Opinion | Portfolio Yoga

Should Interest Rates in India go down to Zero

I am not much a fan of Macro Economic Analysis and yet Macro fascinates me more than a lot of equity factors do. Understanding Macro to me is a way to design models that can benefit from the broader philosophy to understand and implement at the micro level.

I have had some fascinating discussions revolving interest rates in the past and my view was that India with no social safety net could not afford negative interest rates. When I say negative, I mean less than Inflation and not the negative we see in Europe or Japan currently.

There was some bias given that most of my father’s money sits safely in a fixed deposit allowing him to lead a comfortable life without the need to take risks. Why should he take such risks at his age. That reasoning remains but I think that he is a small minority vs the large majority who cannot afford such luxuries.

On one hand, I doubt India can have the kind of safety net that the West has been used to – Quality Public Healthcare, Quality Public Education, unemployment benefits among others. That requires the kind of money that we don’t have and may not have for the forthcoming future.

India is capital starved. Ask any Entrepreneur and he shall say his biggest worry is access to capital that doesn’t require a hand and a foot to be exchanged. While RBI reserve rates are in single digits for a long time, in the real world, the cheapest finance you can get is 13 to 15% for personal loans and 18% at to an atrociously high 60% in the private markets depending on your urgency and credit assessment by the lender (and let me not even go to the Daily Interest Loans where you just don’t want to annualize the same).

The high level of interest is a boon to the middle class and above while a curse to those who don’t have enough capital. The high interest rates has meant that if you are comfortable, you are better off working for someone than starting a business and providing jobs for others.

While in India, there is a certain stigma attached to failure, the cost of failing in a business can many a time end up with losing everything one owns including one’s home. Not an acceptable cost.

If you were to look at Budget 2020, the biggest share of the pie in terms of expenses for the Government of India is Interest. This takes away 18% of the total income and is a bit less than the total sum the government spends on Subsidies and Central Sector Schemes.

A low interest rate is beneficial for Industry and enables Job creation. In the new world we face post Corona, Jobs will be harder to get given that a lot of business will be stressed and saving it will require firing employees rather than adding more.

Cutting down on Interest Rates would allow the government to save a bundle. This can come at a cost of FII’s not wishing to invest in Government Treasuries. But even today, Foreigners hold just 3.7 per cent of the almost Rs 60 trillion ($835 billion) of sovereign bonds issued by India, and the government has set a 6 percent limit on foreign ownership. Once this crisis started, FIIs have gone out in droves even though the interest rate differential is now even larger.

Borrowing by Private Companies tends to get shadowed over by Borrowings by the Government. This means that other than the bluest of the blue chips, the cost of capital for even mid and small sized firms are nowhere close to where they should be. They are not Junk and yet treated as Junk.

With no Junk or Distressed Bond markets, small businesses are forced to accept the high interest rates of the Bank – why are they high – well, because the bank’s inefficiencies can be easily passed along to borrowers who aren’t easily welcomed elsewhere.

The coronavirus impact is not going away the moment a vaccine is in the cards. When it comes to trade, I strongly believe that there is going to be large scale reorganization and a fresh look by the West at outsourcing as a whole. Unless the government wishes the next generation to be a Ninja, we need radical steps that deviate from the past.

As I was writing this, a new podcast came out. Is worth hearing to understand how logic in Monetary Policies have been turned on its head by the US, Europe and Japan.

James Montier on Fear and Investment

Financial Repression seems like a negative word, but the time I think has come to accept the same for a better future for the majority who don’t have idle savings that can help them cruise through life.

I could be very very wrong. Would love to know and learn. Please do share your views either in the comments section here or the #fixed-income channel on Slack.

Should you invest in PMS Schemes

One of the great surprises of the 2008 financial crisis was that investing in Hedge Funds did not really hedge you when markets turned down. You lost as much if not more of what a simple Index fund investor would have.

While India has had a few Hedge Funds, one strong growth area has been Mutual Funds and Portfolio Management Schemes. This is not surprising given that most countries at one point or the other have seen a financialization of savings.

While both Mutual Funds and PMS are sold directly, a greater proportion has been sold by co-opting advisors by paying them a fee that is related to the amount of investment and the tenure of such investment.

