Commentary | Portfolio Yoga

Its the Quantum that is Important

Real Estate has given some crazy returns in the last few years and there is not denying that. We can always pick and chose stocks that have maybe given even better returns, but the big question is, are they even comparable.

While there is always the case of stocks like Infosys / Wipro / Motherson Sumi, the net results if one looks at the Index itself is not as promising.

Even taking the most optimistic scenario that is used by most fund managers (investing in 1979), the returns come to some 17%. On the other hand, I know of properties that have (at current market prices) given a return of similar proportion for a much longer time.

But as usual, I am digressing from the subject on hand. On Twitter and elsewhere, I constantly hear about investors making 2x, 4x, 10x their investments in certain stocks.

The returns are fabulous if one were to put it, but the question is, is the return really worthwhile in money terms?

Let me give a example of my own. In 1997, I bought a certain company called Indo Count Industries. It was a penny stock at that point and remained one for a very long time. In fact, when markets collapsed in 2008 / 09, this stock traded at around 2.50.

Things started to change in 2013 and in 2014, this stock galloped 800%. This year, it has already gone up 80%. For me, this stock is near to a 100 bagger. Theoretically speaking, I should actually be able to retire on just this stock alone.

But as usual, there is a caveat. I invested 700 bucks (in 1997) and today while its worth 65,000, the sum is pretty low for thinking of any dream purchases, let alone retiring.

Lets assume instead of buying Indocount I had bought some real estate (of course, I could not get something for 700, so amount of investment would need to be higher) and it became a 100 bagger, I could actually have retired for a comfortable life.

The key difference is the amount of investment that is required / invested when it comes to the stock market vs the investment we do when we enter into real estate.

In Real estate, not only do we invest every Rupee we have got but actually leverage ourselves by taking on loans that magnify our returns.

When it comes to investing though, we rarely invest what we can (our Liquid Networth), let alone investing it all and then adding some leverage on top of it.

The key reason is the lack of conviction. While we are convinced that Real Estate markets shall not drown us, we aren’t so sure when it comes to the stock market.

The reason we aren’t convinced that stocks comes down to the fact that most of the time, we are clueless as to how to analyze companies / investment and even when we are, having either burnt our own hands or seen the destruction suffered by others, we worry too much about what if it goes wrong.

A friend of mine has a couple of crores in investment in real estate while having a couple of lakhs into the market. Even if his investment in the market doubles / quadruples, the returns are literally are literally a drop in the bucket so as to speak when compared to what the returns (a big IF) that are generated if his real estate investment doubles.

Of course, I am not advocating real estate. I strongly believe that while we may not see a crash of the kind we saw in US, the forward returns from Real Estate will be pretty low (and this even before Indexation) for the foreseeable future.

On the other hand, if India grows in the way countries like United States / South Korea / South East Nations / China have grown, there is a lot more to look forward to.

But you will only build wealth if you not only invest significantly but also be willing to stay through it through thick and thin. But that requires a lot of discipline since its not easy to stick to our process when the times are tough.

At PortfolioYoga, we introduced a Asset Allocator model sometime back. We believe that rather than invest everything when the markets are high, it makes sense to have a lower exposure and increase the exposure if market gets cheaper. Else, while returns will be lower than complete exposure shall provide, at the very least, you shall be able to sleep well at night.

Big money, both in markets as elsewhere, is made by those willing to bet it big. That of course does not mean take un-necessary risks. But with the right risk models, you should be able to build your wealth without having to go through the pain of having your investment stuck with no way to exit in a hurry as is the case with asset classes like Real Estate.

Trading with the Longer Trend

One of the often quoted things is that one should always trade with the higher trend. So, if the higher trend is bullish, it makes sense to avoid shorts and take only longs and vice versa. As much as the advise seems great theoretically, its only after testing can we really be sure whether such a strategy really makes economic sense.

