Opinion | Portfolio Yoga

Panicking is okay. Jumping out is not

We humans are prone to panic. Why else do you think we have so many horror movies that try to scare the shit out the viewers. In panic, we also do things that many a time can be regretful. We have seen more than once of people panicking and jumping out of buildings on fire. He survived the fire but died from the fall is rarely a good headline.

Today markets are on fire with Nifty down big time, something that was not seen post 2008. For any investor who entered the market in the last decade, this is akin to a building on fire where he feels trapped inside.

Everytime market falls, it’s generally because the world seems to be coming to an end and everytime one is disappointed that it isn’t so. Maybe, this time it’s different?

For the last few days, the US markets have been falling like a pack of cards. India not surprisingly is following suit for what the US does, we copy. Need more proof, check out this chart in a tweet I did a few days back

https://twitter.com/Prashanth_Krish/status/1234941743318982656

But the difference is that as recently as February, 80% of the stocks in US were trading above their 200 day EMA’s. Comparatively in India, we have been below 30 for a very long time (we briefly went above it recently just to get back to square one today).

This is my 3rd Bear market. The first bear market I experienced was the Dot Com bust of 2000 and while every fall is unique, the final outcome is similar – stocks get cheaper by the day till its so cheap that it starts to bounce back.

When we are suffering from a severe headache, the inclination is to remove the head to stop the pain. Thankfully, we cannot do that without killing oneself and the headache passes away in some time. It’s normal to feel similarly when it comes to our stocks and investments. The brain is screaming to cut out the source of pain, but cutting off other than letting you feel happy of having done something generally achieves the very opposite of what you aimed for when you started this journey.

Don’t be a Hero is being said of those who want to venture out to buy equities. Yet, these are the very people who in good days quote Buffett and the importance of buy and hold. Buying equity today is not about being a Hero.

Markets overreact all the time. In recent months, quality stocks were bid to the moon as markets wanted comfort in known names regardless of the price that was being paid. Today, some stocks are being sold at throw away prices because the same investor wants comfort and hold cash.

I have for nearly 5 years now been providing a simple asset allocation mix. On the whole, even the Aggressive model seems Conservative. But today when markets are falling like ninepins, this is what has given me comfort for I have enough dry powder that I can deploy more into equities and still be able to sleep well at night.

Diseases first kills people with pre-existing diseases and we are seeing the same when it comes to CoronaVirus as well. Bear markets such as the one we are currently in the middle of kills investors who are over-leveraged.

I bought a small bit of equity today and intend to add more in the coming week or so. But this is not a blind strategy speculating on a possible bounce in the near future. I have no clue of the coming weeks or months but if you were to talk about years, I am pretty certain that unless 90% of the world’s population dies, we shall have long past moved from this uncertainty.

If you have a cash flow and are comfortable with Risks, continuing to add is the right strategy. The very reason equities deliver a return higher than fixed in the long term is for taking such risks. If you are not comfortable with adding more risks, that is okay too. But do note, no opportunity comes with a blue sky scenario. Anytime you invest in equities, it’s a leap of faith.

Do note that any investments may not generate the returns you desire for the next one or even two years. Once you are comfortable with that, you can make your peace with whatever markets can throw at you including days like today.

Is Yes Bank Failure the Lehman Moment for India

When the Federal Reserve decided not to provide a rescue for Lehman in 2008, it created utter chaos and confusion resulting in credit markets basically freezing with banks unwilling to lend to each other let alone to others.

India has seen many Bank Failures including the failure of a Scheduled Bank, Global Trust Bank way back in 2004. Recently we saw the failure of PMC Bank which was a cooperative bank but was still large enough to send shockwaves through the system.

Unlike Global Trust Bank of 2004, two things have changed. One, Yes Bank is or was the 4th largest private sector bank in India. Second, unlike in 2004, the availability of 24*7 news channels and social media means that the risk blows up big time for others for fear can drive people to act irrationally.

RBI’s action on Yes Bank has come too late and by penalizing the depositors is setting a bad example that shall not be forgotten for a long time.

I don’t want to add fuel to the raging fire. Markets will take a while to recover from his hit. Invest with care.

