Category: Mutual Fund

The single biggest reason you are given as to why you should invest in stock markets using a Mutual Fund and not via a Exchange Traded Fund or a Index Fund is proved by showcasing long term returns of few select funds that have over the last decade beaten the Index returns handily.

In past posts I have reflected on why this is not really the ideal comparison given the Survivor bias such lists tend to have yet the fact remains that few funds have really performed well over the long term. No two ways about it.

Here is a table detailing the percentage of funds that have beaten Goldman Sachs Nifty ETS Fund returns.

On the face of it, it seems that on the short term, funds really do deliver the results with more than 90% handily beating the benchmark ETF we have chosen for this exercise.

But this seems to keep dripping down as more time passes by though theoretically given the Survivor bias as well as the understanding that Alpha is generated by focusing on the long term growth, we should have actually seen that rising.

So, what is happening out here?

On the short term, there is a very high possibility of luck being mistaken for skill. Extreme short term returns aren’t hence the best viable way to evaluate a investment, especially one during a bull market where you can get away with higher risk (and hence the higher return) without anyone being wiser.

For instance, while on a 1 year basis, Goldman Sachs Nifty ETS Fund has given a return of 6.82%, over the same period, a Index fund tracking the Sensex had a range which went from a low of 2.85% by LIC MF Index-Sensex Plan to a high of 7.34% by HDFC Index Fund – Sensex Plus Plan. With both Indices seen as benchmark, and both Sensex plans theoretically following the same allocation pattern, one wonder what gives for such a large difference in returns. While the range wasn’t as big in Nifty Index funds, it still stretched from 5.19% (IDBI Index Nifty Fund) to a high of 7.96% (Edelweiss Exchange Traded Scheme-Nifty 50).

In his book, The Success Equation, Michael Mauboussin writing has showcased the importance of Luck and how tough it is to differentiate that from skill in the short term though on the long term, skill clearly distances itself from results which are owed primary to the significance of luck.

There are two ways of investing in funds. One is by way of lumpsum and another is by way of Dollar cost Averaging (commonly known as SIP). Both have their own advantages / disadvantages depending mostly on when the investment was done and the length of time it was held.

A few years ago, Vanguard had done a extensive test on whether a investor should go with a DCA approach or a Lumpsum. You can download the study from this link. In recent times, a investor in mutual funds has been bombarded with information on why SIP is the way to save.

But, how do you choose among the hundreds of funds that are on offer? When Index funds themselves have such a wide range of returns, the range expands more as you start comparing actively traded funds. And here comes the financial advisor who says that since you really cannot expend the kind of energy needed and understand the intricacies of those funds, we will (for a fee that is duly debited from you) help you pick the right fund.

Today, I noticed that Quantum Long Term Equity fund has reached the summit in terms of 10 year returns beating every other fund. But when it comes to AUM, its way lower since they were the first and till date the only fund that doesn’t utilize the services of a distributor. But I am digressing.

To help you pick the right fund, most distributors have what they would say as funds they believe is right for you. Yesterday, I was going through the Select funds of a major online distributor and was surprised at the number of funds that were added and removed in the short time frame I looked at.

When it comes to Systematic Investment Plans, the question is how long you should keep investing. Most application forms these days have the option of investing for eternity (theoretically) since the belief is that if you keep investing over a long period of time, the return you get is substantially on a higher level.

But while investing regularly for long is a correct thought process, the returns are dependent on the choice of  instrument.

In the table, you can see that funds are constantly getting churned all the time. While the advisor does point out that removal doesn’t warrant a exit, it still is suggesting that maybe further investing in such funds are sub optimal in nature.

When people flash about how 10 year SIP would have given so high a XIRR return (a number that most people confuse for CAGR but isn’t – read by previous post), how do you do that if large well known distributors keep shuffling funds based on short term returns (based on my understanding of what they looked at before removing).

If you started out in a SIP today in a fund that is part of the list but subsequently gets dropped, do you continue to invest in a scheme that may be sub-optimal. What if 10 / 15 years hence it showed that if you had just continued to invest, you would have beaten 80% of other funds and what if 10 / 15 years later you learnt that because you kept investing in bad fund, the returns are sub optimal?

In other words, Question leads to more Questions and further more Questions without there being a clear cut answer. If you are saving for your daughter’s education which maybe 20 / 25 years, do you really know which fund you should seek out to help you in mobilizing the said amount?

I don’t exactly remember when, but on the short term, Quantum fund was under performing due to its high cash holding. It was also the time when it got kicked out of Mint 50 (a set of best funds that you can select from). But given the funds recent performance as well as long term, how much of a cost would that have meant for a investor who was blindly following what was advised?

