Commentary | Portfolio Yoga

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.

Asking the right questions

In the movie, I, Robot, James Cromwell playing the part of Dr. Alfred Lanning make the following statement.

I am currently exploring the field of Data Analytic’s and Algorithmic Trading. One key aspect of this compared to the other ways of Analysis (Technical Analysis for example) is that one needs to throw the right questions to be able to get answers that can help us understand market actions better and in that way enable us to make the right decisions on When, What and How much to Buy / Sell.

In advertisements of Maruti, the key question that gets asked is “kitna deti hai”. While this is supposed to go with the Indian mentality of looking at the maximum mileage for money (fuel), the question that does come up is, Is that really the biggest question for a probable Car Owner. Yes, mileage is a important parameter, but how much important is it when compared to say a factor like Safety?

In the Mutual Fund / Stock Market arena, every adviser seems to suggest that without his guiding light, its easy to get lost. Assuming that is true, what are the right questions to ask such advisers? What are the right questions to ask?

Is asking about performance (of the past) a good question? Most advisers suggest a set of funds to Buy based on multi year performance. Stocks that have shown momentum in the past are seen as potential candidates to provide the best returns in the future as well. But how true is this given the fact that there is a large amount of Survivor Bias that is build in.

These days I am finding advisers providing solutions which supposedly address long term goals such as Retirement / Marriage / Education, etc. As much as the idea is nice, how many clients ask the details behind how they come up with both the list of funds to buy and the amount to buy (based on what we want at the end of X years). Much of these calculations are based on projections on how the market shall perform, the interest rates one can foresee in the future, the inflation we may face among other macro ingredients.

When Economists get long term views wrong, what are the chances your adviser shall get those numbers right? As much as one understands the variability of such forecasts, one does wonder what is the worst case scenario since as we come closer to the target area, there is little time to make up for major deficiencies.

In most industries, if you deliver your client a shoddy product, not only shall you lose the client but also may have to miss the payment due from him. Investment advisers do not leave that door open as they ensure that perform or not, they receive their dues well before the time of delivery. Isn’t it time to ask them, Why?

Inactive Intraday Trading

In the book, Trading in the Footsteps of Sherlock Holmes: Balancing Probabilities for Successful Investing, Dr. Anthony Trongone defines Inactive Intraday Trading as some one who is not actively following the market but trades when it works best according to the system or fits within one’s specified trading schedule.

When I tell people that I am a full time trader, most of them assume that I am a guy who is stuck to the monitor for the duration of the market as I try to decipher the dark secrets of the market and pull wool over my competitors (other traders who take the position opposite to mine). Of course, that is far from the truth as I spend more time away from the monitor than in front of it.

Even though I do trade on the Intra-day time frame, my average holding period for a trade is around 5 days and that means that more often that not, I have not much to do other than twiddling my thumbs so as to speak. And then again, since at the current juncture I do not trade shorts (most trend following systems haven’t rewarded shorts for a long time now), the holding becomes even longer.

For instance, I got out of my long on Monday & have not placed a trade till date. The thought that immediately pops up will be, WTF! aren’t there a lot of other opportunities present in the market and would not it make sense to try and maximize the capital that is otherwise being left underutilized?

In most business, more the time you spend, greater the possibility of a higher income. If a Taxi driver decides to drive for 12 hours instead of 8, he has a very high probability that his Income will be higher (even after accounting for the Expenses). The same applies to a whole lot of other business / professions as well.

But when it comes to trading, more time or more trades does not have to mean a better result. Trading is asymmetric by nature which means that some one who places just a single trade may actually be able to beat you even though you are trading ten trades every hour.

Markets provide opportunities for a trader every day, every hour, every second. But be as it may, the fact remains that we can identify, execute and capture only a very small number of such opportunities. Only in hindsight do we realize whether we were truly successful or not.

But there is also the bigger issue of position sizing. If you put in a large number of trades, the risk per trade needs to be pretty low. But if you were to risk a small amount of capital, the rewards too will be small when measured against the total capital available.

On the other hand, if you were to start risking bigger chunks of capital, you could either start blowing up through you account way faster than what is sustainable or end up moving the markets every time you take a trade since the quantity you trade is higher than the liquidity that is present in the market. Either of them is dangerous to the health of your capital and since the impact of losses are much higher than the happiness of wins, the damage to the traders health can be pretty dastardly.

Since 1st January 1996 till date, CNX Nifty has moved up by 7211 points over a period of 4929 days giving us a average gain of 1.46 points per day. But if you were to have a crystal ball which could predict before close of today the closing price of tomorrow, you could have gained those 7211 points by being in the market for just 32 days (0.65%). Yes, just 32 days of rise accounts for the total gains made by Nifty over the last 19 years.

My point in providing the above static is not to say that one needs to search for a Crystal Ball (Holy Grail) that can identify such days. Rather, my thought out here is that the above numbers showcases the fact that with the right tools and strategies, no investor / trader needs to be distraught at missing small opportunities. On the other hand, its important that not only we have a system that can be rightly positioned when the big moves happen (here is a clue: most big moves have happened in line with the trend that was in effect) and more importantly we have the know how and ability to bet big.

Trading can be a enjoyable and profitable venture. Do not make it into something that eats into your life day in and day out. No amount of money / profits that you earn by taking that kind of stress can ever repair long term damage to the health and psychology that occurs due to such continuous strain.

The power of Authority

Yesterday as I watched the Bio-drama based on the life of Social Psychologist Stanley Milgram and it occurred to me that the same reasoning may hold good for why despite plenty of evidence, investors in market believe that by paying some one, their investing results may get better than what it would if they did not.

A very long time ago, I started a website where I wanted to share my system signals with the investor community at large. Of course, this was no philanthropic endeavor as I charged a princely sum of 1K per month. I also changed the way as to how the client paid by having him pay after the month was over (and was profitable) rather than have him pay first without any linkage to actual achievement.

While the site died within a couple of months as the system faltered and barely made any money ( I traded all the Signals personally as well), looking back, it was a very educational experience. I still remember friends of mine who had subscribed to my service (friends acquired via the Social Media rather than the old kind of friendship) claimed that the performance was not so bad since they rather than waiting for my Sell signal had booked profit in the interim (being a trend follower, I till date do not believe that partial profit booking can be a profitable way for systems which attempt to catch the outliers).

Fast forward to today and I see a large number of advisory services (most of them nothing more than a shack in a box) who claim to be able to provide you with the know-how of how to navigate this treacherous market for a small fee per month / year.

Its a well known fact that 95% of traders end up bankrupt over time (friends of mine who are NSE members say this percentage is even higher). Most investors too end up substantially under-performing the markets as a whole. There have been realms of data behind both of these available for quite some time now.

Despite the orgy of evidence that suggests that most of us are better off with simple investment products like a ETF / Mutual Funds, day in and day out people go out and pay advisers, most of whom would be no better than they themselves but for the fact that they seem to talk with a certain Authority.

Its honestly amazing how many are able to talk with such a authority that makes you feel that maybe they have the market all figured out and you the lowly human being are better off subscribing to his service. Come to think of it, this bias does not come due to the evidence you have in hand – while every tip seller claims to have bought untold riches to their subscribers, I know of none who are willing to provide you with a long documented and audited track record.

There are no guarantees in market and I am sure everyone accepts that. Yet, isn’t it amazing that tip sellers want you to trust them with your money (first in terms of subscribing to their service and second in terms of investing your savings based on their advise) without a iota of proof that they actually are able to do what they claim to do?

The other day, some one tweeted this

Most people would rather lose 50% on free advice than make money on a paid one !

As is my wont, I tweeted tongue in cheek saying

If Paid Advise could “Guarantee” me my Capital (forget Profit), why not?

Before reading any further, can you think of what I have missed in my reply?

What I missed saying was the time frame. I did not lay out a fixed time frame within which I wanted my capital back. In other words, I left the door open just in case some one felt that he could provide such a service if there was no fixed time frame.

Unfortunately, none caught onto that and instead harped on how even Lawyers and Doctors do not guarantee any results. But that is a outright lie and everyone knows it. Doctors for example are able to treat successfully a large number of ailments and in cases where they can’t, its well known even beforehand.

New evidence that is coming to the limelight (in US specifically) suggests that you may well forget beating the market consistently for a long period, that is not going to happen. Even generating 20% compounded returns is a mission impossible since at some point of time you will have to end up owning more than half the market.

While I myself do not subscribe to any vendor, I do wonder as to what makes a large proportion of investors / traders root for the guys who sell subscriptions despite the fact that they are as blind as others when it comes to knowing whether the guide really has a deep understanding of markets or whether its the Authority bias that makes us believe he knows better and hence not want to question him.

Long time ago, a friend writing in his blog said that if one wanted to really get onto fund management / advisory, the least he should have is a nice car and a nice office. What he left unsaid was whether it was necessary to actually know anything more about the market than the average Joe on the street does.

Over time, I have been able to make friends with a large number of professional investors / traders and one thing I have found in common is that the better you are in analyzing the market, the lower the probability that you have anything to sell.

Remember, the market is the only field where you can survive based on only your knowledge. A doctor, no matter how great he is, has to have patients if he has to put bread on the table. The same holds good for a Laywer / Chartered Accountant / Salesman / ….. No other fields provides one the opportunity to make money sitting in a air conditioned cubicle without having to bother with clients, payment deadlines / strategy meetings and what not.

So, the next time some one approaches you to pay for their services, at the very least, question them on what they bring to the table and what is the proof they know what they claim to know.

“In a World Of Talkers, be a Thinker and a Doer” – Anonymous

The Impact of Taxes

In my last post, where I linked the Peter Brandt interview, I was myself surprised by how big a investment of just a hundred thousand could turn out to be. Since the results are said to be audited, I have no doubt that the numbers are real. What I missed though is the impact of taxes and how they can literally destroy long term gains.

World over, Short term capital gains is taxed more than Long term capital gains. While in India, Long term tax is free, if you were to generate majority of Income via trading, your Income could be treated as Business Income and taxed at the appropriate slab.

As I wrote in my previous post, if you are able to generate 41.6% year on year (compounded), a investment of just a Lakh would turn out to be worth more than 340 Crores. But how much impact do taxes have? The calculations really surprised me as the damage, especially if taxation is high can hit really hard on the eventual pot of gold at the end of the rainbow

Here is the table of Calculations

A tax of 30% would make the moolah appear way too small by comparison to what without taxes seem to suggest. In fact, we lose nearly 94% of the growth due to the periodical dipping into the capital to pay the taxes on the gains we make.

Generating income from short term trading is tough, but as the above data suggests, even after sweating blood and endless sleepless night, you could actually we way better by long term passive investing. Its no wonder that everyone wants to sell you short term advise than trade the same on their own funds.After all, why bother with the risks, when sheep willing to offer themselves as the sacrificial lambs, Right? 🙂

The Peter Brandt Interview

Couple of days ago, a friend of mine provided a link to the interview of a trader who despite his humongous returns has never been in the lime light as many others with even lower success have been. In fact, the interview starts off with the line “may be the greatest trader you’ve never heard of.” and damm if that is not true, especially in the Indian context where we are regularly exposed to few proprietary traders who have made it big not by investing but by trading.

The returns (Audited) he has generated is something that is really out of the world so as to say. He has in a sense converted a sum of Rs.100,000.00 (One Lakh) to a astounding Rs.240,34,45,879 (Two hundred & forty Crores and some change) in a span of 29 years.

Below is a chart of the time and years taken by the top fund managers

Peter Brandt is in a league of his own. And the best thing about his return is not the amazingly long period he has been able to achieve but that he has achieved more or less without much of a noise.

Some of the really quotable quotes I liked in the Interview (and my thoughts)

And I felt so strongly, that “this is it…the time to bet the farm.”

A wonderful quote says and I quote “The greatest risk is the one not taken”. A famous quote by by Ed Seykota says – Know when to break the rules. While I myself do not think that breaking the rules is a worthwhile strategy for all, the fact remains that the greatest investors and traders realized the road to success lay in not being in the safe zone all the time.

As much as its important not to over leverage, when a once in a Century opportunity comes along, its also necessary to be nimble and take a risk that may not be what most prudent investors advise you to.

For me, one of the biggest things was realizing I was not going to be right 80% of the time, or even 50% of the time. I would be right about 35% of the time – but that was over an extended period of time

Being a trend follower, does it delight me to see him emphasize on the fact that to be a successful trader, the strike rate is not something that should lie in the high 80’s or 90’s.

And depending on how bold I am, how I feel about the market, I might risk up to 1.5% on the trade. There are times where I have risked 3%. But it’s rare that I do that.

I am amazed when I talk to novices who tell me they risk as much as 10% of their capital on a trade! Well I did that too. Back in the late seventies I did that, and I can tell you it doesn’t work! Risking 10% of capital on a trade is a well traveled road to ruin.

Risk Management is a area which is not given enough thought. While I do see people talk about stop losses a lot more these days, the fact remains that very few are disciplined enough to execute a stop when it hits. Our behavioral biases make sure that letting go of a losing trade is tougher than letting go of a winning trade (opposite the way it should be).

Question: Have your signals or trading decisions changed much over the years?

PETER BRANDT: For me my signaling hasn’t changed much, although I’m moving toward the point where I’m wanting longer term signals – almost to where I can throw my daily charts away and just deal with weekly charts.

Sometime back I remember reading (or hearing in a podcast) a similar question being asked to William A. Dunn, the founder of Dunn Capital who too has a very long run of great returns though his draw-downs are way deeper than what Brandt has ever got hit with.

Most traders love to change strategies / systems as soon as the one they are trading seems to get bogged down. But if the greatest traders have survived without tinkering much (and employing way more capital than most of us can even dream off), I wonder how much of this tinkering actually is destructive to our long term aims and goals.

And so, without much ado, here is the link for the Interview (Interview with a trading Legend).

Personally I would suggest you not to rush off in reading since there are quite a few things that provide a lot of learning’s and in a quick scan, its way easy to miss the meat of the interview itself.

If there is one thing, one learns from episodes such as this, its the fact that the top guys rarely make any noise while they go about doing their business as if time has stood still. They aren’t the first to jump about to tell everyone about how good a call they made in the daily circus that is run on the Idiot Box, most of them don’t have anything to sell (other than a book or two) and finally are humble.

Financial mis-selling

Financial mis-selling is a term that is common these days to indicate selling of financial products which are not suitable for a customer. For example, when some one offers to sell a 60 year old client a 20 year money back policy, he is plainly mis-selling a product that may not be suitable for the client.

Today’s Economic Times carries this picture of how Banks try to sell Insurance policies when asked for Investment advise (other than the FD).

And Business Standard carries a article on how Insurance companies will be held liable for misleading advertisements (Link).

Have you ever given a thought as to why this happens? Blaming the Agent / Distributor / Adviser is the easy part, but what is the role of the customer in all this.

Lets move outside the domain of finance and go into a shop that sells high end electronic items. You have a need to buy one and ask the salesman out there what is the best out there. 9 out of 10 times, you can be dead sure that he will recommend you the product that gives him the maximum margin.

But generally we do not fall prey here since most of us do a lot of homework and already have a idea on what we want. But for the guy who has done nothing, the only input he has is the Salesman’s advise. When you really have no clue, its really tough to ignore the recommendation of the salesman who one hopes has a much better insight into these things.

A secondary thing you shall ask before buying is the warranty for the product to ensure that if it does not perform as its advertised to do, the product will either be serviced or replaced for free of charge. After all, you don’t want to buy a product that works at the showroom but the moment you are at your home decides that it would not work.

Lets now move back to the financial world. How many investors approach their agents / adviser after already doing a bit of homework? Agreed, finance is not a easy subject to master but when you are investing your savings, is not the trouble worth the possible returns?

The thing with finance is that other than for Fixed Deposits, there is no guarantee of returns from any other product, but our mind refuses to accept that there could be a probability that after investing for X number (X = anywhere between 1 to 50 if I go by US data), there exists this chance that the net returns will be Zero or worse, negative.

Lets take Insurance first – the reason that Endowment / money-back policies are such a hit is due to 2 factors

1. Risk is covered (even though the amount is way small compared to what we are already pitching in with) AND

2. We get our money back (and if Lucky a additional Bonus too).

In the stock market, advisers advise on buying call / put options with the bait that it could easily double / triple. I wonder why no Insurance company tries that way of advertising (only difference being you will be dead, but hey, investment yielded 10x returns)

Financial Advisers these days are coming up with plans on how you can save for Retirement / Education / Marriage by just being a systematic investor. What they don’t say is that there is no guarantee that the amount you require will be met. After all, who knows how the markets shall behave, Right?

When it comes to mis-selling, I would lay a equal amount of blame onto the client rather than blaming the guy providing such advise of 100%. After all, most clients come up with the idea that they can have their cake and eat it too.

Markets (Equity, Debt, Real Estate…) all move in cycles and while the hope is that at the end of ‘n’ years, we will be better that what we were at the start, there is no such guarantee. Worse, almost all markets in the world have at least once seen a fall greater than 60% from its peak – in our own case, following are the percentage falls from the high points

1993 – 49%

1995 / 1996 / 1998 – average of 32%

2001 – 41%

2004 / 2006 – average of 22%

2008 – 55%

2011 – 13%

All the above are based on weekly closing hence actual peak – through draw-downs will be slightly higher. But the point I am trying to make here is that investing is never a smooth ride

Unless you are ready (mentally and financially) to ride through the storm, no amount of projections of the future is going to provide you with the confidence to invest when the chips are down.

I keep hearing financial advisers claim that the reason you should go through them is because during these tough times, they hand hold the clients to ensure they stay investing. Well, the thing is not to give you a hand when you seem about to drown but to warn you that while the river at the current juncture seems calm, there is a rapid on the way and worse, there will be a precipitous drop in the future that may wipe out years of growth.

The picture below perfectly illustrates the risk that will come in your way (and after all that you may still not be able to reach the chequered flag)

Most of us spend 8 – 10 hours every day to earn our living (Salary / Profits, whatever). How much time do you think you should allocate to ensuing that the hours spend the amount earned all does not get wasted since you followed someone who showed you dreams vs following some one who showed you the hardships that is reality

Despite widespread knowledge and regulations, the Nigerian scam is still able to dupe people to part with their money and in the same way I don’t think that mis-selling is something that can end with better regulations. It can only end if people invest a fraction of their time to understand the concept of time and return better compared to the amount of time they spend to earn that money.

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