Commentary | Portfolio Yoga

Panics, Strategy, Tactics and Momentum

The headlong Fools Plunge into South Sea Water

But the sly Long-heads Wade with Caution a’ter

The First are Drowning but the Wiser

Last/ Venture no Deeper than the Knees or Wast

Someone the other day sent me a Video of the Alexandra Waterfall. Alexandra Waterfall is a small waterfall that flows normally for nearly 6 months of winter. But this isn’t what is amazing about this waterfall.

For much of the winter, the flow of water is constrained to a small area which is kind of a pressure release and ensures that there isn’t much water build up behind the ice. But as summer approaches, an Ice Armada approaches the water fall with a huge amount of ice. The pressure on the ice wall that is holding up much of the length of the waterfall holds back for a long time until it gives way in one single swoop.

Something of a similar nature took place in the markets. For nearly 9 months now, investors have seen mid and small caps being crushed even as the market itself ignored the destruction and kept making new highs.

In the space of just about a month, the wall has been broken causing a stampede of proportion not seen in recent times. Stocks have crumbled regardless of whether they had gone up in the earlier march or not.

Markets all about sentiments and when sentiments take a turn for the worse, even the best of news isn’t good enough to stop the carriage from rolling over. When going up, stocks go up for a variety of reasons – some individualistic, others not. But when falling, it really doesn’t matter whether the stock is a Blue Chip or a Coconut Chip, everyone falls like nine pins.

The difference though is both in terms of the depth of the fall and the reversal one sees at the end. The blue chips fall shallower than the coconut chips and are also faster when it comes to recovering those losses.

On Social Media, I see those who didn’t participate in the rally now mocking those who participated and are now getting burnt as the pull back is in full swing. But there is an issue with not being invested either.

Let’s take asset allocation for example. The one I publish here is one which goes gradually from 0 to 100. It is the contrarian way of allocation since it asks one to reduce as markets keep going up and adding more allocation as markets keep going down. It takes a real lot of faith to be out of the market when its going up and keep adding more money when it seems the world is ending.

But there are ways of asset allocation where its more binary. You are either all in equities or all out. Meb Faber’s timing model which is based on where the market is with respect to its 10 month moving average.

If you were using the Meb model, you would have been long on Nifty since January of 2017 and would now be looking at exit given that its currently below the 10 month MA though the trigger will be when the close happens.

On the other hand, my own Asset Allocator started off in January 2017 at 75% but quickly went down and 30 to 40 would be long term average. Given how markets exploded this looks like a missed opportunity.

But the problem with binary rules is the problem of whipsaws. For example, the same model has whipsawed quite a bit over time. Chart with arrows depicting when the Signal went into a Buy mode and when it went into Sell mode.

While it has over time captured long trends, the final result is that the cost of whips means that we don’t capture all. Instead, we end up capturing 90% of the gains (2003 to 2018) while suffering half the draw-down Nifty suffered (during 2008). Not a bad deal, eh?

The logic behind both is similar – not to be exposed totally at the worst possible time and they achieve the same in different ways. But the key to success in both is sticking to it and that’s where the problem lies.

Markets are falling currently and if you were to be following the model of adding more at every fall, this is the time to add to equities. If you were to be following the second model, this is the time to exit everything and shift to safer assets.

While selling after markets have fallen is tough, tougher is to actually go per plan and add more money at this juncture. Fear envelops the best of mind as we argue whether this is the time or is there still more pain-down the road.

In hindsight, Panics have been the best times to invest, but when one is a participant in such a panic time, forget investing, it’s tough to stay put with current investments.

Take Momentum Investing. If you are a momentum investor, should you be invested in the market, let alone add to your holdings. Logic says that when markets are going down, Momentum is the worst strategy to be invested in. But is that supported by data?

Momentum investing is very similar to Value Investing or investing in Quality companies. It’s a strategy like any other with the only difference being in the way stocks are picked. In strong bull markets, Value investors find it tough to get enough companies to invest into, but even in the strongest of bull markets, there are generally section of markets that appear fairly or cheaply valued enough into.

During the last year or so, much of the market was in the grip of a strong bull market and yet, if you were a Value investor, you could have found pockets of value in areas such as Information Technology and Pharma.

Markets are currently weak, but that doesn’t mean lack of stocks with positive momentum. Like in Value, we can differ on what exactly is positive momentum. The list of stocks with positive momentum has seen a decline in recent months, but even after applying filters to eliminate stocks that don’t have enough liquidity, I can still find 70+ stocks available to invest into.

Friends of mine who run advisories based on quantitative momentum offer dynamic asset allocation based momentum strategy which goes into cash when markets are weak and boosts up the portfolio holdings when momentum is back.

Similar to the asset allocation difference I wrote, tactical asset allocation mixed with momentum strategy, both styles come up with their own advantages and dis-advantage. The choice is left to the discretion of the investor based on what one is comfortable with.

My own choice has been to keep asset allocation outside of the system similar to how money management in trading systems is kept outside of the trading algorithm. This for me ensures that I can use strategies such as Value averaging to add more money to my portfolio whenever such opportunities arise while at the same time ensuing that I always know where I am in relation to the overall asset allocation.

Market falls like now can be an opportunity if you were to believe that we are closer to the bottom or a threat if one perceives that the bottom is still far away.

One way to look at is to see the breadth of the market and compare it to historical numbers. For example, the percentage of stocks that are trading above 200 EMA is now below the 20% mark. Historically, this has been seen when markets were closer to the bottom than closer to the high though the exception to the rule would be 2008 when the percentage went below 20% in March. If you invested at that point in time, by the time a year was up, the market itself was down another 50%.

But ignore the 2008-09 drama and the reality differs. Only once in all the instances (25 of them) did markets close in negative even a year after the event (Feb 2011 Entry). The Median return for buying when the percentage of stocks trading above 200 EMA went below 20 was a decent 23%.