The biggest draw-back so as to say when it comes to trend following is the streak of losses that one sees. This generally takes place when the markets are undecided on where next to go and oscillates between a high and low point.

With the current trend among traders being “Market Profile”, this area is also seen as bracket area where both the bulls and bears are in control of their respective zones and defend the same. So, when markets go to the upper range, bears become pro-active as they short the market with the anticipation of a pull back to the lower zone where bulls are willing to take charge.

For a trend follower though, such back and fro movements are killers as they get repeatedly stopped out while the market in itself would have not moved anywhere. Or even worse, we get caught in counter trend trades, even as the larger trend in itself is relatively undisturbed.

For example, take a look at the chart below. Its of CNX Nifty (Spot) with Arrows being the Buy & Sell signals generated based on a simple 3 * 5 Moving Average Crossover

Specifically concentrate on the marked area – the markets were well and truly bearish, yet, our buy signals got triggered a lot of times before the final Buy actually resulted in a good profitable move

What would happen you may wonder if I were to add another longer term Moving Average to figure out whether the trend is Up or Down and act based only upon that.

Since we are looking at the whole situation objectively, we will need to not just randomly pick up a Moving Average which shall tell us whether the trend is up or down but find that number by analyzing all possible options.

One way to do that would be simply optimize the parameter at hand. Of course, we shall then fall into fitting the curve, but since the idea is to see whether our logic is right or not, we will not worry about it for the moment.

So, on top of the 3 by 5 Moving average crossover, I tested for what variable would be the best fit (one for the Bullish trade and one for the bearish). After testing through nearly 35,000 options, the best among the lot seemed to suggest using 150 day MA for our bullish objectives and 200 day MA for our bearish objectives.

Before we go ahead and see the results based on this, lets first see the results of the standalone system.

The test was carried out on EOD CNX Nifty (Spot), No commissions were included and all trades were taken on the closing price of the same day. No compounding of Positions was allowed.

As you can see, while the long trades are extremely profitable, even shorts end up in profit territory despite the fact that markets as a whole has moved up by around 6500 points in the interim.

Now, lets apply our filter of going long only if Signal has come with Close > Moving Average of 150 periods and going short only if Close is < Moving Average of 200 days.

Because of the additional filter, this system will not be a Reversal system anymore (i.e., Long exit is also Short entry & Short exit is also the trigger for Long)

Results are as follows;

So, what are the key differences between them.

First is the fact that having a filter reduces Net Profits. While a simple Crossover provides us with 10,363 Nifty Points, the Filter reduces this to 8,181, a reduction of 21%.

The Number of trades is lower for the Filter compared to the plain vanilla approach. While the plain vanilla approach has 504 trades, the filter reduces this to 232, an incredible reduction if one were to say. This reduction also means that we are not always exposed to the markets as in case of plain vanilla.

While the plain vanilla crossover approach requires us to be in the trade all the time, in this case, that requirement is no more present. The filter version is in the market for 2117 days vs the normal which is in the market for 4333 – again a huge difference.

And finally, lets look at the most important factor – draw-down. System draw-down for the plain vanilla was 15.62% vs 8.63%.

All in all, having a filter will help in having a smoother returns but has the opportunity cost of missing trades (ones where the market trend is changing from Bull to Bear and vice versa).

Its all finally about give and take. If you are happy with a lower return (point wise), you can smoothen your equity curve. But if you are happy & are able to take in volatility, plain villa offers you a higher profit ratio.

Permanent loss of Capital

One of the often quoted reason to invest in the stock market is that they have delivered XX% returns since 1979. This of course is bullshit given the fact that Sensex did not even exist in 1979, let alone a retail investor have the avenue to invest in its constituents.

And then there is the tales of how investing just 10K in 19xx would have turned into Crores of Rupees today. Just today, on Whatsapp I received the following message

Motherson Sumi announces :- 1:2 Bonus on 10th June’15
See Wealth Creation of Motherson Sumi :-
Motherson came out with IPO at 25 INR per share in April-1993
Only 2500 INR of investment on 100 shares.

