ETF | Portfolio Yoga

Mutual Funds or ETF

The topic is something I have written about earlier but given the nature of the market, it keeps propping up as one or the other side unearths what seems to be new evidence which show why one is better than the other. In the United States, its more or less settled that Active funds cannot beat simple ETF’s and this is not just limited to Mutual funds as the bet by Warren Buffett is showcasing.

Ravi Dasika, Co-Founder, Tavaga.com wrote a post on Medium trying to show why the viewpoint of Sharad Singh, Founder and CEO of Invezta.com wherein it was claimed that 95% of all funds beat ETF’s was simply and absolutely wrong. Before we go any further, a word on these two sites. Tavaga.com is a site founded to provide investors a way to build portfolio’s using simple ETF’s while Invezta.com is a site that provides investors with the ability to invest in Mutual Funds Direct (other sites such as FundsIndia for example are sites that provide avenue to invest via Regular schemes which are more expensive ,0.5% to 1.25% approx depending on fund.)

In other words, they offer their customers a choice that is pretty much opposite (Passive vs Active) and even while the total pie of investments that is coming into the equity markets is pretty high, like in the United States, at some point we shall see some sort of cannibalization.

Given the background, lets explore what Sharad Singh wrote at Business Today in his post More than 90% active mutual funds beat the indices. There is still time for ETFs. I would suggest you read the article though the conclusion (as would be evident from the headline itself) was that ETF’s were inferior to active Mutual Funds.

To make a case for Active, Sharad combined ETF’s and Index funds on one side and all Mutual funds on the other. While Index funds are supposedly passive and theoretically should move like the Index, it rarely does so thanks to Tracking Errors that dominate. Either way, Sharad takes a total of 17 ETF’s. I on the other hand could find a total of 24 funds (18 Index, 6 ETF’s) with a minimum track record of 5 years.

Here is the list with returns

As the data evidently shows, ETF’s handsomely beat Index Funds some of which can be attributed to fees (IDBI Nifty Index fund for example charges 1.74% as its Expense) while others maybe due to the churn needed to continually adjust for the inflows / outflows. While even ETF’s face that issue, due to the size of the Creation Unit being large, I believe that impact is much lower in their case.

Now, lets look at Mutual Funds (and since Direct funds are still a very small portion of Retail Investors, I shall use Regular)

On an average, Mutual funds have indeed outperformed both Index Funds and ETF’s by a margin. But what data misses is the fact that this data is skewed in two ways.

One, the starting point of the 5 year analysis starts right after the bear market of 2011. A fund which had a higher beta than the Index would surely outperform given the overall bullishness in the period.

Second, the 10 year returns are of funds that continue to exist. Any fund that was closed / merged would be missed propping up the returns higher (since its generally weak under-performing funds that find themselves under the axe).

Even more important point to note is that if you had invested in any of the funds on the left hand side, you would have either kept in line with the ETF or under performed. On the other hand, investing in funds on the right hand side should have given you a return much higher than what you could have got through ETF’s / Index funds. But either way, its not a 95:5 split but more of a 50:50 (Coin Toss). (Errata: Only 22% of funds have under-performed not 50%. Apologies).

Do note that while we compare all the funds against Nifty 50, its actually a wrong way to compare since many of the above funds have pretty large investments in stocks outside the Nifty 50. On the other hand, if you were to invest equally into both Nifty 50 and Nifty Next 50, you would more or less get the entire population. But since we have just 2 ETF’s with minuscule AUM’s, it would not be a fair comparison.

Over the last 5 years, Nifty Next 50 has given a return of 20.24% showcasing where and how the extra returns by the funds above maybe been garnered. One can only hope that we see more launches to track indexes such as these making it easy for potential investors to invest in a ratio that has a very high probability of beating the best of the funds (which are recognized only in hindsight).

If you were looking at investing for the long term, a good mix of Nifty 50 and Nifty Next 50 on the equity side should beat the shit out the majority of funds 10 / 20 years from now, that is unless you know which fund to buy and forget for the next decade.

Finally, the goal of investing is to ensure that our Goals are met. The road you prefer is left to you and while most of us will still arrive at our destinations, the time taken maybe different due to the different roads we took to reach.

Here is what happened in 2016

Year end posts are obligatory in nature. So, this is a list of stocks that went up, this is another list that went down and hey, this what I think will happen in the coming year.