Since my last post here, markets have deteriorated significantly in a very short span of time. Rather than a gradual time based correction, this has turned to be a strong price based correction.

Based on one’s risk appetite and liquidity position, I believe this is an opportunity to add. It’s not yet time to go over-board – for me that will be if Nifty tests the 9000 levels, but rather ensure that fresh money is deployed to return the allocation which would have suffered due to the current fall back to equilibrium.

When 9000 and not 7000 or 3500 as someone on Twitter tweeted out? 9200 is the 200 Weekly EMA and if you look at history, other than in recessions and 2008, this has been the point of bounce.

Secondly, 9000 also means a 20%+ correction from peak. Given the destruction we have already seen in the market, further fall is tough to see at the current juncture.

It doesn’t matter if you are a Value Investor or a Momentum or a Quality, given the breadth of the fall, you should be able to find good opportunities. They may become even better opportunities, but in the face of the fact that we don’t really know the future, not betting anything isn’t the best solution, especially if you are comfortable with both the liquidity and the asset allocation.

It’s not enough to just read about the great investors and traders, when the time comes, it’s the ability to stay the course and take the risk that differentiates (subject to surviving though) the professional from the amateur.

Alpha doesn’t come free because you wish to invest when everyone is doing the same, Alpha comes for being different and this is one such time.

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Not a time to be a Hero, but not a time to run away either

On 18^th July 1948, Havaldar Major Piru Singh laid down his life while attempting to eliminate the enemy during India’s first war with Pakistan in Kashmir. For his bravery and ultimate sacrifice, he was awarded the Param Vir Chakra, the 4^th such awardee in Independent India.

If there was an award for bravery in stock markets, I am sure most of us will qualify. But unfortunately our rewards are based on the results. If the act of bravery works out, you have some bragging power among friends and if the act falls flat on your face, the reaction is based on how much have rubbed them the wrong way when the times were good.

Last week saw stocks across the board falling like nine pins. Of the stocks that are traded on the NSE, nearly 92% of them closed in negative territory. Regardless of fundamentals, stocks have taken a beating like no other.

The trigger for the whole correction came from the default by IL&FS. Though the default was more of technical nature and one that would have had no direct repercussions on the market, it was a excuse that was not to be wasted.

Since 2014, thanks to inflow of money through mutual funds like they have never seen in the past, stocks had propelled higher regardless of whether it made sense to buy at such valuation or not. Selling by Foreign Institutional Investors, Political uncertainties, Rise in price of Crude and the widening deficit among other news that earlier would have torpedoed any rally were thrown to the sidewalk.

The fear of missing out on the action meant that investors jumped into the pool regardless of knowledge of depth or whether they actually knew to swim in the calm waters let alone troubled waters in the first place.

Crash in stocks like Yes Bank and Dewan Housing Finance has meant that there suddenly investors are wondering, which stock has the possibility to be drawn into question tomorrow. And then is Infibeam which fell 71% on Friday and in September alone has wiped out all the gains it had seen since its listing in April 2016. This is not the elevator coming down but the elevator crashing after the ropes have been cut.

Amidst all this, the US markets seem to be well on the way to another all-time high showing no sign of any weakness as the economy is growing at its fastest pace in a long time. But with easy money on the way out, the question is, how long this can last.

The US Federal Reserve has been tapering its balance sheet since quite some time now though that pace would fasten since the schedule of security reductions should see the Fed reducing their balance sheet by 50 Billion a month from October onwards, it was 40 Billion a month for the last few months.

“In order to rise from its own ashes, a Phoenix first must burn.” ― Octavia Butler

Every bull market is marked by excesses that is seldom understood or recognized during the phase of the market itself but once the bubble is burst, it’s easy to point out the same. This bull market has been led by financials – private banks, NBFC, Housing finance companies as such.

Of course, unlike the Infotech boom of the 2000, all sector booms have been growth led and this has been no different this time around. Low Interest Rate, Public Sector Banks going into a shell when it came to lending and aggressive sales meant that financial companies grew at a rapid pace.

While much of the banking sector is in a mess, Private Sector Banks were able to grow their books without getting caught in the kind of problems faced by Public Sector Banks. This isn’t the first time we have seen rise in NBFC’s though as they would say, “Its different this time around”

Good friend Vijay Sambrani has been in the markets for longer than I have and importantly has the ability to connect time lines across decades. His view on the current market conditions;

1994 REDUX ???. I have been having a recurring nightmare since the beginning of this year seeing the aggressive buying in mid caps and small caps since Demonetization. Was unable to recollect anytime in the past bull runs where the mid caps /small caps Indices’s P/E ratios were higher than that of the Nifty/Sensex .

Then I went back to my charts/notes/memories and remembered distinctly that this kind of scenario prevailed between Mid 1993 and Mid 1995. Then as of now the mid and small caps had a runaway rally , there were a slew of IPOs and retail which had been burnt by the 1992 HM scam came back with a vengeance .

I remember the NEPC Group, Tatia Group, Sterling Group and stand alone entities such as Balaji Steel, Femnor Minerals , Caplin Point etc etc which were the darlings of speculators/investors. And then came a host of NBFCs like ZEN Global, CRB etc and sprouting of Benefit Funds which funneled large parts of inflows into stocks which created a mini mania . And then one day , in September 1994 at the start of the month long NON-DELIVERY period the Sensex peaked after crossing the 1992 peak by a few points.

That market was led by a huge dose of liquidity which came in through by the newly formed Pvt Sector mutual funds and FIIs like Morgan Stanley. September 1994 peak coincided with the Peak Liquidity. Then the liquidity tap began to dry and slowly and steadily the market lost steam without any “apparent bad news”. In April 1995, the MS Shoes IPO failed and that led to a panic and no amount of assistance by MFs /FIIs could stem the downward spiral and slowly the NBFCs began to fail and the Sensex had dropped below 3000 in less than 8 months and bottomed out only in June 1996 .