The biggest reason I like ETF’s is that after accounting for Expense Ratio and Tracking error, I know for sure how much I can get depending on the choice of instrument / index I have chosen. That is way tougher with active funds (Quantum included) since it requires a reading of the mind of the fund manager and what he believes is the way forward.

These days, I find a lot of funds coming out with what they say are their core philosophies. If you were to understand and accept that, it makes a lot more sense to just stay with them (and hope that they stick to their words) then keep switching in and out in an attempt to find the best funds.

But if you were to look at persistence of returns, as time passes by, I feel that you will find a way smaller list of funds that can persistently deliver. The pool of actual alpha generators is anyway way smaller than what we assume it to be based on short term out performances in a bull market.

Indian’s have generally been Risk Averse and that is seen in the percentage of assets an average household has invested in markets (Direct or Indirect). Real Estate on the other hand has had huge amount of backing given the rally we saw in the last decade. But with Real Estate prices shooting for the moon and one which is affordable by a very small segment of population, investors are now turning towards equity in an attempt to get returns that are better than Inflation.

Mutual Funds in India has been as old as the hills with plenty of funds being launched by Unit Trust of India since the 1960’s. While the Asset under Management has been growing in time, given the growth in economy, it was still a lagger.

While Mutual Funds have all sorts of schemes, for the retail investor, most funds recommend Equity since only Equity has ability to provide for positive returns after adjusting for Inflation. And then there is also the small thing about being able to extract a higher fee from equity than from Debt.

In recent times, we have witnessed funds going all out in attempting to push investors into embracing equity investing through SIP’s. In this blog itself, I have written enough on the Pro’s and Con’s, so I will stay away from the same.

Today, lets talk about the term Equity Risk Premium. Investopedia defines it as under;

Equity risk premium, also referred to as simply equity premium, is the excess return that investing in the stock market provides over a risk-free rate, such as the return from government treasury bonds. This excess return compensates investors for taking on the relatively higher risk of equity investing.

Its effect is better seen if you were to compare Nifty Total Returns (the benchmark I like to use) vs a Liquid Fund (SBI Magnum Insta Cash Fund).

As you can see, its really one sided with Nifty Total Returns beating the Returns of the Liquid fund hands down. But that is the reward. What about Risk?

Liquid fund has no draw-down. Every day is a high day and you cannot get a better picture than by seeing the chart of the fund. In other words, at no point of time is the value of your investment lower than what you have invested.

Equity on the other hand provides no such guarantees. As any investor who invested in late 2007 can tell you, at the depths, you wonder if you have lost everything you have invested even though you may have invested in a Index rather than individual stocks (where such risk definitely exist)

At multiple points in time, you had 40% or more of falls from peaks and this is Risk that you, the Investor is willing to carry for the +ve returns you hope to get.

But how much extra do you really get? To get to that answer, I used Nifty Total Returns and subtracted the returns of the Liquid Fund. Results are as here under;

(Click on the table to expand if you cannot view data for all 17 years).

What does the above table tell you, especially the row that I have color formatted (Median Returns)? Do note that the data is not adjusted for Inflation.

SIP is a excellent way to save money, but is it the best way to invest in markets given the near uniform distribution of returns? Good Friend, Kora Reddy the other day tweeted (read from last to first),

The data in the table I presented above is more of a synthesis of what Kora tried to put up.

If you invest in a SIP and can do so for more than 10 years, you really start to see the benefits start to show up.

But once again, there is the question of whether the fund you choose to invest will be able to beat the Index over the next 10 years. If you were to look at data that is publicly available, the percentage of funds that have beaten Index is very high at the 10 year mark (due to Survivor bias effect) and keeps coming down year upon year.

These days, most SIP’s have option to invest for perpetuity and hence if you can hold onto your behavior when markets crack next time around (and hold onto your Job as well) and if you have chosen the right fund, you may be happy with what you have achieved once markets come back (as has happened ‘n’ number of times in the past).

But money has a utility value and if you need that money when markets is not at its best (its all correlated – market falls / job loss / health issues – everything happens at the worst possible time), you know whom to blame, or do you??

A friend of mine has a shop selling something which in theory has no moat whatsoever. If you wish, you could easily put up something right next to him and start doing business. Margins are good which means that there is pretty high attraction to getting into his business. Where there were just 2 a few years ago, I now count 6 within walking distance from his shop.

