Category: Asset Allocation

In reaction to my tweets as well as my blogs where I am not exactly fanatic about Systematic Investment Plan, a reader queried me on “How to build Wealth”.

Wealth is described as “an abundance of valuable possessions or money”. While I don’t know who you are, the very fact that you are reading this means that you are comparatively well off. You may not be “filthy rich”, but you are rich enough to understand the nature of things and are interested in improving yourself.

Most advertisements of SIP suggest that by putting your savings into equity (specifically mutual funds), you will end up wealthy. While definitions of wealthy would differ (most of us consider ourselves not wealthy), a UBS survey in 2013 put the definition at $5 million with $1 million in hard cash. In India, that would come to (based on PPP) somewhere near to 10 Crores (8 Crores of Assets, 2 Crores of Cash).

Given that most of the Richie rich figure in the Fortune 500, let’s glance at it to see how they came to acquire such wealth. While Forbes doesn’t list out how much of the wealth was self-generated vs inherited, the top is dominated by persons who started out companies that went onto become mega corporations. Among the guys from Finance, many of them are fund managers who made their riches managing other people’s money.

 Of course, the list is a list of Survivor’s for only those who survived and continue to thrive find a place. For every one of them, you can easily count 10 – 20 who may have come close if not for an error in business / strategy that dragged them down and another 1000 – 10000 who started businesses with similar ideas but went nowhere.

The biggest wealth generation happens if you start an industry and find yourselves incredibly successful. If you start of something and it fails to get traction, you could end up losing what you have. Entrepreneurship is not for everyone and hence while the riches at the end of the line maybe great, let’s accept that is not an option for the vast majority.

Investing in Fixed Deposits / Bonds though have a place in one’s portfolio is unlikely to provide you with strong inflation adjusted returns, forget about building wealth. Insurance is not an investment regardless of how your agent put it. Real Estate was in the last decade a real wealth generator but I believe prices have reached way above their equilibrium making them an asset class that could actually destroy wealth, forget generating it.

Gold has in recent past given good gains though given that there is no value other than maybe the fear that drives its price (other than our own incessant demand), I doubt it could generate wealth though it could protect if a catastrophe were to hit the country. Then again, if a catastrophe of that nature were to hit, the price of Gold would be the least of your worries.

 That leaves us with only one asset class – Equities. As long as the country is growing, firms will grow in line with it providing us growth of the nature that cannot be attained elsewhere. Here is a chart to showcase how great the difference in returns can be

As the chart (from US) clearly shows, equities beat other asset classes by a wide margin and this through 2 World Wars, Vietnam War, the Great Depression among other catastrophes that struck the country through that time.

But investing in equities is not an easy task given that at any point of time, there are more than 2000 stocks that trade on the Indian stock markets. While Direct Equity investing can be an enriching experience, it’s not suitable for everyone given the efforts required to be put in and the understanding required to be able to differentiate between good stocks and bad.

One can avoid this problem by investing with a fund / fund manager of repute. Here again, our options are

1. Mutual Fund
2. Portfolio Management Schemes (PMS)
3. Alternative Investment / Hedge Funds

For most investors, the first carries the biggest appeal since the entry requirements are low. Add to that, tax treatment of profits is the best only for those investing via Mutual Funds.

But once again, we face a problem due to the huge number of funds available for investing. For example, there are (including Index / ETF’s) 80 Large Cap oriented funds. Add Mid / Small / Multi Cap, Debt / Fund of Funds and the list grows to a phenomenal 582 (as of Feb-16) funds.

If selecting stocks to invest was tough, selecting the right fund managers isn’t easy, especially given the fact that even fund managers change firms rather regularly. Most financial advisors take the easy way out and recommend the best performing schemes of the last X years. But when asked the probability of them remaining best performing in the coming X years, they draw a blank.

 Once upon a time, fund managers beat the index handily given the clumsy approach by which indices were built and maintained. Those days are over though as data shows a drastically reducing out-performance by fund managers which comes to our next point.

If fund managers (who are professionals with huge amount of experience and knowledge) cannot beat the market consistently, what other options remain for an ordinary investor who cannot spend the time to learn and invest in the right stocks?

