Asset Allocation | Portfolio Yoga

Investor Education

One of the pet peeves of Mutual Fund advisers and Fund managers is that the lay investor needs to be educated about the benefits of equity. If only more people knew the riches that could be obtained by investing long term in equity, much of their problems will be solved.

While its one thing to educate the public on options when it comes to the asset classes available to invest, its quite another to take them for fools who don’t know the difference between a stone and a diamond. The common investor is much more educated and knowledgeable than many are willing to accept.

Investing in Gold / Real Estate as much as they may be hated asset classes has done a world of good. While there is always the question as to whether the next 20 – 30 – 50 years will be as good as the previous, one really cannot just ignore the stark reality that the bulk of the returns generated by vast majority of folks has been via their investments in real estate.

Recency Bias affects everyone of us and that is the reason why money flows into asset classes which are showing momentum (even when it comes to Mutual funds as I showcased the growth in Mid and Small Cap funds as the market started hotting up). When the tide turns, money flows out to destinations which otherwise would have been over looked.

Investing in Equity (Direct or via Mutual Funds / PMS / Hedge Funds) is not the only solution. Every person has his own reasons which make him invest the way he does. With Interest rates pretty high and being risk free, it will take a long time before investors appreciate the advantages of equity. No point trying to push them when they aren’t mentally or financially ready to take the risks that come associated with investing in the stock markets.

Benchmarking it right

Wikipedia defines Benchmarking as the process of comparing one’s business processes and performance metrics to industry bests or best practices from other companies. Unless one compares and contrasts, one never knows where one is placed relatively speaking.

But the key point to note is that Benchmark works only if done correctly. As a joke / moral goes (Cartoon below), if you were to select a bunch of animals and benchmark them against a single target, you aren’t benchmarking it right.

When it comes to investing, Benchmarking is important since it enables you to get a much better perspective on whether you are getting it right or wrong. If your returns on investments over a period of time cannot even match returns generated by the Index, does it really make sense to keep trying by spending valuable time or whether will you be better off by just buying a cheap ETF that tracks the Index and be done with that?

Mutual Fund managers / PMS fund managers and even Robo Advisors love to tell you how good their picks were and how they have beaten the Index by a comfortable margin. But given the fact that there is plenty of evidence on the other side of the Atlantic about how very few fund managers are able to beat the Index, it makes one question what is missing out here.

The question we need to ask is, Are our fund managers way better in ability to invest than their counterparts in say the United States? After all, if fund manager after fund manager cannot beat the Index on a sustained and continuous basis (heck, even Warren Buffett changed how he measured performance of BRK vs the S&P 500), how is that our fund managers are able to do with such ease.

One reason could be that our Indices are still evolving and hence a lot of quality stuff are left out while including a lot of low quality stocks which end up ensuing that if you replace all the bad apples in the Index and add a few good apples, probability of your returns exceeding the Index is pretty high.

Lets take the broadest index out there, the Nifty 500 and review its list of stocks. Here is a list of 10 of them,

GTL Infrastructure Ltd.
Alok Industries Ltd.
Gammon Infrastructure Projects Ltd.
Unitech Ltd.
Jaiprakash Power Ventures Ltd.
Lanco Infratech Ltd.
GVK Power & Infrastructures Ltd.
IVRCL Ltd.
Usha Martin Ltd.
Jaiprakash Associates Ltd.

What is common in every one of them? Other than that they are all embroiled in debt of the nature that they cannot possibly repay in full, literally everyone has gone through Corporate Debt Restructuring and unless one has been under a rock, the probability is that they shall all fail. Yet, these gems form part of the largest index, stocks that theoretically are penny stocks and have no business getting traded, let alone being part of a index.

Of course, the weight of these are small, but do note that if you can identify stocks that like above and make no allocation, you will beat if you buy the rest in the proportion they are weighted. Its as simple as that. You don’t even have to go out and try and identify stocks out side that are way better than these junks and you shall still be a winner.

A secondary way to beat / or showcase beating the Index is by comparing with the wrong set. Literally everyone loves to compare himself with Nifty 50, but is Nifty 50 really the correct benchmark if you are investing in all kinds of small cap and have a large turnover ratio?