The Company’s Bonus History and Multiplication of Shares as follows :-

1997-98: Bonus 1:2 – 100 shares became 150 shares
2000-01: Bonus 1:2 – 150 shares became 225 shares
2002-03: Split into Rs.5 paid up – 225 shares became 450 shares
2003-04: Split into Rs.1 paid up – 450 shares became 2250 shares
2004-05: Bonus 1:2 – 2250 shares became 3375 shares
2007-08: Bonus 1:2 – 3375 shares became 5062 shares
2012-13: Bonus 1:2 – 5062 shares became 7593 shares
2013-14: Bonus 1:2 – 7593 shares became 11389 shares

So, 100 shares became 11,389 shares.

Current market value of 11,389 shares=
11,389 shares*Rs.489(Current Value)=55,69,221 INR

So, Total Value of Rs.2500 invested in IPO including cumulative dividend is Rs. 56,71,602 as at 10th June, 2015.

Thus, 2268 times increase in Investment Value in 22 years!!!

Patience is bitter, but its fruit is sweet

The compounding is really amazing but what the message does not say is that this is Selection Bias at best. While Motherson Sumi survived and thrived, there are thousands of IPO’s which came in the same era and which are not even listed on date.

If you had invested 10,000 Rupees (which in 1993 represented maybe a couple of months salary for any mid level employee) into every IPO that came out in 1993, I can assure you that your returns today, adjusted for inflation would be measly at best and disastrous at worst.

That does not mean, no one has invested and held on to great shares. There would be quite a few such folks who would be sitting on tremendous returns realized from those investments. But the reason for them to hold would be far away from any fundamental or technical arena.

These days, I find many a folk advising one to invest directly in the markets despite the fact that the probability of a investor really outperforming the market on a long time frame is in the low single digits. We are told to invest in blue-chips, but how many blue-chips remain blue-chips over a period of time?

Yesterday, I finished reading a book written in the aftermath of the 2000 bubble. Its amazing how easy it was then (as it seems to be even now) to manipulate the small investor / trader to buy stocks that are touted as the next big thing.

While 2000 was purely a Infotech led bubble, the 2008 bubble was much broader and hence I wondered as to how many stocks have survived over the last 7 and a half years and what has been the return between then and now.

The results as shown in the tables below is literally devastating. Many of the stocks which traded in the high 100’s and even above 1000 are now more or less trading or were de-listed at pennies.

Take for example a stock like Koutons Retail. The stock which came out with its Indial Public Offering in September 2007 was over subscribed by 45 times when it offered its shares for sale at 415 Rupees (Link).

With markets in full flow, almost all major brokerage houses / newspaper recommended investing in the same.

Koutons Retail: Invest (BusinessLine Review)

An investment with a one-year perspective can be considered in the initial public offer (IPO) of Koutons Retail India (KRIL). KRIL is a player in the menswear segment with a network of stores mainly in northern and western India. The offer proceeds will help the company expand its retail network.

The price band of Rs 370-Rs 415 values the company at 33-36 times its 2006-07 earnings per share, on an expanded equity base.

KRIL’s premium pricing appears to factor in higher growth rates compared to domestic apparel majors such as Raymond, Zodiac Clothing and Kewal Kiran Clothing. The latter trade at price-earnings multiples of 15-20 based on trailing earnings.

However, KRIL’s performance over the last couple of years and its proposed expansion plans provide some justification for the higher growth expectation.

The expensive valuation for the offer, however, does not provide a margin of safety in the event of disappointing performance. This makes it suitable only for investors with a high risk appetite.

While the huge over subscription would have meant limited allocation, investors who did get a small piece of the cake were left happy with the stock moving higher. In fact, so good seemed this stock that even as rest of the markets were getting slapped in early 2008, Koutons made a new high in late February (by which time, Nifty was down 17% from its peak).