Almost all the NBFCs failed , and most mid caps/ small caps also got delisted. The high flyers of this era lost 70- 90 5 of their value ultimately. I remember that one market maker on the Floor used to offer two way quoted for one of the most sought after scrip : Balaji Steel at Rs. 350 . Within the next 20 months it went to zero. Such was the carnage. And it all happened when there was no visible Major Bad News.

I distinctly remember I held significant holdings on my own and my clients behalf in Femnor Minerals, NEPC , Zen Global, Balalji Steel etc which have now become “junk”. All the profits I had made in the previous year vanished as I kept averaging on the downside. Time has made me more cautious , maybe more than necessary . So when I see many similarities between this bull run and that of 1994 , I shudder to think , whether History will repeat itself. I sincerely hope my thinking is WRONG.

I don’t have his experience or insight but what I do understand, I do hope that he is wrong for the emotional impact that kind of fall will have on investors who are just stepping into equity will be unprecedented.

Markets trade in cycles – we cycle higher and then we fall lower and then we climb higher once again.

In the movie Inception, there is a dialogue by Mal who herself is a imagination by Cobb, she says

“But Pain, Pain is in the Mind”

Right now, Investors are in a lot of pain. Just a few days back, I had a long conversation with my Chemist who has invested a significant sum of money for the first time in his life and is now seeing the value decrease day in and day out.

While the investment is significant, given his Networth from what I know of, this is a dip in the ocean. Yet, the pain haunts him making him wonder if he should just cut out the pain by redeeming the investment.

The recent bull run has meant that a lot of investors were herded into markets, some with basic idea of how the markets worked but most who had no clue other than that this will generate strong returns over time.

The panic we are seeing currently is from investors and traders who went overboard by building positions using margin. While leverage can help during bull markets and provide gains beyond what is accomplished by others, during bear phases it becomes a killer.

When markets fall as it has recently, the probability is very low of a V style recovery. The dust has to settle first before the next green sprouts seem to spring up. There is no reason to be aggressive in an attempt to maximize the opportunity for the opportunity maybe here for long.

What matters is where you are when it comes to your asset allocation and how confident are you about being able to hold out the pain in the event that his becomes an extended event. Bear markets are sharper and shallower than bull markets, but given that we had seen a multiyear bull market, any bear market will not be one that is over in a month or so.

If you are fearful, the best route out is to just stay put (assuming that your investments are in Mutual Funds where the churn from bad companies to good companies are taken care of by the fund manager). Add no more money for no amount of profits shall compensate for sleepless nights but withdrawing at a loss will be the worst possible way to deal with the situation.

If you are light on equities and are confident that going further markets will once again be better, this is the time to start adding again. We may very well fall further, but adding small amounts will provide you with a feeling of comfort that even in the unlikely case that markets recovery and take off from here on, you aren’t left behind.

On Twitter, everyone who doesn’t manage money seems to say, I told you so. They enjoy a luxury of being right despite being wrong for long enough to make the right inconsequential. The current fall is more of a correction of valuations than a fundamental change in the economy.

As long as you believe that the Indian economy will do good over time, it should not dissuade you from betting on the same. Betting on the Indian economy is best done by being a entrepreneur who takes advantage of the opportunities provided but since most of us aren’t good at that, the next best step is to piggy back on the entrepreneurs by buying their stock in the secondary markets.

Even though this is an opportunity, don’t over-invest for like leverage, your hand will be forced at the worst possible time. Stick to what is comfortable and allows you to sleep well at night. Reducing weight doesn’t really require selling off – you can reduce weight of your equity if you feel it’s too high by just not investing further.

Our family’s investment journey in markets started through a mutual fund we invested in 1996. By 1998, it had lost 50% of its value. Being new and fearful, I exited the fund in the heat of 2000. For some time, that looked like a fine decision. Today, that same fund has a NAV that is 12.5 times above where I sold.

The next couple of years should in hindsight provide for wonderful learning opportunities and opportunities. Being in constant fear will only make you miss out on those while not really doing anything to make the situation better.

Don’t be a Hero and try to buy stocks unless you really know what you are doing. That said, don’t be a coward and run away in fear for where opportunities lie, so does Risk. It’s two sides of the same coin.

Figure out your ideal asset allocation and stick to it. Sticking is the key, not identifying the ideal allocation for there is none.

Here at Portfolio Yoga, I have been publishing a simple asset allocation mix. Hope that gives you idea of where you should be.

The Gazette Notification awarding the Param Vir Chakra(Link)

Social Media – Echo Chamber or a Learning Tool?

It was 22 days since I quit twitter and it’s interesting that I did not feel like I was missing anything. But I am back. The free time has also given me a lot to think on whether Twitter is what Morgan Housel would say, a product that solves a customer’s problem or a product that scratches a customer’s itch.

Much of Twitter is dominated by Politics – both paid and unpaid. In fact, the unpaid actually show much greater determination to showcase why their leader / party is right than what even good paid PR can generate.

Who doesn’t love to discuss politics – in the evenings, this used to happen at coffee joints while during the day at offices it took place near the water-cooler / lunch time. Twitter being available 24 * 7 has meant that rather than this being a one off past-time, this is not a full time venture of bashing anyone who doesn’t believe in what you believe.

In the area of Finance, much of the debate is how people are stupid to invest in X when you can invest in Y and get better returns. Are Direct funds better or Regular. Does advisor add value or not. Should you follow Momentum or Value. Does…

Depending on one’s own bias and job description, every one of the answers can be easily guessed. A advisor believes he is adding value his client. Mutual Fund managers dependent on Distributors for raising money believe that Regular is better for Clients versus Direct. Value investors believe that Momentum at best is a fad and worst is fraud.

The nice thing about Twitter is that since it remembers everything, most of us are chained to our views even when there seems to be evidence to the contrary. Changing tack is difficult even though most of us are happy to quote Keynes.