The thing with static indices is that they are always Long – no matter what and even if you can reduce exposure a bit and if those days are bad, you can turn out to be a winner. You will argue of course that how the hell does one know about bad days in advance and for that, I shall post this tweet from a twitter friend who posted it recently.

80% of the worst daily return days happened when Nifty was < 200 MA..same if we exclude 2008 pic.twitter.com/kfGSrpT6mv

— karanb (@karanb_k) January 26, 2016

80% of those bad days had a single independent factor that is known before the bad day has taken place. Now, lets go back the question, How difficult to reduce allocation when Nifty is below the 200 day average? We aren’t talking about shorts or even selling in full. All I am talking about is reducing exposure of equity to 80% and keeping the 20% in cash. What probability do you think you have when it comes to beating Nifty. Remember, we are not even adding stocks from outside, its all a question of allocation.

I am not sure how many are aware of a Index NSE has (and in recent past, NSE has started way more indices than your fingers can count) that goes by the name Nifty Alpha 50. To read more about that Index, please do download this document (Nifty Alpha 50).

To me, the biggest disappointment is that while NSE keeps introducing Index after Index, we really have no way to invest / trade in the same. One hopes that someone with the powers that be shall take notice of this and do something to remove the anomaly. But first, lets compare the performance of the Index vs our Nifty 50

In all years when Nifty was +ve, save for 2013, Nifty Alpha 50 has beaten it. While 2008 showcased how wrong thing can go, 2015 was a case of Alpha trumping even as Nifty closed the year with -ve returns.

If you feel that I am comparing wrong and should be comparing against the Nifty 500, let me show you those numbers as well

Not too different, ain’t it? So, how many funds / advisers have you found bechmarking themselves to the Alpha Index?

Another way to beat benchmarks is to select the period that works best to showcase better returns. A famous fund manager plastered the town with 100% returns over the period of 1 year. But this wasn’t a financial year, it was just from the date he accomplished that number to 1 year prior. The financial year number was 35% (IIRC) below the 100% mark, but he had achieved infamy by then and why bother with these small details.

Advisers (who just provide advise for a fee) who beat the Indices generally do no even bother with small things such as slippage / market limits (as to how many stocks you could have possibly bought at that price) among others. Why let data interfere with the selling they would say.

Benchmarking is a important process and regardless of how others do, its important that you understand the biases and fallacies that can accompany one. After all, its your money everyone is after.

Buying Cheap or Buying Early

A couple of days ago, I read a blog post by a Distributor of Mutual funds showcasing the difference of what FII’s are doing and what DII’s are doing (in terms of buy / sell) since the beginning of this year. As has been the case most of the time (and even historically), most of the time, DII’s do opposite of FII’s. So, in months where FII’s are buying, there is a high probability that the sellers are DII’s and vice-versa.

In fact, since April 2007 to Dec 2015 (105 months), only in 29% of the months have both been on the same side (16 Months when Buying and 15 Months when Selling). The writer of the blog using the data of the recent past hypothesizes that Mutual Funds are “essentially bargain hunting; probably buying quality stocks at low valuations.”. In other words, the author seems to believe that FII’s are selling cheap (Idiots probably) while the funds are lapping them up (Intelligent folks, eh?).

Before we go further, lets first check what FII’s and DII’s were doing as the market tumbled in 2008. Yes, its true that we did recover from that fall (and unless the world is going to end), probability is very high that we shall recover from every fall given enough time, but if you were a investor during those times, its tough not to remember that many funds actually lost way more than what the Indices lost.

So, while its true that they eventually recovered and made it up, any investor who invested or was invested fully during those months had a wait a very long time before he could see the NAV’s he saw before the crash.

The above picture depicts the amount of selling and buying by FII’s and DII’s from Novemeber 07 – March 08. As can be seen, other than in December 2008 when both ended up being buyers, in all the other months, FII’s continued to dump which was picked up by the DII’s even as Nifty tumbled from 6350+ to a low of 2252 in October (a loss of nearly 64% at the bottom).

The next question is, are we expensive. If you are a reader of this blog, you will know that while I have many a time said that we weren’t extremely expensive, we aren’t cheap either. That was based on my reading of the PE ratio (I know, I know, its not accurate to depict the future given the changes it frequently goes through and is hence a broad indicator) of the Nifty 50.

