Portfolio | Portfolio Yoga

2 Years of Momentum Investing – An Overview

“When the student is ready the teacher will appear. When the student is truly ready… The teacher will Disappear.”― Tao Te Ching

2017 in hindsight was a fantastic year for the change in scenery from Bangalore Stock Exchange where I had spent a better part of my time since I came into the market made way for time at the office of Capitalmind.

I have been a systematic trend follower for a long time, but owing to reasons including running inadequate capital, I had never ventured into Systematic Investing in the way I did post my joining Capitalmind.

I wrote about my first year of Momentum Investing last year and thanks to a run-away market, the outcome was way better than what I could expect. 2018-19 though has turned out to be a test though given my own experience in markets post the dot com bubble and the infra bubble of 2008, this isn’t anywhere close to the worst one could expect, it did provide with a deeper look at what to expect and how things could change rapidly.

Two years is still a small period and the performance can only be ascertained to be good or bad post at least a decade. Yet, more the time spent on an endeavour, better one’s understanding and in that respect, 2018 while not fruitful in terms of gains was a good year in terms of understanding the points of strength and failure of the strategy.

When I started trading the strategy, it was more rudimentary in approach based on available data sources. The back-test too was on a smaller data sample. This year, thanks to my friend and mentor, @jace48, I was able to test the strategy comprehensively for the period starting in 2005.

Testing on a long period of data allows one to get a better feel for the strategy though a back-test can never replace real application with all its issues. But without a back-test, risking real money is equivalent to betting blindly in the hope that Lady Luck will always be in one’s favour.

The Back-Test

The strategy was back-tested for the period 2005 to 2018 using the same attributes and filters that is being used in the real world. Since slippage and others costs aren’t taken into account, we need to be aware that the results could slightly overstate the reality. To compensate for that, the returns below were adjusted by removing 0.50% per month (6% return reduced per year)

Of the 165 months in which the strategy was tested, the strategy delivered positive returns in 106 of them versus negative returns in 59 months. 2008, 2011 and 2015 were negative years reflecting the general trend of market being weak during those years.

Momentum or for that matter, any strategy that is long only will fall mostly in line with the broader markets. Risk measured through draw-down from peak or even Volatility of returns and Return compared to other available asset classes are the only way to test whether a strategy is worth pursuing or not.

The results showcased above are for trading a portfolio of 30 stocks, rebalanced monthly. While the logic was 30 was to compensate for the fact that when we trade using momentum, we aren’t really looking to understand neither the nature of the business or the cycle it currently is, testing for different portfolio sizes showed up exactly the same. The optimal portfolio size is between 25 to 30 stocks.

50 Stocks offer the lowest draw-down but returns dwindle as well. On the other hand, if one were to trade just 10 stocks, returns go down the drain while risk explodes. A 50 stock portfolio can be seen as advantageous even though returns are a bit lower if the capital is too large and liquidity is starting to hurt deployment. In most other cases, 25 – 30 stock portfolio should suffice.

Draw-down comparison shows how deep the 10 stock portfolio moves in 2008 versus the best (among the worst) which is 50 stock portfolio. Excluding 2008, while others get close to merging with one another, the 10 stock portfolio draw-down stands out as the worst at any point of time.

Now the Reality:

In 2018, the strategy delivered a loss in 8 of the 12 months. But the standout was that the loss for the calendar year was just 15.57% which was more inline with performance of Nifty Mid Cap 100. This even though we began the year with a median portfolio market capitalization of just 5000 crores which put the portfolio well and truly into the Small Cap bracket.

Confidence in strategy is the only way one can sustain the barrage of weakness we saw in markets and which was reflected in the portfolio loosing for a consecutive 6 months through 2018-19. If not for the back-test and the reading which provided a better understanding of what to expect, its easy to see why investors would rather cut position and wait in cash than continue to take all trades as the strategy expects one to.

The portfolio had a max draw-down of 25% though its bit disappointing to see that we haven’t yet recovered from that fall with the current draw-down still at 20% from the peaks we had reached in January of 2018. The equity curve chart pattern though offers some hope J

Be it Momentum or Value, strategies that require one to track portfolio’s, change as required and be up to date on what’s happening if only worth the time and trouble if the returns are more than what one could have achieved by just buying a simple ETF or Mutual Fund.

Since the momentum strategy is agnostic to market capitalization, the best benchmark would be the performance of multi-cap funds over the same period. The best fund over this 2 year horizon is SBI Focussed Equity Fund which in its Direct plan which delivered a CAGR return of 15.37%. Adjusted for AUM, the overall returns from all Multicap funds came to 9%.