This is not a new model and one that has been there for ages. In fact, in one post of mine here earlier I had highlighted how I started in business by canvassing for fixed deposits. The reason for such canvassing was the percentage cut I used to get. It’s amazing when I look in hindsight how for a small cut, we the advisor are willing to put our name at risk with friends and family.

Portfolio Management Schemes are seen as strategies for the sophisticated investor and the way we define sophisticated is that they are able to invest a minimum of 50 Lakhs to get an entry.

Why the high minimums? The idea is that if you have 50 Lakhs, you should be able to take a much higher risk (and hence afford to lose much more). No one wants to lose money, but without risk, there is no reward either.

I am sure most readers are familiar with what a PMS is, so I won’t expand on them but on why I don’t think PMS should be part of your investing basket. Yep, you read it right. My view is that other than the very rare instance, PMS doesn’t really add value to your investment

First, let’s see how PMS are different from a Mutual Fund. The biggest difference is that unlike in Mutual Funds where the funds are pooled and stocks bought for the whole pool with investors allocated units, in a PMS, all the stocks bought stay in your own Demat Account.

Does this really add value? Aashish Somiah explained in a tweet a while back on why this was advantageous to the investor.

PMS has chance to beat due to 1) concentration & no 10% cap 2) no pressure of fund flows 3) ability to charge as low as one wishes
— Aashish P Sommaiyaa (@AashishPS) August 15, 2016

Concentration is the key differentiator between a Mutual Fund and PMS for most part. Take for example HDFC Top 100 fund. It has 53 Stocks in the Portfolio. Most PMS on the other hand have portfolios of size that are 20 or lower. This along with good stock selection makes it possible to out-perform in bull markets though in bear market and sudden bear attacks like the one we saw in March, they are as caught as any other fund, personalized or not.

‘Will fund flows have an impact on your returns? It depends on multiple factors including the fund size. A small fund for instance may be forced to exit good stocks to pay off existing investors who want an exit leaving the rest holding illiquid and maybe bad stuff. This is especially true in Debt funds where funds saw their bad assets grow in size because of exits by other unit holders who were paid off by selling good assets.

But if the fund is of significant size, the impact from others behavior is lower though I don’t think there is an easy way to calculate it.

So, why don’t I think it’s worthwhile to invest in a PMS and instead a Mutual Fund or a Index Fund is a much better option.

The first reason is fees. Mutual Fund fees, especially direct are falling and now available at a much lower rate compared a few years back. Index funds for instance charge just around 0.10% (Large Cap) which is really rounding off error in the long term. You cannot go anycheaper than that for a market that is not the size of the United States.

PMS on the other hand have 2 types of fees. A fixed fee that is anywhere between 1% to 2% and a performance fee that incredibly is not linked to the market but a fixed return. This means that if the market moves up 50% and I generate 50%, I take a cut (above 5% or 10% or 0% hurdle rate). The only silver lining is that many firms do have a high water mark cut off which means that once you have paid a certain performance fee, the next fee calculation will start only above it.

Fees are a hindrance to Compounding. Longer the holding period, more the impact of fees. In 2018, Vikas Bardia wrote a post showcasing the difference in returns if Berkshire Hathway was a 2 and 20 Hedge Fund Manager. The clincher?

However, if instead of running Berkshire Hathaway as a company in which Buffett co-invests with you, had he set it up as a hedge fund and charged the usual hedge fund fee structure of 2/20 (i.e. 2% management fee + 20% of any gains), then the ₹10,000 investment would’ve only become ₹89 lakhs — the balance ₹10 crores would’ve been pocketed by Buffett as fees!
Vikas Bardia

The second impediment is tax. Till 2018, Long Term gains were tax free and till 2020, Dividend tax was paid by the companies. Both have changed and are negative to PMS investors versus Mutual Funds for PMS investing is treated to be the same as Individual Investing with taxes being paid every year.

Mutual Funds, Index Funds, PMS, AIF have all one thing in common – churn. Some are high, some are low and churn has costs that are common to all of them. Whereas the churn of your mutual fund will not mean anything for you, churn in the PMS needs action from your end in either having to pay the required taxes or claiming the losses for future set offs.