Yet, if you really dig the data you can find some interesting facets that may have been easy to miss otherwise. 2016 was literally another dud year, the 2nd in the row. Yes, we did have some great moves and huge volatility, but we are still where we were at the beginning of September 2014 and surprisingly despite the passage of time, we aren’t any cheaper than we were at that point of time. Says something, ain’t it?

Lets start of with the percentage move plotted in a distribution style chart.

While the year may have been flat, we have had a lot of stocks that doubled or more. If you were invested in such stocks, 2016 would have been a awesome year for sure. For others (and that would include me), better luck next time, eh 🙂

The biggest gainers, gains > 100% were mostly mid and small caps with very few of them starting out at 100 Rupee or more. Sugar sector had a awesome year with the equal weighted index rising as much as 74% and hence its no surprise to see many a stock related to Sugar at the top of that list.

On the negative side, ignoring the random names of small cap stocks that are on the route to oblivion, the biggest disappointments would Tree House, RCom and Just Dial. And then there are stocks whose charts suggest a clear cut pattern of pump and dump, Global Offshore for instance

But overall, with 48% of stocks ending in positive territory, it isn’t so bad either. And before we move on, here is the list of the Best and Worst 25 stocks

Stock picking is tough in the best of times and even though the current year hasn’t been bad, anyone (and there are literally thousands of investors) who are holding stocks that literally bled to death this year are unlikely to believe that Equities are the best way to invest for a secure future.

Yes, the hope is to catch as many of the Green ones as possible, but how many do you really have the expertise to catch and a bigger question, will you know how long you need to hold it?

Global Offshore for example went up from 50’s to 800’s and yet some one who bought with intention of sitting tight would have seen all his gains withered off.

On the other stocks like Mandhana after having literally no returns over the last few years finally gave way as it fell 80% from its peak.

ETF’s are still a nascent product in India though with the arrival of Robo Advisory and investment by EPFO into ETF’s, hopefully going forward we should see more momentum .

Almost all ETF’s ended in the Green with the only exception being the Infra ETF.

While not all sector index are available, with new launches we are seeing quite a few options other than Gold and Nifty which still constitute the maximum number.

With mainline indices being flat for the year, the Top winners and losers among Mutual funds were dominated by Sector funds.

DSP had a good year with 3 of its funds being among the top winners though it also holds the ignomity of having a IT fund that lost a great deal more than both the Nifty IT Index (its benchmark) as we as its peers.

For the Second year running, FII’s continued to be Net Sellers and like last year, the only solace and what maybe saved the markets from having a much rough year was the steady stream of investments coming in from local funds (read Mutual Funds) which thanks to the weakness in Real Estate, Falling Interest rates and good advertising has been able to rake in much higher amounts than it used to.

But with there being a very high correlation between Nifty and FII investments, its essential that they start trusting the markets with their money if we were to have a bullish year like the ones we saw in 2012 or 2014.

Internationally, were were more or less on in the middle with neither we being great performers nor being the dogs of the year.

Since the table uses local currency to measure the gains, any gains accruing due to depreciation alone gets counted when its essentially just adjustment (Example: FTSE 100)

And finally, Nifty Sector / Thematic Index returns over the years. I have broken it into 2 pictures. One with at least 10 years of data and in the other you shall find all Indices with their returns over the last 5 years.

And finally, the best and the worst performing Indices over the years. Here is the interesting thing in this data set. In the winners, you can find Nifty Metals represented three times and yet if you were to measure the returns over the last 10 years, its a pittance to say the least. Once again, blind buy and hold doesn’t work other than in hind sight and with money you really have no requirement for

Nifty Pharma had one of its worst years since 2008 and while its still not yet very cheap, I see it getting (stockwise) to that zone from where you could see it bounce back providing decent returns at the very least.

So, here is me hoping that 2017 bring out the best of opportunities for us.

ETF aren’t Stocks

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

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

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

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

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

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

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

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

Fire your Financial Advisor?

In today’s Mint, Monika Halan has a post titled “When to fire your financial adviser“. While I am sure she knows way better than me when it comes to advisers, I felt that she had used a large brush without providing contexts when its right and when its wrong. So, here I go as usual with my thoughts;

MH: An adviser who gives you the average without separating out the asset classes when disclosing returns needs to be questioned.