Should you Panic – CoronaVirus

Coronavirus is said to have been transmitted from Bats to humans first. Today, it has spread from humans to stock markets as markets around the world tumble on the likely economic impact of the Virus that currently doesn’t seem to have any known cure.

Panic happens when we have inadequate information and coronavirus is one such case. On one hand, there will be an impact when an economy such as China more or less shuts down even partially. On the other hand, how should we act is a question that props up.

Let’s start with the worst case scenarios taking the idea from thousands of fictional novels and hundreds of movies which have dystopian futures as the key element of the plot. 99% of humankind is wiped out and the survivors fight back.

If that is to be the case, should you sell everything and buy Gold (which is rocketing currently). The answer of course is Nope for what use is Gold when it cannot protect your life or the ones of your loved ones. Heck, it may actually turn out to be a liability given the ease at which it can be stolen.

Should you Sell everything, convert your fixed assets to cash and wait to see how this pans out? Seems like a great idea, but like in Gold, this has a draw-back. What happens when there is a cry of Fire in a crowded theatre? A stampede.

If things go really bad, the first thing to shoot up would be Inflation as everyone wishes to stock up. While having cash may help you in the first phase, as prices keep going up, your money in the Bank like the Zimbabwean Dollar becomes a worthless currency.

Most conspiracy sites quote the “Spanish Flu” as bearing resemblance in terms of spread and hence in terms of damage. The difference in my opinion though is that unlike 100 years ago, we have much better knowledge and much better infrastructure to treat those who have been infected.

But since our focus is on markets, let’s look at its impact on markets. The Spanish flu killed Millions worldwide including an estimated 5% of India’s population at that point of time (Link). In the United States, 28% of the population of 105 million became infected, and 500,000 to 675,000 died (0.48 to 0.64 percent of the population).

Since we have US Dow data of those times, it’s pertinent that we visit them to see how badly it impacted them. The key here is understand the Risks that may be out there and try to prepare for them rather than panicking like everyone else.

Do note that the period of time was also the same period when World War I was finally coming to a close and hence there would have been overlapping factors at play.

If you were to start when the Spanish Flu first erupted till when it halted, the Dow actually was higher than where it had started. Do note that for the Dow 1917 was a bad year and 1920 turned out to be another bad year (down 30%). Post that though, Dow shot up 400% in the coming years until the crash that brought upon the Great Depression.

I don’t believe that now is the time to dump stocks and move to cash. Instead, if the crash continues, I would rather be adding for its only in hindsight we recognize good opportunities.

Nifty 50 has not seen a fall in a long time even as the economic situation has deteriorated around. Not surprisingly just 2 days of fall seems to be creating some amount of panic when the truth is that only today the index closed slightly below its 200 day EMA

Before the financial crisis, Indian markets like a clock easily slid down 20% from its 200 day EMA literally every alternate year. Post 2008, we are yet to see one such move.

Plot of how far away has Nifty 50 swayed from its 200 day EMA

It’s important that you have a plan of action for having a plan in advance avoids panicking and behaving like the rest of the herd. If you strongly feel that markets may melt down, it’s not wrong to exit and reduce the risk exposure even now.

If you think that even this shall pass and are comfortable with the current asset allocation, moving higher or lower based on market triggers is the right approach.

Do note that as Equity markets fall, so shall your exposure to markets even without you having to do anything (as total percentage).

Every time markets fall, it seems that the world as we know is ending and everytime we are in for a disappointment as it did not end. If the world does end due to this virus, I doubt you shall complain to me that I was wrong, if it doesn’t hopefully this post would have given you an ability to create a framework on how you shall deal with this crisis – both financially and personally.

Choosing the Right ELSS Fund

While India hasn’t been caught up as much in the move from active to passive other than on Twitter., the truth is that such a day is not far away given better education of the client since data that shows how few funds are able to beat the benchmark they track.

But while the odds of an active Mutual fund beating the benchmarks today stands at less than a coin toss, there are funds that have beaten the benchmark even on a 10 year stretch. The big question though is whether we can identify such funds other than in hindsight.