Launching a Mutual Fund requires 50+ Crores in Capital and 5 Crores (was 2 Crores until recently) in Capital for PMS. It’s not surprising to see the huge number of funds. I myself was until recently involved in a Portfolio Management company but unlike others we offered differentiation in terms of being able to have your own asset allocation mix and a price momentum portfolio that for now has no competition.

With more funds chasing the very same stocks, it’s not easy to really differentiate one from another. Finally, when investing for the long term, fees really add over time. As a saying goes, The only two certainties in life are death and taxes – we cannot avoid death, but we can to an extent save on Taxes.

Life is all about Trade-Offs

Most of our investing career is just built around 20 to 30 years. The initial part is spent figuring out oneself and the strategy that suits oneself. The last part is mostly reaping the benefits and moving to a safer and income driven strategy.

Depending on how much you can save, the 20 to 30 years can provide for very strong growth in your asset base. But the issue is that once every decade or so, you will face a situation which makes you question everything you know and believe in.

Regardless of what kind of investor you are, there are always trade-offs to be made. As a discretionary investor who studies companies, bottom-up, there is a limit on how many Industries you can study and learn enough to be able to bet significantly upon. A systematic investor on the other hand has to make choices when he is building his algorithm.

We make trade-offs all through our lives. When we finish our 10th Standard Exam, we need to take a decision that will have an impact all through our life – should we take up Science, Commerce or Arts being the monumental question we are faced.

For Science, the trade off continues as they finish 12th. Should I go for Medicine, Engineering or pure Sciences? Each decision has a certain pay-off – if it works, you congratulate yourself all through your life for a well made choice.

When it comes to investing, it’s not very different. Should you invest on your own or should you invest in a mutual fund. The choices don’t end there. If you wish to invest on your own, what philosophy should you choose – Value, Growth, Quality or Momentum or a mix of them. When it comes to Mutual Funds, every fund house has a dozen or so funds trying to provide for any segment you may wish to invest and there are 41 such folks.

For the last two years, being a large cap investor would have provided you much better returns than a Mid or Small cap investor. But pull back a bit more, say 7 years and it’s not so much clear for quite a few funds outside the large cap universe provided similar if not better returns.

Franklin in the debt fund space had made a name for itself by producing superior returns. But when the chickens came home to roost, some of the Alpha got wiped out. But that is the nature of return – higher return comes with certain caveats including risk of capital loss.

Asset Allocation is a trade off. When you choose a conservative model, you are letting go of the upside for more protection on the downside. Today, it feels awesome to have a draw-down in single digits, but that is the trade off you made by willing to not having a large equity exposure.

I track PMS returns every month since unlike mutual funds, there is no publicly available database I know of. Anyways, one recent addition to the list I track is a multi-cap pms but one which I was told was more small cap oriented. The return since its launch (2013), an awesome 26% as of end february. The negative, well, even before we hit Corona, the fund was down 50% from its peak. At its peak, the CAGR was an incredible 60%. While it’s normal for their clients to feel bad about the recent performance, for those who came in early, the return vs risk is still very much acceptable.

If you are getting into equities today, you have a trade-off to make. Should you choose the well known large cap firms or the beaten into nothingness small cap. Few days back, I ran a poll asking where people were investing. 2 days back, I saw a similar poll by a AMC head. In both polls, very few claimed to be investing in small cap with Large cap being the first choice. Once again, the Risk and Reward is different for both choices.

As a quant, we make choices when we build every model. The Asset Allocator model for instance is worried about taking risks, the Momentum Model on the other hand is 50% invested even today. Different goals, Different strategies.

In the United States, it’s said that there has been a flight to safety. Investors as usual are fearful, not just about markets but about future prospects as job losses climb to numbers never seen. It’s once again a choice between probable future gains in equity vs the pain of continuing losses especially if that comes in even as one is unemployed.

Choosing the trade-offs themselves is tricky. In good times what trade-off you may feel is acceptable may not seem like a good trade-off when the times turn around. Ask Softbank as it tries to recuse itself from buying 3 Billion Dollars of We Work shares it agreed upon when times were better than its today.

In hindsight, we often feel that there was no trade-off to be made and the choice was very easy to make, but the reality is that there is always one. How you play it and the results makes us look back and think differently on the choices we were offered.

