Mutual Fund | Portfolio Yoga

Get busy living, or get busy dying

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Long Term Investing and Trading

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

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

— Sunil Arora (@moneybloke) June 30, 2015

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

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

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

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

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

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

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

— Sunil Arora (@moneybloke) June 30, 2015

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

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

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

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

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

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

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.

Trusting financial Intermediaries

In response to a tweet of mine, Anupam Gupta (b50) tweeted this

@Moneylifers @Prashanth_Krish such huge distrust in the entire financial distribution chain, including MFs? any reason?

— Anupam Gupta (@b50) May 22, 2015

They key question is, should we trust those who claim to work on our behalf while having a business model that goes against that very logic.

Lets start of with the much hated Stock Broker. A stock broker was one who in earlier days allowed persons to buy & sell securities for a small commission. The commissions which were huge in those days steadily has crept downwards with advent of technology and more competitors.

Its general knowledge that its very tough (will not say impossible since there will always be guys who claim to make a living out of it) to make money trading the markets, especially on the intra-day time frame. Yet, almost all big brokers send daily flush of SMS calls asking their clients to Buy ABC, Short ZYX and so on and so forth.

How many brokers have you come across who shall say, well, the way to wealth generation is not by trading but by buying and holding shares of good companies over a long period of time (I kind of disagree with my own statement out here, but I hope you get the point). How many brokers advise you to just do a SIP on Nifty Bees since the probability is high that the returns you generate by doing that is way bigger than what you can achieve on your own.

On the other hand, I come across statements such as, Invest only that money in the markets that you can afford to lose. Its no wonder that people invest a Lakh in stocks and goes out and invests a Crore in Real Estate. Worst case, he knows that the land is his no matter what happens.

For the not so sophisticated investors, there is another way to get into markets – Mutual Funds. But just like most financial products, even this needs to be Sold. So, the mutual fund distributor also becomes a kind of Financial Advisor.

A financial advisor generally makes his money by charging a X% of fees on the total assets he manages. But since most of us would not want to pay from our pocket, the advisor instead advises on funds where he gets the biggest commission. And since tail commissions are low, lets churn the portfolio every time there is a new fund offering. After all, buying at 10 is cheaper than buying a fund with a NAV of 100, Right?

In India, Insurance is not seen as a hedge but as a way to save (Invest). Its no wonder then that most Insurance Advisors (agents really) advise one against buying Term life policies and instead go for Endowment / ULIP plans where the commission paid is much higher. Even after accounting for the risk coverage, the return is so low that is makes zero sense, but hey, I get back my money here seems to be the logic.

And finally we have the Financial Advisors who claim to help you trade / invest in markets for a small monthly / quaterly fee. What I find amazing about these guys is that all of them want you to pay up in advance regardless of the results. Not a single guy says, Here is the way I do business. I advise you on what to Buy / Sell for X months. If you feel the advise is worth it, pay me XX so that I continue for the next Y months, else, no worry.

Nope, every one of them wants you to trust them with your money while not trusting you for one second. Do you really think they work for your benefit?

And finally, Portfolio Management Schemes. I have tweeted on it quite a number of times and every time i look at those numbers, I wonder who would want to invest in a product that under performs all the time. Most PMS model is build upon generating brokerage. If, and that is a big IF, they do end up making some money, they want a cut of it as well.

Almost all models in the financial sphere is out there to get a cut of your savings. There are of course, many honorable guys out there who do business which is worth for both the client and himself. But they are so far and so tiny, that you rarely hear about them, let alone learn more about them.

As the saying goes, “There ain’t no such thing as a free lunch”

We spend our lives trying to save every rupee we can, but what use is it, if we allow ourselves to stumble upon when the it comes to making the money earn for us.

Privacy of our Financial Information

Privacy in the Internet era is literally down to Zero. Our mails are read, our buying patterns are analyzed, we ourselves via social sharing websites provide out information on what we do, when we do, where we go, who our friends are among thousands of other data points.

To learn about how much of our information is online and available to companies, do watch this very very interesting video – (Link). Even for those folks such as myself who know quite a bit on these issues, this was pretty mind blowing information.

What about our financial information you may ask. Aren’t they pretty secure?

A few weeks back, I received a post from NSDL (mind you, posted using normal post) that combines all my stock holdings at all the Depository Participants and to top it up, provides the value on date.

Now, they don’t stop at just stocks that are scattered across various depositories but also have column’s for the following asset classes

Equities

Preferential Shares

Mutual Funds

Corporate Bonds

Money Market Instruments

Securitised Instruments

Government Securities

Postal Savings Scheme

Mutual Fund Folio’s

In other words, other for investments in Real Estate, this more or less provides a complete overview of one’s financial affairs and this is sent by Normal Post (Postage of 3 being affixed). Interestingly half of my family did not get this post and as I write this, I wonder – did it get lost or was it ….. (Conspiracy theory)

If this is one level of stupidity, I stumbled upon another a few days back. Few days back, one Mr. Nilakantan Rajaraman of Funds India wrote a interesting blog post on their successful investors. While no personal data was revealed, if you need to analyze data, every person’s data was seen.

Funds India is a financial intermediary who make it simple to invest in Mutual Funds (though now they also enable you to trade, buy Gold, enable investing in fixed deposits of companies, get Loans (Personal) as well as buy Insurance and the best part, its all FREE

Of course, we all know, There Ain’t No Such Thing As A Free Lunch and in almost all the cases where its free, there is a commission that is paid. But that is paid which is not so bad since they do provide you the ability to do investments more easily.

Of course, with Mutual Funds now enabling Direct investing which cuts out on the commission, there is pretty big a loss for you in the long term if you are using such services for only the ease of use rather than having them act as your personal investment advisor.

But I am digressing (as I usually do) and so, lets return to that blog post (Link). The blog post is able to get a lot of details of where they are investing, how they are investing, how much returns are generated among a lot of info. Then again, the fact that they shall collect and use that info is embedded into their Privacy policy (Link)

If its ain’t bad enough that the Investor loses on potential gains due to the trailing commission that gets charged, its worse in my opinion that private information is shared with them and all that for just enabling you to invest a bit more easily than you can do by visiting the websites of the concerned mutual funds.

I am sure that the information they collect is secured. But the question is, are you comfortable and is this worth it??

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