The last year and half has been more about Mid and Small Cap than the Large Cap. While I have no data, I wonder if like in 2000 when IT funds were all the craze and in 2007 when Infrastructure funds were able to accumulate a lot of assets, this time I wonder if Mid Cap funds have got a pretty large amount of inflow given the strong 1 year returns most of them were able to generate.

Lets hence first look at the PE chart of Nifty MidCap 100

Nifty Mid Cap 100 Price Earnings ratio at the start of the year was at a all time high – a high well above the one we saw in 2008 and even after the current fall, it has just come back to its 2 Standard Deviation. Now, valuation in itself doesn’t mean anything. After all, high growth companies command a very high PE and still provide returns to investors (Example: Page / Eicher in the last few years). But are companies in the Nifty MidCap 100 Index growing at 25%+ is the question one needs to definitely ask.

Because if they are not growing, the future returns (even in the best case scenario) are pretty bleak. So, before we move to Nifty 50 PE chart, would you consider the above to be Cheap / Distress Selling??

Compared to the Nifty Mid Cap 100 PE chart, this is a bit more pleasing to the eye. We haven’t touched any of the peaks that we touched in previous rallies and in that sense, its good. But as I have emphasized earlier, we aren’t cheap even today. In fact, unless you believe there has been a lot of good things that happened since the coming of Modi, why should a investor pay anything more than what he paid earlier?

The reason to utilize charts is because we are clueless when it comes to the future. But historical insights give us a clue on what could be expected of the future (all being nothing more than probability).

In one of my earlier posts, I commented that just sipping month on month without accounting for market valuations will get you average returns. There are times you should buy more and times you should actually sell. Buying all the time is good for everyone other than your own finances as average returns means that you need to invest more to achieve a return which could have been achieved with just a little tune up in terms of how much to be invested at current juncture.

Investing all the time helps the distributor get his commission, but is he really hand holding you and informing you about the risks of investing (even in SIP) at high levels and investing the same amount when markets are historically cheap?

Caveat Emptor should be how you look when investing since bad advise / investments can take away many years of toil.

Investing and a Road Trip

Lets assume that you are on a trip to reach a place which is 100 kms away. Now, lets assume that you need to make to that place in 10 hours. Would you ride 100 kms per hour regardless of road conditions or would you slow down on bad roads and make up the time by speeding on good roads (lets assume a 50:50 split between them).

Distributors of Mutual Funds want you to keep investing in good times and bad the same amount of money regardless of where the markets are (in terms of how expensive or cheap they are), they are suggesting that you ride along the road even though common sense will indicate that it makes a lot of sense to slow down on bad roads (to make the journey a better one) while making it up in good roads (when markets are cheap).

A 5 year return (End 2010 to End 2015) is bound to be disappointing since you entered the markets why they were pretty expensive. But stretch this to 7 years (another 2 years back) and it becomes one hell of a investment even if you did not do anything but sit as markets cratered 30% from its peak in 2011.

But what if you actually reduced your allocation on way up and added the same on way back down? The results thence is even more phenomenal. And before you think about whether I am just using hindsight bias to justify my view, I actually have build a model which reduced exposure as markets went up and added on the way down. And the returns were achieve without having caught either the high or the low.

In my opinion, regardless of what time frame you measure your returns, the overall returns should be not too jerky for even the best of minds can go crazy once we see our lifelong savings evaporating just because something bad happened in a country that one did not know existed before.

If you know your Risk Tolerance, do check out this sheet (Asset Allocation ) which provides the output from my model. Due to the fact that changes can be frequent (once or twice a year at max), I like to use Nifty Bees and Liquid Bees as the instruments of choice.

Review of the year gone by, 2015

Market participants would have entered 2015 with a lot of anticipation given the strong performance we saw in 2014 and expectations of a block buster budget which would hopefully take Nifty to highs never seen before. While Nifty did cross the 9000 barrier, we ended the year slightly negative with a loss of 4.1% (not adjusted for Dividend).