Me: Assuming your have your entire networth here, its actually how much your networth is growing. Now, if we start splitting, why stop with Debt vs Equity since not all Debt or all Equity are the same. The difference in returns between investing in a large cap equity fund vs a Thematic equtiy fund can be huge. But that difference arises due to one being of a much lower risk than another. If Equity returns are bumped up due to a couple of them, is your advisor a Genius or one who is taking bigger risks?

Coming to Debt, are all Debt funds the same? Of course, not but will you understand what risk he is taking or what time frame he is looking at just by concentrating on the returns he has generated?

MH: If you have more than a total of 10 funds—across all categories—you need to question your adviser.

Me: To me, this answer once again misses the context. Its not about how many funds you are having that is the problem. The problem will be in terms of how correlated they are and how much portfolio overlap you are seeing. A large number of CTA’s trade as many as 100+ non correlated assets at any point of time. If you are having multiple funds but very little correlation between them, you are actually pretty well diversified. Of course, this could also mean lower returns, but volatility will be lower too.

MH: The guy is churning you; maybe to win a junket his fund house is offering.

Me: This is the risk of going to some one who you think offers his services for Free but makes money in the back-end. Fee based advisors have on the other hand no such conflict – they receive a fixed amount and hence are less susceptible to making you churn your investments.

So, how do we know whether my advisor is doing the job or is it time to fire him?

The biggest issue that is not addressed in the article is what benchmark is the one you should aim for. In my opinion, if you are a risk averse person but one who wants a bit of higher returns for his investments, you should ideally got for a split of 40 : 60 in favor of Debt to a max of 60 : 40 in favor of Equities.

It would have been lovely if we had a ETF similar to Vanguard Total Stock Market ETF, but given that we don’t have that, our best bet will be to use the GS Nifty Bees as the Equity component benchmark and something similar to the LIC MF G-Sec Long Term Exchange Traded Fund as our Debt fund benchmark.

Now, lets get back to our starting point. Assume you invested a year ago. Download data for the ETF’s you have selected – the debt fund ETF above may not have that much data in which case you will have to use the Index it tracks.

Once done, assume your investment was made in the ratio you are comfortable with or are invested in. Based on present value, does you returns match or is higher than this? If Yes, your advisor has generated better returns which is good.

But Rewards are one side of the coin – on the other side you have Risk. So, using the same data you now need to calculate the volatility of your investment and compare (not sure you can easily get such data from your advisor, but you pay him and he needs to provide you with it at the minimum). Here, our aim is to see if we are having a lower volatility. A high volatility means that you are taking a much higher risk to generate the said returns – seems acceptable in good times, its only in bad times that we wonder what hit us. Yes, doing such Analysis is tough, but hey, its your money and the least you can do is try and understand how its doing once in a while.

Either way, understanding what your financial advisor is bringing to the table is the key in deciding whether to continue with him or fire him. Nothing comes for free but not all costs are acceptable.

The future is Passive

The big news this week was about the inflow into Vanguard, the world’s largest mutual fund company which attracted $198.4 billion in the first eight months of this year drawing money from Active Mutual Funds and even Exchange Traded Funds as investors poured money into its low cost Index funds.

On the other hand, we in India recently had a SIP day when more than 30,000 investors signed up (in other words, parted with their money) to active funds in the hope that these funds will deliver more than what passive investing will return.

While I am a believer in ETF’s being the future, for now, one cannot dispute the fact that a lot of active funds have generated better returns (historical) than a passive Index. But the question that is rarely asked is

How are Indian Mutual Fund Managers generating Apha even as American Mutual Fund managers have a hard time catching up with the passive returns?
Secondly, the bigger question is, how long this out performance will sustain. Will the next 30 years be similar to the previous 30 years?

Lets first address the first part – the Alpha generating Fund Manager. A lot of funds have indeed generated Alpha over the last ‘n’ number of years but as the recent experience with HDFC showcased, if the fund manager bets wrong (and bets big on it), one would be destined to under-perform for a pretty long period of time. So, basically it boils down to fund managers being able to pick right and sit tight (not that most do as you can see from their churn ratio’s, but that is the basic idea).

The reasons for managers to generate Alpha is many, but one key fact is that the Indian Markets is still dominated by Retail investors. As Aashish P Sommaiyaa, CEO of Motilal Oswal tweeted, the number of Share holders in RIL, RCOM, SBI etc is greater than most MFs investor base.

