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July 2021 Newsletter – Measuring Performance

Do-it-yourself (DIY) investing is all the rage. NSE data reports that retail now commands 45% of the total turnover on NSE

Turnover doesn’t equal ownership. Retail ownership has moved slightly higher versus its lows but even if the indirect ownership via Mutual Funds are included, it’s still very much below its all time highs.

One explanation for the fall in direct ownership over time would be the rise and growth in assets at Mutual Funds. Retail has slowly shifted away from owning Individual Stocks to owning Mutual Funds.

From both the tax point of view as well as the cost structure, owning a fund is generally cheaper. This is more so for the investor who looks at investing a large part of his net worth in stocks.

Indian Markets are very illiquid. What this has meant is that the majority of funds concentrate on the top 400 stocks at the most even though NSE alone sees daily trading in more than 1700 stocks. On the BSE, there are another couple of thousand stocks that are not even part of the ecosystem of most investors let alone Institutions

The above chart plots the number of new demat accounts that have been opened.

Now, you can look at it from both the bullish angle as well as the bearish. The bearish angle will claim that the retail rushing in is a clear signature of the top. After all, isn’t there a saying,

“Fools rush in where angels fear to tread”

The proverb is also apt given that despite all the positive news we keep hearing, FII’s have been sellers in the recent past.

I look at the data from the bullish angle. My view is that while there will always be excesses, the data of the past cannot be directly compared to the data of today. Context is the key.

For a long time stock market investing was equalized with gambling. This was due to many factors including very low compliance and rampant frauds – from the broker upwards. In recent years, compliance has really improved a lot.

While we even today have broker defaults, the hit for the investor is constrained thanks to better regulations and the backstop of the exchange guarantee funds.

Access to knowledge has improved by leaps and bounds mostly due to technology. This has meant a better understanding of the markets and how they operate in the long run. This doesn’t mean that investors as a whole will make money.

Rather, I feel that the Pareto Principle is as relevant here as it is elsewhere. 80% of the money will be made by 20% of investors. A study in the US shows that all the wealth ever made in the US Markets has been just 4% of stocks.

The entire report is worth reading, but here is the key conclusion

While the overall U.S. stock market has handily outperformed Treasury bills in the long run, most individual common stocks have not. Of the nearly 26,000 common stocks that have appeared on CRSP from 1926 to 2016, less than half generated a positive lifetime buy-and-hold return (inclusive of reinvested dividends), and only 42.6% have a lifetime buy-and-hold return greater than the one-month Treasury bill over the same time interval.
The positive performance of the overall market is attributable to large returns generated by relatively few stocks. Rates of underperformance are highest for small capitalization stocks and, as would be anticipated based on the evidence in Fama and French (2004), for stocks that have entered the database in recent decades.
When stated in terms of lifetime dollar wealth creation to shareholders in aggregate, approximately one third of one percent of the firms that issued common stocks contained in the CRSP database account for half of the net stock market gains, and slightly more than four percent of the firms account for all of the net stock market gains. The other ninety six percent of firms that issued stock collectively matched one-month Treasury bill returns over their lifetimes.
With odds as unfavorable as these, it’s not surprising that long term wealth creation by Do-it-yourself investors is a rarity. Yes, everyone has that stock that one bought at a low level and held till it was a multibagger, there are exceptional years such as the one we are presently in. But one swallow doesn’t make a summer

One of the most surprising things is the fact that very few investors actually take the trouble to measure their performance.

Sharmaji ka Beta is the benchmark for most parents. If that boy can do it, why can’t you achieve the same. This is also called Cross Sectional Momentum. The comparison is never against self but against the rest of the colony / class.

Yet when it comes to one’s own performance, there is very little clarity as to how we are doing. Measuring performance is akin to keeping a dairy. It helps understand how we are performing and compare and contrast with the opportunities that are available elsewhere.

Measuring helps understand whether we are doing the right thing or not. When I used to be a broker, I measured the performance of myself as well as a few friends who also happened to be clients. This helped in understanding how I was doing in the scheme of things and where I could do better.

In Measure what Matters by John Doerr, the author expands on OKR’s (which stand for Objectives, Key & Results). Once you get them right, all you then need is a checklist to ensure that execution is as good as the process.

Since I started investing based on the Momentum factor, I have kept detailed records not just of the transactions but the ranks the stocks were during the time of entry / exits. This is helpful in removing chinks that are part of my system.

The way to identify the chinks though comes with Performance Attribution and Performance Measurement.

In the 2017 bull run, I remember a fund manager who ran a small cap fund but compared his returns to the large cap index. This turned out to be a good way to sell, but reminded me of the famous quote by Richard Feynman

“The first principle is that you must not fool yourself, and you are the easiest person to fool”

What is the appropriate benchmark for a DIY Momentum you may ask.

I believe that comparing an active strategy such as Momentum with a passive index is doing a disservice. Yes, the outperformance is awesome, but the products are as different as chalk and cheese – this more so for the Multicap strategy.

Momentum has been awesome since April 2020, but if I were to plot the NAV of my own personal performance with Nifty Smallcap 250 Index and the Nifty Smallcap 100 Index, this is how it would look like

The above chart is useful to understand where the performance is being driven by. What this also provides is a framework of the risk such a high Beta strategy will face if the markets were to start rolling over.