Most mutual fund rankings that exist today are heavily tilted towards the recent performance of the fund. If the fund is performing strongly vs its peers, it gains a higher rank and vice versa. The problem with such rankings is the volatility of the ranks themselves. What is a 5 Star rated fund today can in a few months from now be a 3 Star rated fund.

Randolph B. Cohen, Joshua D. Coval and Luboš Pástor wrote a paper titled Judging Fund Managers by the Company They Keep. While this paper came out in February 2003, it was only recently that I was able to read the same. I am not aware of any fund site that uses similar methodology to rank but the thought process seemed to have legs.

Investing in ELSS funds to save tax may not be required going forward for those who don’t wish to take advantage of the exemptions offered. While the tax advantage may go away, the bigger advantage of investing in a ELSS fund is that thanks to the lock-in, scope of one panicking and exiting the fund at the wrong juncture is minimized. I recently wrote a post around that though process – ELSS as a Nudge for Long Term Investing

Personally ELSS is my choice when it comes to tax saving instruments and every year I keep experimenting with strategies on which fund to pick. While it’s tough if not impossible to predict which fund shall do well over the next three years, I believe that it makes sense to give it a try than invest randomly even though the results of either endeavor maybe the same.

This year, I decided to modify and apply the strategy of selecting the fund based on the paper I have quoted above. With every fund house having an ELSS fund to attract such investors, today we have a choice of around 38 funds to choose from.

18 Funds with Assets under management of greater than 1000 Crore have cornered 96% of the corpus (of approximately 98K Crores). I decided to take a deeper look at only these funds with two exceptions being Parag Parikh and Quantum.

The method I choose to rank has two parts. On the first run, I decided to weigh their portfolios based on the strength of the portfolio stocks multiplied by its weight. The strength of the stocks was determined by their long term Momentum Score.

A stock such as Bajaj Finance has very strong momentum while a stock such as Lupin scores very lowly on long term momentum. By multiplying the score by the weights, I am trying to reward funds that have strong stocks as their top picks versus funds that may hold the same stocks but have weights that are much lower.

While a high Momentum Score is good, what we also need to look at is how unique or otherwise the portfolio is. One way to go about doing this is find the covariances of the managers portfolio versus other portfolios.

In other words, the focus here is to pick a portfolio that consists of good quality stocks that have generated strong risk adjusted return in the past and one that is as unique as possible compared to the alternative portfolios in existence.

Do note that when we talk about portfolios, we are talking about the current portfolio which is bound to change over the coming years. But if the fund manager has a great portfolio today and one that is unique, he would rank higher versus a portfolio of stocks that have given poor growth and one that is not unique either.

To give an example, Pidilite Industries is a great company with a delightful product and more delightful advertising (in the past at least). Yet, only one fund has an allocation to this stock among the 20 we are scrutinizing. On the other end of the spectrum, you have Quantum which is the only fund to hold Yes Bank while SBI is the only fund that continues to hold Manpasand.

By combining the scores, here is the final list of funds and their relative rank. It should be interesting to see how they fare at the end of 3 years from now.

Do note that Prediction is Impossible. Idea of having a method is any day better than making a random choice. Past Performance of a fund may not be indicative of its future performance, but the Past Performance does provide data points which could be useful and the above analysis is one such attempt.

My past fund choices

2017: Axis Long Term Equity Fund

2018: Invesco India Tax Plan

2019: Canara Robeco Equity Tax Saver

Some Trivia:

Of the 20 funds, 19 of them have ICICI Bank. PPFAS is the odd man out.

Across the 20 funds, they own around 350 Stocks with 185 stocks finding a space in only one fund.

IDFC Tax Advantage fund has the highest number of stocks in the portfolio {73 Stocks} while PPFAS has the smallest portfolio with only 20 stocks finding a space.

Tesla, The great Short Squeeze & the Lesson it Offers

You would have to be living under a rock to not have but noticed the twitter chatter around the ever rising price of Tesla’s stock. We are just one month into 2020 and yet it seems that traders who shorted Tesla may have already lost $8.3 billion this year alone.

But first, the Tesla Chart

This is a kind of move that can make or break careers. In 2009, when Porsche squeezed the shorts in Volkswagen, it ruined many fund houses then.