When you login to Facebook, you know what to expect. You like to connect with your friends – mostly friends from School / College / Work. You like to share your new experiences with them in the same way you may have shared with them physically if you met them. You love to read about what is happening in their life among countless other small things.

What is the expectation when it comes to Twitter? Most will say, here to Learn. But does that really happen in Twitter or do we consign ourselves to an echo chamber which keeps repeating what we like or what we believe in.

While there is only one Warren Buffett, Twitter is full of Buffett gyani’s who spend their whole time quoting him as if that act itself will lead to better decision making when it comes our finances.

One key output of being on Twitter is the enormous amount of blogs / tweets and books that are recommended as good reads. While many are indeed good reads, the question is, how much of it is implementable. Charlie Munger had this to say on reading;

“We read a lot. I don’t know anyone who’s wise who doesn’t read a lot. But that’s not enough: You have to have a temperament to grab ideas and do sensible things. Most people don’t grab the right ideas or don’t know what to do with them.”

Reading for the sake of reading barely achieves any meaningful objective other than being able to discuss any topic that seems to have taken the twitter by storm.

As I was writing this, I stumbled upon a very interesting blog post by Josh Brown of The Reformed Broker fame. While in the post he doesn’t refer to Twitter, which isn’t surprising given that his firm’s entire strategy has been evolved around Social Media, one particular phrase caught my attention.

You’re asking someone to deviate from every public pronouncement they’ve made and all of the comfort and support they currently have in their community of likeminded fellow Unreachables. You’re asking them to betray what they’ve already told the world they are!

And what are you offering in return? Facts? Logic?

Nobody cares about what your facts are. People have facts of their own that they like better. And when has logic ever been the crucial factor in human decision making, like, ever, throughout world history?

The timeless XKCD Cartoon “Duty Calls” laid out the fact that there will always be people out there who in our view are wrong.

My inspiration for quitting twitter came from Cal Newport’s book, Deep Work where he lays out how the achievers were able to reach their goals by avoiding noise and twitter is similar to trying to study for the exam sitting in the stadium watching one’s favourite game.

But there is a catch.

When you are starting up a new business, twitter can be great at attracting the eyeballs to initially give momentum. But the sticky clients are those who like your product and are willing to come back to you, not people who have randomly spotted you on the internet.

If you are fund manager, Twitter may help spread your word, but your own name and fame comes from the actual ability to manage and deliver returns. This holds true for most other businesses as well.

If you are an advisor, you can get a few clients by being active on Twitter all day long answering all kinds of mundane questions. The ones who shall stick though are one who believe that they got the better off in the bargain.

In 1848, James W. Marshall struck gold in the California, it started what is now known as “California Gold Rush”. While miners took enormous risk to mine gold, the actual beneficiaries who ended up with far more money were merchants. Samuel Brannan made it big by providing supplies and Levi Strauss who sold Demins to miners.

Twitter is becoming something close to that especially with the great Indian bull market being in full force. There are more and more sellers of shovels than actual risk takers. Why bother with managing real money when it’s easier and much cheaper to teach or advise for a fee.

“Nourish yourself with grand and austere ideas of beauty that feed the soul. Seek solitude” – Eugène Delacroix

On Twitter, everyone wants to be seen as Intelligent folks who have the answer to all queries that life may throw, so let me end this post with a brilliant quote from who else but Charlie Munger

It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, ‘It’s the strong swimmers who drown.

So, why am I back?

For all the negatives of twitter, there is also the biggest positive of you getting feedback that you may not have received otherwise. If one is open about really learning, Twitter friends can provide you with instantaneous feedback on which is invaluable.

While I was frustrated with the relentless on your face selling by many, I do understand the power of twitter is second to none. All that hype means that even snake oil sellers appear to hold crystal balls as they try to make it sound like they have figured out everything. Yet, for every 100 oil snake oil vendors, you also have 1 genuine advisor who is willing to provide you the information you look forward to without any quid-pro-quo.

Coming out with cheeky 128 character tweets is easy, writing a 1000 word blog post is tougher for it requires deeper understanding of the issue on hand. Writing a 30 thousand word book? That requires one to distil years of experience into a comprehensive document that is easy to read yet adds value to the reader.

These days though, everything is in oversupply. It’s not surprising hence to see Nassim Nicholas Taleb recommend one to read books that been around for long. Books too are fragile – only those that survive are worth spending time upon.

The problem with social media is that the deluge of information in small chunks can eat up precious amount of time and energy without a output which can be measured upon. Long ago, my former boss, Dr.C.K Narayan commented that one of the reasons he wasn’t (then) on Twitter was that thanks to the endless supply of reading material, one link led to another which led to yet another till we ended up reading all kinds of nonsense & exhausted all our energy not to forget time.

My influence for “trying” to quit Social Media came from Cal Newport’s book, Deep Work. While I didn’t last 30 days (Twitter deletes all stuff at end of 30 days & I wasn’t going to test its limits), in the book, he asks two questions

Would the last thirty days have been notably better if I had been able to use this service?
Did people care that I wasn’t using this service?

While the twenty odd days without twitter can be regarded as a small sample size, I felt that my ability to read and work improved tremendously. While I bought books to fulfil my itch, in the last few weeks, my reading per my own belief improved tremendously.

Friends did ask the reason for me quitting twitter, but I am 100% sure no one is missed. We start forgetting loved ones who have passed on after a bit of time, who can even remember anonymous tweeters who are quickly replaced by other charmers.

The key reason for me being back is bit of selfishness – while I have nothing to sell (at the current juncture), I still hope that my writing, however shoddy it is, is read by more than a handful. Logging off from Twitter crashed by traffic by 90% and that was a tough pill to swallow.

My reading during these intermittent days didn’t suffer for technology has made it easy to pursue blogs that you love to read and surprisingly I found even more and far better book recommendations that I may have missed out earlier.