Comparatively, despite the multiple months of negative returns, the strategy ended year 2 of operation with 18% CAGR returns. While this is still below what top class fund managers target and return, given the early days and the overall market environment, feel its not something to sneered at.

Here is the NAV chart from start;

I have compared the performance against Nifty Alpha 50 since that is the index that matches the philosophy of the system though it being limited to the top 200 stocks works against it during good times while saving it during bad (lower draw-downs).

Recently, well known Value Investor Rohit Chauhan shared the performance of advisory model portfolio over the last 8 years. What was amazing was that the performance was very close to the back-test results of my own Momentum Strategy (with Momentum doing slightly better). But better or worse is not the question, the fact is that systematically following a strategy can for the investor deliver more than what markets in general can.

I hope that I can continue to invest and grow the capital and showcase a decade of performance 8 years from now. This post is an attempt to enable a better understanding of momentum as an investment strategy that can stand against other factors on its own merits.

I had recently given a talk at Bangalore Investors Group. You can check out the slides here.

Dogs of Nifty 50

Dogs of the Dow is a very old strategy strategy popularized by Michael B. O’Higgins in 1991 (Wiki Link). The concept if you aren’t too interested in checking out the link is to buy the top dividend yielding firms and holds for a period of 1 year before a new set is selected and invested therein.

On the US markets, this strategy has shown promise as per stats (Link). I haven’t back-tested the same on Nifty 50 though I would assume that the risk of such a portfolio would not be too different from holding a portfolio of all Nifty 50 stocks.

So, here are the Dogs of Nifty 50. Will check back on this in Jan 2018 to see both the performance and the changes required for the forthcoming year.

Cost of huge Returns

Michael Batnick who is Director, Research at Ritholtz Wealth Management tweeted out the following chart of Amazon

Implicit in the message (my presumption since nothing was blogged / tweeted) was that its not enough to buy a great stock, you need to have the stomach to take big draw downs like Amazon say (90%+ after the IT bubble crashed in 2000).

But what is missed is the fact that Amazon was one of the very few survivors of the carnage of the 2000’s. While I don’t have the actual stats, my guess is that greater than 80% of the stocks that were listed at that point of time don’t even exist (in any form) today. Pet.com / Webvan.com / eToys.com being some of the biggest losers.

The same is the case with Indian IT stocks as well with very few surviving the carnage. In Bangalore which was and has been a Infotech hub, we had stocks like Shree MM Softek, International Computech, Cybermate Systems among others (50 IIRC) that no longer even exist. Bigger ones you may remember would be Pentafour Software / DSQ Software / Aftek Infosys among many others.

Returns don’t come from suffering unbearable draw-downs. Returns come when you are able to balance out the risk with probable rewards and if your stock is down 80% or more, you have a 20% or lower chance of ever getting your money back. Things like Amazon / Apple happen, but only in hindsight do we recognize the great opportunity that it was.

And last but not the least, while its seem one easy way to avoid total destruction would be to be well diversified, it has to be across asset classes / sectors / industries. Buying 10 NBFC companies (Today’s hot sector) or 10 Pharma would either make you very rich or very poor and is not definitely for someone who wants to achieve returns greater than what a simple Index fund would provide.

A small table listing out % of stocks that are at different draw-down levels. Remember, these are those who survived and continue to be listed – many don’t.

Managing risk using Put Options

One of the ways to manage risk of a portfolio it is said is by buying Out of the Money puts so that in the event of a market meltdown, one’s portfolio (assuming total correlation to Nifty) will be protected from the point where Put option gets in the money.

Since options are expensive, there is no point buying a At the Money option but if you were to buy a Out of the Money Option, it comes pretty cheap (more like a Term Insurance Policy). If market drops catastrophically as ZeroHedge predicts day in and day out, the option can save the distress by ensuing that losses aren’t as huge as one would experience if one is unhedged.

But is it a worthwhile strategy is the bigger question and for that we really need to test based on some real data.Testing option based strategies can be a real nightmare given the amount of data we have and unless one has some good programming skills, it can be tough.

But we have CBOE to thank here since it runs a Index called CBOE S&P 500 5% Put Protection Index (PPUT). Following is the description of the said index from the CBOE site

The CBOE S&P 500 5% Put Protection Index is designed to track the performance of a hypothetical strategy that holds a long position indexed to the S&P 500 Index and buys a monthly 5% out-of-the-money S&P 500 Index (SPX) put option as a hedge.

The PPUT Index rolls on a monthly basis, typically every third Friday (OTM)y of the month.

In other words, this Index replicates what you would stand to gain by having a long S&P 500 hedged by puts (at 5%). So first lets see the historical chart for the said index. Remember, the chart is one of Gains / Losses accrued through being long S&P minus the cost of Options bought.