The slide started from then as markets tumbled even further and even Koutons caught onto the fever. But Brokerage houses were not one to be moved by this volatility as they continued to recommend the stock even as it went down the rabbit hole.

Some of the few brokerage reports I could find can be downloaded here (Koutons Research Reports). Since their publication, the stock had gone just one way – down the rabbit hole so as to say, but while I could find Buy Reports, I found Zero sell reports. The reports though seem to completely stop in 2011 with the stock having breached the 100 mark as well.

Yesterday, I tweeted the complete list of winners and losers. For those interested, here is the spreadsheet with the same data for you to check any company you would like to. (Link) Do note, that most of these prices are adjusted for Splits / Bonus and hence the actual closing prices may have been different for a few stocks. Add to that, some stocks which got delisted / merged and where the earlier ticker bore no resemblance may pop up, apologies for that.

Also, this list is only of those stocks that are listed on NSE. (Link).

To summarize, Direct Investing while seeming to be way more attractive than investing via a Mutual fund can be very expensive in terms of your ability to meet your goals as also enable your savings to grow if you are not able to choose the right stocks. But what are the right stocks becomes the bigger question when stocks supposedly great end up on the mat.

If the mutual fund universe were to be scanned using a database of Survivorbias free returns, I believe you shall find that even there, many investments would have given partly gains. But the key difference is that the percentage of such funds are lower than what we can find in stocks. Also most funds which tripped where sector focused funds which anyway’s carry a much larger risk than a diversified fund.

Direct investing is very risky unless you are prepared to do all the hard work required. Direct investing in funds these days costs just around 1.25 – 1.75% and I strongly believe that this is a small price to pay for the ability to at the very least keep up with the market. ETF’s are another route, but unless we have a more broad based ETF markets (Mid Cap / Small Cap / Sectors), it will remain a fringe industry (though one that has proved based on performance to be better than most Mutual Funds in US where there is both depth and variety)

Selection Bias in Mutual Fund

When we are told that Mutual Funds beat Benchmark & hence generate Alpha, we are given the list of funds that have achieved that landmark. What we aren’t shown is the list of funds that have under-performed (who wants to highlight losers anyway) as also how 2 similar funds managed by a single fund house can have returns that are hugely diversionary

The rationale for this post comes from this tweet by Manoj Nagpal (tweet). The fact that despite trading under the same fund house (and hence similar philosophy), the returns are dramatically different

Here are the returns and comparison to the benchmark via ValueResearchOnline

(Link to above Fund)

And here is the table for the Second fund

(Link to the above Fund)

So, what is the difference in the funds that could be the reason for such a wide parity. The difference comes in who is managing the funds.

Fund-1 is managed by Star fund manager Kenneth Andrade while Fund -3 (the Second fund above) is managed by Ankur Arora & Meenakshi Dawar.

In a way, the whole Alpha of the fund seems to be credited to the one guy and not exactly because of fund philosophy or any other nonsense that is generally seen as key factors and that brings us to another question as to what does one do when the key player quits (as is being rumored in case of Kenneth) or unfortunately dies as in case of Parag Parikh.

In case of Parag, my own rationale (which seemed to be different from what most other financial advisors were saying) was that it made a lot of sense to exit the fund for now and wait to see how the fund performs in the future.

Kenneth Andrade, Prashant Jain are among the few widely known fund managers who have been drivers of not just their funds but also have made it possible for people to experience what long term compounding can achieve.

There is a huge amount of literature out there since Internationally, a star fund manager leaving for fresh pastures happens all the time. Here are a few of them

Star fund manager quits – what should investors do? (The Telegraph)

Should You Sell a Fund When the Star Manager Leaves? (Morningstar)

Don’t jump ship after star managers quit (FT)

Reach for the stars? (SquareSpace)

While the jury is still out there, I believe in that one should look at safety first and in that, it makes a lot more sense to exit a fund when the Star Manager quits rather than hoping the the next one in line is as good as the former. After all, its our money at risk.