Social Media is a godsend for those who can build a business around the hyperbole. But if you are catering to a genuine need and not just a customer’s itch, your business will not suffer even if you don’t tweet for months on end. After all, they do say the proof of the pudding is in the eating.

I recently stumbled upon the twitter account of a very famous fund manager who is very well known in the circles. He had exactly 2 tweets – one, when he joined twitter and second when he changed his job recently.

Another fund manager who has made a lot of waves and manages a few hundred crores of other people’s money on his own and yet the number of tweets he has put out is less than 1 per month since he came onboard.

Finally, some time back was given a presentation of a fund manager who is supposed to manage a very large sum of money for very high HNI’s but doesn’t have a website or a social media account. He picks clients rather than clients picking him and is said to be pretty choosy as well.

Real business doesn’t need the crutches of Social Media. If you are successful, people will chase you regardless of how easy or tough it’s to access you. If you aren’t, well… its not tough to speculate on how many want to be associated with you, let alone chase you for your inputs.

If you aren’t here to sell, you are here to entertain yourself. The question you need to ask yourself: Is the Entertainment worth the cost of time and effort you are investing.

Do you learn what you seek through Social Media?

The website, http://www.worldometers.info/books/ suggests that a book is published every 12 seconds. Number of books published has shot up phenomenally in recent years thanks to coming of age of self-publishing which has democratized the ability of anyone to be an author plus our own desire to be well read.

Writing a book is a serious work. Even well-known authors who are in the flow don’t churn out more than one per year and many an author has not more than one book to his credit. Yet, with a growing population of readers and writers, writing a book is fast becoming the new calling card.

One step below the book would be the Blog. It’s much more easier to churn out a blog post than a book and with no barriers or cost associated with blogging other than your time, Blogs have taken off since the arrival of Blogspot and WordPress.

Googling for the same gets me the answer – a mind boggling 440 Million blogs and counting. While the number of blogs that are active (at least two posts a month for instance) can cut down the number, we are still speaking about a number that cannot be easily wrapped around our head.

Further down the food chain lie the tweets and facebook posts. These require literally zero effort in producing. It’s no surprise to hear that Facebook users upload 300 million photos per day. Just to give a perspective, if they were all viewed in a slideshow with each picture being given 1 second, it would take you 9.5 years just to completely view of one day’s upload.

8000+ tweets are sent every second. In other words, if you sleep for 8 hours, you are missing out on 23 Crore tweets that went out. How many were worth spending time on versus how many were just passing moments that one wouldn’t remember the next hour, let alone the next day?

While these numbers seem like excess, they have also been the catalyst for greater interaction, even if limited to only on these channels with more people than you could have ever have done if you went through your normal life without internet.

From discovering interesting places to visit, books to read, movies to watch – the possibilities of new things are endless.

“Too much of anything could destroy you, Simon thought. Too much darkness could kill, but too much light could blind.” ― Cassandra Clare, City of Lost Souls

Social media is addictive is a well-known fact. The blame lies in how our brains are modelled when it comes to acting on our needs and desires thanks to a chemical called Dopamine. In a 2017 article titled “How evil is tech?”, the New York Times columnist David Brooks wrote: “Tech companies understand what causes dopamine surges in the brain and they lace their products with ‘hijacking techniques’ that lure us in and create ‘compulsion loops’.

As if these weren’t enough to distract us for most of our waking hours, we have applications like Whatsapp which ensure that you never run out of Good Morning Quotes. At traffic junctions, its normal to observe most drivers utilizing the time on scrolling through their Whatsapp time lines.

The best thing about all these great technologies is that you are never asked to buy anything or at least directly. Thanks to falling prices of mobile and data connectivity, it’s never been cheaper to spent humongous amount of time with no feel of regret.

Early on in my own twitter career, the dopamine kick was given by the increase in number of people who followed me. But as the number of followers went up, that wasn’t enough to give me my kick. Rather, I got the kick by seeing how many liked or replied to my cheeky tweets, most of which I wouldn’t remember the next day forget about others.

For all the amount of time I spend trying to impress the thousands of my followers, my reward other than the regular kicks was the fact that my blog did see a bit more volume than it saw once I deleted my twitter account.

But even my best blog posts, never achieved the kind of viral re-tweeting that a random cheeky thought I posted once in a way. Not surprising that one of the accounts I have seen with the fastest growth in followers is an anonymous account who through the day tweets more or less tongue-in-cheek.

On the other hand, well known people in the area of finance who run real money and who can really be a good wall to bounce of ideas from are barely followed. Why follow someone who requires application of System 2 when its so easy to just use System 1 and move on.

Social media is an interesting way to connect with independent thinkers who otherwise may not be well known, but as Social Media has grown by leaps and bounds, finding those guys is becoming the proverbial needle in the haystack problem.

While twitter itself hasn’t been able to monetize to the extent it wishes to, it has helped create a platform for sellers of shovels to whoever is interested in digging gold. From selling software that can give you easy entry / exits to courses teaching the holy grail of trading, nothing is out of reach for the street smart entrepreneur.

Real learning never happens by accident – its always purposeful application of the mind on the subject at hand. Twitter and Facebook are distractions that sway you away from such thoughts for why bother with the hard work when you can get more excitement by posting a tongue in cheek comment.

The role of Incentives and what it means for your Retirement

There is this famous skin Doctor in Bangalore whose clinic is thronged by patients all-round the year. Being famous generally also means that one gets expensive but it ain’t so here, the Doctor Consultation fees is lower than what any other specialist anywhere shall charge.

But there is a catch – you need to buy the ointment he prescribes at the Chemist shop next door. The chemist dispenses the prescription which can be split into two parts. One is the actual ointment, an as I have experienced, this is not one easily available elsewhere. Second is a cold cream which is manufactured by a very famous multi-level marketing company.