The world today appears dark and bleak. It’s like a tornado has hit the town and we are in the dark in the Shelter. When we go back, things may not be the same, but human nature rarely chances in a matter of days let alone years. Investing should be driven by such constructs. The portfolio may not be “Antifragile”, but our behavior can be.

Staying the Course

In January of this year, I made a pretty massive investment for one of my family members in a mutual fund whose philosophy I strongly believe in. I had the option of investing in the Liquid and doing a Systematic Withdrawal Plan to invest in Equity or invest in lumpsum. My own testing has shown that its basically a coin toss on which is better and I opted for the Lump Sum.

Today, that investment is down 24% and it pains me that no end. But this investment was done not for any short term goals but a goal that is 18 years away at the minimum. While the bad start point will do doubt have an impact, I think that the investment based on my assumed return will still meet the goal.

I came across this tweet today and while I did pass a sarcastic joke, the fact remains that the best thing to do if you continue to believe in the fund and their philosophy is to just sit tight

https://twitter.com/_Mutual_Funds_/status/1246464026051141632

This is not to say that the fund will perform according to one’s expectation, but unless you are a professional, I can say with 80% confidence that over a long period of time, you will find it tough if not impossible to beat returns generated by the majority of funds while investing directly in stocks.

When we invest in stocks, we are not just managing a part of our money but need to act as our own fund managers. But we are in many ways handicapped – from our ability to research the companies we wish to invest in to our own behavioral biases which do not allow for acts like cutting the losses.

DSP Blackrock Micro Cap Fund in 2008/09 fell nearly 75% from the peak. Subsequently though, it rose from a NAV of 4.50 to a high of 73 in January 2018. This was accomplished I believe by not just sitting on the portfolio of 2008 but being active.

I don’t know when this bear market will end or how long it will take, but data shows that unless you are able to catch the absolute low, you are better off just staying the course. For instance, I checked the difference in one’s return if one invested 3 months before the final low and 3 months post take off when it became clear that the crisis had passed off. Being early was as damaging as being late. Since the 3 month prior and the low can be known only in hindsight, this is at best a theoretical exercise with no practical value.

Mutual Funds wish that you keep sipping to infinity regardless of the underlying markets. But if you were to be practicing any sort of asset allocation, you know that just the market returns alone can significantly boost your equity exposure. When times are good, it’s best to sip into debt and when times are bad, make the switch the other way.

The reason for every bear market is different and yet the final outcome is similar – the weak get punished, the strong survive and later thrive. As a theoretical exercise, it’s interesting to wonder if we could have exited before the big crash arrived, but if everyone thought the same, one needs to wonder if there would have been a market to sell.

Personally I practise a medium to long term form of momentum investing which means my exits are not quick enough in crashes such as these. But history has taught me that if I stick to my system and the signals, I will be able to generate a return that helps me in achieving my goal. To me, that is the final objective.

The Corona Virus doubtless will change a lot which means that a lot of companies will end up on the losing side of the battle. By buying an Index or a fund whose philosophy you strongly believe in, you should be rest assured that the winners will most probably be part of your portfolio while the losers are ousted. Finally, that is what matters between the Winning Portfolio and the Losing Portfolio.

Twitter Polls and Markets

If you were wishing to conduct some large scale social experiments, there seems to be no better medium than Twitter. Given the wide diverse audience, this provides for a nice mix of what people are thinking. That said, since it takes just a click to answer, not every poll will provide you the right context or meaning.

Take this poll of mine for example that I conducted on March 9 (Nifty @ 10,450)

How is the josh?
— Prashanth (@Prashanth_Krish) March 9, 2020

Just 8.9% were selling and in hindsight they seem to have hit the nail right. I of course was kind of mixing between Buying (a bit) and Chilling. Who knew that one can develop hypothermia so fast 😉

Anyway, not satisfied, I decided to another one (Nifty still at 10,450)

Is it too late to panic? #AskingForAFriend
— Prashanth (@Prashanth_Krish) March 11, 2020

Given just 2 options, the audience was evenly split. And Yet I did not. To add, I actually wrote a couple of posts around the time Corona started to break out expressing the view that everything would get better and it wasn’t really going to go bad. Man, was I wrong.

