Category: Asset Allocation

Today I came across a interesting post by Dev Ashish at Stable Investor about why a investor (especially if he is young) should yearn for a bear market than a bull market. The logic he provides is pretty right given that the cheaper you buy a stock / index, the higher the probability that you shall make a decent return on the long run.

Then again, a bear market is a symptom of a disease rather than the disease itself. A bear market is primarily caused by a change of opinion about future growth of the economy. A good economy that is not overheated and yet growing on a consistent tick can provide way better returns than any buy you can make in a deep bear market. Don’t believe me, well check out the chart below which plots the performance of the Dow Jones Index from 1982 to 2000.

Over the period of time (18 years approximately), the Index went up 1,113% (or 11.xx times its initial value). Only once during the entire phase was a strong opportunity (Black Monday of 1987). If you started investing in 1982, you had to wait till 1987 for a bear market and if you started in 1989, your opportunity came only after the IT bubble burst.

In previous posts I have detailed about how I use multiple ways to determine whether market is bullish or bearish, but that is more from a technical perspective.

A drop of 20% (one of the ways a bear market is classified) doesn’t happen a lot of the times. In fact since 2009, we have had only three times Index has fallen by 20% or more and each time the scare is that this is just the start with worse yet to come.

But do investors really need to await for a bear market to come before investing money for the long term? Even in bull markets, you can find sectors / industries that are hitting the floor due to issues. 2008 marked the peak of the Nifty Metals has been smashed like anything. In fact, other than realty, this has been one of the worst performing Index. And yet, after each big fall, the Index has risen like a phoenix.

PSU Banks were literally written off thanks to their disclosure of high NPA’s quarter after quarter and yet in the recent months, they have given nearly 80% from bottom. Of course, none can catch the bottom and 80% is not something that could have been achieved (and the other thing it would have needed is to time the top as well). But what about 30%?

Asian Paints has been on a one way trajectory and yet if you were to check out the charts, falls of 20% or more have been all too common. Unless you believe the company has gone to dogs, does it hurt to risk a bit when stocks that are excellent have been plummeted due to one or the other issue that has taken over the media frenzy at that point of time? Or what about Apple or closer home ITC or Hindustan Unilever among hundreds of others?

Okay, you are using hindsight and selection bias to showcase companies that have survived you may claim and I plead guilty. But while companies may die, do sectors die? Nifty IT which represents the cream (and not so creamy) companies is down nearly 20% from its peak. Valuations are at multi year lows, is it worth a Buy?

While I have invested a small bit, I am waiting for confirmation of a trend reversal to plunge in more. In that way, I want the fundamental evidence I have in hand to match the technical parameters I follow. From its peak, Nifty Pharma index is down more than 20% even after considering today’s rise. Yet, given that Pharma as a Industry should continue to grow, doesn’t it make sense to risk either when it becomes too cheap (it hasn’t for now) or showing the technical evidence necessary that makes it a worthwhile sector to pick?

Do note that every opinion including mine are biased based on our circumstances and our beliefs. Anyone who isn’t holding any investment in Real estate (and that would include me) is hoping for and building a case as to why Real Estate prices should fall, but if you ask one who are invested, they can give you as logical answers as I do on why it will not fall. Either way, none of us know the future.

A bear market is useful for building stocks only if your own job is secure but deep bear markets don’t arise in a well doing economy. It arises when shit hits the fan so as to speak and when that happens, you would wish that you rather have your job back than a opportunity to buy stocks cheap. Rather than wait for a proverbial bear market, I think it makes a lot more sense to take advantage of market miss-pricing in individual stocks / sectors and hope that the long bull run continues without too many a hiccups.

Till very recently, Finance was simple. You earned X, spent Y and the remainder Z was usually put away in a Fixed Deposit for a rainy day or as savings for a future goal – House / Marriage, etc. Equity exposure was the last thing most people had in mind unless of course you were in Mumbai or Gujarat where it seems markets run through their blood veins.

Most articles on finance end with a phrase “Please consult your financial adviser or investment adviser” when it comes to advising on what to Buy / Sell. But who is a financial adviser in the first place?
When it comes to other fields, you have recognized degrees that suggest that the person you are approaching for advice has the necessary qualifications to help you. A Doctor for example needs to study and pass a 5 ½ year course in Medicine before he can start advising on what medicine you need to take, a Lawyer needs to pass a Law Exam (once again after 6 years of study (non-Integrated)).