To me (and as investors are finding out in a big way in US), rather than keep jumping through he loops on which fund / fund manager shall work in the coming year, the best way to generate wealth in equities is to invest in the Index itself. While buying and maintaining 50 stocks (Nifty 50) is not easy for anyone, we do have an easy way in terms of Exchange Traded Funds.

Exchange traded funds have the same advantage of Mutual Funds when it comes to tax treatment. Since it’s a single instrument, you will not need to invest into 3 – 5 mutual funds in the hope that the diversification will ensure that one bad fund will not ruin your returns.

Research has shown that a 60::40 allocation to Equity::Debt with say a yearly rebalancing is a combination that is tough to beat by most funds / fund managers. Now that isn’t so tough, is it?

 The biggest advantage is that when either Bonds become over-valued or Equities go into a bubble, your rebalancing will ensure that when the drop comes you aren’t as much affected compared to someone who blindly keeps investing without regard to valuation.

It’s an automatic way to address concerns of buying when markets are expensive and selling when markets are cheap since the rebalancing will ensure you do just the opposite. As stocks fall (and your value of investment in Equities decline), you will shift (at the time of the rebalancing) from bonds to equities thus adding when markets have fallen. And when markets perk up, you do the reverse ensuing that you lock up some of the profits rather than see it wither away when markets turn for the worse.

Of course, despite all this, you will not still build real wealth. Real wealth is built by taking risks and concentrating on absolute returns and not relative returns. But that is a story for another day.

When a weak student joins a tuition class, the teacher promises the parent that his ward will improve and while may not end up as a rank student will at the same time not fail the exams. On the other hand, when a student who is already doing well joins, the aim is to try and see if he can come in the top 10 ranks.

A lot of water has flown about whether systematic investing is good or not without there being much of a context attached to it. Any investment plan that inoculates savings is good as long as there it’s saved in asset classes that provide one with positive inflation adjusted returns over time and is not a scam (read Teak Investments / Emu, etc).

Personally, I was a believer in systematic investment planning though I haven’t invested into mutual funds. I too believed like vast majority that this is a good way to invest and grow for the long term. The biggest advantage of SIP is that it’s easy – once you sign-up, amounts will get withdrawn periodically and as the law of large numbers dictates, over time, you investment will be closer to the mean than either ends.

SIP is supposed to be done blindly, yet the same advisers who advise SIP rightly advise that picking the right plan is paramount as well. This though creates a dilemma given the large number of funds that we have – which funds are good and which aren’t?

To solve that dilemma, let’s assume we hire an advisor who knows better than me (after all, if he is as clueless as me, what’s the whole point in paying him) and who can guide me better.

Most advisers seem to stick with funds that come from large houses (HDFC / ICICI / Franklin) given that they have showcased good return over time. But does historical return itself is enough to judge whether a fund is worth investing into?

As on date, there are around 130+ large cap funds. An adviser who manages 100+ Crore of investor funds some time back tweeted that the length of any SIP has to be at the minimum the length of a business cycle – 8 years.

Let’s assume that the advisor has a list of 3 funds which he believes you should invest into. It’s all Good, Right?

The biggest disadvantage of SIP is that it forces you to invest into expensive markets as well as cheap markets. Now, while markets do not remain cheap or expensive for too long, they do enough times over time.

For an investor who has been goaded to invest with the hope of good returns over time, deep draw-downs are killing. After all, you are supposedly saving a goal – Retirement / Child’s Education and here you have a statement telling you that after saving for X years, current value is lower than what you invested in first place.

No wonder it is that most people stop SIP at the lows of the market as the pain of looking at the loss and adding to it (in their view) becomes too unbearable.

I can understand a Do it yourself investor doing such a fuck-up. But once you go through an adviser, isn’t he supposed to be there to help you. I am not speaking about the supposed hand holding they claim but in terms of real valuable advice?

IDFC Mutual Fund has brought a nice graphical ad of how to lose money in markets – easy, Buy when markets are expensive. But how many advisers advise an investor to save into debt funds and shift (while adding more) once markets go cheap?

Mid cap stocks have had a great run in recent months, but do you know that its valuation a couple of months back was at a never before seen high. Yet, money has flown like never before as investors latch on to the hot hand fallacy.