While large cap remained lackluster, small and mid caps continued to rally. Of the 1405 stocks that were traded on NSE, just 484 under performed Nifty. The best performing stock (among those listed on NSE) was Uniply which shot up from 13.40 to close the year at 159.65. Among the shockers for the year was Bank of India which lost 62% of its value.

Over the past year, NSE continued to introduce new indices though the fact that we do not have any ETF’s that could be traded on them makes them nothing more than a passing trend. Best performing among Sector Indices was the Media Sector while PSU Bank Index performed the worst.

While we saw strong FII flow in the fist half of this year, towards the last few months, they became consistent sellers depressing prices even as domestic institutions tried to make the best of the opportunity. Mutual Fund inflows have been very strong and has been one of the positive factors to look out for as Indians move away from Gold / Real Estate and invest in the economy via the stock markets.

At Portfolio Yoga, we do not believe that one should invest in the markets at all times. Our Asset Allocator infact reduced exposure to markets at around 8800 levels on Nifty (Feb end) and went back to their opening exposure levels when markets went down to 8000 levels (End August). Markets continue to be not very cheap but cheap enough to justify significant exposure even by those who consider themselves as conservative investors.

Markets in India have fallen in 1992, 2000 and then in 2008. This has made forecasters try to present 2016 as the year of the great fall (there is very little harm in crying Wolf year after year as long as you make it presentable). But my own reading is that any fall to even 7500 levels should provide excellent opportunities for the coming future and unless there is a world wide catastrophe, its very unlikely that we shall see a significant fall from the current levels.

Investing they say is a Marathon and not a Sprint. As any long distance runner will say, the secret to crossing the finishing line is not to expend all the energy at the start nor store so much that one is trailing behind literally everyone else. Stick to a process that is backed by evidence in terms of historical testing while also being a strategy that lets you achieve your goals without causing sleepless nights.

Hope you have a Wonderful Year ahead.

Real Estate and the Stock Market

Indians are generally fascinated investing in Land and Gold and financial advisers generally try the hell out to make it seem like they are making bad investments out there and how if the same were invested in the equity markets, the returns would / could be much more than either of the two above. But how far is those statements true.

When advisers want to showcase the lower returns by Real Estate for example, most try to chose the one that did not grow. For example, one of the examples that is given to justify that real estate investments aren’t as good as anecdote holds is about how prices in Nariman Point have actually gone down over X years which is Selection Bias at its worst.

Bangalore Development Authority (BDA for short) recently called for applications for allotment of sites and while the response has not been to the extent that it used to get earlier (biggest reason being the higher cost of land this time around), it still will be able to sell off without much of a trouble.

This frenzy to buy even though the layout it developed before this is still entangled in a mess of issues and the fact that they cannot sell for at least 10 years (a kind of lock-in) made me wonder whether people were just investing due to the herd mentality or was there something we really are missing when we recommend investing in stocks vs other asset classes like Real Estate.

Most investors / general public are thought to be financially illiterate though evidence has repeatedly shown that they aren’t the fools that most academicians / advisers think them to be. For instance, if you were to analyse mutual funds and rank them based on their last 5 year returns, just 6% of the AUM resides in those funds that come in the 4th quartile. Some illiteracy that has to be.

So, when investors rush to invest in Land (sites), I wondered whether there was a foundation to the thesis of it being a good asset class to invest. I started off inquiring the returns generated by friends and family on their investments in real estate and while on the extreme short term, returns seem to be plateauing a bit, the longer one goes back, the better the returns it has been.

A investment in 1964 for instance as on date has achieved a CAGR return of 21% while those who invested in the 80’s and 90’s have achieved returns of 20 – 25%. Higher returns have been generated by those who were lucky to invest just before the current bull market in real estate started (pre 2005) with some able to generate >40% CAGR over more than a decade.

Now, if you are a investor / trader in the market, you may think that if the same guy had invested in stocks such as Eicher or Page or whatever is the currently fancied ones, the returns would have been much higher. After all, has not even the greatest investor in India, the big bull Rakesh Jhunjhunwala showcased how he lost a lot of money by selling stock and investing in buying a property (Link).

Rather than compare against stocks, I decided to compare against the benchmark. While Sensex has a longer history, with data of its earlier years being suspect, I decided to use Nifty 50. I could have used Nifty 50 Total Returns Index but did not due to

The length of its history is much smaller than what Nifty 50 provides
Its end of the day, a index that cannot be traded / invested and its assumptions (re-investing for example) cannot be done as easily as its done academically.