While not shown in the chart above, the draw-down in 2008 / 09 was to the tune of 41% vs 53% suffered by S&P 500. Lets now move on to a chart that compares this with the S&P 500.

In other words, lets compare this performance with that of S&P 500 and see if the cost we are paying has benefits.

What one observes here is that some one who held this index was almost all the time under-performing one who had just bought and held onto the S&P and the only time the twain did meet was in Feb 2009 when for a brief moment of time, he actually held a upper hand.

The under-performance is guaranteed given the fact that the investor of the Put strategy needs to keep buying puts which got way way expensive as markets cratered in 2008 / 09. But is the whole thing worth the trouble?

You may say that he will get a slightly better benefit if he compensated for the cost of puts by selling out of the money (5%) calls. But as we very well know, Put options (due to a variety of reasons) are always more expensive than Call Options. Just to give you a idea, lets take the case of Nifty 50.

Nifty current month futures closed at 7568 and if you had to hedge at 5%, that would mean buying 7200 puts (rounding off from 7189) and selling (to compensate for the Buy Call options of strike 7950 (rounding off from 7946). On Friday, the 7200 Puts closed the day at 35.50 while the 7950 CE closed at 11.40 (nearly 3x the price of Puts).

There is no simple way to avoid market crashes and the only way to ensure one has lesser pain is either by trading some kind of timing system or having a higher cash component / lower leverage. Buying puts while sounds like a nice theory will only end up enriching the seller of the option for most of the time.

Debt and Investor returns

Growth is rarely possible without some amount of debt, at least at the initial stage if not later. But while some companies try to pay of their debt as soon as situation becomes better and internal accruals can fund their needs, some promoters get addicted to cheap debt and many a time end up destroying what was build over decades, even generations.

While the advise generally is to invest in good companies which have very little (or better Zero debt), the question I am asking here, is what is the difference in returns. To get to the bottom of that question, I did a small test.

I selected the top 50 (based on Friday’s Market Cap) Debt free companies and selected the top 50 companies with the largest debt. Since Banks / NBFC companies cannot go without debt, I excluded such financial firms from my test. The test though suffers from Survivor bias since all the data is from Friday and any company that has got delisted from exchanges due to Debt goes scot-free as such.

The first chart is of the returns generated by investing 10,000 into each company shares (since this is more of a theoretical exercise, fractional shares were allowed to be bought).

While one would expect Zero Debt companies to beat High Debt companies, the picture above seems to indicate that while Zero Debt companies would have beaten High Debt (though both end in losses, remember our total investment was 5,00,000.00) if you had invested 1 year back, on the shorter term, the High Debt companies have given stronger returns if the same was done just a month back. A Quarter back, it was more or less a draw.

What does the above data show? To me, it suggests the importance of timing regardless of the kind of company you are investing in. Now, lets explore this idea and use a much bigger data set (in terms of look back time). Instead of the max period being 1 year, how about we see how this would have worked over 3 / 5 and 7 years.

There is a issue here though – some companies were not even trading 5 / 7 years ago. To make the comparison uniform, I have assumed that they generated Zero returns (i.e., capital remained the same at the end of the period).

While high debt companies may have given some amount of competition on shorter time frames, on longer time frames, its beaten black and blue. Of course, do note that one will need to make a more detailed test since 7 years back, some of today’s high debt companies may actually have had low or even Zero (looking at the list I doubt, but better to be wary than accept facts blindly).

Change in difficult

I am a sucker for quality writing and twitter has exposed me (and anyone interested) to a host of writers who are able to produce writing of a quality that is seldom available (and much of this is actually free, think about that).

Just this morning, one of the bloggers I never miss to read tweeted this

People in the investment industry spend far too much time trying to convince others about things they’ll never change their mind about

— Ben Carlson (@awealthofcs) September 24, 2015

Reading the above tweet made a lot of sense of why despite tons of data and articles, investors rarely make the right choices. Changing one’s view requires one to first accept that the current view maybe wrong and who in the right mind can accept that challenge.

Writing in his novel “Unwind”, there is a dialogue between two characters and I quote

You can’t change laws without first changing human nature.’
-Nurse Greta

You can’t change human nature without first changing the law.’
-Nurse Yvonne”

The finance industry is one where investors are taken for a ride and most of the time its despite the investor not being as clueless as he is supposed to be.

Take for instance the huge industry of advisory, specifically stock advisory. Just a simple google search for “Nifty Tips” gives me 3,38,000 results. Adding more options will (Commodities, Stocks, Forex) will needless mean a even bigger number. While there would be some amount of overlapping, I am sure we can hypothesize the size of the Industry.