If you are investing into mid-cap funds using SIP or lump sum, do you know the probability wherein 5 years down the lane, you could still be underwater?

Some time back, I had worked on future returns based on current price earnings ratio of the index. Reproducing the same one again, its clear as to how great returns can be achieved by buying cheap.

 

To me, an advisor who advises SIP (in Equity) for everyone and more importantly all the time is a lazy advisor and will get you returns that are average or below. If you are a weak student, yes, you shall pass. But if you were a student who was already scoring A’s, do you really want to be given a prize for getting a C?

Ecclesiastes 3:1–8 is a well-known passage that deals with the balanced, cyclical nature of life and says that there is a proper time for everything:

 “There is a time for everything,

and a season for every activity under the heavens:

a time to be born and a time to die,

a time to plant and a time to uproot,

a time to kill and a time to heal,

a time to tear down and a time to build,

a time to weep and a time to laugh,

a time to mourn and a time to dance,

a time to scatter stones and a time to gather them,

a time to embrace and a time to refrain from embracing,

a time to search and a time to give up,

a time to keep and a time to throw away,

a time to tear and a time to mend,

a time to be silent and a time to speak,

a time to love and a time to hate,

a time for war and a time for peace.”

For a longer list of what should you NOT expect from an advisor, do read this post by Yamini Sood (Link). In addition, I would suggest reading of the transcript of a speech delivered by Jason Zweig (Link).

As Lou Holtz once said, “Virtually nothing is impossible in this world if you just put your mind to it and maintain a positive attitude.”

Let me conclude this post by quoting a passage from the book, Investing with the Trend by Gregory L. Morris (Book Link)

My decades of experience have taught me that there are times when one should not participate in the markets and are much better off preserving capital because bear markets can set you back for a long time, and they are especially bad when they happen in your later years. Keep in mind that the closer you get to actually needing your serious money for retirement, the worse the effect of a severe bear market can have on your assets. It is critical to understand the concept of avoiding the bad markets and participating in the good ones. It is never too late to invest intelligently for your future.

 

The other day Jim Rogers claimed that he foresaw a 100% probability of a U.S. Recession – a probability that gives him no room to escape, but then again, this is not the first nor the last time he has predicted the unpredictable. In his book, Clash of The Financial Pundits, Josh Brown writes about one such guy – Joe Granville and its a fascinating story to say the least.

Mutual funds are good generators of wealth in the long run if the markets where they are invested see a good growth. Every country has seen at least one big bull run which provides unprecedented gains to the investors.

As much as Technical Analysis is about basing the future on the way its past has been, its no advocate of blindly trusting that historical patterns will occur in the future as well. As Mark Twain eloquently wrote, History does not repeat itself, but it rhymes.

Some years back, in a moment of euphoria a Goldman Sach’s Analyst decided that the next big growth will come not from advanced countries like America or Europe but from 4 countries – Brazil Russia India and China and so came the acronym, BRIC which later on became BRICS thanks to the addition of South Africa to the list.

Over time, the bricks have been falling off to the extent that the lone man standing now is India. Brazil which showed so much promise has been done by the collapse of commodity prices, Russia in addition to getting hit by commodity prices also got hit due to its incursions in Ukraine, China – country whose stock market literally shook the world markets is someone whose numbers are always under question.

For a while, it was good with the worldwide growth washing away everyone’s sin’s of omission and commission but while investors may have a short term memory, markets remember.

In a recent article, I read about the last 150 years of innovation has been on lines that has never been seen in any other 150 years. So, when we look back on the markets of the last 15 years and think that that next 15 will be similar or even better, how realistic our assumptions really are?

My idea of critiquing investment methods / strategies is not to say that they aren’t worthwhile but to provide you with a perspective of things from a different view point. Anyone and everyone makes money (some by hard work, some by luck, some others by Inheritance) for money is the key essence to survive (forget thrive). But unlike say our grand father or his father before, we want to do a lot more – more travel, more entertainment, more outings with family. And then who doesn’t want a bigger home, better education for his kids among other wishes.