To make the comparisons a even keel, I assumed that a investor can only put 20% of the value today and draws the rest from Bank Loans.

Periodicity of the Loan was assumed at 15 Years and Interest rate used was 11% per annum. Since we have a loan of 15 years, I calculate the probable returns of Nifty at end of 15 years. I did this by taking the long term average return over 15 years and then using Standard Deviation to look at both sides of the equation.

For Real Estate, I simply calculated end returns if it grew at X% per annum. As you can see, there are quite some assumptions out here, but the idea was to make the whole process easy. 15 years is a pretty long time and one honestly doesn’t know what the future unfolds, so why complicate when we are looking at understanding whether one asset class is better than the other.

The results were pretty interesting. If markets went up at the average rate they have and real estate prices grew less than 10%, investing in equity was a no-brainer. But if real estate prices grew higher, it would need a stretched returns to generate similar returns from the markets (and the only times we have had that growth is if you have invested just after a bust).

This post is not about convincing you to invest in real estate. Rather, the idea is to open your mind to the fact that blind dismissal of other asset classes may not be a good idea. As a famous quote goes, ” In God we trust; all others bring data – W. Edwards Deming”

The excel file with my workings can be accessed here (Link). I did not use Mutual funds since they too have not enough data and add to it suffer from Survivor Bias. Looking at only the surviving funds can give you a very wrong idea on what the future expected returns can be.

By using Nifty 50, I am missing out on Dividend Reinvesting which should add a bit more to the return, but when was the last time you used dividends to buy additional shares of the company? If you did not, that is one more data that is not accurate in real life.

And before I conclude, above thesis is for guys who aren’t knowledgeable about market and not full time pro’s for whom Nifty is not the right benchmark anyways.

Future Uncertain!

Many moons ago when my Sister was born, a relative of ours recommended a financial scheme where we invested X and when she reached 18, we would get back 1,00,000.00. In those days, 1,00,000 was a very huge sum. In fact, the cost of building a simple house more or less was equivalent to that amount. That sum was assumed to be good enough for Marraige and more. But when she reached 18, forget getting married, her Engineering Fees was nearly 50% of that for every year.

Most investors invest with the best of intentions and hope that things work out as planned and enable us to meet our Goals. But do we really have a clue as to how the future unfolds and how best to prepare for them?

Equities are claimed to be the asset of choice if you need to beat Inflation and evidence does show that there is merit to that argument. But the evidence is nothing more than a look at the rear view mirror. While the logic behind is indeed sound, the fact remains that end of the day, there is no such thing as a Guarantee in the world of finance.

On Twitter (where I am active), I get into frequent debates with distributors of Mutual funds on whether Direct is the way forward or should one go through a Distributor. Both have their Pro’s and Con’s, but the unfortunate thing is that you are no wiser as to what is the right choice until its been too late to change.

While no one can guarantee about the outcome of investing today, a qualified financial planner can help you make the necessary changes as time goes by. A mutual fund distributor is not a financial planner in any sense. He is no more than a salesmen hoping to make a sale while in turn will provide him a Income.

While he will to ensure continuity try his best, the fact remains that he can only do as much as his knowledge enables him to. Any and every action of his has to be backed by evidence which in turn has to pass through the biases we frequently face – Survivor / Selection among others.

In the aftermath of the housing crisis in US, there were hundreds of stories about investors who lost everything and were forced back to working at a age when they should have led a comfortable retired life. While its easy to blame them for their greed and lack of understanding, its a story that is repeated across countries and across generations.

Fixed Deposits / Gold / Mutual Funds / Real Estate all have their place and time. While the proponents of Equity will have you believe that FD is the worst form of investing, if you had invested in a FD 5 years back and you were in the Zero Tax bracket, you would have made more money than investing in Nifty Bees. And all that without having to bear the pain of negative volatility.

End of the day, its your money and your future that is on the line. In times of need, its you and you alone who has to face the responsibility, blame game can only go so far.

Share this:

Share this:

Share this:

Share this:

Share this:

Share this:

Share this: