Commentary | Portfolio Yoga

Real Estate vs Equities

Writing in Valueresearchonline, Aarati Krishnan says “Equity funds often do beat real estate, but it is all about behaviour and perception of investors”. I am not sure as to how many investors agree with that, but that is not the point.

In that article she correctly points out that while investors in Real Estate not only are willing to put in a bigger lumpsum but also keep paying EMI’s which are way bigger than what most equity fund SIP’s are. The affect of leverage also adds to the returns (especially since until recently, there was hardly any fall in prices).

But how correct is one to compare investing in real estate vs investing in mutual funds (equities). I for one believe that there are quite a few.

To start with, for most, investing in real estate means owning their own shelter. Of course, there are people who buy second / third or even fourth home, but for majority, one barely is able to see through one.

When one buys a home, he buys not with the intention that this shall provide him the money required for Retirement or for his Daughter’s Wedding or her Education. He buys for the simple reason that he believes that buying his own home not only is a viable and wonderful investment (that shall keep appreciating) but also a sign of prosperity and sign of success.

While in the older times, people waited till they nearly got to retirement age before many actually bought / constructed his house, over time, people have become more faster in acquiring a house regardless of whether he requires one immediately or not. After all, what is the whole point in waiting when its so easy to get loans and with prices that keep increasing, it seemed that waiting was a losing proposition.

The bigger question that the article raises is that if one made the same kind of investment in equities, one could have got similar / better return. But there is a catch and even the Author seems to agree with it when she says “people seldom take loans to make equity-fund investments (it’s not a great idea anyway)”

Much of the investment that goes into real estate is by way of Loans which can compound the returns even more. While the author does say “its not a great idea to invest on borrowed money”, its actually tough if you really wanted to do it since no banks will lend money for investing in stocks and shares. Also, unless you believe that the return from the investment is way higher than the interest cost, it makes no sense.

In fact, the very reason a lot of small investors are attracted to stock futures and options lies in its ability to provide massive returns if one is right for what is assumed to be a small risk.

Since unlike real estate, the very idea of investing in Equities is to achieve a goal, its actually important that you have a plan since there is no guarantee that markets will be where you would want them to be when the time comes to withdraw.

The draw-downs in Real Estate does not matter since the investment is not with the aim to reaching a specific goal. On the other hand, when you are investing in Equities with the understanding that this shall help in reaching one’s goals, its equally important to be able to time the market (on a broad level) since otherwise you may start at the worst point (to invest) and need the money in the best time (to invest).

While most advisors and fund managers harp upon SIP (Systematic Investment Plan), if you are investing for a Goal, do take into account that a plan of how you exit is also as important. After all, our needs will not match with market cycles and hence one needs to plan the same.

Its hence imperative that you have a proper asset allocation with multiple plans of action on how you shall deal with various stages of market and how they shall align with your goals. After all, what is the point in saving if it cannot come to use when one really requires the same.

Why Equity Funds Don’t Beat Real Estate

The proof of the pudding is in the eating

The proof of the pudding is in the eating is a age old adage which is said to mean that you can only judge the quality of something after you have tried, used, or experienced it.

In the financial industry, one key thought process is the concept of “Skin in the Game”. If I were to advise you to buy a certain product, the least I am expected to do is risking something of my own in the same product.

Mint today reported that Kotak Mahindra mutual fund staff told to invest in-house. The concept in itself is not new with the same being practiced in US for quite a while (see pic below) while PPFAS was one of the first to explictly showcase the skin in the game concept out here in India.

We believe this is a very welcome move. While it may not mean that Kotak funds will move to the top of the bracket, at the very least, one hopes that pressure from employees will have some impact and ensure that their funds are not bottom scrapers in their respective segment (Kotak’s funds fall mid way in terms of 5 year performance)

Performance of Kotak funds (data from mutualfundsindia.com);

And the Greek Votes No

So, against what the markets in my opinion seemed to have expected, the Greeks have overwhelmingly voted No to accepting the deal that was offered by the European Union. Of course, since its very much doubtful that most voters had a clue about what the offer meant and what accepting or rejecting the offer will bring, it came down to who was able to convince them better and in that aspect, the Greek Prime Minister had his way.

Over the last 3 days, I have read a lot of reports on Greece and yet find it difficult to come to a conclusion as to whether they had a better future going with the recommendations of the European Union or they will have a better future risking the future (based on what a lot of top ECB folks are saying) and tie themselves with whatever plan Alexis Tsipras has in his mind.

Everyone who seems to have supported a No vote seems to indicate that since there is no way the Greece can payoff the debts and some amount of debt write off is necessary. A nation is unlike any other business where ff the compang unable to earn as much as necessary, the lenders will take action including pushing the company into bankruptcy and closure to ensure they get whatever they can get.

A nation on the other hand cannot be disbanded and sold off piece meal because the lenders were not paid their dues back. Greece is not the first country nor will it be the last to default on its obligations. In this 21st Century itself, we saw Argentina default on its debt and despite it passing 14 long years, is unable to access the International markets even today.

Russia defaulted on its debt in 1998 while in 1982, Mexico said that it would not be able to pay its debt triggering a full blown Latin American crisis.

One of the ways to get out of the sticky situation is by allowing its currency to depreciate and hence make Imports expensive and Exports cheaper. Unfortunately for Greece, even this option is ruled out for now since being in the Euro, it has no currency on its own to make that kind of transition,

One of the interesting things I learnt while reading about the Greece situation is that, this is not the first time Greece has gone into default. In the modern era itself, Greece has defaulted on its loans in 1826, 1843, 1860, 1894 and 1932. Its as if the country has never been able to be on the right side of the law.

There has been a lot of hand wringing by Analysts about the Greek tragedy and how it affects the commoner. Most seem happy to blame the creditors for all the pain and since Germany leads the list of creditors, its the one that commands the most hate.

But the big question is, What next for Greece and how will that impact the markets.

As of now, the SGX Nifty is down as are the futures of Dow, Dax and FTSE. Markets are disappointed since a Yes vote would have meant at the very worst kicking the can further down the road. With a No vote, none is sure as to how the European region will react.

A No vote we were told will mean a Greek Exit from the Euro. Since the agreement which facilitated the Greece (as well as other country entries) in itself does not have a exit clause, Greece cannot be kicked out but will have to go on its own.

Banks in Greece has been closes this last week since once the referendum was declared, ECB decided to stop its Emergency liquidity as well. If ECB does not open its purse, Banks will remain closed for the foreseeable future. Going back to their old currency, the Greek Dramcha was spoken about though that would literally mean that all the savings of everyone who still holds it in Banks will more or less get wiped out.

Greece will be able to start a new life with its own currency, but the pain of changeover can be huge. After all, if everyone loses all their savings (more or less), its very difficult to kick start the economy. Yes, tourism may boom since Greece becomes way cheaper for the rest of the world, but these things take time and time is something they don’t have the luxury off.

As traders / investors, all we can do is follow our rules and hope for the best since there is little impact on our markets / country directly. If this goes into a full blown European Crisis, we shall be impacted as well. The question hence becomes as to how well can the ECB ring fence the Greece crisis from affecting other weak countries in its region such as Spain / Portugal / Italy among others.

On Friday, before the markets closes, I tweeted that I was Long since I believed market know best. Depending on how big a opening gap down we see, I shall have my moment of truth and reckoning. But I continue to believe that markets will not be unduly ruffled since this was a out come that was expected as well (even though probability may have been lower).

This coming week will more or less provide us a glimpse of how this situation will evolve and the path forward. While the sword may still hang over the neck, I doubt markets to be unduly shaken off unless it starts affecting other as well.

καλή τύχη

Get busy living, or get busy dying

Once I read Kiran’s wonderful post, I knew there was a post that I could write on things I felt he overlooked. Tougher was getting the title though 🙂

First of all, I would suggest you go ahead and read Kiran’s post if you have not done. There is a lot of things I actually agree with him (Link).

I am a strong believer and I believe even wrote in a previous post of mine that since we do not know the end date, there is no point in saving to the point of not having a great life. Yes, the children, grand children maybe happy, but were you happy while you saved every penny and invested in the best possible way to achieve the best possible return is my question.

The biggest issue of not knowing our end date is that we end up saving more than we require or worse, using up all our savings even before we meet our maker. While in the first case, the kids (or to whomsoever our assets go) will be more than happy, in the case of the latter, we find ourselves living out our last days in a way that we never hoped we would.

Kiran is right in pointing out that we need to make up our capital and be able to start spending when our health is still in the prime. After all, when we reach a stage when its difficult to climb up a staircase, would be want to endeavor walking through Paris at night?

Kiran’s scorn seems to be reserved for those who are happy with achieving 18% returns (CAGR) and says that if one needs to achieve, he needs to at the very least double that.

The problem is not the 18% either since evidences in US has shown that normal investors have generally performed even poorer than what the market has returned. So, when Kiran talks about 18% (which is what Mutual fund managers claim India’s market has returned over the long term), its something that a lot of folks in the market have trouble reaching in the very first place.

He, of course points out that achieving 35%-40% CAGR is not easy. Let me quote his own words

There is a lot of hard work, there is a lot of luck and there is a lot of position sizing science involved before you make that million dollars.

The thing about hard work is that, markets do not work on hard work alone. You could have done all your homework and finally decided to risk your money in a stock that then went ahead and got embroiled in a scam that no one had a clue about in the first place

A wonderful book with regard to Luck is Michael Mauboussin’s “The Success Equation”. In that book, he has the following picture

As shown in the above picture, stock markets come in a place where luck plays a great deal of role compared to say games like Chess and Athletics. In other words, without Luck, you maybe at the right stock at the wrong time.

But coming to his verdict that one needs to generate 35% – 40% CAGR over 15 years to be able to do whatever one wants to do before one gets too old to be able to do that, I decided to check what Investor model (among the great investors) should I follow for achieving a return of similar nature.

Here is a list of top US fund manager and their returns

Since the long term returns (dividend reinvested) for S&P 500 comes to 9%, anyone who has delivered above 26% and over 15 – 20 years would fit our profile. The only guy who seems to fit is the Hedge fund manager Joel Greenblatt whose book “The Little Book that Beats the Market ” has attained cult status. Other than Greenblatt, Soros and Buffett have in their initial years achieved similar high returns though with passage of more time and more assets under their belt, their net returns do not come above the 26% barrier.

Its not that 35% is not possible. Its possible and I am sure guys like Kiran and many others have achieved even higher returns. The question though is, are they the outlier’s in terms of the ability to not only understand companies way better than what most of us do, but also devote the kind of time and attention that is required to achieve those results.

Investing in mutual funds systematically can maybe achieve a number closer to that, but even that requires

1. A deep bear market so that you can invest a lot more when the markets are cheap AND

2. Your ability to keep investing even as the market tanks and the world seems to be coming closer to a Apocalypse.

While a bear market can make asset prices cheaper, it also means that there is plenty of risk to our bread and butter (unless one is a Government employee or knows his company needs him more than vice versa). What use are cheap assets, if one’s own future is unsecure.

As a trader, I target 100% return? But its one thing to target / aim and quite another to achieve. My own testing has indicated that the draw-down one sees in one’s investment is 2X the long term return. So, if I am aiming for a 40% return, I should also be prepared in the worst case scenario to see my equity portfolio go down 80%. More importantly, I should even during the worst time not move away from my process.

Its all easy to be said while tweeting and blogging, but when our real money is going down the drain, the first thing to go out of the window is our discipline and method.

In my opinion, there are no easy way out to most of the things that trouble our little minds. But as Kiran concludes, enjoy the process of investing without worrying too much about whether the outcome will be enough to satisfy our and the future generation or not.

After all, if you are were to study history, for thousands of years, life was so uncertain that nothing other than what could be ported out at a moments notice was not valuable. So, Real Estate was never valuable in the way it is now though Gold had its predominant role due to the ability to run away with it.

As much as the Greece episode has given many investors a ability to buy some stocks cheap, do give a though to those who have their life savings stuck with no idea what will be the final outcome. Same goes to the citizens of countries like Venezuela, Zimbabwe & Argentina. We on the other hand are way better off and hopefully will remain so for a long period to come.

P.S: The title of this post is from a wonderful film called Shawshank Redemption.

Perhaps the best way to sum up the key to life is wisdom from the movie Shawshank Redemption when Andy Dufresne said to his fellow inmate Red: “Life comes down to a simple choice: You’re either busy living or busy dying.” It isn’t just a quote from a movie, its advice for all of us.

Long Term Investing and Trading

Today morning, good friend and guide, Sunil Arora tweeted the following

The only way to make money in the markets is Long term investing. have no doubt about that. I have now completed 31 years in the markets

— Sunil Arora (@moneybloke) June 30, 2015

On the face of it, that statement makes complete sense in every regard. There is tremendous evidence that traders end up losing their capital within a short span of time. In fact, evidence from brokerage points out that 95 to 99 percent of all traders end up either having wiped out their capital or at best generated returns that aren’t commensurate to the amount of time and energy spent on achieving the same. While there is no such static with regard to investors, I wonder how many really thrive – in sense, how many actually are able to generate healthy returns for the efforts put in as compared to what could have been achieved by just buying a Index ETF and sitting on the same. Its tough to measure success / failure for investors due to various reasons including but not limited to fact that there is a lot of Survivor bias and Sunk cost fallacy at work. Investor buys stocks like Koutons (which today we know is bad, but as I pointed out in one of my earlier blog posts was recommended as a fine stock by major brokerage houses) and if he had just sat on it, it would still be on his demat account even though trading has long stopped. If one has caught onto the right stock and sat on it, the returns would be fabulous indeed. But once again,as I wrote in my previous blog post, its the Quantum of profit that becomes important than just percentage since unless the bet was fairly large, even a 100x return can be meaningless in today’s money. The biggest difference between a trader and a investor is the time required to get a feed back. A investor generally has a large amount of time before the feed back is received as to whether his logic was proved right or wrong. A trader on the other hand has a much faster feedback loop with he knowing within a very short span of time how good or bad his decision was. A secondary difference between a trader and a investor is the use of leverage. While a trader loves to leverage his capital in the hope of capitalizing more gains, a long term investor can rarely leverage and hence can invest only as much as his capital would allow him to. The biggest advantage of not using leverage for a investor is that he knows that the only way his capital can go to zero is if all his picks go to zero. A trader on the other hand can get chopped out even though the markets may have moved nowhere. For example, just today, ReformedBroker posted this tweet

If you’ve been buying and selling the S&P 500 this year on every 50-day moving average cross, you’ve traded 27 times pic.twitter.com/HtmpVx6N2l — Downtown Josh Brown (@ReformedBroker) June 30, 2015

If some one had traded every signal with a fixed position size, he would have run out of capital long before we hit this 27 mark. Of course, even a guy who uses position sizing would get killed (not to mention lose his hair trying to stick to his system) if he followed the same blindly.

Then again, if trading was not a feasible way to generate profits, could we see the kind of returns that Dunn Capital Management has generated using purely trend following systems?

While the fund goes through gut wrenching draw-downs that have in some cases gone on for years together, the end result has been one where the program has strongly beaten the markets (as measured by S&P 500). In fact, if you were to search the CTA world, you would find many such examples, though Dunn as far as I can see is the one with the longest track record.

Long term investing does not mean easy money as Sunil tweeted in his tweetstorm

If someone thinks making money is easy in the stock markets, think again. It takes real hard work and then some

— Sunil Arora (@moneybloke) June 30, 2015

Earning a profit higher than what the markets provide (again, as measured by the benchmark) is neither easy nor possible for a large number of investors.

In fact, I strongly believe that majority of the investing population out there neither has the capability nor the band-width required to be a investor / trader and are better off achieving their goals by prudent investing in Mutual Funds / ETF’s.

For every one stock that has given abnormal returns in the long term, I am sure one can easily find 5, if not 10 stocks that seemed to make even more sense at that point as a great investment just to be wiped out in time.

Every market peak has seen hundreds of stocks making the news and every bust has seen most of them wiped out. The few survivors that are left are those that could pass through some of the booms and busts and yet survive. In the 2000 IT boom, at Bangalore Stock Exchange, we had around 50 stocks that got traded. Of them, I wonder if even a dozen survived (forget about thriving since many of them are yet to see their highs of 2000, 15 years later).

I am all for the long term if you are willing to work hard at identifying opportunities that get presented by the markets and are willing to wait for long time frame to pounce only when a opportunity presents itself. Else, your long term is better off as a investor in Mutual Funds / ETF’s which enable you to more or less achieve what the markets provide without you having to sacrifice personal and family time in an attempt to beat the market and grow your capital.

List of Companies that have got delisted over time is available here (Link). The list of companies that have got delisted either due to Compulsory Action (many a time for not adhering to listing requirements) and due to winding up of the company is fairly large.

Trend following & the Greek Referendum

One of the reasons I am a strong believer in trend following is that I have observed that in all cases where markets were supposed to be caught by surprise by an event that shook the markets, the trend was already down. I have in the past given presentations and talks using examples such as the Kobe earthquake, September 11 attacks, our Election results among others. Every time, the trend was already established in line with the future unfolding.

To that extent, this day’s opening gap down of 1.6% was definitely a surprise since markets seems to have had the least amount of any such anxiety going into Friday’s close. In fact, even the Greece markets seemed to have missed any clues as it closed in the Green on Friday.

The non believers though seem to have been having a field day

So Greece was not priced in?

— zerohedge (@zerohedge) June 29, 2015

So, I decided to see, how often this is the case – the case of the short-term trend being up and markets opening down 1.6% or greater. For the short-term trend filter, I used a 15 day EMA.

Since 1999, we have had just 4 such instances with the last event being on 16th July 2013. And other than the 1999 event day, every other day, we actually closed above the open price though on no occasion did the markets close in positive territory (and that includes today obviously).

The table below showcases the performance of the markets for the next 5 days post such events

Based on historical evidence, t+1 which is tomorrow, seems to have an edge in terms of a positive close. But more interesting is that other than in 1999, the bullish trend of the past seems to have held on with this day being an aberration of some sort and not a deal breaker (given the low number of instances).

Core Competencies

We all have our area of expertise which is where we have spent much of our energies both in terms of education as well in terms of the job we do.

Charlie Munger once said and I quote

“Warren and I only look at industries and companies which we have a core competency in. Every person has to do the same thing. You have a limited amount of time and talent and you have to allocate it smartly.”

As a amateur trader / investor, its normal to jump from one strategy to another in the hope that we find the golden goose. But as we mature, both in terms of age as well as in our ability to understand things better, we concentrate our energies on what works best for us and try to make the best of the situation.

But even the professional gets swayed especially when one’s strategy is going through a tough time. Trend followers for example have’t had that much of returns in recent months even as the rest of the market seems to be having a jolly time. Value investors have doubled / quadrupled their investments while the best we seem to be able to achieve is just hanging on to our capital.

Recently, there has been a spate of discussion on my time line regarding Market Profile, a strategy that has suddenly got the limelight even as many other strategies falter. I personally too got swayed and read a introduction to Market Profile just to get a hang of it.

But does it really make sense to switch gears in the middle? Can a Veterinary Doctor switch to Dental because it seems to make more business sense?

In last one year, we saw a sway of Mid and Small Caps throwing up some crazy returns. But how many investors really have a clue as to what they are buying? How many stocks have some truly great qualities and how many are just the Mom and Pop store that got caught in the Dot Com craze?

I love twitter for the ability to connect with other people and read articles / books which they feel is worth one’s time. But when it comes to trading and results, how realistic are those in the first place? I constantly use the word “Twitter Traders” since I seldom see some one taking losses with most claiming to be making a packet. Since markets, especially derivatives, are places where one cannot win without some one else taking a loss, one wonders as to where are those losers?

Every strategy has its weakness regardless of what their ardent followers may claim, nothing is fool proof. In my own view, over the really long term, the returns of almost all strategies (those with decent expectancy) should be around the same.

So, while 2014 may have been the year for Value Investors, 2015, the year for Mean Reversion traders, 2016 may favor some other methodology. By jumping around, all one will do is miss out on all opportunities since we would never have a domain expertise to know the good from the bad and worse, miss the early juicy part while competing with others for the left overs.

Building domain expertise is a life long endeavor and honestly it is not worth the time or the effort to try and compete with all. After all, despite the fact that software engineer’s get salaries way above what other jobs pay has not meant that we all have jumped and tried to become software engineers ourselves. So, why should our way of investing / trading in markets be any different?

Food for thought?

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