Now to check against some Momentum Indices – primarily Nifty Alpha 50 and Nifty 200 Momentum 30

While Nifty Alpha 50 is not an investable index owing to no funds, it’s a pure Momentum strategy and hence a worthwhile opponent to compare against. Nifty 200 Momentum 30 on the other hand is more like a Nifty Plus strategy and not a pure momentum one given how lagging its rebalances are, but since it’s possible to invest, it’s another one which can be compared against.

Do note that a straightforward comparison in a way is wrong too. Unlike DIY, Mutual Funds gains are tax sheltered and in the long run that can really mean a huge world of difference. Not to mention the advantage of Buy and Forget in the world of Mutual Fund while having to be alert and tinker with the portfolio every week or month as the rebalance frequency tends to be.

The other day, I tweeted this

What is the difference between a Good Invsestor & a Great Investor?

Hint, its not Returns

Ans: Longevity
— Prashanth (@Prashanth_Krish) August 1, 2021

In my 25 years I have spent in the markets, I have seen a lot of people come and go. Some had exceptionally good returns for a while but mostly lost their way. I wish & try to meet people who are exceptions to that rule.

For a fund manager, beating the market is what he gets paid for. He can’t have a few lost years and a few great years. Even if the ultimate returns are better than the benchmarks, clients won’t stay {Exceptions alway exist}.

A Momentum or a Value or even a Quality factor will be unlikely to beat the markets every year. This means that one has to have the framework to allow oneself to be beaten by the markets once in a while (or maybe even a bit more).

Finally allocation is more important than returns. Allocation though comes with comfort in the strategy. As a Do it yourself investor, the key is to understand the source of the return and the failure points. It’s that which can help stay sane when the strategy is not working while also not getting hyped up over excess returns in one or two years.

The reason funds managers get rich has to do not only with the leverage provided by assets of the client as also their own confidence in their strategy that allows them to be 100% invested. As a DIY investor, we are our own fund managers. Its up to us to take the steps necessary to make sure that we are on the right path.

June 2021 Newsletter – The Fear of a Crash

“Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”
Peter Lynch

The biggest question most people seem to have about markets today is not if a correction is going to happen but when. The list of reasons seems to keep growing. The US housing market for instance is posting the largest annual gains since 1980.

Both in India and the United States, Retail Investors are jumping into the action like never before. Millions of new accounts are giving a boost to the bottom lines of brokers. Look at the spike in trading numbers at Angel Broking, a discount broker.

While investors who have seen multiple cycles are exercising caution, the plethora of new investors whose only historical understanding is – Buying on Dip is the easiest way to make money is in the frontline of activity.

One of the biggest winners in the last year has been Saregama. Saregama has moved from 180 which was the low of March to 3480. Incidentally Saregama was a big winner in the Dot Com boom too, moving from a low of 12 in March 1998 to a high of 2310 in March 2000. Sometimes history doesn’t just rhyme but actually repeats.

Some disconcerting charts from the US Markets

I am not a great believer in surveys and yet this showcases how one sided market participants may have become in this rally.

Previous chart seems to go perfectly well with this chart. Buy Right and Sit Tight – who does that anyways.

Since April 2020, Nifty Small Cap 250 Index has seen a negative month just twice and even there, it was not greater than 2%. The index itself has risen 210%. This is a phenomenal return that we have not seen in the Index in such a short span of time.

Year to date on the National Stock Exchange, we have had 199 stocks that are below where they were at the beginning of the year and 1441 stocks that have gained. The average gain being 61% vs average loss of 14%.

When markets move too much too fast, it only brings bad memories to those who have seen a bear market or two. Is this the end one starts to question. This more so when one sees stocks that have been dead being rescued more by narratives than numbers.

Near the peak of the dot com bubble, we had an Initial Public Offer by a company called (I hope memory serves me right here) Computer Shoppee. The company was a new one and hoped to set up computer shops throughout the country. What was interesting about the issue was that the issue was at a face value of Rupee One. I don’t even remember if it was listed since the bubble burst soon after.

The Public Offer of Reliance Power which has become folklore. Cut to today and we will shortly see public issues by companies that have over time lost tons of money and even today have no clue about when it will eventually turn profitable.

One way to look at if markets are closer to a peak is to look at the percentage of stocks that have generated high returns in the last 3 to 5 years. The thought process here is that at peaks, most stocks would have gained tremendously. This is also a reason for the public to get attracted because it shows them that making money in markets is fairly easy.

The above graph denotes the percentage of stocks (Y Axis) that had the gains in the bracket. So, for example at the peak of 2008, 35% of stocks listed on the National Stock Exchange had 5 Year CAGR returns between 25% to 50%. Today this number stands at 26%, similar to what we saw at the end of 2017.

Since February of this year, we are seeing divergence in performance between the Large cap Index and the Small Cap Indices, This again foretells of a high probability of reversal on the cards though how long a divergence can remain is anyone’s guess.

While there are enough and more reasons to be bullish on India today, the fact remains that like Siamese twins joined at the hip, we are joined at the hip with behavior being dependent on how the markets of the United States behave.

Just take a look at the 10 year comparison between Dow Jones (in USD) and Nifty 50 (in INR). Where is the Modi magic one may wonder.

In 2008, India did not have a housing crisis or were its Banks in any sort of trouble. Earnings growth was strong and the future outlook remained strongly bullish. We even had a word for the short term divergence our markets saw with respect to US markets – decoupling.

