adjust for the inflows / outflows. While even ETF’s face that issue, due to the size of the Creation Unit being large, I believe that impact is much lower in their case.

Now, lets look at Mutual Funds (and since Direct funds are still a very small portion of Retail Investors, I shall use Regular)

On an average, Mutual funds have indeed outperformed both Index Funds and ETF’s by a margin. But what data misses is the fact that this data is skewed in two ways.

One, the starting point of the 5 year analysis starts right after the bear market of 2011. A fund which had a higher beta than the Index would surely outperform given the overall bullishness in the period.

Second, the 10 year returns are of funds that continue to exist. Any fund that was closed / merged would be missed propping up the returns higher (since its generally weak under-performing funds that find themselves under the axe).

Even more important point to note is that if you had invested in any of the funds on the left hand side, you would have either kept in line with the ETF or under performed. On the other hand, investing in funds on the right hand side should have given you a return much higher than what you could have got through ETF’s / Index funds. But either way, its not a 95:5 split but more of a 50:50 (Coin Toss). (Errata: Only 22% of funds have under-performed not 50%. Apologies).

Do note that while we compare all the funds against Nifty 50, its actually a wrong way to compare since many of the above funds have pretty large investments in stocks outside the Nifty 50. On the other hand, if you were to invest equally into both Nifty 50 and Nifty Next 50, you would more or less get the entire population. But since we have just 2 ETF’s with minuscule AUM’s, it would not be a fair comparison.

Over the last 5 years, Nifty Next 50 has given a return of 20.24% showcasing where and how the extra returns by the funds above maybe been garnered. One can only hope that we see more launches to track indexes such as these making it easy for potential investors to invest in a ratio that has a very high probability of beating the best of the funds (which are recognized only in hindsight).

If you were looking at investing for the long term, a good mix of Nifty 50 and Nifty Next 50 on the equity side should beat the shit out the majority of funds 10 / 20 years from now, that is unless you know which fund to buy and forget for the next decade.

Finally, the goal of investing is to ensure that our Goals are met. The road you prefer is left to you and while most of us will still arrive at our destinations, the time taken maybe different due to the different roads we took to reach.

 

Dogs of Nifty 50

Dogs of the Dow is a very old strategy strategy popularized by Michael B. O’Higgins in 1991 (Wiki Link). The concept if you aren’t too interested in checking out the link is to buy the top dividend yielding firms and holds for a period of 1 year before a new set is selected and invested therein.

On the US markets, this strategy has shown promise as per stats (Link).  I haven’t back-tested the same on Nifty 50 though I would assume that the risk of such a portfolio would not be too different from holding a portfolio of all Nifty 50 stocks.

So, here are the Dogs of Nifty 50. Will check back on this in Jan 2018 to see both the performance and the changes required for the forthcoming year.

 

Retirement Woes

One of the key reasons for savings is to ensure that once one retires from their job, they have enough resources to help them lead a comfortable life for the next XX years they may survive. The last thing most people want is to become destitute’s in their old age and dependent on either their children or worse relations.

If you were to read the key problems facing Americans, most of them aren’t ready financially for retirement and even those who thought they were were rudely awakened when the global financial crisis hit the town in 2008. In India, savings for Retirement is generally made via Provident Fund if you are employed. State / Central government employees contribute part of their income to ensure that after they retire, they can get a pension (which is adjusted for inflation) till the end of their lives.

While under savings is a horror story many hear and for sure don’t want to be on the same boat, over savings (which like anything else in life comes at a cost) is meaningless especially if comes at the cost of sacrificing things you may have loved to do during your younger years but got too daunted since that would have eroded a substantial part of the savings.

In last few years, I have lost two family members and the story of their lives is so much similar and yet so different. While both faced hurdles at a younger age, one was able to enjoy life much better than the other. I was reminded of them when I was having a conversation with a good friend of mine who wanted to do certain things given that as one ages he knows that he will not be able to do the same as he gets older, yet the lack of understanding of what he really requires to lead a comfortable life post his working career means that he would rather save as much as he can (and given what I know, he already has exceeded what would be required at the current stage of his career).

Financial Planning these days is all about Excel and Calculators to show  that if you spend X now, 10, 15 years later you will need (m * n), but does one really have a clue as to how the world will shape out 10 / 20 / 30 years into the future?

10 years ago, I did not dream of spending as much as I do on Telecommunication as I do now while on the other hand, what I thought would be really expensive hasn’t really lived up to the fear. 10 years from now, do we really know what our major spends will be given the pace at which technology is changing our lives?

Former prime minister Indira Gandhi coined the term “roti, kapda aur makaan” as an election slogan and truth be told that its the basic requirements I think most of the readers here would already possess. Census 2011 said that 86.6% of the population owned their houses and yet the Real Estate boom has meant that rather than enjoying what we possess, we try to gather more in the hope of even more gains.

Food Inflation has been pretty high in recent times but given that is a commodity at best, the same cannot go on forever since consolidation of land, better quality seeds, use of technology will make food cheaper at best or roundabouts here.

While Textiles has turned out cheap, the one factor most didn’t account for and is a major dent for families is Education which has become way expensive over time. Then again, not sure if anyone thought people would ponk up the kind of money they do now.

But with Massive open online course (MOOC) catching up, do you really think that 20 years from now, Children will have to spend a Crore or more to get into a college in America?

Savings is important but so is leading a life as carefree as possible. Right now I am in the middle of reading Shoe Dog by Phil Knight and while its a case of Survivor / Selection bias (he wrote the book because he survived the adventure and we read because Nike is after all one of the biggest brands out there), I still wonder how many families allow their wards to take risks he took early in his career.

Not all risks pay off, but the experience stays and helps one feel of a life led according to ones wishes and dreams. So, how many dreams are you killing for a goal about which you don’t have a clue let alone know the path? Food for Thought?