You buy both and go back to clinic where the Doctor’s assistant mixes the same, labels it and then goes onto provide you with the next appointment date. While the Doctor fees is generally small, the charge for the ointment is extravagant – especially the cold cream.

You by now would have clearly guessed how the Doctor can afford the small fee and yet earn big. Is this Illegal? Of course, not. He doesn’t really compel you to buy at the chemist next door but I have tried and failed at sourcing the ointment elsewhere, so where else would you really go.

Second, once you accept this as part of the fees, you are okay for your main criteria here is not about paying money but getting rid of the disease that afflicts you.

Is this ethically or morally wrong?

What about if the Doctor charged a much bigger amount as his fee but then recommending medicine that is more affordable and not limited to that one store. Would that change the dynamics for his patients?

Or, what if he charges a low fee but prescribes high cost medicine and gets compensated not by the Chemist but by the Pharmaceutical company by way of tickets to seminars in distant countries or just a direct cut from the sales of the said medicine. Would that make any difference?

Let’s move the discussion to the world of Finance

Stock Brokers for long have chased their clients in an attempt to get them to trade more – higher the trading, more the brokerage. This is of course not in the best interest of the client, but targets have to be met, incentives have to be lapped up – so who is really counting.

While brokerage rates have fallen, even today many a stock broker dealer (the guy who places the order on your behalf) is determined not by how faultlessly he handles the transactions but how much brokerage he can generate.

Don’t we all have an Aunty or Uncle who after becoming a LIC agent would pressurize one to buy a policy which while actually not serving our real needs would help the Aunty or Uncle meet his targets and collect his cut of the cake.

Introduction of Unit Linked Policies took this to an extreme and while the trend has reduced a bit thanks to curbing of how much the agency can pay as commission, the highest and the worst form of financial misspelling still lies in the Insurance Field.

In an attempt to incentivize its distributors to sell its funds, Mutual Funds offer two kinds of payments – Upfront Commission and Trailing Commission

Upfront Comission is paid for any funds received – be they lumpsum or SIP. They range from 1.5% at the higher end to 0.25% at lower end with the Median upfront commission being 0.65%.

Trailing Commission is the commission paid on the value of your investment. This is to incentivize the seller for helping the client stay with the fund. It’s also a kind of ransom paid to ensure that the seller doesn’t take his clients money out at the end of the first year to only re-invest & hence obtain the upfront commission. This commission ranges from 0.75% to 0.25% with the median working out to around 0.50%.

Debt funds, a category of funds that invest only in Debt products with return comparable to Bonds on the other hand has way lower incentives. The incentives themselves depend on the product with Liquid funds which are favoured by corporates getting the least amount while Gilt and other longer duration products commanding a higher fee in recognition of the skills it takes to sell those.

“Show me the incentive and I will show you the outcome.” – Charlie Munger

Incentives aren’t just limited to the ones above. After all, when people complain that Tata Workshops don’t distinguish between the Taxi driver who is driving a Tata Indica and the owner of Tata Safari, Star Distributors cannot be satisfied with financial incentives alone.

A large mutual fund house for example takes its Star Distributors to Omaha to attend the annual pilgrimage that is the Berkshire Hathway Annual General Meeting. While the meeting itself is in recent years broadcasted live, there is a world of difference in attending it live versus attending it from the comfort of your room. Attending at the comfort of your own doesn’t give you the bragging rights compared to what you get when you attend it live.

It’s ironical that they are sent on a trip to Omaha given Warren Buffett’s own views when it comes to Investing. Speaking to CNBC, he said

“Consistently buy an S&P 500 low-cost index fund. I think it’s the thing that makes the most sense practically all of the time.”

How many advisors, whether they visit Omaha or not will dish out this advise to their clients? While its true that in the recent past, active funds have beaten the passive indices, with new changes, do you really think that they will continue to beat forever.

SBI ETF Nifty 50 is the largest fund out there thanks to it being the fund of choice for the Employees Provident Fund Organisation (EPFO). It is also the cheapest fund around and the one with the lowest tracking error.

Over a 3 year look-back, this fund is the 12^th best fund of 68 funds. Most of the 10 above this, the 11^th fund is its cousin – SBI ETF Sensex, we have only Axis Bluechip fund with almost all others ebing passive ETF’s.

Going further, I believe this trend will accelerate with more and more ETF’s and Index funds being in the top decile.

But ETF’s and Index funds have a problem – they are no one’s baby. So, regardless of the returns, barely any advisor will recommend the same to his clients. Over a 10 year period, the best performing large cap fund is Reliance ETF Junior Bees. Its AUM – a measly 515 Crores.

In the United States, this problem has been taken care of my Fee based financial advisors and wealth management firms who have succeeded in breaking the taboo of investing in simple and plain products. In India, you have better luck finding a needle in the haystack than finding a financial advisor who is fee based.

Fiduciary Duty: A legal obligation of one party to act in the best interest of another.

Fiduciary duty of an Investment adviser is similar in thought to the Hippocratic oath that requires a physician to uphold ethical standards. Keeping the objective of the client above oneself is the key trait of the Fiduciary duty.

Time and again, data has shown that Investors exit and enter markets at the worst possible moments. While one cannot time entry to perfection, when one exits in a panic, the reason is not just about loss of money but loss of confidence.

Mutual funds today are being pushed as the answer to all ills with all kinds of numbers floating around on what to expect. Rather than temper expectations which also leads to a better informed client, very long term historical numbers are used to suggest that one can expect to become rich by investing a very small sum today.

The primary reason for disappointment comes from unable to reach or beat estimations that one figured would be reached. When a product is sold with expectations of high returns, any deviation will result in the product being blamed rather than the message.

Recently I saw an advertisement from a fund distributor that saving just Rs.3000 per month could make one a Crorepati in 30 years assuming growth of 12% per year. There is nothing wrong perse with the above statement.

But what is missing and critical is the value of that 1 Crore, 30 years later. Can you buy what is worth 1 Crore today for the same price 30 years later?