The United States was not the first country to go for massive quantitative easing. That was Japan. Will the US go the Japan way as many bears seem to suggest? In the recent past I have been trying to read more about the macroeconomic situation in Japan both pre and post the fall and my guess is that the risk of the United States going that way is fairly low.

The Japanese tend to feel shame and disgrace upon a failure such as a bankruptcy. In the United States, bankruptcy is just a way to clean out the slate and start afresh. The ideological difference cannot be more stark.

While cheap money does lead to bubbles – the dot com bubble for instance is blamed upon the easy money policies instituted by the Federal Reserve post the 1987 crash, bubbles aren’t a one year phenomenon either.

For a while now, I have been strongly bullish on the markets and continue to believe in the same. Having said that, drawdowns are one of the ways markets tend to shed off excess weights. Here is a chart that plots the maximum drawdown seen every year since 1996

A 30% drawdown was a pretty normal occurrence in the markets pre-2008. Post 2008, it’s become a rare species. Drawdowns to me are opportunities.

How many days does it take the market to recover and move to a new high. The above chart tries to denote that. The year is when the markets hit a new high and the time spent (trading days) in the drawdown.

The recent experience in a fast recovery from a significant drawdown is not really rare. 1994 saw markets touch a new high just 2 years after the scam had broken out and the Index had plummeted more than 50% from the peaks.

Not everything is bad though. Writing in Economic Times, Aashish Somiah writes,

Nifty earnings grew by 14% in FY21, at its fastest pace in 10 years.

Also, in contrast to the trend of downgrades seen over the last few years, FY22 and FY23 earnings estimates continued to remain steady. In fact, if realised, the FY22 earnings growth estimates of 35% as per sell-side consensus would be its highest since FY04.

I look at market breadth for they tell the story way better than what is told by the large cap indices. Across the board, markets are bullish. This is as true for Large Caps as for Micro Caps. The divergence is building up.

In early 2008, the number of stocks that were hitting new 52 week / all time highs dried up even as the indices were kissing all time highs of their own. No such divergence this time around.

There is no real play book that provides a way to play out the current scenario. Advisers generally prefer caution and advice reducing exposure as a way to limit the risks. The trade off is that if markets continue to gain, the opportunity cost could be fairly high.

A secondary way to reduce equity exposure would be to wait for the market to begin its downward march before reducing exposure. The trade off is that one cannot exit at the peak but close to 20% away from it. The advantage being that one can stay until the music has been turned off.

Of course, historically the best way has been to stick with the system and the markets come rain or shine. But we all know that, ain’t we. You don’t need to read a 1300+ word drabble to know that the best returns are those who don’t try to time every aspect of investing.

I captured this image from a video on SpaceX but I think it closely resembles the actions of majority of investors. Wonder who can the Pied Piper of Investors in India.

Portfolio Yoga Monthly Newsletter May 2021

What makes a Great Fund Manager?.

How to spot a good fund manager was a question asked at a Twitter Spaces event. This was a question that Swarup Mohanty answered. I wish I could understand the answer he gave, but I don’t know Oriya :). What I could understand about the answer he gave was to forget about Fund Managers and focus on the Advisor.

If you were to dig down the reasons , the answer appears simple. Recognition for a fund manager has less to do with his philosophy. Or how erudite he is but more to do with his or her past returns. Period.
Beating the market is the prime criteria to be get judged by history as a great fund manager. The moment you stop beating, critics latch on to you. So, Warren Buffett with one of the longest period of performance has become a good guy to hit at.

https://twitter.com/stoolpresidente/status/1270350291653791747?lang=en

Dave Portnoy called him a washed up Investor. But this is not a fringe opinion (Dave Portnoy for instance has 2.5 Million followers on Twitter). The worst performing Indian mutual fund outperformed Warren Buffett in dollar terms by over four times in the past 17 years remarked Nilesh Shah a while back.

An old saying suggests that a movie star is as good as his last few pictures. This is something that is applicable from Sports to Movies to Markets. You are only as good as your last trade.

Last year we saw some interesting funds register astonishing returns. Quant Small Cap fund for instance has a one year return of 200%+. The funds asset under management today is low (268 Crores). It should be interesting to observe how their AUM moves if they can deliver good performance. Even if they aren’t able to repeat the blockbuster performance of 2020 – 21, process is the key.

The current hot fund manager of the moment is Rajeev Thakkar. PPFAS has been consistent in both process and returns for a long time now. Their fame though has shot up in recent times. The 10-year track record of PPFAS Long Term Equity Fund is now the best among all multi-cap funds.

In 2018, I attended the Morningstar Investment Conference in Mumbai. While a lot of unknown but famous RIA’s got mobbed around during the session breaks, Rajeev was standing with a colleague of his at the corner with none to hound.

Despite being an introvert, I introduced myself and had a couple of minutes of general talk with him. Today I am sure he will get surrounded by investors who wish to know what the future of the market is. Whether investing in the US which is one of the current rages, will continue to hold or not for example.

Business Channels love speaking to fund managers but unfortunately big mutual fund managers are generally very busy to give them the bites they are looking for. We have a good ecosystem of Portfolio Managers who most of the time wear the cap of not just the Chief Investment Officer but the Chief Marketing Officer willing to spare time as often as possible.

But with 350+ portfolio management firms and around 500 managers, you have plenty of options. Business Channels love hedgehogs more than the foxes (Link if you are wondering what is the connection between the two).

Business Channels love fund managers whose strategy is not only hot at the moment but where the fund manager has the ability to mesmerize their viewers. Interviews are generally softball questions with any data that points out to the silliness getting rejected without a second thought.