But life is costly and there aren’t short cuts to success. If you were to look at the Fortune 500, you shall see the list of men who risked big and survived. You shall not see a Vijay Mallya there since while he did risk big, the bets didn’t pay off and instead have taken their pound of flesh in terms of loss of existing wealth.

The reason investors are generally skeptical of equities is because of their inability to understand the risk component. Understanding that is the key to getting a better than average return. Everyone aspires for average returns, but for the average to be average, some will be above the average and some will be below the average. Where do you prefer to be?

Mutual Funds /Equity / Bonds / Cash all have their place in one’s portfolio provided you understand their pro’s and con’s before getting sold on what may or may not be ideal for you. To conclude, let me quote this from Howard Marks, a guy who has delivered returns which are closer to equity but by using bonds.

“If riskier investments could be counted on to produce higher returns, they wouldn’t be riskier. Misplaced reliance on the benefits of risk bearing has led investors to some very unpleasant surprises.”

 

First off, the Title is a Rip off of a very interesting book by Ned Davis that I read and recommend you read it if you are interested in looking at market in different ways. Of course, not all the charts that are provided in the book can be easily re-created, but at the very least it will give you a idea on what to look at.

Yesterday, Bloomberg carried a report on  Khmelnitsky, an analyst at Veritas Investment Research Corp being the only Analyst to issue a Sell call even as hedge funds piled in. While he now turns out to be right, in the interim, the stock had doubled (from time of his Sell call). In fact, its still yet to reach the price where he called “Buyer’s Beware”. Chart from Bloomberg below (article link)

 

On Social Media / Television, Analysts keep calling for either a strong fall or a strong rise (new Low or new High in their lingo) even as much of the time, market seems to do the opposite of what they are calling for. But markets being markets, they do get it right at some point of time. The question as in case of VRX above is, does getting it right after being very wrong for a large period of time makes enough amends?

As one very well knows, Being Right is easy, making money, well that is a problem that sometimes seems absolutely insurmountable. But to make money, one needs to be right in the first place and right in the right time frame. There is no point in being right but being unable to make money due to the pains that the position caused first.

Investing / Trading is all about timing and positioning (size). If you get the timing wrong, you will end up taking substantial losses (Notional or Real) whereas if you get positioning wrong, you either end with too small a profit to bother about or too large a loss to be never able to trade again.

The reason Systematic Investment Planning (SIP) is most preferred is because rather than doing the hard work (of both timing and sizing), one hopes that over a long time, everything will average down and provide a better return than what one time lump-sum can provide (a thesis that can be easily tested).

Yet, its surprising that the very same people who argue for SIP argue against a Exchange Traded Fund claiming that since some funds (remember, Survivor Bias makes the whole testing meaningless) have given true alpha and hence in the Indian context Mutual Funds are better than Exchange Traded Funds. If timing is not possible, how can you really hope to pick up the right funds (average return of funds are generally lower than their bench-mark which means that there are a lot of funds that under-perform) all the time?

But I am digressing, this post is not for or against SIP. This post is about whether it makes sense to even follow Analysts / Fund Managers who claim to be right. Today morning for example, a famous PMS fund manager posted about how he hoped investors took advantage of his bullish tweets and invested in the market. But guess what, I scrolled through the gentleman’s twitter feed and he has tried to call markets bottom at every major level.

His target for Nifty (since Jan 2015) is 10,000 and I am sure he will be right. But how many have the ability to withstand the pain that came in between. Stocks, fancied or not have had a hell of a time in recent months with even marque names taking a substantial beating.

To me, timing is crucial – its easy in hindsight to say that, all you needed to do was sit tight, but sitting tight is not the answer most of the time unless you want to be like the average investor. But a average investor has no clue and does no home work, so why should your returns mirror his?

The future is unknown. Yes, we can make speculative / probability based guesses about it, but truth be told, no one has a clue of how it will unfold. The investors who have done big for themselves didn’t make it by taking small risks that will not hurt them if they got their Analysis wrong. Concentration was the key – it made some guys while broke many others.

As a parent, would you ask your ward to give his best (and hopefully come on top) or say, you know what – do as much as the average kid on the street. Why bother with hard work as Edgar Bergen says — ‘Hard work never killed anybody, but why take a chance?