In United States on the other hand, Institutions dominate the landscape. In markets, its common knowledge that the retail investor (includes us) are the weak hands while Institutions are the strong hands. As long as the ratio is maintained, funds can and will beat the passive indices comfortably.

But competition is brewing in the fund industry itself with more funds being launched and more monies being collected. With there being just around 400 or so stocks that funds invest in, as time goes by, it would be tougher to beat the rest of the pack unless a manager makes some serious bets and then comes a winner.

Take for example, the number of Mid Cap funds over the last 10 years. On ValueResearch I find that there are only 18 funds with a track record of 10 years or longer. But if you come down to 1 year, you find as many as 40 funds in the same Universe. Assets under Management too has exploded significantly while the number of stocks they can invest in hasn’t caught up in a similar way.

This is also showcased by the difference in returns between the best and the worst funds. On a 10 year time frame, the best fund has generated twice the returns of the worst surviving fund. Among funds with 5 year track records, this difference is 2.5X and for those with 1 year track record it spirals to 5x.

But lets get back to United States and the developed markets. Let me quote from an in-depth study by S&P Dow Jones Indices here

“There is a widely held belief that active portfolio management can be most effective in less efficient markets, such as emerging market equities, as these markets can provide managers the opportunity to exploit perceived mispricing. However, this view was not substantiated by our research, as over 70% of active funds underperformed their benchmarks across all observed time horizons.

In the U.S., the performance of equity markets remained solid, albeit weaker than previous years. However, over 84% of U.S. active funds underperformed the S&P 500® over the past one-year period. This poor performance continued over the longer term, as over 98% of active funds trailed the benchmark over the past 10 years.”

Let me put that in perspective. If you had invested in any mutual fund in US in 2006 (when it was still very much a bull market), you had a 2% probability that you will come out a winner in 2016. While I don’t think Indian funds will match such numbers over the next 10 years, its very much a possibility as you extend the time frame.

In 1995, a news paper reported this on the Pager Industry and its future growth prospects

“Just as microchips moved in the 1980s from the computer into washing machines, toasters and telephones, so tiny paging microchips are being developed for lighting, cars, vending machines, and notebook computers. “We’re at the tip of the iceberg of paging applications,” said Jeff Hines, paging analyst at brokers Paine Webber.”

While the paging industry did touch Indian shores, by the time people became aware, the Cell Phone had arrived and made it obsolete. Investors in United States are realizing only now that not all active funds are created equal and most funds find it tough to beat a simple index despite (or is it thanks to) their staggering fees / research.

I have no doubt that the Mutual Fund industry will continue to grow in size since there is plenty of money out there looking for avenues to invest but that doesn’t mean that they will all perform. Some will, most will not and many in between will just perish.

Its hence important that you analyze the facts carefully and take a call based on your reading of the situation and how it can / could develop from hereon. As a saying goes “”The past is history. The future is a mystery. The present is a gift.”

Today, the average investor has access to information that wasn’t there a decade back. The one’s who will thrive in the future are the one’s who make the best of the opportunities that such information / knowledge provides.

Right time to Buy

Yesterday was a pretty lucky day for me. Some kind soul had triggered my stop loss on Wednesday and while I had cursed him that day and the next day as well, man, was I happy to be neutral in markets as it tumbled on the opening bell in response to the Britain Referendum results.

Too many (and I am Guilty of being one of them) use Buffet quotes when it suits us best. Many a fund manager harp on value buying like Buffet while loading their portfolio up with momentum stocks at premiums. Its one thing to say that I can wait for eternity for buying good stocks at right price and yet another thing to twiddle one’s thumb even as market rockets one way.

With plenty of time on my hands, I created a poll on Twitter asking what people (those who follow me) were doing. The question itself was bit slanted to suggest this as being a opportunity. Here are the final results of the same.

While majority of folks seem to be waiting, folks outside seem to be rushing to use the opportunity to buy. Manoj Nagpal tweeted that yesterday saw equity mutual fund purchases being three times the normal.

For the record I did not buy since I am a systematic trader and no system had triggered a buy signal. On the other hand, Juicy volatility attracted me to sell some options in the belief that with the event being over and small time frame to expiry, Implied Volatility is sure to crash.

