Commentary | Portfolio Yoga

ETF aren’t Stocks

In 1994, Morgan Stanley came up with its first India based Mutual fund aptly named Morgan Stanley India Growth Fund. Investors who had no clue about Mutual funds, felt this could be a IPO opportunity similar to the forced IPO’s of multinational companies in late 1970’s.

Forms were sold at a premium and even before listing, the stock was trading at a wild premium. While I wasn’t a participant there, I wonder how the investor felt when he saw the IPO open below par. The amount the fund collected was way above their own expectations but unfortunately for investors, the investment (even for those who bought at IPO price and not at a premium) was a investment that didn’t prove its worth.

These aren’t early days for Exchange Traded Funds and yet I was surprised to see a investor willing to buy a Index ETF at a 15% premium to the NAV (for a long time Morgan Stanley India Growth Fund was actually trading at a discount to its NAV, so much was the disappointment for the Investor who had literally given up on it).

Most Index ETF’s are a fraction of the Index they track. While some are 1 / 10 of the Index, some others are 1 / 100. But the smaller the fraction, larger the chance for buying / selling at levels which the Index isn’t trading.

Take for example the Edelweiss Mutual Fund – Edelweiss ETF – Nifty Quality 30. The ETF is a 1 / 10 tracker of Nifty Quality 30 Index. While Nifty Quality 30 currently stands at 2099, the NAV of the fund is at 211.42 (positive Tracking Error).

On NSE though, its last traded price is 241. Now, 30 bucks in a stock may not mean a big thing. After all, stocks can and do move big time a lot of times. But 241 on the fund is equivalent to 2410 (approx) on the Index, something the Index hasn’t seen till date (All time high being 2292).

To give a better comparison, Nifty is currently trading at 8180. Would you be willing to buy it at 9300 levels right now?

While we have seen growth in ETF’s in India, the liquid ones are still very few. When you go out to buy a ETF, do note that slippage can harm your returns by a margin that you weren’t expecting when you placed the order. Remember that while ETF’s trade like a share, they move like a Index. So, don’t pay for a tortoise assuming it will run like a Hare.

Misunderstanding of Absolute Returns

In school, I never wanted to be scolded / hit / made to stand on bench by the teacher and while I was never a meritorious boy, I did enough to ensure that I never got on the wrong side. By the time I finished studies, I was sure I wanted to get into business and not a job. Why? Well, you never get scolded by your boss while you can easily (or at least those were the thoughts in those days) make as much or even better by being your own boss.

I read stories of the successful men and women who went to the top starting with not much than a Garage and a few ideas (I don’t remember reading too many Indian Entrepreneur stories). Then again, no one told me that failure was plenty in business and very few actually made it through.

Its been 20 years now since I went on my own and its been a journey of up and down’s and like in markets, have always used the stairs to climb while lady luck (why blame myself) pushed me back through the elevator vault to nearly where I came from (with only experiences to carry forward). On the other hand, the 1 year I did work under some one else was a revelation and a thoroughly enjoyable experience. Talk about getting misled by faulty opinions.

Being a trader I talk with a lot of people and the one common refrain I hear (especially among trend following friends) is that the reason they chose this method over others is their belief that only this method provides them with “Absolute Returns”. But digging a bit deep, it seems for majority of the folks, Absolute Returns = (Strong) Positive Returns regardless of where the market has done.

Much of the literature too tries to showcase how trend followers blew our their competitors in 2008 even as much of the competition just packed up and left. But that is just half the story. Lets start with one of the most famous trend followers and CTA – Dunn Capital Management.

Draft DUNN Information September 2016.xls — Dunn Capital – Equity Curve

The chart (Click to Expand) showcases 2 things – the out performance of Dunn Capital over the S&P 500 as well as the major draw-downs it had during the course of the journey. [A note here, Dunn trades more than just S&P 500 and hence the comparison maybe down right faulty]

When one looks at charts such as these, its easy for the mind to assume that we would be more than happy to have similar kind of returns.

But then again, that is due to the visual nature of the chart which leaves out a large part of the information.

Take for example their draw-down of 63% (heart breaking for anyone regardless of how well his previous returns have been) that seems to have been touched in late 2007.

Let me expand on that a bit. You are down 63% on your capital (measured from your peak) even as markets have bit a new all time high. While the rest of the world (your friends basically) are partying, you are left wiping up the ashes your system seems to have left behind.