While I can prepare my company’s balance sheet, I cannot sign it off and that falls to a guy who has passed his CA exam (which takes time given the low passing percentage) and this after spending a minimum of three years working under an existing chartered accountant.

But when it comes to advising one about how to achieve one’s goals, there was no exam as such and anybody could and did claim to be a financial advisor even though many barely had a clue on how to guide the person who came to him for help in managing his finances.

These days everyone claims to be a financial advisor, be they selling tips on what stocks to buy or advising you on what mutual fund to invest in with most of them now flaunting a SEBI Certificate that enables them to claim to be a registered investment advisor.

Most of the Indian middle class I doubt has much exposure to a financial advisor who can advise on our finances in totality. The Mutual Fund distributor advises on which funds to buy, the distant aunty of ours throws in a few LIC policies which she claims shall secure our and our children’s future while the stock broker (if you haven’t yet gone fully online) provides you with ideas on what stocks to Buy and last but the biggest of all, our neighborhood friendly PSU Bank offers to sell Fixed Deposits.

In other words, financial advice is based more on what they want to sell than what we really need to buy but then again, Finance for long has become a push based strategy than pull. But are we well served by buying what is advised by those who honestly do not have a clue on what our requirements are, let alone our goals / dreams and fears?

Yesterday I decided to ask my twitter followers the one thing they look forward when choosing their financial advisor. Some of the answers I received;

“Credible track record, transparency around compensation, Strong grounding in ethics. Trust. That comes from multiple factors – incentive structure, track record, investment philosophy, clear communication etc, Trustworthy, Integrity.”

As W. Edwards Deming once said, ““In God we trust; all others bring data.” Trust is important, but trust without data to back it up it is nothing more than a cognitive bias more specifically referred to as Dunning–Kruger effect.

When we invest for a Goal, we are investing in a uncertain future with the only road map being of the past and it’s hence important that we select the right people to help us in that journey of ours since if one screws up, the impact is one for the life time.

A lot of friends compare advising (finance) to how a Doctor advises his patient but the fact they miss out is not only are there specialist but even they (many a time) ask you take a second opinion when it comes to say a operation / method of treatment. When it comes to investing, how many advisors have you met who say, why not take a second opinion on whether this path is right for you or not?

An advisor is not a seller, Period. He needs to assess your financial position, your goals, your wishes, your fears and provide you with advise based on what is best based on current set of data and one that could undergo change as time passes by. An Advisor has a Fiduciary duty to act in the best interest of you and you alone. He will of course charge you a fee for doing the work, but then again, we all understand there is no free lunch.
While it’s easy to believe that choosing the best stock / best fund will make a large difference to our final results, the truth is that its Asset Allocation that is more important than the never ending search for the holy grail of funds / stocks.

If you have invested 90% of your money in the wrong asset classes, even great investing of the remainder 10% barely will scratch the surface. Empirical evidence has shown that most funds find it tough to beat a simple 60 / 40 allocation that is rebalanced regularly and yet, we get impressed by the tip selling friend who claims great returns on back of his advise.
It’s shown (once again data backed) that costs are the prime killer of returns in the long run, but based on selective / recency bias, funds that charge as much as 3% of your AUM on a yearly basis continue to gain fresh funds.

Most investment advisors I have seen seem to suggest strategies which believe that you shall continue to earn and save for the next 20 /30 years. What if economy went into a recession and you lost your job not to mention the unmentionables – health / death, etc. Is your plan still worth the paper it’s written on?
Preparing for all contingencies is essential and if you cannot ask the right questions, you shall be taken for a ride since end of the day, the risk is yours only. Gains if any are always shared.

On a monthly basis, I update a Asset Allocation matrix (Link) which this month recommended a reduction in allocation to Equities. A day or two later, I wrote that we are maybe at the start of a new bull run (Link). Now, with both being in conflict has meant quite a few readers raised as to what is happening and what should be the way forward.

Before I venture out there, a word of caution. I am not a Registered Investment Advisor nor should you take my views as Advise to Buy / Sell. The idea of this site is to help Do it Yourself investors get access to research I carry out for my personal investments. Since sharing of ideas provides opportunities for critical review, I do share whatever research I carry out.

Now that, that’s done, let me first try and explain what the Asset Allocation Matrix is all about and how it works. On the web, you can find hundreds and thousands of research reports / tests that emphasize that most investors are better off with a simple 60 / 40 (Equity / Debt) allocation balanced regularly (generally Yearly).