The moment that trend fades away, the channels have no qualms about dropping him like a hot potato and moving from a fund manager who loves shitty companies to a fund manager who thinks investing in quality regardless of valuation as the way to go.

As an investor, your best returns are when the fund manager is unknown. When Peter Lynch took over the Fidelity Magellan fund, he was an unknown manager who got entrusted with a 20 million dollar close ended fund.

By the end of 5 years though he had shown his mettle with his CAGR return being 35% vs the S&P 500’s return for the same period of 2.70%. The fund was then opened to fresh subscriptions and over time the AUM soared to the extent that when he finally exited in 1990, the AUM was to the tune of 20 Billion.

The performance for the years when it was open is a CAGR of 21.80% versus market return of 11.70%. A hefty outperformance indeed but not as much as his first few years. This is true for almost every fund manager out there – the bane of a successful fund manager it seems is he getting discovered by the masses.

But how do you go about finding those successful diamonds when they are still pretty much rough and undiscovered. Compared to the past, today fund managers are way better prepared when it comes to communication skills to the extent that talking to the fund manager can be a misrepresentation of who he really is.

In markets tops are tough to predict, predicting bottoms are a lot easier. This is because while the market can be irrational when it comes to how high it can go, it’s not that irrational to keep going lower and the bottom is closer than what many actually fear.

When it comes to fund managers, it’s easier to know who will not be the best of the performers for the future. But way tougher to catch the best performer of the future before they became the best.
If you have invested in a fund manager who today is hot, would that mean its better to exit the fund. While my guess is as good as yours, hot fund managers future returns generally are not be like the past. This is more evident if the fund added dollops of new assets under management.

Cathie Wood has a wonderful long term track record. But only in recent months that she came to become the messiah of the masses. Be it Crypto, Tesla and other hot stocks, she is the go to fund manager.
Assets under Management spiraled higher. This created a need for to her to chase stocks at prices she may in the past may not have been comfortable with. Since February of this year, the fund is down 30%. To give a perspective – the fund faced a 42% draw-down during the market meltdown of March 2020).
Nothing destroys returns like amassing of assets.

This has been true for both fund managers and advisors. In a way, it’s a dilemma for if you become too famous, you end up with substandard returns for your clients. But if you don’t become famous, does the world even care about the returns you generated for your clients?

This month I had a talk with good friends Anish Teli and Pravin Palande on the topic of Tail Risk Investment. You can watch it here

The hot topic for the month has to be Crypto and the volatility we saw there. What I learned recently was that Crypto has 1.5 Crore traders . This is huge given that this compares to around 3 Crore Individual Mutual Fund investors. Then again, the number could be a hyperbole for I am not sure if there is a trustable source.

I have been a listener at a Club House discussion on Crypto vs Stocks and what is astonishing was that even though some of the speakers are well versed in Crypto, there is still confusion on what Bitcoin actually represents. Is it a Currency, Is it an Asset, Is it a transitory investment.

In a Club House meet where I was a speaker, we wondered about whether investing in Bitcoin type of assets will qualify as a tail risk investment. Currently investing in Crypto is hard compared to Equity investing. A firm in the US seems to want to make it easy by having a Bitcoin ETF and since Elon’s tweet about Energy Consumption being negative, this will be ESG certified as well.

While I may not invest in a crypto asset, ESG or not, what is interesting is how the purely belief holds up the system – belief in the bigger fool theory.

An investor who is buying a Dogecoin is not buying because he thinks it’s a good investment to own that will generate cash flows but because he believes that some time down the road he will find someone who will pay him more versus what he himself paid for it.

In 1996, Alan Greenspan coined the term Irrational exuberance. Nasdaq was at 1300. Nasdaq peaked in 2000 at 5140. While it did come back to 1300 twice (once in 2002 and once in 2009), it’s hard to say that he was right in calling the bubble. He was way too early and anyone who sold on his call did not get a chance to buy at much lower prices.

I don’t know how Bitcoin or any of the other coins will move but they seem sure to stay around us for a long time to come.

Pitfalls of Momentum – January 2021 Newsletter

When I was younger and more naive than what I am today, I used to argue strongly for Technical Analysis vs Fundamental Analysis. In a way, I thought of myself as a crusader for an art that few seemed to understand much let alone use it.

Today, anyone and everyone has access to a freechart with drawing tools making them experts in patterns and indicators. With a 50% probability of being right (it being binary) and hundreds of charts, it’s easy to look like an expert.

One question that troubled me the whole time though was why if Technical Analysis was so good was not used by any major fund managers. What was inhibiting them from using Technical Analysis when it seemed like it was a great way to not just hedge the risks but pick the winning stocks.

Today, the same questions can be asked about Momentum Investing. For all our claims, there is just one PMS which has a pure price based momentum portfolio. Why is that so? If as some advisors claim, Momentum Investing is the greatest innovation in finance, why aren’t they managing money?

While we do have CTA’s that do use some sort of Technical Analysis, the returns in the last decade and more have been unsatisfactory to say the least. In case of Momentum, we do have Hedge Funds and ETF’s trading the same in the United States but the AUM is measly in comparison to the mainstream ETF’s

Here is a performance comparison of iShares MSCI USA Momentum Factor ETF vs S&P 500

India is yet to see anything close to that. One reason I believe is a major inhibitor – liquidity. Momentum or Price chasing works on the concept of buying what is going up and selling what is going down.