Hedge funds lose $30 billion on VW infinity squeeze

While one can lose money by going long in a stock, a stock can at worst go down to zero. But when you short, there is no limit on how much you can lose since there is no limit on how high the stock price can go.

Most Long – Short funds which have a large portfolio of short positions short stocks that they strongly believe are candidates for bankruptcy or are frauds. In the case of Tesla, many of the ardent short activists believe both to be true.

But my or your beliefs don’t make the market. The markets finally are Supreme even if they are wrong on many occasions. What is interesting about those who shorted or have a negative view on Tesla is how they seem to be blindsided that there are shades of Good, Bad and Grey in Tesla as it is with any other company.

I am neither an investor in Tesla nor own its Car nor tweet about US markets regularly. Yet, I have amusingly found out that I am blocked by dozens of folks and the only common thread between them is that they are bearish on Tesla.

Given that I have never followed or even replied to their tweets, the only way I would get blocked is if they specifically searched for me and blocked me. To me that shows a kind of hatred that has nothing to do with money.

But coming back to Tesla, it’s okay to be wrong but not okay to stay wrong is an adage everyone knows and yet Fund managers managing Billions of assets seem to believe that “apna time ayega”.

In India, Nifty today is a hated Index. The reason for the hate is that the Index is up while portfolio’s are down. Wouldn’t it be simpler and more profitable to own Nifty versus wallowing about how it’s all manipulated and stuff. How different otherwise are we then to folks who are bearish on Tesla and go about tweeting any and every conspiracy theory they can lay their hands upon.

Success in markets I have learnt comes in two ways. The first is to have a strategy that works on the long term for no strategy works all the time and will be wrong some of the time.

The second is behavior where one requirement is the ability to understand what is within our abilities and what is not. No point wishing for things which we cannot be influencing in any way.

It’s been 2 years since my portfolio saw an all time high. In my own past world, I would have already jumped through at least 2 if not more strategies to try and compensate for the chronic under performance I am observing.

But data I have tells me that this move has been well within the boundaries of what I should have expected. The risk was known and is well under control. As long as you have control of the risk and its not exceeded preset limits, there is no reason to switch to what is working today for tomorrow even that may stop working.

The reason for me to follow this strategy versus buying a Nifty ETF was to get a return which is greater than say buying and holding Nifty 50 and there is no reason for me to quit the same. This is one way to look at your portfolio when your strategy differs from the one everyone is tracking.

Kingfisher Airlines stopped operations in mid 2012. The stock continued to trade till September 2014. More recently we saw similar trading in Jet Airways long after the company had shut the door. I remember the same enthusiasm when Global Trust Bank botched up and it was to be acquired by Oriental Bank of Commerce with all equity being wiped out.

Investors continue to lap up even dead stocks in the faint hope that maybe one day it will all work out okay.

I am a strong believer in trends and regardless of how great a stock is, having learned my lessons at great cost, I would not wish to hold it once the stock starts to trade below its 200 day moving average. A 200 moving average is no different from say a 199 day moving average or a 201 day moving average. What all of them offer though is a defined exit that I can rely upon.

If you were short Tesla with a stop above the 200 day moving average, you would have been out of your short position when it traded at $300. Today its trading 3 times that number and we haven’t seemingly done yet.

Risk Management is critical for any Investor or Trader. If you don’t manage your risks properly, all it requires is for one to hurl you towards financial ruin for it’s a slippery slope with very little support on the way. The funds and individuals who are short Tesla today are those who ignored the Risks. Some may survive, but the harm it does in terms of psychology alone is Irreparable.

Don’t fall in love with the stock is an adage as old as the hills. It works well to remember every time we try to defend a stock we are holding for we are just side-car participants in the company’s boom or bust.There are no additional points for you just because you happen to love them more. Have a plan on containing the risk a stock can do to your portfolio and stick with it. It’s that simple to avoid financial ruin.

Thoughts on the Union Budget

The Union Budget is a statement of account of the economic performance of the year gone by and the expectations of the year ahead. Thanks to the impact it has on literally all sections of the society, it is watched, debated and analyzed for days on end.

