Category: Mutual Fund

Yesterday’s edition of Mint featured a wonderful article on Robo Advisories in India (Link). Its a very nice review of the ones that are available in India though the article doesn’t go deep into their philosophies and methodologies. For me though, the last para (part of which is reproduced below) held the key.

Ultimately, its portfolio performance that will matter. So, the algorithm has to be accurate and better than others in selecting and reviewing recommendations. It’s too early to judge or analyse the existing platforms, but as these firms go through more market cycles and recommendations change, the winners will come through.

I am a systematic trader and in the arena of the stock market, I see people constantly peddling black box strategies that are supposed to have delivered wonderfully over the back-test period. The problem though is since you do not know anything about the strategy, you are just blindly hoping that the said performance will continue in future as well.

Also given that market cycles are long (a business cycle for instance lasts around 5 years) and given that there is no public info on how good their algorithm is proving to be (other than for those invested), how good it will be to know 15 / 20 years down the lane that the algorithm was not as good as promised?

The current crop of Robo Advisory as far as I can see is a set of black boxes with each firm claiming to have done extensive research and validated the results to come up with the said model. But for you the end user, you are pretty clueless as to why a certain fund was selected as the choice of investment while another fund was redeemed out.

In United States where the concept of Robo Advisory originated, the logic is to use low cost ETF’s and a re-balancing strategy to ensure maximization of gains for the client. Since ETF’s are very low key in India, most Robo Advisories are going through the Mutual Fund route given that they have shown ability to out-perform (on long term) Mutual Funds. While I doubt how long this can last, for now, Mutual Funds are the way (if you select the right ones, that is).

While researching for this write up, I came across list of funds recommended by one such Robo Advisor. The year and funds they were in is listed below

{Click on the image above for viewing it in full}

They compare their performance to Nifty (not TRI as far as I can see) and claim to have succeeded. But the kind of churn witnessed really boggles my mind. Its as if they are trying to jump from one fund manager to another in the hope of better performance. Also as is the case, Nifty is not the right benchmark if funds are being invested in both Large cap and Mid / Multi cap oriented funds.

They also claim not to invest in sectoral / thematic funds since they believe its best left to the fund managers discretion on which sector he wants to invest more. But if one is indeed punting on momentum (which is what all the fund picking is all about), would it not make sense to have at least a small portion allocated to the sector that is showing the best momentum across board? Would it not add the Alpha one is searching for?

While I see various experts preaching on how you should not go by historical performances when selecting funds but also weigh in other aspects, as far as I have seen, fund performance is what dictates everything. When a fund manager is on a hot streak, his AUM literally explodes (unless he is Direct only like Quantum) and when the said streak ends, slowly but surely AUM keep dropping until the only guys left are those who have forgotten they have invested in such a fund.

As a trader and a technical analyst, I see nothing wrong there. After all, you end result is based on the returns you are able to generate, doesn’t matter what philosophy you may choose to use. But being open about it enables one to understand both in good times and bad. The reason investors jump out of ship when the performance goes down is because they have no clue about the philosophy of the fund manager and the risks such a philosophy would entail.

Robo is the future, but unless I can understand their process (and hence understand the risks), I would stay away from Black Boxes which seem to have figured it all.

Way back in 2000, while trading had already moved from the pits (or rings as it was called in India) to the VSAT linked trading terminals, we still did not have any stock broker who allowed or offered internet trading to retail clients. Clients either visited the stock broker office or called on the telephone to place orders.

In those time got launched a new venture called 5Paisa.com. At a time when intra-day trading meant paying the broker 0.10% on either side, this site started straight away at 0.05% and what more, offered you the ability to trade directly from your home without the need to call your broker to know the rates or place an order.

While I wasn’t a broker in those times, I was around them most of the time and the feel I got was that this was not going to change anything. After all, clients depended on the broker not just for rates but also advice and handholding.

And for a few years, they seemed to be right as internet trading really did not take off as one would have expected. But they constantly kept the brokers on the toehold and brokerage rates fell from 1.0 to 1.5% (which most brokers charged for delivery) to miniscule percentages and finally today we can buy stocks without paying a Rupee in Brokerage.

But is the old model dead and buried?

Well, even today you can see brokerage offices having clients who sit through the day and place orders. But the business model has changed and the good old days of the past will never come back.

Disruption of existing model is never liked by those who stand to lose. When Uber got launched, the main skepticism was that these new drivers could never match the knowledge of taxi drivers who knew the road map of the city like the back of their hand. How wrong were they?