Over last couple of days, my timeline has witnessed immense activity between various persons on whether or not SIP is the best way to save and invest in markets. My last two posts were a consequence of trying to put my thoughts on the same.

To clarify before I move further, I am not against saving and not against SIP as a medium to save. But, please, lets not consider it wealth building giving it value more than what it deserves. Adjusted for Risk, any investment that provides a positive value adds to our kitty, but the definition of Wealth is somewhat different since it brings out dreams of one being able to afford things that he doesn’t seem to think is possible in the current.

While SIP’s in Equities can provide a much better return than Bonds, please do note that if you are not used to seeing months of gains wiped out and threat that even the principal maybe at risk, you may not be the ideal candidate to make such investments. For better or worse, sticking to tried and tested methods will ensure you get a good night sleep even if your returns are below what can be optimally achieved by taking a small dose of risk.

Difference of opinion in markets is normal – I for instance have for long received brickbats for insisting that any and every strategy needs to be validated using non discretionary tools. As a Technical Analyst, we as a group are held at ridicule by investors / advisers who believe that Balance Sheets and Cash Flow provide a better understanding of the company than how the price moved over the last ‘n’ periods.

Efficient Market Hypothesis, a subject that is taught to every Management student claims that stock prices reflect all available information about companies and investors can’t beat the market indexes by stock picking. In fact, when some one says markets cannot be timed, he is knowingly or unknowingly reflecting the same. But ironically the same persons then go out in search of funds that are consistent in beating the markets.

Every fund manager tries to time the market in his own ways. The fund manager of Quantum for example took to timing by reducing exposure to stock in the hope that markets will weaken at which point he can re-enter providing value and a better return to his clients. He had done this before and it worked, but this time, he went to cash a bit early and given the current fall, added exposure a bit more early.

Prashant Jain of HDFC is a case of taking risk on a sector which did not turn out the way he would have thought it will. But go back in history, and risks taken by him gave him a pretty large addition that what other managers could deliver.

You can see this in the International arena as well with Bill Ackman having a ball in 2015 but facing literal rout in 2016 (even though we are just 1.5 months into it). LTCM delivered superlative returns for 4 years before it fell of the sky and went under.

On the other hand, we have John Bogle of Vanguard who makes the following points when it comes to Mutual Fund investing

1. The vast majority of managed funds underperform their respective relevant market indexes
2. There is no reliable way to predict which few managed funds will outperform the market
3. The intelligent investor therefore invests in index funds

He believes that most investors are better off with a cheap (and his company Vanguard has shown time and again, how cheap index investing can be) ETF that tracks the Index.

When it comes to leverage, literally everyone is against it. But does it mean that leverage trading / investing is bad?

I believe the bulk of what we believe is based on two factors

1. What appeals to us the most
2. What seems to provide what we are looking for (Long Term Returns / Regular Income / Stability {Real Estate}

For me, the appeal has been to Technical Analysis since end of the day, I believe that trying to gauge the quality of management of a company or my ability to understand the nitty-gritties of how the business is run is beyond my understanding and abilities

But some one who has the abilities I am missing on the other hand will be fascinated by how one can go about picking great business which can provide returns better than market.

In India, Mutual funds are pushed since historically they (or at least funds that have survived) have proven to be market beaters. But without the evidence that comes from analyzing survivor free database, its similar to claiming that if only you had invested 10K in the Infosys IPO, you could have retired way before time.

As a full time trader and investor, my bias is towards attaining absolute return regardless of the behavior of markets. This cannot be done without some kind of timing tool and while my time frame is short, testing (by self and others) have shown that you can get way better returns by having a simple 60 – 40 (Equity:Bonds) asset allocation than by trying to select the best funds and hoping that the fund manager does the right things all the time.

Each and every one of us develop our own biases based on either the focus of our work or what we have observed over time. This bias affects our judgement to make the right decisions and hence the reason to turn towards experts. But unfortunately experts too are biased and would not change their view even if provided with contradictory data.

Most of us spend 8 hours or longer to earn the Income, a part of which gets saved. If you cannot spend a bit more time in understanding the various facets of market and what is that you are really looking for, nothing really can help you out.