This draw-down started not in 2007 or 2006 or even 2005 but in 2003 / 04. Remember, that was the start of a great bull run that ended in 2008 even in US. Can you really live with that kind of performance number.

I don’t know about you, but I personally would have long died (not financially but due to the emotional hit that such draw-downs create) long before the next peak in my equity curve arose .

When folks talk about “Absolute Returns” they aren’t meaning returns that are different in nature from the S&P. What they mean (in their view) is returns that are positive regardless of the state of the market. In other words, they are looking for the Utopian dream of “Permanent Returns”, something that can be achieved only by the much abused (by market folks) Fixed Deposit.

For long I have been a votary of Trend following and have given talks on the same to showcase why people should give a thought to this kind of strategy. But the question that I hadn’t focused was whether it was suitable to everyone I preached. An even more important question I left asking (to myself) was whether I was willing to take the pain of short term draw-downs and be able to live with it.

Most trading systems I have come across don’t beat market returns (if you measure / compare correctly). They do beat over short to medium time frames, but over the long term, very few are able to consistently beat and compound the returns.

For many, the way out is to leverage. If your system generates say 10% vs Nifty move of 12%, a leverage of 3 times should provide you with 30% returns. Easy right? But then again, draw-downs are thrice what your historical draw-downs will be and given the fact that leverage means paying up the margin / marked to market losses means that the risk is that rather than seeing yourself with 3x returns, you will have a much higher probability of seeing your capital deplete by 65% or even more.

“Bulls make money, bears make money, pigs get slaughtered” is an old Wall Street saying that warns investors against excessive greed. As traders, I wonder whether we ever think that we could be the pigs (majority of us since few will always be there with mind boggling returns). Food for thought, eh?

Waiting for a Bear Market

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.

Blind Belief’s

Belief is defined as “an acceptance that something exists or is true, especially one without proof.” Focus specifically on the underlined portion for that conveys all that is wrong with belief’s in the first place. Investing is a belief that what you are doing is the right thing and the only thing that should matter.

Speaking on CNBC, Irfan Razack, Chairman and Managing Director, Prestige Estates says the time is in fact right to buy property because the fall in property prices is unlikely. Then again, he is in the business of Selling Real Estate and its highly unlikely that he would speak otherwise.

Ambit the other day came out with a bearish view on Indian GDP, but even after that, they managed to provide a positive target for the Sensex (by extending the time frame further). Any surprises given that they are Sell side advisory firm?

On 2nd November, with Nifty 50 trading at around 8500 levels, Porinju Veliyath who runs a portfolio management service tweeted that he foresaw Nifty 50 trading at 9120 levels if Donald Trump got elected within 6 weeks. With markets down 600 points from that point, he tweeted today that this fall was similar to the bottoms we had seen in earlier times. Then again, being a long only fund manager, he cannot tweet about a oncoming bear rally, can he?

Today I came across a tweet by a Value Investor who claimed that he is bullish on India since he is 100% invested in Equity.

International experience has shown that you have a much higher probability of great returns in Equity vs Bonds but even there the result is not 100% since there have been times when the bond returns was way higher than what markets provided (unless you were invested in a time when there was no way to invest in the way we do now – Index ETF’s).

While its important to be optimistic, its doubly important that we are realistic in our assumptions for faulty assumptions can and shall lead to a outcome that we least desired when we started out on the journey.

The other day I tweeted out the following;

Draw-down in Nifty & Nomenclature 🙂
Bloody: 10%
Rare: 20%
Medium well: 30%
Burnt: 50%

If you know your beef, you know where I borrowed the expressions from.

10% falls are common. After the great crash of 2008 and the amazing recovery we saw in 2009, markets fell by a bit over 10% 4 times in between June 2009 to November 2010. While Nifty was trading at 4500 at the time of its first 10% reaction, it was at 6300 before the reaction took a more serious turn.

In between 2003 (July) to 2008 (Jan), we saw 7 falls of 10% of which only 2 times did it turn more serious with the falls finally getting contained at around the 30% barrier (all percentages calculated from previous peak or 52 week high).

Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, is credited with saying that “The time to buy is when there’s blood in the streets.”

When markets are flying we think we shall buy when there is a correction / reaction. But do we really buy when markets are falling. For example, right now markets are falling and yet rather than buying I see people anticipating lower (Am guilty of posting one such chart today) levels where Nifty 50 could come.