Home Country Bias

At heart, we are all very Nationalistic. We love our country regardless of whether its the United States of America or Zimbabwe. One reason for the unreasonable love maybe due to the fact that we are all invested in the progress of the country we live in (which for a large part of the population also happens to be the country one is born in).

We earn our living in the currency of of our country and invest our savings in assets in the same currency. We are in a way tied to our country’s progress. If our country sees strong growth, it makes our investments do better than if our country goes through a turmoil.

For instance think about a rich Zimbabwean who after years of toil had saved a good amount which he believes should see him through. And then, Robert Mugabe happens and by the time he realizes what is happening, his savings is really worthless (regardless of how much he had saved).

While the Zimbabwean Dollar has long been replaced in the country, two days back, it was given the Official burial with the final exchange rate set at $5 USD for 175 quadrillion Zimbabwe dollars. Any idea how many Zero’s it takes to make it a quadrillion?? Its 15 Zeros – FIFTEEN.

Recently, in Venezuela, the stock market exploded going up 92% in May. Of course, this gain is really notional given the fact that Inflation last week broke through the 500% mark. It will take even more of gains just to be at the same place where they were say in the last year.

While we are lucky that India may not face such a exigency, the fact that we are completely loaded on our home country is a risk we carry at all times. Our Jobs, our Investments, our Savings, literally everything is Rupee Denominated.

Of course, this is not surprising given the fact that home country bias (in Investing) exists in every country where the vast majority either have no way to diversify or prefer not to diversify. But given the enormous risks we take, would it not be a bit better if we could save a small portion of our savings outside India.

A report I found on a investment website gave the percentage of assets we Indians have in India at 99.7%.

A key reason for the low percentage maybe due to the fact that most Indians could not have until recently invested outside even if they wished to, unless of course they took the ill-legal route.

Savings outside of one’s country diversifies oneself in two ways,

1. The savings being in other country is not exposed to the risks that the Indian Economy is exposed to AND

2. The savings being invested in a currency other than our own means that in the unlikely case that the Rupee goes for a tumble, our savings continue to hold value.

Lets for example take the case of Gold. Gold moves daily based on two factors – Demand Supply and Currency moves. Demand Supply is a key criteria but even if Gold was stagnant for a day, the price in India may change due to the change in Indian Rupee vs the US Dollar.

When one buys’s gold, one is hence also hedging against the Rupee. If for example, Rupee appreciated strongly against the US Dollar, we could see (assuming on change in price of Gold in USD terms), a fall of a similar ratio and vice versa.

One of the best books in this area would be Meb Faber’s Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies.

In this book, not only he reasons out why one should invest outside one’s country but also provides strategies as to how to go about it. I strongly suggest you read the book to have a better understanding of the rationale behind investing outside one’s own country.

But investing outside one’s country is not easy for us since unlike the United States, our exchanges do not have any ETF’s of other counties (save for the highly illiquid Hang Seng Benchmark ETS). But in the Mutual fund arena, we do have a bigger choice with multiple Fund of Funds available for investment. In addition, we have funds like PPFAS which invest a substantial portion of their portfolio in stocks outside India.

If you are a serious investor with the ability to invest directly into country ETF’s, you can always do that by investing via a broker who allows you to buy securities traded on the US stock exchanges.

But with India growing at 7.5%, you may wonder if this really is a worthwhile route. To answer that, lets check out the chart of HangSeng Bees plotted against Nifty Bees.

Despite the fact that we have had a Modi Rally, Hang Seng has literally beaten us black & blue 🙂

While Meb Faber in the book I referred to earlier goes to say that one should invest as much as 40% of one’s portfolio, I believe that at the very minimum, one should consider investing at least 10% of one’s investment outside India.