But if you are managing a 1000 Crore fund with a 20 stock portfolio (5% equally weighted) and don’t want to move the market, how many stocks shall qualify (assuming that you can buy / sell upto 10% of the volume traded in a day?

Using a 12 day average volume (not delivery which is even lower), we can get only 32 to 35 stocks where you can buy or sell 50 Crores worth of securities without exceeding 10% of total volumes. If you are willing to go upto 20%, the number of stocks available move to around the 75 mark, better but way lower.

Most fundamental portfolios have a long holding period (even though they may churn a small bit of the portfolio much more frequently). Even with a monthly reshuffle, my own holding period falls to just around 4 months. Dip to Weekly and you shall end up churning the portfolio every second month.

In advisory, since it’s up to the client to execute, all these headaches vanish instantly. Momentum Investing in many ways is similar to Micro Cap Investing. There is a reason for no Micro Cap funds out there too – again it’s a question of Liquidity.

Today, there are close to 22 advisors on smallcase alone who have a Momentum Portfolio. Since many have more than one portfolio, we are talking of nearly 75 to 100 portfolios. I have no subscription to any of them but my guess is that the stock overlap would be close to 80% across the board.

Having started my stock market journey on a regional stock exchange and one thing we feared the most – market orders. With low liquidity, we had no way to know how far away we would get filled. I don’t remember punching in a market order once, it was always limit orders at the best Ask or Bid price. New age rodeo’s on the other hand fancy market orders. While market depth has definitely improved quite a bit, the hard reality is that when thousands of orders are punched at market, there is a risk of the cart moving the horse than vice versa.

“Not everything that counts can be counted, and not everything that can be counted counts.” goes a popular saying wrongly credited to Albert Einstein. While we can count the impact of Brokerage and Taxes, what is missed out is the Slippage.

While slippage is low when we send an order for a few thousands of rupees, the impact of slippage when the amount becomes bigger becomes very noticeable. Big funds hence spend a lot of time and energy to try and reduce such impact to a level that is more comfortable.

Compared to other factor based strategies, Slippage is something that can have a large impact in Momentum based strategies versus Value or Quality where the churn factor is very low. A value fund can take months building up a position while a Momentum fund would have already entered and exited a stock in a month or less.

Momentum strategy like any other strategy is bound to go through its bad times. My own equity curve hit a high in January 2018 and that high was surpassed only in late 2020. The worst thing though was that this happened even as the markets continued to hit new highs.

This is tough compared to say a Mutual Fund or a PMS since you are required to continue to monitor / action every month or week. If you are not mentally prepared for such eventuality, you will find yourself exiting the strategy at the worst possible time.

Momentum in recent months has seen a huge upswing, but then again, what hasn’t really. This seems to have made it seem like a riskless way to make money. This has been further encouraged by advisors who are experienced enough to know that risk in do-it-yourself is multiple times higher than with even an average mutual fund.

As I was writing this, the wonderful Bob Seawright’s newsletter landed up and one quote that stood up

“There’s plenty of people who sell bad stuff knowingly, but I think the far bigger problem is inappropriate sales that are well-intended. I’ve seen people who sell bad stuff to their moms, because they thought it was the right thing.”
Bob Seawright

Momentum or Value or Growth – everything can be mis sold. It’s finally your money on the line and if you don’t care enough, no one else will either. If you are not prepared to be invested for a long period of time, no strategy or investment will ever suit you.

Ending the Year on a High – The December Newsletter

What a year 2020 turned out to be. The year the Rat as per the Chinese Calendar, it seemed like it chewed more than it could bite. While the negative side is well known, the positive side is that thanks to the Medical Advances and the ability to arm ourselves with better knowledge than ever before, the death tally was relatively low when one compares with pandemics of the past.

If some one had slept through the year, he may wonder what the hulla-bulla is all about. After all, the Index has moved higher as much as we had seen in the 2019. What is special about this year he may ask.

When markets fell in March, it was an opportunity of a lifetime as a Portfolio Manager put it. While I disagreed it was an opportunity of a lifetime having seen my share of bear markets, it was definitely an opportunity that we had seldom seen in the last 5 to 6 years. Yet, rather than hope, most of us were despaired. If only prices will come back to our earlier levels, we shall be happy to get out. Looking at the Mutual fund data, this is what seems to be happening too.

We have seen this earlier – in 2008/09. Investors did not withdraw from the markets during the fall but later exited once the market got back to normalcy. Investors came back in droves only from 2014 as the new bull market started and have more or less stayed back in full. This is a very huge change from the past that we have seen.

One of my favorite books is Reminiscences of a Stock Operator by Edwin Lefèvre and one paragraph is quoted extensively on Twitter

It was always my sitting that highlighted the advantage of Buy and Hold versus jumping around. In 2018, as part of the Capitalmind Research Team, one of my picks was Majesco for the Multicap Portfolio. I had studied the stock and got what I thought was a broad understanding of the business. But what I had in reality was nothing more than a hunch that this stock was one of the very rare Indian companies to have a listed US subsidiary. A few months later, when we were looking for new ideas, I decided to drop the stock.

In March of this year, this seemed like an excellent decision given the way the stock had fallen post the decision to exit. Post the pandemic though, the company sold its US subsidiary for more than what the market thought it was worth and in December it announced a dividend of Rs. 974.00 for its shareholders.