But will it go down to those levels? What if markets jumped back from current levels back to new high – is your exposure to equity good enough to overcome the regret bias. On the other hand, if you are over invested, would you be able to psychologically sustain yourself even as markets continue to drift lower and showing better opportunities if only you had waited.

Given that investing is a belief, ensure that the beliefs you hold dear to your heart are supported by evidence. Skepticism is the highest duty and blind faith the one unpardonable sin.” — Thomas Henry Huxley

Reforms and Larger Impact

In 1972, the Indira Gandhi led government initiated a series of reforms aimed at ensuing that rich feudal land system was done away with. While in states like Kerala and West Bengal, it took off to the fullest extent, its application was widely varied across India.

One of the stories that has been passed on to me by my parents / grandparents was about how at one point of time (time of my Great Grand Father), we had agricultural land. Since my grandfather moved to town, this land was supposedly let out to be cultivated by a local farmer who sent once in a while a part of what he produced.

1972 reforms marked a end to that long distance farming and our family lost the land we supposedly owned. While I have no clue about how deep the impact was (both in terms of loss of Income as well as loss of what we supposedly owned), the future generation (including me) has done well for themselves. But the story I doubt will ever die.

The demonetization of the currency note by the Modi government is one such grand move that people will talk about for generations to come. While the target for the move was purely to eliminate black money / fake currency, the impact is on a much more broader level hitting commoners as much as the big guys.

If you have recently transacted in real estate, you know that there is no such thing as full payment by way of Cheque / Demand Draft. Depending on how far away the government rates are, it could easily be anywhere between 40% of the amount in Cash to eve 70% of the amount being paid in cash. The payment done in cheque is often showed as the transacted price.

The reason for both the parties being willing to undertake such transaction is to avoid the high incidence of tax. For the buyer, he saves on paying stamp duty while the seller saves on the long term (or short term) gains he needs to disclose and pay tax upon.

Now real estate is not the playing field of only the rich. Everyone seeks out the comfort of having his own house / land which provides him both a way to park his savings as well as a emotional attachment of having achieved something in life.

Sellers on the other hand have their own reasons to sell. For some, its to invest in another upcoming project, or for paying off expenses / debt incurred (in rural areas, marriage is one key reason for sales) or any one of the other myriad reasons. Very few sell and stuff the money in Bank lockers so as to speak.

Theoretical distribution would suggest that a large part of the money that goes through such transactions go back into the economy. In other words, when people talk about how maybe 33% of the big denomination notes will never come back to the system and hence get extinguished, majority of it would not be notes that were kept in lockers but something that used to go around.

I would not like to talk about the morality and if the guys deserve their fate, but lets focus our energies on the impact it could cause on the economy. Since the demonetization move, there has no lesser than a few thousand articles detailing either the positive part of the negative.

When cash is low, the first causality is spending. We try to limit our spending to things we really require rather than going out to buy things that can wait for a while. As I write this, I am also following the tweets of https://twitter.com/acorn as he goes around Bangalore trying to judge its impact on the lives of common man / small businesses.

My view is that there will be some kind of cascading impact due to the demonetization. With outflow being seen in emerging markets as a whole (after the Trump Win), this is creating a kind of a spiral in the domestic stock markets which has gone down a bit but its interesting to see that the fall is also being seen in supposedly defensive counters and one where its not too pricey.

Going into the US Elections, Indian markets were not cheap. While this fall has made a few sectors seem cheap, we shall really know whether it was really cheap or not only after the next quarter results are out.

Bear rallies end in two ways. One, we keep weakening for a while, make some sort of bottoming formation and then rise for there. Recent rise from Feb lows was a textbook example of this. A second and more ferocious way is when markets go and hit the lower circuit. Big moves generally portent end of a bear rally unless the market sees them happening at way too higher level (like in 2008 when the first freeze happened at the start of the bear run).

Despite the fall, I have not seen any change in my allocation matrix which leads me to believe that a larger fall maybe on the horizon unless earnings suddenly start catching up (or interest rates take a dive). Nibbling in falls is good as long you have enough to nibble if markets really take a crack. Else, stick with what you have and wait for the dark clouds before risking more of your money in the hope of a bounce back to reality (our assumed reality that is).