In the US, over a 20 year period (1996 – 2016), tution cost went up by 200% even as general inflation itself went up by 55%. Quality education in India is becoming expensive by the day and given our inability to finance, we are ending up with students passing out of colleges without much of the knowledge and experience required by the Industry.

Tution cost for a two year post graduate degree from the Indian Institute of Management currently stands at 22 Lakhs. Add to this cost of living, cost of books, transport among others and we are quickly looking at somewhere in the 30 Lakh benchmark. Even assuming it grows at 6% per year, 30 years later, you shall be looking at something in the range of 1.75 Crores.

In the above advertisement, 12% return is the post expense return. What this actually means is that a regular fund has to generate 14.5% returns to get you 12% returns. Direct fund requires generating 13.5% returns while the ETF needs to generate just 12.10% returns to meet your 12% requirement.

What if instead, we assume that all funds can generate just 12% returns before expense. Assuming you were saving 3000 per month, what would you end up in the 3 different examples?

Even though the savings and the market returns were the same, the difference in returns is staggering. This is the act of “Compounding”. Returns and Fees both compound – one adds a positive flavour to your returns, another negative.

I am a strong believer in Active Investing and while Active Mutual Funds have had an exciting time, the days of strong out-performance vs the benchmark is more or less gone. The culprit may not be the rules as much as their own growth in assets which limits flexibility on what you can buy.

But that doesn’t stop funds from accumulating more and more for higher the AUM, higher the Income for everyone who is in the food chain.

Well, I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther – Charlie Munger

At the Intelligent Fanatics website, a case study was recently posted on the site with a lot of real life examples of how human behaviour was moulded by the wrong kind of incentives. From selling more loans to get meet the incentive plan (sell less than 80% of goal & you had no incentives awarded) to classifying orphan children as mentally disabled since the subsidy by the government was $1.25 per day for an orphan versus $2.75 per day for psychiatric patients.

If my reward to sell a particular fund was a free trip to Omaha, would I really be concerned about whether the fund suited the client or not?

If you are saving for retirement which is 20 / 30 years away, the savings from fee alone can make a huge difference. Remember, at 6% inflation, a Crore wouldn’t go a long way 30 years from now – you will need at least 30 Crores to make the nest count.

Market performance is not something you can control, on the other hand the cost you pay to achieve market returns is very much in your control. The question is, Will you Act?

An Experiment in de-addiction – Deactivating from Twitter

Addiction is what we all suffer from, some from addiction to narcotics, some to alcohol, some to couch surfing. These days, many of us are addicted to social media as it exploded in usage. Facebook is able to get a 500 Billion Dollar Valuation not because it sells something exotic but because it has been able to capture the time and imagination of millions.

“Time flies, whether you’re wasting it or not” wrote Crystal woods and its true then as its now. It’s said on an average, people spent around 50 minutes on facebook each day. An hour a day spent watching countless videos and photographs of people known and unknown.

I have always believed that I am a product of Social Media. I got into Social Media when it was not FB or Twitter that dominated timelines but forums where you spent time reading views of others and arguing the pro’s and con’s.

It was also a period of substantial learning for even though less than 5% of users actually wrote back, those 5% spent significant amount of time to buttress their views and opinions and one that couldn’t be easily challenged.

The arrival of Twitter and Facebook has though demolished such forums for who has the time and inclination to write a 500 word email when you could just post a funny though in 140 characters.

Warren Buffett did not become what he is by reading quotes of Graham but we seem to have come to the conclusion that the way to Nirvana is by reading quotes of the great people while moving in the opposite direction in our own way.

I have been on Twitter for nearly 9.5 years and during this time, have tweeted out more than 56 thousand tweets. For all the time I have spent, I have been able to accumulate a total of 17 thousands followers.

I am without doubt an addict to twitter but once in a while I have always thought as to how much of value it has added to me compared to the amount of time I have spent on reading, replying, re-tweeting the hundreds and thousands of tweets that keep rolling off my twitter stream every single day.

Reading books has always been a hobby of mine from school days and yet somewhere I lost that commitment. Thanks to arrival of Amazon and its patented one click ordering, I have been able to get back to reading.

But reading is tough, it requires one to put aside other thoughts that may try to occupy the mind and focus intensively on the book on hand. Addition to Twitter makes that near impossible for there is always the thought that lurks in the back of the mind even when I am in the midst of the reading – has anyone tweeted to me, am I missing out on any interesting tweet among many others.

My table and book shelf is loaded with books, some of which can really help achieve what I wish to achieve only if I can put in the time required. Addiction to Twitter makes that nearly impossible for the mind is too timid to resist the attraction to reading things that one can relate to or not.

Speaking of reading, I am currently in the middle of Cal Newport’s Deep Work. This is a phenomenal book that explores the impact of new age technologies and how they impact our ability to do what we are else capable of.

People are remembered and honored for what they achieved in their real life and twitter can be real damaging even to those who aren’t as much addicted as some of us. Have a doubt, well just ask Elon Musk.

In the past, I had tried half measures to get rid of twitter’s ability to take-over my time like no other but half measures always fail. It’s taken a long time but as I now understand, the first thing to accept is to accept that one is addicted. Treatment can and shall follow later.

It’s a matter of great pleasure that I am followed by many people who have achieved a lot in their real life. Yet, if at all I wish to get anywhere close to where I want to reach, I need to work smarter and better and this cannot be achieved by being on Twitter 24 * 7.

So, as an experiment, I shall de-activate twitter tonight. Twitter TOS suggests that I will then have 30 days to restore my account. If being out proves too hard, count on it for me to come back. On the other hand, if I can survive the 30 days and be able to accomplish things I want, well, this will be permanent.