The episode shows that it’s not enough to buy a stock because you find the business attractive but also have the conviction to hold to that idea when the market seems to have rejected the thesis. This is also a reason why Value Investing is tough – it asks you to hold an opinion that runs contrary to the market and one that may take a long time to be proven right. In this age of Social Media and everyday checking of portfolios, it’s doubly tough.

From the talking heads on Television to the Finance Twitter guys, 90% of the talk is about stocks and very less if anything about Asset Allocation. This is not surprising since Asset Allocation is a bland subject. How cool to say you bought a stock that doubled versus talking about why you think your exposure to equities is just 35%.

My personal asset allocation is a mix of multiple logic chief among them being how I think the market will behave in the coming year. In 2019, I started to feel that 2020 will be the year when the markets will finally have bottomed out and we shall start a new bull market. My thesis was this would start somewhere in September.

So, I decided to allocate to equities slowly till I reached a number I would be comfortable with. But as Robert Burns wrote, The best-laid plans of mice and men often go awry and Corona hit with an intensity that I did not expect. In fact, going into March, I continued to be bullish since my belief was that like SARS or MERS, this would not be too bad. I also checked out how markets had behaved in the years 1918 to 1920 when Spanish Flu hit much of the World.

Dow Jones from the beginning of 1918 actually started moving higher and peaked out 71% higher from where it started in late 1919. While markets did fall in 1920, this was post the epidemic and not during the epidemic which wiped out 5% of India’s population at that time.

“History may not repeat itself. But it rhymes.”
– Unknown

Optically the market looks extremely expensive. But unlike in case of previous high’s, this is not something very few have noticed. It’s the talk of the town and the reason cited for a bear run if not a full on bear market.

A bear market requires a trigger and while Corona has had a tremendous amount of impact on life, this doesn’t suffice especially in the light of the kind of liquidity that has been delivered by Central Banks and the promise of low interest rates for the foreseeable future. Indian Real Interest Rates have for the first time in a long time dropped into negative territory.

While financial repression is bad for those dependent on Interest for running their daily life, it has a favorable impact for new capacity addition by companies which hopefully will set the ball rolling for a stronger growth. Negative real interest rates also push savers to take more risk and risk is taken by investing in assets such as Real Estate or Stocks which again pushes up the prices of these assets.

While I don’t believe in Prediction, especially of the future, I have been interested in cycles since it gives me a better understanding of how and where to invest into. Based on some studies I have done, here are 3 predictions for the coming year.

Two are moderately bull cases and one is an extreme bull case. The thing about cycles is that sometimes they could be inverted. I do hope that is not the case with these charts but hey, who said Prediction is Easy 🙂

Here is to hoping at least one of them comes out right. Wish you and your family a very happy, prosperous year ahead.

Portfolio Yoga Monthly Newsletter – November 2020

{This post is an edited excerpt of the November 2020 letter to our Subscribers}.

Hope it adds Value to you.

November turned out to be a good month for the Portfolio. For the Multi Cap Portfolio, this has been the first complete month. The Multicap Portfolio registered a gain of 7.87% for the month. This was a month for the laggards with the best performance being from Metals and Financials leading. The rally for now is pretty broad and yet the markets are not at a juncture where we have seen tops emerging in the past. Will this time be different, only time can tell.

Anchoring bias impacts us in many ways, some known and some unknown. One question I keep getting asked is why the Portfolio Rebalancing is Monthly and not Weekly. I shal try to address this question via this long drawn post.

But why is such a question asked in the first place. While India doesn’t have any Momentum ETF’s, the US has many ETF’s that are based on the Momentum Philosophy.

One common attribute across the ETF’s – the rebalancing happens every Quarter. A few rebalance just twice a year. Closer home, the new Nifty 200 Momentum 30 Index has a rebalancing schedule of half yearly while the older Nifty Alpha 50 and Nifty 100 Alpha 30 rebalance quarterly.

In Annie Duke’s latest book – How to Decide, she provides a Six step path to a great decision process. Whether or not this is a great decision will be proven only in time , but in this post, I thought of using the framework to try and explain why Portfolio Yoga Momentum Portfolios are rebalanced Monthly against the conventional way of using Weekly rebalance schedule and the Trade offs we face in this regard.

Why do we rebalance the Portfolio

The answer to that question lies in the fact that stocks that are in Momentum suffer what we call as Momentum Decay. What this means is that given no stock can keep going up higher for ever, the law of diminishing returns starts somewhere and our objective is to ensure that we are out of the position before such a possibility happens to our portfolio stock.

This is true for a Value / Growth Investor too. If you are a value investor or a growth investor, you watch out for decay in terms of company fundamentals or the growth. You get basically 4 data points per year to analyze whether the company’s progress is as per what you estimated and if the stock is still worth holding on to.

Indices rebalance removing stocks whose market cap has fallen and replacing them with stocks whose market cap has risen subject to the stock also fulfilling certain other criteria.

The big question though is how frequently should one rebalance. Indices such as Nifty 50 do it twice a year, Momentum Exchange Traded Funds in the United States rebalance for most part once a quarter with some doing twice a year as well.

In India, most advisors offering Momentum factor strategies rebalance on a weekly basis. We on the other hand have stuck to our choice of doing the same on a Monthly basis.