From Twitter to Newspapers to Blogs, its filled with Analysis of every statement and line that is found in the Budget Documents. In this post, I don’t wish to go down the same road and drown you with more of the same.

Once upon a time, we used to have the Budget at 5 PM on the last day of February, This practice was inherited from the Colonial Era when the British Parliament would pass the budget in the noon followed by India in the evening of the day. It took more than 50 years till the time was changed to a more manageable 11 AM.

Since the budget lays out the taxation for products and services, the direct impact on companies can be substantial and to ensure that the markets are not caught off-guard, the markets have been open during the presentation of the budget.

One commonality among literally all budgets is how much of expectation is built into the budget and how most people somehow are disappointed at the end. This year was no different other than for the fact that somehow the finance minister has seemingly angered literally everyone.

The stock market was upset because Long Term Capital Gains Tax was not removed and more importantly the tax liability on dividends shifted back to the investor. Worldwide, the poor aren’t greatly represented when it comes to investments in equity, it’s the rich who are able to divert a substantial part of their savings to equity.

90% of India’s population has no participation in markets. Yet, like the tail wagging the dog, the small minority of investors who get impacted by bear markets seem to believe that the prime function of the government is to keep the stock market happy.

The main line indices are often said to be barometers of the economy. If that is true, Indian Economy is in great state with Nifty 50 and Sensex being less than 7% away from their all time highs. Then again, whom are we kidding.

It had been 325 trading days since Nifty 50 fell 2.5% or more and the disappointment in the budget was evident when this spell was broken. Stocks which were seen to have a negative impact fell even more. But this is not the end nor the beginning, it’s just one more random day in a random year.

Flush with savings that have shifted from other asset classes to equities, we had bid our stocks too high even as the earnings showed no sign of catching up. The chickens have since 2018 have been coming home to roost. While it’s easy to shift the blame for the fall to the introduction of Long Term Capital Gains tax, the reality is that the rot had set a long time ago and all it needed was a little push.

The issues facing the country are many and yet we shall thrive somehow. Markets are mean reverting in nature and currently in a downphase but at some point will start moving higher regardless of whether the government acts big or not.

Markets get cheap – Markets become expensive – Markets get cheap again. It’s a cycle that has lasted time and again and something that is bound to continue in the future as well. The path forward is not to get disheartened by setbacks but see them as opportunities.

The disadvantage of being a democracy has meant that very few politicians want to take the long call with everyone focussed on the short term calls that can boost their popularity. This has meant that we have missed opportunity after opportunity to set right the course. This ain’t getting solved in this budget or the next.

To conclude, a Budget that seems bad for the stock market may actually be a good for the real economy. If the real economy flourishes, markets will turn on a dime. A growing pie is what we need for once the pie is growing, opportunities come to the fore despite government floundering.

Killing the Small Advisor

First they came for the Stock Brokers, and I did not speak out –
Because I was not a Stock Broker
Then they came for the Portfolio Managers, and I did not speak out –
Because I was not a Portfolio Manager
Then they came for the Advisers, and I did not speak out –
Because I was not a Adviser
Then they came for me, the Investor – and there was no one left to speak for me

With due apologies to Martin Niemöller

SEBI was instituted to safeguard the interest of investors, but the way its acting in recent times makes one wonder if there will be any investor left to safeguard at the end.

Like any other professions out there, the financial services industry has seen a large number of bad apples. In an effort to remove those bad apples, SEBI is in recent times trying to implement the policy of kill a fly with a cannon.

While there have been a lot of good moves in terms of regulation with respect to Stock Brokers, the high level of compliance costs and the falling revenues from transactions has meant that brokerage industry is now dominated by a handful of companies with the capital to survive. A small broker with limited abilities stands no chance today.

Portfolio Management Service (PMS) is a unique concept that is not found elsewhere in the world of finance. This was before the arrival of the Alternative Investment Funds the poor man’s alternative to Mutual Funds.

Today, with a Net-worth Requirement of 5 Crores, minimum investment of 50 Lakhs, the concept is essentially dead especially considering that your tax liability is far higher than with Mutual Funds. I wrote about this here

The small investors who were once serviced by small stock brokers are today advised by either a Registered Investment Advisor or a Mutual Fund Agent.