For now, everyone seems to be happy and have enough business, but as my friend knows, the business runs in cycles and there are times when he has hardly any sales. But he has a edge that the others don’t. While others need to make enough to at least cover their rents (and the area is notorious for its sky high rents), he owns his shop making it much easier for him to overcome those dull times.

Mutual Fund and Distributors are these days spending money and time trying to convince you that investing in a Mutual Fund via SIP is the best way to save for your future goals. Theoretically they are right, its much better to save more systematically each month as it all adds up over time.

But when it comes to Mutual Funds, there are literally hundreds of choices out there. How do you choose the one or the select few that you think will help you in reaching those goals.

Stock Advisory is as old as the Stock Market itself – why bother to research on your own when you can just pay a small fee and be provided the stock to buy / sell rather than you having to wade through hundreds and thousands of stocks.

And then there is Insurance. If you were to carefully check out advertisements of Insurance Policies, you would have heard “Insurance is the subject matter of solicitation” but have you thought about what it really means? . Not many customers bother which means sellers have a field day.

What is common among sellers of all the above products?

They all profess that they can help you reach your goals which generally is about making X amount of money by Y time. Some are qualified, most are not but as long as they have the gift of gab and have the ability to make things up as they go, how many will really question things they claim to be true but which aren’t.

When you go out to buy a product, lets take a Cell Phone for instance, we do plenty of research before we even hit the showroom. We ask Friends about the one they use, we browse the internet trying to find out more details and finally figure out the brand which we want to buy.

Having done all that, its still easy to fall to the talk of a sales guy who tells you how great this new Cell Phone is is and how much its been selling in the market (even though before this day you would have barely heard its name). A few years ago, me and my friend went out after doing research to buy a Samsung phone but ended up buying a Karbonn since we fell to the talk of the sales guy who in all probability would get more commission to sell a phone like Karbonn than selling Samsung.

The phone wasn’t as great as it was advertised and after a couple of years using it, my friend junked it for a better one. But while he was unhappy with the phone, he seldom felt the same about the seller despite the fact that the sales guy had the Edge in terms of being more knowledgeable than we were.

The reason we get misled in finance though comes down to our aversion to learn even the basic things about savings and how the various choices pan out against each other.

The web is filled with information that you seek but you need to search it out for it to be of any benefit. While most of us are happy to slog for 8 hours, when it comes to learning / understanding about finance, we are just too tired and want some one else to make the decisions for us.

That some one needs a motivation – it maybe in terms of a trailing commission as in case of Mutual Funds and Insurance or a fixed fee per month in case of stock advisers or a one off payment in cases such as the Real Estate broker who helps you find a house to invest your money.

When it comes to investing in Mutual Funds, how many times have you heard your adviser speak about Quantum Mutual Fund – a fund that   has outshone its peers in recent times and stands among the best even when comparing with others on 5 year returns. How many times have you heard your Insurance agent talk about Insurance not being a Investment and hence you should look for Term plans vs Moneyback Plans or ULIP for instance. How many bank employees have advised you that if you were in the highest bracket when it comes to Tax, you maybe better off with a lot of other debt based assets that yield more after tax than a simple Fixed Deposit.

You don’t hear any of the stuff because saying so would mean cutting off their own money tree and who in the right mind would want to do that. Advisory is supposed to be a Fiduciary duty and yet for most, its what makes their dough that is the biggest concern, not what is right for you.

To say that you need to save more is easy, To say that you can save more by investing better is way tougher because the future is uncertain and non one has a clue other than to look at history and hope that history repeats itself.

If you are reading this, I would guess that you already have a Edge. You know what works for you and what doesn’t and aren’t swayed by glossy advertisements about returns that seem out of the world. You know about the various biases you can fall into them without even our knowing.

But then you are part of the minority (and this applies equally to any country you can think of). The reason for starting this site were many and one of them was to help provide perspectives to investors and traders alike. While I have no clue whether my posts here or my rants on twitter are doing anything, the way it has rattled some tip sellers I hope means that I have hit some right spots.

So, back to the Question. What is your Edge when it comes to Investing? If you can answer that (and hopefully is data backed), you have ARRIVED.

The holy grail of returns would be if you could get equity like returns while having bond like volatility. While in theory such possibilities do exist, the question that arises is whether its feasible / practicable in execution where reality meets fantasy.

Motilal Oswal Mutual Fund has indeed launched one such fund aptly named – Motilal Oswal MOSt Focused Dynamic Equity Fund. In the words of Aashish Somaiyaa, CEO, Motilal Oswal AMC;

Now, as a systematic trader, my ears perk up when people talk about how great a system has been in back-test. Having build and buried thousands of systems that look great in back-test but fail miserably when it comes to the real world, there is a very high risk of the out performance being more of a mirage that seems to be out there but never can be reached.