With a intention to regulate the Tip Community, SEBI came out with new laws making it mandatory for Advisers to register with SEBI. When I checked the list yesterday, I could find 313 (not all of whom are Advisers who advice on what stock to Buy / Sell) which IMO is too minuscule a number. I am pretty sure that if you were to watch all business channels for a week, you will find more advisers than that number.

But leaving aside that, while in a previous post, I welcomed this attempt to regulate by SEBI, I had my worry on what exactly it would mean other than the fact that you had to put in a registration form and pay a fee to SEBI.

In a age where most of us stumble on managing our own finances, advising others isn’t easy and yet, there is nothing to say that a adviser needs to have some professional qualification (and am not speaking about MBA either).

Earning any degree requires one to master the art by studying for years and then passing the exams which try to determine how good your concepts are. But what if I was given a degree for just registering and paying a fee? You would straight away tell me that all I have is a “fake” degree.

Just today morning, a financial adviser writing in a Financial paper wrote and I quote

“Have a mix of around five asset management companies (AMCs) for a portfolio; and a choice of two-three schemes within each AMC”

With 15 schemes are you really better off than having say 2 schemes? Is there any data backed evidence to say buying more funds (which have plenty of overlap of portfolio given the fact that the whole Mutual Fund Industry has very few stocks which it can easily pick) will provide one with a lower volatility of return?

I have in the past written about why Direct is the way to go for the Investor (if he is inclined towards mutual funds) and yet, the whole business of distributors passing themselves as advisers is a never ending saga. Is your distributor really providing you with information worth paying for?

These days, its all about investing in SIP for long time with the anticipation that thanks to compounding, you will be able to reach your goals?

The other day, I tweeted this picture

This is based on test I did on Sensex (n = 417). How many advisers have preached that, there is this possibility of the fact that the market value of your investment after 10 years of constant Sipping month after month could still be in negative territory?

I have not used MF data for above test since I do not have access to Survivor Free Mutual Fund databases. Using data from websites shall give you wrong results since they don’t include funds that failed and got merged in between. All you see are the winners.

To me, Advisory is one of the easiest way to earn a living in markets. No one has a clue other than the fact that maybe he is a better salesman than you. Yet, people pay good money to listen / invest on recommendations by folks who are able to talk their way through bullshit if need be.

A ex mutual fund manager who has a terrible record as a Portfolio Manager is now a SEBI registered analyst and comes on Television advising one and all. Do you really want to listen to guys such as these whose own history is strewn with losses (and that too in bull markets no less).

To conclude, I am not surprised to find reports suggesting that the average investor severely under-performs the market (based on US data). After all, he has made up his mind on the fact that Passive is bad and Active is good and no amount of good advise is going to change that.

Post Script: The pic had wrong data for Best Gain and Worst Loss. Thanks to Karan for pointing it out

Permanent loss of Capital

One of the often quoted reason to invest in the stock market is that they have delivered XX% returns since 1979. This of course is bullshit given the fact that Sensex did not even exist in 1979, let alone a retail investor have the avenue to invest in its constituents.

And then there is the tales of how investing just 10K in 19xx would have turned into Crores of Rupees today. Just today, on Whatsapp I received the following message

Motherson Sumi announces :- 1:2 Bonus on 10th June’15
See Wealth Creation of Motherson Sumi :-
Motherson came out with IPO at 25 INR per share in April-1993
Only 2500 INR of investment on 100 shares.

The Company’s Bonus History and Multiplication of Shares as follows :-

1997-98: Bonus 1:2 – 100 shares became 150 shares
2000-01: Bonus 1:2 – 150 shares became 225 shares
2002-03: Split into Rs.5 paid up – 225 shares became 450 shares
2003-04: Split into Rs.1 paid up – 450 shares became 2250 shares
2004-05: Bonus 1:2 – 2250 shares became 3375 shares
2007-08: Bonus 1:2 – 3375 shares became 5062 shares
2012-13: Bonus 1:2 – 5062 shares became 7593 shares
2013-14: Bonus 1:2 – 7593 shares became 11389 shares

So, 100 shares became 11,389 shares.

Current market value of 11,389 shares=
11,389 shares*Rs.489(Current Value)=55,69,221 INR

So, Total Value of Rs.2500 invested in IPO including cumulative dividend is Rs. 56,71,602 as at 10th June, 2015.

Thus, 2268 times increase in Investment Value in 22 years!!!

Patience is bitter, but its fruit is sweet

The compounding is really amazing but what the message does not say is that this is Selection Bias at best. While Motherson Sumi survived and thrived, there are thousands of IPO’s which came in the same era and which are not even listed on date.