Why Monthly vs Weekly or Quarterly

The best rebalance period is Daily. This ensures that stocks can enter and exit the portfolio at the earliest opportunity. Unfortunately, this also means that there is not only a very high amount of churn but also stocks have very little opportunity to prove themselves. Unlike other strategies, in Momentum we are looking at Cross Sectional strength – what this means is that not only has the stock we wish to add or wish to continue to be part of the portfolio need to be good but it should be good relative to all the other stocks in contention. This results in a constant move in ranks – the sharper the move, smaller the lookback.

Weekly is NOT the time frame that is discussed in a lot of literature. If you check out any of the Academic Papers, you shall find that most of the testing happens with a monthly time frame. Yet the community in itself has embraced weekly. What explains the conundrum?

One reason is that many hold the strategy as a satellite strategy and not the core portfolio. “What’s in a name? that which we call a rose. By any other name would smell as sweet.” ― William Shakespeare wrote in Romeo and Julie and yet somehow it seems the name accounts for a large part of how we look at a strategy in itself.

One of the reasons Momentum is seen as a Satellite Portfolio and not a Core Portfolio is because of the number of transactions. Investopedia says that Core-satellite investing is a method of portfolio construction designed to minimize costs, tax liability, and volatility while providing an opportunity to outperform the broad stock market as a whole.

Since launch I have had numerous discussions with both subscribers and prospective investors and the one common thread for many is the way they treat Momentum Investing vs Value or Growth Investing. The comfort factor that comes with other strategies is missing in a pure price action strategy such as Momentum.

Add to it, transactions are a distraction for most investors. They would rather prefer to just buy and forget than having to keep changing the portfolio regularly. By investing in a Mutual Fund or a Portfolio Management Service, we try essentially to outsource this painful activity.

Weekly rebalancing when done with the same exit criteria as monthly has 80% more transactions. While you can reduce the transactions by having a larger rank exclusion (say instead of saying I will exit a stock once it goes below rank 50, changing it to 100 will provide for lower transactions), the constant need to check is in my opinion a hassle especially as the size of the portfolio gets larger.

The Upside and the Downside

First, let’s talk about the Upside and the Downside of having a monthly rebalancing strategy.

The biggest upside for obviously is the lower number of transactions. While some costs can be measured, some others cannot. The biggest cost when it comes to churn for instance is not transaction costs – they aren’t that big but the slippage that goes unseen.

While slippage differs from stock to stock, unless you are investing in large cap stocks only, the pressure of multiple people trying to buy a stock at the same time can push the spreads dramatically upwards.

A couple of decades ago. I was a trader in a regional stock exchange. Liquidity other than for a handful of stocks was brutally low. This meant that we never used a market order to place orders for the Impact cost would kill whatever small margin we hoped to produce out of the trade.

Liquidity begets Liquidity and hence we find that BSE is finding it tough if not impossible to match let alone beat NSE in terms of market share. But even on the NSE, liquidity is pretty limited outside of the top 100 to 200 stocks.

The problem is accentuated by the fact that today Momentum Investing is seemingly coming to be a mainstay of small investors who aren’t wary of placing market orders in order to get a confirmed fill. Add to the mix the fact that 80% of the stocks across most momentum advisories will be similar, you have a potent mix that can make buying and selling expensive as a whole.

While we use filters to eliminate low liquid stocks, the spread is not known for most stocks and even in fairly liquid stocks this can be killing. Monthly in a way limits this by ensuring that the number of trades are fairly limited. To understand how Impact Cost is calculated, do check this by NSE NSE – National Stock Exchange of India Ltd. (nseindia.com)

A bigger factor is also our belief that stocks don’t go up vertically and those that do are not worth risking big money upon. They tend to move up, flatten while oscillating in a range before they commerce the next move. By trying to be with only the top stocks all the time, we will end up getting out of trends before the trend has truly exhausted.

While the advisory is just one month old and hence doesn’t have data to back my statement based on my own data, the average holding period has been to the tune of 4.5 months with quite a few being held for more than a year.

Our attempt here is not to maximize returns. That would require me to have a smaller focussed portfolio and a high churn rate. While that would be an attractive marketing strategy, I for one would not be comfortable investing a substantial amount of capital in such a strategy and it would be hypocritical to ask clients to do what I ain’t doing myself.

The portfolio we offer on the other hand provides me comfort and hence as of today comprises nearly 65% of my networth.

Disadvantages of Monthly when compared to Weekly rotation

Let’s look at the downside of Monthly vs Weekly. The biggest downside was seen in March of this year when markets meted down inside of a month. This was the biggest monthly drop for the Nifty 50 ever outlasting even the fall of October 2008. A weekly strategy would have saved me 10% (I closed the month with a loss of 23.70%) and while 10% seems not much, the fact that to recoup a 10% loss requires a bounce of 11% and that is a missed opportunity (remember, the gains would have come anyhow).

On the face of it, it seems that Weekly makes more sense than monthly. But the downside of constant tinkering comes at the cost of allocation. Higher the number of trades, lower is one’s ability to deploy a significant sum of money.

To deploy a significant sum of money, a strategy or an asset class should fulfill two conditions

Its something you feel will not let you down and will not make you lose sleep. A reason Real Estate is a preferred way to invest for majority is because of its ability to remove the friction and noise that pervades other asset classes like Equities.

The ability to not have to transact often and one reason why there is so such of stickiness with mutual funds even when results aren’t in favor. Unless the investment is a substantial part of one’s net worth, most are happy to let it stay than keep shifting.