SEBI has now floated a Consultation Paper on Review of Regulatory Framework for Investment Advisers.

Before we get into the paper, let’s try to understand what a Registered Investment Advisor {RIA} can do and cannot do. A RIA can advice his clients for a fee on creating personalised Portfolios using mix of Equity, Debt and Funds, Asset Allocation and provide Financial Planning services.

What he cannot do is offer execution or directly manage the monies of clients or sell products where he shall receive a commission for his efforts. Of course, the rules are for those who follow and as I wrote in my post, SEBI is sleeping while the regulations are openly flouted

Today and even tomorrow, all it requires for one to sell intra-day tips is a database of phone numbers. Most of them I doubt even go through the registration process that SEBI has put in place let alone adhere to them.

The number of RIA’s that offer Financial Planning is barely a handful in number with most RIA licenses being used to offer Portfolio Advisory which is more simpler and easy to sell. But portfolio’s are not designed with regard to one’s own risk temperament nor is there advice on how much of one’s assets should be invested in what kind of allocation.

Both of these fall into the bracket of a financial planner who places a lot of time and effort to understand your requirements, get a hold on your limitations and plan the most optimal investment portfolio that suits both your goals and yet doesn’t require to take more risks than what you can bear.

Portfolio Advisory on the other hand doesn’t require a deeper understanding of the client’s financial abilities or even his risk temperament. The advisor is offering a portfolio which is sold on a certain attribute and one that is designed for the do-it-yourself investor who understands the market.

RIA unfortunately clubs both of them in the same bracket even though the type of clients they are different with different set of requirements. Since RIA’s who are individuals are prohibited from providing execution services (Corporate entities can offer execution facilities under a separate company and while this is not to be compulsory, we all know how this works)

A while back, SEBI raised the minimum net-worth requirement for Mutual Funds from 10 Crores to 50 Crores. Next it raised the net-worth requirement of PMS from 2 Crores to 5 Crores. Through this consultation paper, SEBI wishes to raise the Net-worth to 50 Lakhs. While its 10 Lakhs for Individuals with clients lower than 150, given the prices that client can bear, 150 clients with its attendant costs {Office Space, at least 1 employee, etc} means that you barely break-even at 150.

SEBI’s recent thought process seems to be that if you are Rich, you won’t pull wool over people’s eyes. The reason I say this is because Net-worth is basically a deposit that is kept at your end and one that can at best provide you a risk free return. It does nothing to benefit either your working requirement (since you cannot use it to buy assets that depreciate) or the client.

When we try to analyze securities, we try to look for companies that have a Return on Capital Employed greater than 20%. Here, your capital of 50 Lakhs will be basically offering a return of 7%. Since this cannot be used for setting up a new office or employing others, basically this is a dead investment. This is true even in case of PMS or Mutual Funds.

To add to the misery, the Consultation paper requires some serious investment and monitoring to ensure that in case of a dispute, you are in the clear. SEBI is attempting to do by asking for all conversations to be recorded. This is already happening at the stock broker level and is not new, but adds another layer of cost especially since these records have to be saved for 3 years. While cloud has ensured cheaper storage space, it’s still an additional cost not to talk about ensuring that these files remain secure since it impacts clients privacy.

What is also interesting, though this is not a new requirement is the primacy given to a degree. While we have no standardized way to test the aptitude of an advisor, exams like CFA / CMT and CFP have been recognized worldwide as a good way to filter out candidates. The NISM exam is really a very low hanging fruit and one that can be cleared easily by even those without a deep understanding of finance.

A person should not be too honest. Straight trees are cut first and honest people are screwed first
Chanakya

SEBI seems to reckon that if you are honest you should be Rich. Given the lack of financial literacy in India, we want more qualified Individuals to embrace the world of advice but by overreaching, SEBI may end up doing the very opposite of what it has set out to do – help the small investor.

Lack of good Investment Advisors is already resulting in mis-selling of products that are not suitable for the investor but yield a good commission to the seller. By enforcing very high standards, SEBI will essentially kill the ecosystem that has just started to blossom. I doubt this is SEBI’s intention though.

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Some Trivia:

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