Do remember, India growth story was more of internal demand than we replicating China and exporting to the world. If local demand dies, what would be the impact is the million dollar question.

Social media Confundere

A month or so back I decided to quit every Whatsapp group I was member of. The decision to quit had nothing to do with the members of those groups, many of whom I continue to interact on WA / Twitter even after the move. While Social groups such as those on WA and Slack provide ability to interact with a lot of folks who are more blessed than us in terms of understanding of market structure, to me, it added more noise than I could bear.

Most groups have a wide variety of participants – from total novices who are there to pick up ideas / thoughts to experts who trade full time and given the randominity, its fairly common to see some one or the other make the right call all the time.

Its only in this business that I have found that most folks are winners, they are either holding a winning stock or had known / identified a stock that is now in the limelight. While data says that 95% of traders lose and a large percentage of investors under perform the market averages, on Social Media, everyone is a winner.

As a system trader trading a trend following system, its normal for me to find myself on the losing side 60% of the time. While in theory its just another number, in reality its a way of life that is tough to practise.

Social Media is a sort of a echo chamber – you generally start finding guys who think in ways similar to you regardless of whether they actually believe it or not. As Brexit and Trump votes have shown, too many claimed to be on the right side just because they were too embarrassed to talk about supporting the Exit / Trump out it in the open.

While momentum is the easy way to trade in markets, its mean reversion that attracts more followers. For instance today I am sure many a group are discussing how markets are showing resistance (if you search enough, you shall find charts suited to showcase the same). Now, if tomorrow market falls, you should see the same getting referenced while on the other hand if market somehow manages to move higher, there is always another chart / resistance that would the next point to watch out for.

But if you are Long or Short, the noise has a impact in terms of you starting to second guess your decisions as also wondering if you are the only loser in town. Rather than being educative, most groups end up emphasizing on herd mentality (unknowingly) since you find yourself nodding in agreement with the rationale than try and find the points where you can disagree.

If you are a investor / trader and believe that you really cannot ignore the noise and focus only on the Signal, I would urge you to seriously check out whether you are really getting value for the time you spend (and I hear of many Premium groups where there is a charge to enter). I personally have found that individual discussions has more value than groups where there is a constant chatter with no one being wiser about who really does what.

Ash Wednesday

Ash Wednesday, the religious day happened in February but for many a investor / trader, its today that holds more importance given the double dhamaka we have witnessed.

The move yesterday to demonetize 500 / 1000 Rupee notes while not essentially not something that was totally unexpected (from Ramdev to Subramanian Swamy among others have long called for it), but the ablity to make such a call, called for real political strength given the fact that Politicians are at the top of the food chain when it comes to black money.

US Elections which was supposed at one point of time to be a walk in the park for Hillary Clinton is now turning out to be a walk out of the Park as the events unfolding seem to suggest that Trump may after all Trump. Then again, after Brexit vote, calculations of rational thought by voters had gone down the drain.

As I write this, Nifty is down 3.6% – big but not really something that we haven’t seen in earlier times. With 85% of money in circulation suddenly being told to come back to base, one really has no clue how it will pan out. India is predominantly a cash based country and given that Rural India is where a lot of demand arose (from Automobiles to FMCG), the impact of this move will be seen only in months forward.

Most Asset Allocation tables I run were in Debt for 50% and while today is a buying opportunity, I am not going out and buying at any price. S&P 500 futures have closed since it breached the 5% limit, how US markets close today will dictate the future course for now.

Real Estate will get cheaper over time since the money that was floating around and changing hands over every deal will now be out of circulation (I have no clue how much money will not come back, but easy to estimate that a large number will find it tough to get back into the White mode). How will this impact on other sectors is something we cannot be sure about.

Could there be Job losses is a additional question to be asked, especially in jobs backed by the informal economy and how will that pan out in terms of consumer spending among others?

Remember, the financial crisis of 2008 was brought on by crash of housing prices which then started a shit storm that took a long time too cool. While we may not go through such a painful period, the next few months will be critical as one evaluates the impact and what it means.

While on the long term Equities will pay out, its times like these that provide one with opportunities that can enhance your total returns. Market even it falls further won’t fall in a straight line given that there will be a lot of Institution support, but unless you are ready and willing to take the risk at points where you believe its worth putting your bet, its just another opportunity that passes by.

So, whatever you do. Good Luck.

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