Investing outside India is not Anti-Nationalistic, its just a way to safeguard our savings against extreme events over which we may or may not have any control.

SPIVA® India Scorecard – A note

Today the Economic Times published a study a that claimed

study by the S&P Dow Jones Indices says a majority of the large-cap actively managed funds in India underperformed the S&P BSE 100 index in the five years ending 31 December 2014

The whole study can be downloaded from here (Link). LT @NagpalManoj

There have been a few questions raised on the said study

1. Uses BSE100 & not scheme benchmark
2. Uses Total Returns (Div reinvested)

My take is that BSE 100 too does not reflect entirely the stocks that are bought in supposedly large cap funds. BSE 200 may actually be better in that regard.

But when one compares one fund with another, the concept is that both are easily tradeable. But this is not the case with most Indices since we do not have ETF’s bench marked to it. So, whether its BSE 100, BSE 200 or BSE 500, unless you are able to buy a ETF, comparing with the Index makes no sense since for most investors, there is no way to participate in those indices.

Total Returns is the Right way to compare since when we compare Growth funds, we are assuming that the Dividends are re-invested into the fund.

The study itself has issues since it uses average returns. Since funds that have out-performed are way bigger in size compared to those that have under-performed, this may not be the right way to analyze.

Secondly, 5 years is too short a period for any such analysis given that we have not seen a severe bear market since 2008. A 10 year study starting at 2005 would have made more sense.

A few days back, I calculated returns of funds (Large Cap) over the last 15 years and compared it to the returns of CNX Nifty Total Returns Index

As can be seen, almost all big funds save for SBI Magnum Equity Fund & HDFC Large Cap fund have strongly out-performed Nifty. But is this the complete list of funds that were available for investment in the year 2000? The answer is a big No, there is quite a big of survivor bias out there and the following table from the report linked above is proof of it

The most astounding number was in the Indian Equity Mid-Small Cap space with look back of 5 years. Over the last 5 years, 30% of funds have disappeared. For a Industry that is still taking off, this is a big number and unless we quantify what happened to investments in those funds (which after presumably under-performing for long with small AUM would have been merged with a bigger fund), its really tough to say how good the performance is seeing only those who have survived till date.

Until the time that we have ETF’s for all our Indices, it makes better case to go along with funds which have a successful track record since there is no way of replicating them for a common investor using ETF’s alone.

Walking the talk

One of the toughest things to do in life is disagree with something and then walk the extra mile to showcase that you really mean what you say.

For example, today Mr. Motilal Oswal who owns and runs Motial Oswal Financial Services posted the following tweet

Trading is injurious to your wealth as well as health. Investing for long term is wealthy as well as healthy practice pic.twitter.com/Y9dH8zTwsy

— Motilal Oswal (@MrMotilalOswal) May 23, 2015

Trading is a tough business, no doubt about it. Depending on what evidence you go by, as many as 95 – 99% of traders end up on the losing side. But the question is, what is the success ratio of those Investing (especially direct investing).

Unlike traders, measuring investor success / failure is tough for one, there is no constant. For example, if a person invests X sum of money and after say 10 years, his investment remains at X, is he a successful or a unsuccessful investor?

But does his own company walk the talk in terms of offering products that he truly believes in. Yes, making such choices can be expensive for the firm in the short term, but if he really strongly believes that his clients health is affected by the choices offered by his company, should he persist in providing those choices?

If one were to visit the website, the page has this advertisement running

Its interesting that not only is the seminar FREE, but you end up getting a FREE gift as well. How enticing 🙂

If trading is really injurious to one’s health, how does attending a free seminar change that. After all, its not saying that it will help you become a better investor but proclaims you can become a Professional Trader (whatever that means)

Taking the high moral road on Twitter is easy, the test comes as to one really goes the extra mile to ensure that the road one takes has that high standards as well. After all, that’s what separates the Men from the Boys.

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