The Robo Advisory model in the Mutual Fund / ETF space is very new even in US where everyone is still working on which model will finally be able to take hold as an alternative to traditional advisory model.

In India, there are very few firms (though one tweet suggested that number is 30) and most of them will fold up over time since we are at a very early stage of the financial evolution. Things are changing as seen from the continued inflow mutual funds have seen even as performance has flattened or gone negative.

An Advisor will play a role for now since most investors have no clue as to what they want, let alone what they desire. But as they start understanding the nuances, they will move to cheaper models (Direct for instance) unless the advisor is able to provide real valuable advise rather than saying they will hand hold you through good times and bad.

I have not much of contact with distributors but I do wonder how many have really worked on models to select the best possible funds or do they just sell you what is the hottest running fund / highest return fund.

It’s nice to have goals such as Retirement funding / Children’s Education among others, but how many advisors really have the skillset to deliver especially when they are at the mercy of the fund manager who can under-perform for long because he chased the wrong ideas.

While 100% Robo investing may take time, the future for now seems to the way Vanguard is approaching with a mix of Robo Selection + Human contact. With growing pool of mutual funds / ETF’s, it’s imperative that the fund section / risk ascertainment process be outsourced to the algorithm while the advisor focus on providing the client hope when times are bad and perspective when good.

Rejecting Robo altogether in my opinion is akin to throwing out the Baby with the Bathwater.

All Mutual Funds carry a disclaimer saying

“Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s)”

Yet, in real life everyone including Mutual Funds want you to see the past performance and while they don’t claim anything, the message sent across is that there is correlation between past and the future and that given the great performance of the fund manager in the past, you can assume similar performance in the future as well.

When I recently tweeted about why I wasn’t comfortable with Nifty Quality 30 Index (despite me liking the idea in itself), one of the questions that I was asked was, you should not look at past performance to judge the future. Yes, past has no relation to the future and yet, every adviser and every rating agent looks at the past returns to come up with a list of Top funds to invest into.

If past performance really didn’t matter, we should have seen a more uniform spread of Assets under Management across various fund houses which is not true and hence showcases that we are really driven by the past performance even if we know that there is no way to know for sure whether the future will be as good as the past.

When the future performance is not in line with the past,we get disappointed and search for excuses as to why the fund manager could not replicate the performance of the past. Let me give a real life example.

HDFC Top 200 fund is one of the biggest single funds in the Mutual Fund industry. While investors continue to believe in the fund manager, there has been more than a murmur of voices as its performance. But is the peformance really so bad?

If you take a look at the fund performance over last 5 years, you shall see that it has performed inline with Nifty Total Return Index. So, why the angst and the disappointments that seem to have surrounded the fund?

The answer lies in how it performed over the 5 years previous to that. Rather than talk numbers, let me provide you with a chart where I have divided the data into two equal parts (10 year data) and re-based everything to zero to provide you with a clearer perspective

The first five year (2006 – 2011) was pretty good for the fund as it outperformed significantly against Nifty generating tremendous Alpha. The next 5 years, returns are all in line with its Beta and therein lies the difference.

When investors look at the past and invest, they are essentially hoping that the fund manager will provide  similar performance in future and any deviations on the lower side is not taken kindly.

Futher Reading: A paper on why you should not buy funds that have recently out-performed

To really generate Alpha using Mutual Funds (even as they decline in over all terms), you need to be the few who identify and invest with him early and exit when he starts to become a house hold name and that is really a tall ask to say the least.

Twenty years is a long enough time frame to understand and validate processes and theories, but does that also mean that the next Twenty years will be similar in nature and stature to the 20 years past? We Technical Analysts believe that “History tends to repeat itself”. But even the strongest votary of such a idea will laugh if you ask him whether markets will provide returns of a similar nature as it has done in the past (especially when we are looking at years / decades).

In Yesterday’s Business Standard, Chandan Kishore Kant writes about how if you had invested Rs 1,000 per month as SIP for 20 years, these schemes (listed in the article) would have turned the Rs 2.4 lakh into Rs 55 lakh. And he is right in the sense that if you were able to identify these schemes when they originated and were able to predict that they will Survive, you may have ended up with gains of the nature that is usually associated with Real Estate investing.

But then again, these are the Top schemes from that period and doesn’t include funds whose returns has not been upto the mark, forget about those funds that have changed hands and now no longer sport its original name (and in many cases, its original criterion). Hindsight as they say is 20/20.

A new newsletter seller yesterday posted about the humongous gains made by some stocks in the Nifty 50 universe over the last 5 years. But how many were there in the Index 5 years ago goes unanswered precisely because many of the top gainers got included very recently.