To ascertain how long has the system been back-tested and how long its running in real time, I asked him details of the same and here is the reply;

The back-test period encompasses both bull markets and bear markets making at the very least it having some kind of validation about having shown its out performance when times were good as well as when times were bad.

But does that provide any sense of understanding given that any and every data mined strategy will pass the back-test with flying colors?

A better way to test would be to run the data through some statistical testing and see if it really is as good as it claims to be.

Unfortunately the Index is not really a Index as it is bounded and will move between a lower and a upper end making it more like a Stochastic.

But Motilal Oswal in a presentation of April 2016 has the following picture

While the comparison between Inception to April looks tremendously good, do note that much of the data is from the back-test. On the other hand, data from 2 Years on wards is of walk forward and hence more reflective of how good it is.

Below find a correlation chart of 100 period returns of MOVI vs future 100 day returns of Nifty 50.

Since the strategy is contra (Buy when market goes down, Sell when market goes up), do note that we need to focus on when strategy is positively correlated vs Nifty and when its Negative. On the face of it, it seems to do the job though the true picture can only be obtained after a few years of operation by this fund.

The key idea behind the launch seems to be with the idea that since Investors cannot digest large volatility (downside), by having a strategy that sells when markets are expensive and buys when markets are cheap, its volatility will be lower and hence hopefully the investor will stay longer.

In 2010, Motilal Oswal launched a Smart Beta ETF on the Nifty 50. The premise here as defined in the leaflet is as below;

What is MoSt50 basket?
MOSt 50 Basket is a fundamentally weighted basket based on S&P CNX Nifty Index (Nifty). The methodology is conceptualized and developed by Motilal Oswal AMC. MOSt 50 includes all the Nifty 50
stocks but not in the same proportion as Nifty. Weightage of a stock in MOSt 50 basket is determined by using Motilal Oswal AMC’s proprietary pre-defined methodology that assigns weights based on
stock’s fundamentals such as ROE, net worth, share price and retained earnings. This is to ensure that companies with good financial performance and reasonable valuation get higher weightage.

Once again, it was a good concept. After all, if you could buy more quality stocks and less of the bad quality, you theoretically should outperform the Index. The said leaflet also had a chart to showcase its advantage vs Nifty 50

As the chart and the accompanying table shows, the strategy was perfect. While you got the same volatility of the Index, returns were way higher. Since the above chart has both back-test data and walk forward, its tough to notice that it had started to deteriorate. So, how did it perform after being listed vs Nifty Total Returns and Nifty Bees;

As the chart clearly shows, the fund more or less under performed Nifty Bees most of the time and not surprisingly the fund house decided that it was going to follow the regular model from Oct 2014 instead of being fundamentally weighed.

This issue is not just of Indian funds. Take the ETF, First Trust Dorsey Wright Focus 5 ETF for instance. Using a concept of Relative Rotation among sectors that are showing strong momentum, the fund showcased how it has trumped S&P 500 returns

As the table showcases, it yielded strong +ve returns vs the S&P 500. Given that fact that in United States, majority of Mutual Funds under perform the Index, this was a real breakthrough or so the Investors must have felt.

So, once again, how has been the real time performance of the fund vs S&P 500

Once again, there is disappointment in store as forget out performance, for now the fund is not even performing in line with S&P 500. Then again, the time frame is short and who knows how it could perform in future.

Sometime back, NSE introduced a new index Nifty Quality 30. The fact sheet quotes “The ‘Quality’ investment strategy aims to cover companies which have durable business model resulting in sustained margins and returns”.

Once again, the idea is right. High Quality companies can and shall (in theory at least) out perform Low Quality companies and this is proved even in their back-test data.

Does the Nifty Quality 30 whip the asses of Nifty Total Returns. Holy Grail Unveiled, or is it?

Once again, its too short term to make conducive large term forecasts, but Quality 30 seems to be facing some strong headwinds as of now. Will it do better in future? I have no clue though if you believe, you now have the opportunity to invest in the Index through ETF’s such as Edelweiss ETF – Nifty Quality 30.

What is common in all of the three above examples is that the heart is at the right place – how to do better than Index with similar or lower risk. But the result is not as one would expect. Would Motilal Oswal fund be different?

Once again, I have no clue but would rather (as a Investor) wait for data rather than rosy forecasts / back-test data which may or may not be the best way to ascertain which strategy is good and which isn’t.

A known devil is better than an unknown angel.