My personal investments in Equity are basically whole and sole in Momentum. Other than ELSS funds, I own no other Mutual Funds that are equity oriented. But when I say Momentum, it’s interesting to observe most to think it as some sort of trading even when the logic is systematic and universal in approach versus just random stock picking based on charts.

So, as usual I asked Twitter for an answer.

Assume you have 2 Portfolios. One Short Term Picks, another Long Term Picks. Now, both go down 30%. Which makes you feel more sad {Amounts invested being same for both}
— Prashanth (@Prashanth_Krish) April 2, 2020

As I write this, more than 50% say they would have felt sad to have lost 30% in a portfolio that picks stocks on short term (Momentum) versus just 16% who would feel the same in a portfolio that has long term picks.

The result is not a real surprise to me since I have seen even die hard momentum investors claim this to be some sort of high risk portfolio and hence more of being a satellite versus a long term portfolio that is seen as the core.

It’s similar to the behavioral study that has shown that people tend to spend more when using Cards versus using Cash. Advent of online ecommerce sites that allow for one click buying and home delivery allow for even more instant gratification (I write this looking at my own bookshelf with books I am yet to read but couldn’t stop myself from buying more).

Mutual Fund returns for the month. This from Valuepickr

I have sorted the same by Month Returns, Worst to Best. The fall has been of such a nature that it has not only destroyed the returns of the year for most funds but also pushed into negative territory most fund styles for 3 years and a few even in the 5 year time frame.

Investing needs to be for the long term, but long term investing is fraught with uncertainties and dangers that is barely discussed for long bull markets makes one forget that one also saw long period of bear markets in the past.

A disclaimer before you go further. All my recent views on the Virus and its impact have turned out to be totally wrong. The only ability that I have is for now sticking to my system even when the gut screams for me to break the rules this one time.

The 2008 bear market was one of the worst bear markets to hit the Indian Markets. But the one that was even worse? The one that started in 1992 and came to an end in 1999. If you were to believe Indian Astrology, you would have heard about Saade Sati.

The 2008 was mostly a walk in the park for anyone not associated with Capital Markets. Life went on for the vast majority of folks and even though the Real Estate Index has never recovered (it’s even today down 90% from its peak), Real Estate enjoyed a few more years of boom till the stagnation came in.

The coming bear market is going to be nothing like that given how much of an impact the current crisis has been having on an ordinary citizen. At some point things will return back to normal, the question is how long it would take and what is the damage we shall see in the interim.

When markets fell in 2008, Infrastructure firms and Realty firms whose Balance Sheets were loaded with debts were those who found the bottom giving up. This time around, even firms with low leverage but falling into categories where shifting consumers trends can create havoc.

What is currently happening is unprecedented and hence the previous market behavior may or may not be of significance. We have no way to gauge the depth or the length of this bear market and its impact on our lives in ways we wouldn’t have thought about in the good days.

Targets of 6500, 3000 and 666 (on S&P 500) are being thrown about as if coming down there will have no impact on the real economy. While the last time around, throwing money was sufficient to lift the sentiments and the economy back on track, this time around, we have a Virus which has no use for Fiat money or Gold for that matter.

Unlike US which can go with a multi trillion dollar rescue package, options for India is very limited. In the longest bear market (1992 to 2001), Inflation was mostly in double digits and Interest Rates compared to today were mouthwatering.

The social and economic cost of this bear market is not something that may go away soon even though we all hope for a fast recovery. Of course, I maybe too skeptical and we may be back to new highs in this year itself, but the odds at the current juncture seem pretty remote.

A dislocation for the Ages

It was 1990 and as a citizen of Iraq, life was seemingly getting better. The long war with Iran was over and while GDP growth was nowhere close to what one would have loved to have and one they had seen before the war with Iran, at least the future it seemed was better. In August, Saddam Hussein decided to invade Kuwait and life has never been the same again.

Countries go through different kinds of dislocation – some temporary, some literally permanent and in between Millions live their lives. Since 1900, literally every country has gone through a period of short or long period of dislocation that has changed life as they knew it before.

When we look at such a large canvas, the current crisis concerning the Corona Virus and the month long lock down India will be enduring looks fairly small. Yet, the implications of shutting down much of the country for a month has a long lasting impact that we cannot fully visualize.