While 60 / 40 is indeed a great way to get the best of both Equity (higher growth) as well as Debt (solidity in returns), it still means that at peaks you will have too much exposed to equity and if your re-balancing month doesn’t coincide with the best, you miss out on the profits that were there for the taking but couldn’t be taken.

Let me provide you with a realistic example of where it would have hurt. Lets assume you followed a 60 / 40 allocation matrix and re-balanced it every year in June.  In June 2007, you would have re-balanced and then saw Nifty move up by around 47% by Jan 2008. So far, so good. But you will re-balance only in June 2008 and by then, markets were 36% below the highs and closer to where they were in June 2007. Since there would not be much change, you would have just left it as it is and waited for the next re-balancing date – June 2009. But in between, markets first cratered to a low which was 55% from the peak and then rebound to square one in June 2009 (level similar to what we saw in June 2007 and June 2008). In other words, we participated in the best rise and the worst fall and yet nothing much to show.

In itself, that is not bad since at the very least we did not reduce allocation when markets were down, but my thought was using a combination of macro, can I do better. The Allocation Matrix is the out-put of one such idea. Once again, do remember that most of the things I post are generally work in progress and a updated matrix is being tested as we speak.

The concept of the allocation matrix is not to maximize gains but to minimize the risk of capital loss. Its all nice to quote Buffett on buying when there is blood on the streets, but given that more often than not, its out blood, we generally get scared away from investing at the best possible time.

Take for example, PSU Banks. Isn’t there blood on the street to justify checking it out (investing maybe a different matter). After all, if India has to grow, Banks will need to power the same and unless you believe Banks will go belly up, at some point they start becoming attractive.

But I am digressing. The whole idea of the AA matrix is to provide you with a view on whether one should take a high risk bet at the current juncture or a low risk. And remember, that like all models, this too can go wrong (whipsaw). Nothing is fool proof.

Hopefully that addresses the question though shall be happy to answer any queries you may have (either use the comments or send me a mail using the Reach Us page.

Now, coming to my post about the start of a new bull market. The reason I added a Question Mark was one is never sure even though logic may suggest it being right.

I derive Income by trading and for that I need to constantly analyze the odds of taking a particular stance. For example, in bear markets, shorts would provide more meat than long trades and vice versa. The reasons I spelled out for saying that maybe we are at the start of a new bull run were all based on Momentum Indicators.

While Momentum is said to be pervasive, there is also a risk that even the best set-up’s can fail. As a trader, one needs to be nimble to reduce exposure / leverage when the odds aren’t in one’s favor while increasing them when it is.

At market peaks, most momentum indicators are generally in buy mode though that would be the worst time to be fully invested in markets by investors. While momentum traders generally shift fast, same is not advisable for investors since it means higher costs and may actually be not practical for many who have full time jobs.

While I do see this as start of a new bull rally, in a way we are accepting the market’s premise that sooner or later, earnings will pick up. If it does, the passive allocation may once again shift to being more invested (whipsaw of current cutting down strategy) but if it doesn’t, traders hoping for a new bull run would end up being disappointed.

Personally while as a trader, I am neck deep in longs (which could change as early as first hour of tomorrow 🙂 ), as a investor, rather than reducing at this moment, I am switching from Nifty Bees to Kotak PSU Bank ETF since chart  wise, I see a bottoming formation. The low’s may once again get broken, but that would be the risk I need to take if this rally is to turn out for real.

Ben Franklin — ‘Nothing ventured, nothing gained!!!

We generally do not like being told what to do, especially in areas where we believe we know better than most other guys and definitely know better than the Charlie with the attitude who thinks he can advise me on how I can invest better.

In my own extended family, most of those I know pretty closely have done way better than many mostly thanks to investing in their own house at a pretty early stage of their career even though at those times, I am sure none had a clue that the investment would yield such enormous returns (Potential since most still live in the same house anyways).

But if you are active on Twitter for instance, you would have heard about how stupid it is to invest in real estate with such low rental yields. Sophisticated guys would then plot American Real Estate prices to show how prices there are (adjusted for Inflation) at Zero returns after 100 years.

Just now, I was hearing to a financial advisor saying that Goals are important than beating some Index. Feels right, isn’t it? But how logical that statement really is, is the bigger question and one that is tougher to answer.

Most advisors advise against investing in fixed deposits showcasing historical data that shows how equities have given higher returns vs. debt. While that overlooks the fact that, equities provide a higher return since you are taking a higher risk, we still come down to measuring returns against another instrument to justify investing in one asset class over the other.