Marketing in its purest form is selling ice to a Eskimo. Some use total lies, some half truths, some do use the real data but massage the same to make it seem way better than it really is. Either way, they want to close out the sale and are happy to tell what you want them to tell.

Being not Rich, I never thought I could watch the Berkshire Hathway Annual general meeting that now attracts fans from all around the world making it the world’s most attended annual general meeting of any company. But thanks to technology, I finally was able to watch Buffett and Munger live without moving out of my comfortable couch.

Berkshire in its annual report every year provides data on how their performance (Book Value) has been when compared to  S&P 500. Returns since Inception was way past what the S&P 500 (TRI) delivered. But then again, how many investors knew about Warren Buffett let alone invest in his company way back in the late 60’s and 70’s?

In the Annual General Meeting Q&A session, I heard many of their shareholders talk and unless I dozed off, I cannot remember too many a investor say he was invested pre-1998. Why 1998 you may ask and to answer that, I shall direct you to the following picture

As you can see, despite everything, returns from owning BRK over the last 18 years has been as good as what could have been gained from owing S&P 500 itself. But that is only half the picture. Lets take a look at a larger picture, shall we?

 

As you can see, anyone who invested in 1998 seeing the past 18 year returns as the proof of the pudding will be left sorely disappointed.

I believe investors who look at fund returns of the previous 20 years and assume similar returns over the next twenty too may be in for a surprise. In the 1990’s, investing in stock markets, let alone in Mutual funds were a real unknown. But today, with growing knowledge and corpus, funds will find it tougher and tougher to keep beating the markets as they did in the bygone years.

Alpha has already been on a steady decline though its still well in the positive territory. But like in US where Mutual funds have not been able to match the Index returns, let alone beat them black and blue, so will be the case (if and that’s a big IF, Index is property constructed) in India as well.

Size is really the enemy of good returns. Buffett has never been able to repeat the performance he showed when he was doing his partnership’s, the first few years of Peter Lynch were way above awesome, same is the case with many well known hedge funds of today.

But picking the next big manager requires dollops of Luck not to mention ability for you to invest a sizable sum so that the returns are really worthwhile (compared to your overall networth).

As Technical Analysts, we trade based on our anticipation (based on history) of how the move unfolds much like the mutual fund investor. But where we differ is that when it’s not going according to our anticipation, we cut our losses and search for new pastures. Do you?

In the second season of HBO’s fantasy television series Game of Thrones, there is a interesting exchange of dialogue about the nature of power between Cersei and Littlefinger. While Lord Petyr Baelish (known as Littlefinger) tries to home in on the fact that Knowledge is Power, Cersei shows that ultimately Power is Power.

I was reminded of the above exchange as I wondered about the impact of Media on the choices we make. The easy availability of a medium such as the web has provided many with the ability to put forth their views which otherwise may have never been heard outside their four walls, when it comes to their ability to influence, they are still nowhere compared to those who are able to get their views expressed in Newspapers or on Television.

But how neutral are the Journalists / Experts who are provided the ability to express their view which is then flashed across to millions of readers / viewers. How many policy makers for instance use the new methods of Twitter / Blogs vs. reading the newspaper or watching the television to get a sense of the opinion of the general public at large?

For years and even today, much of the population believes stock markets are evil and dens of gambling. Any wonder then that the population of investors (Direct / In-direct) is very small despite our stock exchange being one of the oldest in the world (BSE is the oldest stock exchange in Asia).

In his post, “Financial Media & Reader Maturity”, P V Subramanyam who blogs at Subramoney closes of with the quote

What do I do when I read such articles? Nothing. Many of these articles have no take away for me. Generally none.

Its one thing to have a contrary opinion and quite another to say, Ignorance is Bliss. In the recent debate on SIP’s, the one question that was tossed up regularly was, well, what are the other choices anyway.

But when I did provide those choices, those were tossed away as if I had committed some cardinal sin by advocating things that others don’t (buying a random stock every month for instance) believe in.

When NSE got started, there was a hue and cry by the other exchanges who felt short changed but today, when one looks at the history, one cannot but accept that 1994 was the start of a new revolution when it came to increased transparency and better investor protection.

Mutual funds as a whole charge thousands of Crores per year to manage money and those that are higher up the ladder would not want anything to change. But change is one thing that is guaranteed and while some things may take time, Change is guaranteed.

If you are reading this blog, you are one of the very few enlightened investors who believe in understanding finance better than the man on the street. All I can say is, May your Tribe increase. We need more voices and more opinions, not less.