Replacing a one month of no activity can easily take a year or two and even that assuming that the firm is able to survive. The Financial Crisis of 2008 laid to rest the high flyers of the previous years – Infrastructure and Real Estate firms. This time, one wonders who will be the ones facing the firing squad.

But India will move on and that means at some point, Valuations become attractive enough to overlook the immediate risks. The recovery from the 2008 crisis was fairly fast, the recovery from the 2000 crisis took a few years, the recovery from the 1992 crisis took a decade and a bit more.

It’s hence important to reassess our goals and our time frames before jumping into the boiling pit solely because valuations are cheap. What matters more is our ability to sustain for long without support from the markets.

This time its’ No’ Different

Markets Falls are common though we had the uncommon pleasure of not falling big for nearly a decade. What differentiates this fall from others is the fear that the world may never be the same again.

Almost all falls of the past are those that were caused by financial stress or bubbles caused by easy money policies or scams. This is the first real crisis caused worldwide by something that couldn’t have been foreseen.

Personally, I got it Wrong. As the Corona Virus started to make news, I tried to update myself on as much as possible and try to decide the future course when it came to my portfolio. The only similarity I could see is the Spanish Flu.

The American Market was the only one with reliable data I could rely upon. This was the performance of the Dow between 1918 to 1920.

At the time of the start which could be categorized as late 1917, Dow Jones was on a decline. From its peak in November 1916, it had fallen by 26% by September 1917 and fell a bit more before it bottomed out in December 1917.

In fact, by the time it ended, Dow was actually in the positive zone. Maybe this was a wrong example to look out for or maybe the impact then was smaller than its today, whatever it is, markets today are looking worse for the wear.

Yesterday, I popped this question on Twitter

https://twitter.com/Prashanth_Krish/status/1241242995300564993

Thanks for all those who responded.

One difference or this may be due to the nature of the media is that most people are not selling out in panic with most wishing to add more given the opportunity they feel this market reaction is providing them.

What the market does is not something in our hands, but our actions are entirely in our hands. Personally, I regret being unable to exit completely at the start or even post the first gap down. Then again, I was sticking to what my System was telling me and even today, the system has not gone fully into Cash.

Recently, I was reading Stocks for the Long Run by Jeremy Siegel. In it, he narrates a interesting episode which I quote,

In the summer of 1929, a journalist named Samuel Crowther interviewed John. J. Raskob a senior financial executive at General Motors on how the typical individual could build wealth by investing in stocks.
Raskob’s idea or plan for the retail investor was that by investing just $15 a month into common good stocks, an investor could expect to grow their wealth to $80,000.

A 24% return then as is now seemed ridiculous, but then again in the decade of 1920 to 1929, Dow had risen from a low of 64 to a high (set a few weeks after the interview) of 383. That is a compounded return of 25% per annum over 9 years.

But like the Magazine Effect, the Interview came close to the top, a top that was not breached for 25 Years. Yet, for some one who started investing systematically based on his interview was better off than a Bond Investor in just under 4 years. What did not happen though was reaching the 60K target, it ended at 9K.

The key to reaching our goals depends on two key factors. The amount of savings we can mobilize and invest and the returns that the said investment can generate. Equities is a preferred route for those who understand the risks over the long term, they have generally and I use the term generally because it also showcases that equities don’t work all the time, they have provided a higher return.

But when we say long term, it doesn’t mean the taxman’s definition of 1 year or even teh 3 to 5 year period used by most fund houses to sell their funds. Instead, one needs to be invested for a minimum of 10 to 15 years to reap the benefits.

Asset Allocation has to be the key decision for a mistake here has as much an impact as picking up a lousy fund or stock. The maximum pain point you can afford to bear is not something that is easy to locate in good times, it’s only in bad times you come to know what level of exposure was okay and what was not.

If we can agree that when this all ends, we will not end up in a dystopian society or become zombies, at some point the market will settle and then bounce back. No one knows which that level is which means that all predictions are just that, predictions without any greater chance than one you can come up with using a random approach.

As I wrote in my previous post, historically markets have bottomed even before the end of the bad news. Same would be the case here too. Stick to your method, there is no better alternative as long as the method has been tested and found to be something you can come to bear.

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