If you had invested 10,000 Rupees (which in 1993 represented maybe a couple of months salary for any mid level employee) into every IPO that came out in 1993, I can assure you that your returns today, adjusted for inflation would be measly at best and disastrous at worst.

That does not mean, no one has invested and held on to great shares. There would be quite a few such folks who would be sitting on tremendous returns realized from those investments. But the reason for them to hold would be far away from any fundamental or technical arena.

These days, I find many a folk advising one to invest directly in the markets despite the fact that the probability of a investor really outperforming the market on a long time frame is in the low single digits. We are told to invest in blue-chips, but how many blue-chips remain blue-chips over a period of time?

Yesterday, I finished reading a book written in the aftermath of the 2000 bubble. Its amazing how easy it was then (as it seems to be even now) to manipulate the small investor / trader to buy stocks that are touted as the next big thing.

While 2000 was purely a Infotech led bubble, the 2008 bubble was much broader and hence I wondered as to how many stocks have survived over the last 7 and a half years and what has been the return between then and now.

The results as shown in the tables below is literally devastating. Many of the stocks which traded in the high 100’s and even above 1000 are now more or less trading or were de-listed at pennies.

Take for example a stock like Koutons Retail. The stock which came out with its Indial Public Offering in September 2007 was over subscribed by 45 times when it offered its shares for sale at 415 Rupees (Link).

With markets in full flow, almost all major brokerage houses / newspaper recommended investing in the same.

Koutons Retail: Invest (BusinessLine Review)

An investment with a one-year perspective can be considered in the initial public offer (IPO) of Koutons Retail India (KRIL). KRIL is a player in the menswear segment with a network of stores mainly in northern and western India. The offer proceeds will help the company expand its retail network.

The price band of Rs 370-Rs 415 values the company at 33-36 times its 2006-07 earnings per share, on an expanded equity base.

KRIL’s premium pricing appears to factor in higher growth rates compared to domestic apparel majors such as Raymond, Zodiac Clothing and Kewal Kiran Clothing. The latter trade at price-earnings multiples of 15-20 based on trailing earnings.

However, KRIL’s performance over the last couple of years and its proposed expansion plans provide some justification for the higher growth expectation.

The expensive valuation for the offer, however, does not provide a margin of safety in the event of disappointing performance. This makes it suitable only for investors with a high risk appetite.

While the huge over subscription would have meant limited allocation, investors who did get a small piece of the cake were left happy with the stock moving higher. In fact, so good seemed this stock that even as rest of the markets were getting slapped in early 2008, Koutons made a new high in late February (by which time, Nifty was down 17% from its peak).

The slide started from then as markets tumbled even further and even Koutons caught onto the fever. But Brokerage houses were not one to be moved by this volatility as they continued to recommend the stock even as it went down the rabbit hole.

Some of the few brokerage reports I could find can be downloaded here (Koutons Research Reports). Since their publication, the stock had gone just one way – down the rabbit hole so as to say, but while I could find Buy Reports, I found Zero sell reports. The reports though seem to completely stop in 2011 with the stock having breached the 100 mark as well.

Yesterday, I tweeted the complete list of winners and losers. For those interested, here is the spreadsheet with the same data for you to check any company you would like to. (Link) Do note, that most of these prices are adjusted for Splits / Bonus and hence the actual closing prices may have been different for a few stocks. Add to that, some stocks which got delisted / merged and where the earlier ticker bore no resemblance may pop up, apologies for that.

Also, this list is only of those stocks that are listed on NSE. (Link).

To summarize, Direct Investing while seeming to be way more attractive than investing via a Mutual fund can be very expensive in terms of your ability to meet your goals as also enable your savings to grow if you are not able to choose the right stocks. But what are the right stocks becomes the bigger question when stocks supposedly great end up on the mat.

If the mutual fund universe were to be scanned using a database of Survivorbias free returns, I believe you shall find that even there, many investments would have given partly gains. But the key difference is that the percentage of such funds are lower than what we can find in stocks. Also most funds which tripped where sector focused funds which anyway’s carry a much larger risk than a diversified fund.

Direct investing is very risky unless you are prepared to do all the hard work required. Direct investing in funds these days costs just around 1.25 – 1.75% and I strongly believe that this is a small price to pay for the ability to at the very least keep up with the market. ETF’s are another route, but unless we have a more broad based ETF markets (Mid Cap / Small Cap / Sectors), it will remain a fringe industry (though one that has proved based on performance to be better than most Mutual Funds in US where there is both depth and variety)

The Back-Test

Now the Reality:

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