But is this or was this a opportunity to Buy? While markets at one point of time were down by nearly 4%, they recovered some of the losses to close the day with a loss of 2.20%. While I strongly believe “Prediction is Impossible”, that has not stopped me from trying to predict where the markets could be headed (once in a while).

Initially I had thought of having the header as “Blood on the Streets. What Next”. But a casual search revealed that I had already used that heading twice.

In 2014, I wrote suggesting that the fall wasn’t much and it maybe prudent to wait. Markets though had their own agenda as they shot up another 9.75% in the coming months before finally topping out.

In 2015, I once again tried to predict and thanks to a bit more experience I suggested that at best you could increase your allocation to equity slightly since one can never time the bottom. This time around, markets continued to see downward pressure for months to come with the final bottom being around 12% from where I wrote.

The reason most advisers recommend SIP is because they believe timing the market is tough if not impossible. At the same time though, they some how seem to believe that they can select the right fund manager (who will time the market correctly). One of the biggest funds has had a horrendous few years because the fund manager bet on the right set of stocks at the wrong time.

As much as people hate timing and think that it shouldn’t be done, your results are all based on the timing of when you decide to enter and when you decide to exit unless of course you are investing for the sake of investing alone and have no requirement of the money forever.

A fund claims that it tries to steer investors from trying to invest when markets are hot by closing fresh investments. While the PE Ratio at time of when it closed and when it re-opened did not suggest it being a big game changer, fact remains that the fund is trying to time the market using historical Price Earnings Ratio. Once again, they are trying to time the market using historical PE Ratio as the reference for their actions.

Will we once again see a PE ratio of Nifty at 10.68 (low of 2008)? I don’t have a clue but if there is no time frame for such prediction, of course, it could happen – decades later if not now. But I am digressing.

How do you come up with right time to Buy or Sell? In my opinion, the only way is by way of some kind of timing algorithm. If you are from the Technical side, it may be as simple as a 200 day Moving Average and if you are from the Fundamental arena, a simple PE ratio could be your tool.

Was yesterday a good time to Buy? The narrative depends on how the markets move in the coming days. If we strongly bounce back and start testing new highs, this was a opportunity. On the other hand, if the fall continues, this was a time to Sell (and one which only 9% voted). But since we don’t know how the future will unfold, only some kind of timing system would help you take that call (as long as the logic is validated and tested).

To conclude, if you are averse to timing but yet want to get market returns, ETF is the best route given that regardless of changes in fund manager or even the house, returns will be close to market it tracks.

A free trip to Goa

Unlike new age media sites which use click bait article headings such as the one above to enhance their page views (and hence garner more advertising revenue), this is no click bait article though it on the surface would seem as such.

Instead, if you are a Mutual Fund investor (Large Cap), you are theoretically gifting away a fully paid vacation to Goa for every Million Rupees you have invested. And if you are a big investor, you are gifting away a trip to Maldives every year and if you by any chance or a Very High HNI, you are just giving away a paid vacation to Monte Carlo.

Now, as a reader of many financial sites, you very well know that there is no free lunch and wondering what the catch here is. The thing is, there is no Catch. What I am calculating is simply the difference between the charges of most mutual fund and Nifty Bees.

I see the smirk on your face as you think, but then – I am missing the fact that MF’s out perform ETF’s and whatever savings I achieve will not compensate for that loss.

Indian Mutual Funds have indeed been (on a long term) out-performing Index by a margin (Alpha). But this out-performance has been on a steady decline over the years. The key reason for Alpha was that in earlier years, with a smaller capital to manage, stocks had a good time buying quality stocks that weren’t identified by others and then held on to it as both earnings and its Price Earnings got re-rated.

But with more and more money chasing the limited number of stocks, its tougher to beat the herd if you don’t innovate in how and where you invest. But as the recent episode with a large mutual fund manager showed, buying what is cheap and not liked by others may sound interesting on paper, but if it doesn’t work out as panned, investors are in for a long period of under-performance.

I don’t know how the future will unfold, I don’t know which funds will do great and which funds won’t but what I do know is that as we go forward, bigger the fund, tougher it will find to out perform and here no matter how big a ETF grows to be, it will continue to give me more or less what the Index has delivered.

If I can get a free trip every year just from the savings, why bother about the nitty gritties of constantly tracking the fund and the fund manager and switching from one fund to another in the hope that he will deliver what the former couldn’t.

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