As a Idiom goes “You can lead a horse to water, but you can’t make it drink”. How you deal with your money should be your concern, else some one will take the decision on behalf of you – something that could turn out to be good though generally its outcome is lousier than the worst thing you could have accomplished yourself.

 

While we all learn from our childhood the importance of savings, Governments and experts believe that if left to our own devices, we would either splurge out or make wrong investments that is bound to hurt when we need it the most.

Using a combination of Carrot and Stick, the policies of the government try to ensure that one ends up with a decent amount of savings by the time of his retirement. So, a part of one’s income is deducted and which goes into a Provident Fund Account which over time, thanks to one’s own investment + employer’s contribution + the accruing interest makes it a sum worthwhile to retire upon.

Housing Loan payments are set off against tax liability to make it worthwhile (rightly or wrongly) for everyone who desires to get a roof above his head. Same goes for various other deductions which essentially  are investments for the future (one’s own or of ones children).

Investing in equities, specifically mutual funds has been pushed by providing various tax benefits, benefits that hopefully provide a impetus for the investor to make it a worthwhile asset class to invest, risk not withstanding.

One of the ways for many investors to invest is to set up a Systematic Investment Plan (SIP) so as to ensure

• A continuous contribution to equity which can provide a better return than other fixed asset classes
• Enable one to average out his purchase price by buying with total disregard to happenings in market

Systematic Investing is pushed a product for all seasons. Any attempt to provide perspective on the nature of the markets and hence how SIP’s can actually be detrimental to the wealth of a investor falls upon deaf ears and more fixed positioning.

Lets start with asking a basic question.

Who or what kind of Investor is SIP meant for?

The answer I have heard and read about is that this is the best and maybe only possible way for those with a full time profession and unable to understand the market or valuations as such. SIP is also a tool I am told that enables those with buttery fingers when it comes to spending to save a bit from their Income. In other words, SIP is a attempt to force those with no clue of markets to invest in the hope of a better tomorrow (which generally means a decade or two from now).

Despite the good (?) intentions, one of the cribs of fund managers is that even when people enroll for a long tenure of, say, five years, they generally stop after two-three years. Should not one question what makes one stop their SIP early than what they signed up for?

To me, the biggest reason would be under-performance. Just today I tweeted this

If the Mutual fund you are invested in has correlation of 1 to Nifty 50, any SIP started after November 2012 will be under water.

— Prashanth, CMT (@Prashanth_Krish) February 12, 2016

Being a full time professional I understand that markets moves in cycles and how even this bear market will end at some point of time. But what of a lay man who has been promised a CAGR return of 17% (since that is what Sensex has supposedly delivered) over time and how this is a way better investment than any other asset classes.

How many advisers out there start of by showcasing the risks that come with investing in Mutual Funds? Funds have dropped 50% / 60% and more from their high points. Is a lay investor ever educated with the risk he is taking?

In times like these, when theoretically one should be adding to allocation, those chaps would actually be jumping off the burning bridge. Its laughable when advisers say that they shall hand hold the client (and hence justify their fees) during tough times such as these and help them to continue investing.

But how many actually provide them with the real picture of what to expect and the probabilities of what is the worst case scenario’s. Most advisers try to shove the risk under the carpet while showcasing only the good parts. How different this is to real estate builders printing out brochures where it seems that you will be surrounded by nature when the reality is the fact is that the builder has absolutely no control of what happens outside.

Markets deliver higher returns because there is a risk involved, a risk that can lay waste to investments. Mutual funds can help by enabling one’s investment to be handled by a professional and by pooling reduces the risk of a single bad apple destroying the whole basket. But extrapolating the last 20 years over next 20 years which most advisers do while being the easiest path, is certain to bring disappointments on your way.

To conclude, SIP is a good way to instill investment disciple. But unless the risks are fully known and accepted, the risk of early abandonment after being disappointed is pretty huge. Preparing the investor for the risk rather than focus on reward (Gains / Goals) is a much preferable way.

Yet, despite all that, a investor who only knows to invest but is clueless about times when he should reduce is bound to get average returns and in-turn be disappointed by the whole system. There, only Allocation and continuous re-balancing holds the key to a more satisfied client and a better off investor.