“I’ll live the focused life, because it’s the best kind there is.” – Winifred Gallagher

Investing for Long Term is not possible without building Conviction

When it comes to financial advise, everyone knows what is best for others even though one may not be qualified to handle their own money let alone other people’s money. From Fund Managers to your corner uncle who sells Mutual Funds, everyone believes that investing in real estate is a waste. Gold bugs believe that the doom is just around the corner and if you don’t hold gold and that too in Physical, you are doomed.

Insurance agents believe that investing in Insurance is not a hedge against something (Life / Health, etc) but a way to save money. Then again, if I am paid 20% of what you invest, I don’t think I would be complaining about it either.

On the equity side, we have fund managers who believe in different philosophies and refuse to accept that there is more than one way to skin the cat. So, while some vouch by value, some others vouch by quality. Some believe investing in small cap stocks is the way forward while others believe that you are better off with only large cap stocks.

For a long time now, Gold and Real Estate have been the chief investment products for a large majority of Indians. While it’s easy to decry and laugh at their stupidity in investing in assets, the fact remains that financial advisors generally do not have a clue as to why they do what they do.

Let’s take Real Estate for instance. I recently heard about a person who took a house on rent for a monthly rental that is 6 figures. I was wonder stuck as to why anyone would pay that kind of money till it dawned or rather was educated that despite the high rent, the annual rental was less than 1% of the property’s current worth. Add taxes and the real rental is a pittance on the current value of the asset.

On one hand, that looks stupid, but one also has to admire the conviction of holding onto the asset in a period when there is neither a capital gain nor rental yields. Which of course, brings the question back to market?

Since 1981, Apple has delivered a compounded return of 18% till date. But that kind of return comes with its own pain points. Below is the draw-down from its peak the stock has seen over time.

While draw-downs are one thing, the real killer is the time a stock spends in the draw-down. For instance, Apple hit a new all-time high in 1991, a high that wasn’t crossed till mid 1999 during the Infotech boom.

We have similar examples out here in India as well, from Hindustan Lever to Reliance Industries which have spent lots of time post hitting of a new high before the stock could go back to another new high.

What does it all point to?

For me, it just showcases that investing is not a simple affair where buying a good company can provide you great results. Good strategy can survive but only if you also understand the risk of the strategy in the first place.

Thanks to the enormous weight of FAANG stocks in S&P 500, Value Strategy has been an under-performer in US for a very long time. But should one even compare with S&P 500 if one is trading a strategy that is widely different to the underlying Index?

Would you race a dog and a horse and declare one to be the winner since both have similar body shapes and four legs.

In the world of factor investing, one of the major factors is the “Size Factor”. Size factor is calculated by taking the average return of small cap stocks and subtracting the average return of large cap stocks.

From 1927 through 2015, the US size premium was 3.3%. In other words, if you held a small cap portfolio from 1927, your return would have been higher by 3.3% compared to someone held a large cap portfolio in the same period.

Of course, the very fact that they out-perform doesn’t meant they do it all the time. In the same period of time, the probability of your portfolio under-performing a large cap portfolio after 10 years of being invested was to the tune of 23%.

Since 2013, markets had a tremendous run, more so for the small cap than large cap stocks. While the data showcases an outperformance of just around 3% per year, in this case, we had something like a 3x returns.

This was very well known not to stretch to infinity and beyond though every time it seemed like the rally would end it sprung a surprise. In February I wrote in my post, The Rout – What Now? And I quote

“By the time, the bear market got over, a lot of stocks had seen draw-downs from peak of 35 – 55%, a huge difference from the current falls of between 15 – 25%.”

Among stocks that trade on the National Stock Exchange, around 36% of stocks have fallen greater than 50% from their peaks, another 42% have fallen between 35% and 50%. In other words, nearly 80% of the market is now down from their peaks by more than 25%.

But as I tweeted out the other day, this way of looking at markets has issues. When a stock has risen from say 100 to 1000 and falls to 500, it has suffered a 50% draw-down yet is up 400% from the starting point. A case of Glass being half empty of half full.

Valuation is a better way to look at where markets are compared to where they started from. It’s been nearly 5 years since this rally started and one way to figure out whether markets are cheap or not is by looking at valuations.

The rally from 2013 happened due to two reasons – Reasonable valuation and Trigger of a shift in power from Congress to BJP which was till recently seen as the center of right party. The 2018 fall that has started has started with similar reasons – Unreasonable valuations and Trigger of a shift in power from BJP to who knows whom.

To add to worries we have the US Fed hiking interest rates and swapping up liquidity from the markets. Even here in India, growth of M3 as % of GDP has slumped sharply.

So, let’s move back to our original thesis – why do investors prefer Gold / Real Estate over Equity even though they are not fools to know that it won’t go up in a straight line? Why are they able to stay the course when it comes to Real Estate and Gold while the same person behaves differently when it comes to financial assets like Equity.

The answer in my opinion lies in conviction – they believe they understand better about Real Estate and Gold. This conviction didn’t come from seeing advertisements but from either experience of self and close friends.

AMFI has been funding big time advertising the merits of Mutual Funds under the “Mutual Fund Sahi Hai” campaign and I would give it a lot of credit for the shift we have seen in recent times. But what really helped the campaign was not just that the other asset classes were showing weakness even as equity was delivering.

At best, to me this is borrowed conviction and one that is not easy to sustain if the market undergoes a long and painful correction. At Capitalmind we recently wrote about Insurance and one chart was deeply troubling – more than 50% of the policies closed out by the end of the 5^th year.

Once again, massively misselling means that while its easy to get people in, sustaining them is pretty tough. Would equity mutual funds turn out to be any different?

My guess is as good as yours though I believe that the only people who shall stay is who aren’t swayed by the advertisements but have understood the importance of having equity in their asset allocation matrix.

Finding the edge that works for you is not an easy task and one that can years and decades. But once conviction is build, its easier to deal with stuff like draw-downs and volatility. Till that time, one keeps jumping from one queue to another since one’s queue always seems to be not moving.

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