Websites that offer you some kind of planning (Retirement / Child’s Education among other normal major goals) offer a matrix where you invest X, you assume you will get Y% and if done for Z amount of time, you are well and truly home.

The assumption used to calculate is based on historical growth rates which may or may not replicate. It’s one thing to have faith that our goals will be achieved if we save and invest and yet another thing to assume that between now and 10 / 20 / 30 years later, we shall still be able to do the same things we are doing right now.

When designing trading systems, one key area to focus is “path dependence” of the system which enables it to finally reach its final number. Traders who believe the path of the past will repeat similarly in future as well generally get sorely disappointed and are most likely to drop the system even though its behavior is well within limits of what could have happened in the past.

Any financial advisor who promises to you that your goals will be fulfilled is fooling with you since none knows how the future will unfold. At best, all of us can make educated guesses about probability of one being able to achieve our goals which generally start off from a low base and as time goes by and we continue to march forward on our journey gets higher and higher till we see it being accomplished.

“Life is a journey, not a destination”, so said Ralph Waldo Emerson.  While long term goals are important, not knowing how the future will unfold, its way better to have much shorter term goals that are easier to accomplish and at the same time make life more enjoyable.

Each one’s opinion (including mine) is not just based on how we see the world but also the experiences one has had (especially negative ones). Add to that complexity of the fact that advisors look out for their own interest as well (after all, nothing much comes for Free, Right?)

A lot of things are honestly outside our control, so all you can do is control the things that remain in your control (Income and Expenses). Rest is left to market forces and Luck.

Further Reading: The high cost of high expected returns 

Offense is what we like, Defense is what saves us and in between the two lies the gulf of survival and failure. If you are a Cricket fan, you would have at the very least kept score of what is happening at the IPL. At the start of the tournament, one of the strongest contenders have been Royal Challengers, Bangalore given their incredible batting line up. Yet, year after year, they have failed to convert that into winning that coveted trophy. This year too, they are in a spot with them having to beat the opposition in every match from now on to remain in contention for the qualifiers.

So, what is Cricket doing in a finance blog you may wonder. Well, the reason RCB has failed to notch up the victories this time around for instance has not been due to lack of application in the offense (Batting) department. Its due to fact that their defense has been so weak that even big scores have been chased (hopefully today’s record setting score is something that is bit tougher to chase).

As a investor, we all love for our investments to grow strongly, but in bad times, do we have enough defense to enable us to meet our objectives? Equities is the preferred choice for those wanting to beat inflation by a margin but is that the right choice for one and all??

Lets go back a few years and look at the path that may have been traveled by a US Resident. After the crash of 2000, economy started to bounce back strongly though for a large percentage of population, the gains that accrued through their real estate investments was much more higher. So, a typical guy not only had a good / great paying job, but his investments both in Equities and Real Estate were providing him a nice return on his capital. Towards the end of 2007, he would have seen that housing rates were on the downturn but given the strong markets and the fact that he had a good job would mean that he hopefully can wait it out.

A year later, the perfect storm had hit mainland US and though he himself had not done any hara-kiri and despite not having done any major wrongs, he found himself with a portfolio that was down 50%, a house whose value was less than what he owed to the bank and worse, he had no job since the decline in markets affected the company he worked which in-turn laid him off.

We Indian’s have been lucky not to have experienced such a episode in recent years, but as we become more and more integrated globally, we can easily get hit by the Butterfly effect. Or you can also have a string of bad luck that leaves you gasping for breadth. Its at those times that the real value of your investments gain prominence.

When you invest in markets, your gains are all relative in nature. As long as the markets are good, the probability is that your returns will be good too which reminds me of the following quote

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.” – Anonymous

As a investor / trader you should ideally aim for absolute returns but I am not sure how many even understand the difference between Relative returns and Absolute returns. While Mutual fund advisors laugh about those  investing in Fixed Deposits, do note that a FD is a absolute return instrument and one that is highly liquid.

In times of distress, Cash is King.  Real Estate tends to be pretty ill-liquid not to mention dependent on market forces (unless you are willing to sell at a discount) while Equity can get blasted with you value of portfolio down to a number which you wouldn’t have dreamed off when you first started investing.

If you are not a trader with ability to take advantage of both the bull side as well as the bear side, your next best bet will be to have a portion of assets in debt which can come to your aid when you need it the most.

As Warren Buffet says

I have pledged — to you, the rating agencies and myself – to always run Berkshire with more ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits. 

Tough times don’t last, but it pays to be prepared well in advance for all and any eventuality. Maintaining a good asset allocation mix is the first step in that direction.