The advantage of Direct Investing comes in two parts – one the ability to have a better control on the portfolio composition and secondly the ability to shift with the winds of change. On the downside though, it’s easier than say with Mutual Funds to interrupt the process of long term growth.

More the transactions, more the confusion as to whether to follow or ignore. After all, there is always a chance that the stock going up will go higher while the stock that entered in its place goes lower (and while the portfolio is just 1.5 months old, we have seen that happening with Globus Spirits which went out in October rebalance to be replaced with Astec).

It has taken me way too long to figure out that the best way to grow our wealth in equities is to concentrate – not in terms of stock but in terms of philosophy. Every strategy has its good days and bad days but if one were to stick with it through thick and thin, the outcome would be far better than shifting with the winds of change.

Comparative Statistics for Monthly vs Weekly using the same Entry and Exit Criteria

Post March, we have implemented a trigger to allow us to move to weekly in case of big market volatility. Again, no two market crashes will be the same. The March fall and subsequent recovery has never been seen in history – the fastest ever comparable crash and bounceback was seen in the US in 1987 and even that recovery took nearly 2 years. But this addition provides a comfort that if things go to shit one again (and the odds of such a thing happening in say the near future is very low), the portfolio strategy is well prepared to handle the same.

Portfolio Yoga Monthly Newsletter – October 2020

{This post is an edited excerpt of the October 2020 letter to our Subscribers}. Hope it adds Value to you.

Let me begin this letter with a heartfelt thank you for trusting us. Every business has three phases – The Start-up Phase, The Growth Phase and the Mature Phase. While each of them are individually important, the Start-up phase basically lays the foundation for whether or not the business shall be able to move onto the next phase.

The first few months are always crucial and thanks to your valuable support, I think we shall come out flying. A larger subscription base is not just a morale booster but also provides the capital to invest for launch of new products and services.

A monthly report for Momentum is not easy to write. After all, we have no reasons to provide as to why certain stocks went up or other stocks went down. There is no narrative to assuage that while the returns are sub-standard compared to what you could have achieved in investments elsewhere, our companies are strong, focussed on growth, management quality is…, blah blah blah. You get the drill.

Rather, through these monthly posts, I shall try to throw light on the overall health of the market using breadth and allied indicators that have historically proved to be of value. Many years ago, one of my job functions was to write a report on the markets. As much as I love writing, I am pretty sure there is no real utility to such posts that I see coming even today. An example of this would be, Nifty seems bullishly inclined and may test 12000 but if it breaks below 11620, we can move down to 10780.

There is nothing wrong with the statement perse – if you were to look at the Nifty 50 chart, you shall see that I have used a Resistance as the target, a Support as a trigger and another support as a point the Index may reach. The problem though is, what is the probability that anything of that sort could happen?

Markets are all about probabilities derived from historical data and one that we try to find a way to position ourselves. If we were to believe that a strong bear market is on the horizon, we reduce our exposures and if we believe that a strong bull market is on the horizon, we would wish to take more exposure.

But probabilities in itself aren’t easy to decipher or even provide the right answers. Let’s take Nate Silver who became a celebrity when he was able to correctly predict the Winner in all 50 States in the US elections of 2012. In the 2008 election, he correctly called 49 out of the 50 and even the miss was by a mere 0.1%. But this happened in 2016

Was Nate absolute wrong? Well, the answer is not so straight forward for he did say Trump had a 28.6% chance of winning. Post the 2012 Election forecast and wins, Nate Silver was featured as a prophet with a Mashable heading reading “Triumph of the Nerds”. Four years later, he was literally burnt at the stake. Nate wrote a series of posts on the issue of being wrong. It’s worth a read (Link).

Getting back to markets, Valuation based models such as the Portfolio Yoga Asset Allocator has had a tough time in recent years. Markets have never been as stretched as they are and yet, they are staying at the elevated levels longer than they have done in history. The question to be asked is – have the model broken or this time it’s different.

In the United States, Value Investing has been taken to the cleaners like never before to the extent that well known fund managers are quitting the game. As Momentum Investors, its easy to make fun of other strategies that are facing tough times, but our own historical data shows the limitations of Momentum and the difficulties we may face in the future. Only in Lake Wobegon is it possible for all the women are strong, all the men are good-looking, and all the children to be above average.

This being the first letter to you as our client, this is not to scare you but to provide you a context and enable you to set the right expectations. We strongly believe that Momentum has better odds of winning than a pure passive strategy, but it’s not 100% and we will have our bad days or months while hopefully not extending to years.

But enough of narrative, let’s focus on what the market is seemingly telling us as we go into the US Elections and one that seems to have registered heightened volatility in recent days.

First of – our Weight of Evidence Indicator. Since this is still a work in progress, we don’t have a write up but suffice to say that it has value even though it doesn’t predict anything.

The Weight of Evidence currently stands at -1 which is more or less a Neutral Stance with average historical performance over the coming 22 days being slightly positive. The odds of a positive close is 60%. Average win was 3.70% while average loss was -3.84%.

Our issues start with the Internals though. On 28th August of this year, Nifty 50 stood at 11,647. The percentage of stocks on that day that were trading above their 200, 50 and 10 day Exponential Moving Averages were 74.50%, 84.70% and 70.75%. Today, Nifty 50 stands at 11,642 and the same scores read at 49.60%, 33.35% and 33.10%. In other words, the market remains flat while stocks have been hammered tremendously.

In April, one of our trading systems based on the above data went bullish. On the 21st of this month, it turned bearish. While we don’t expect a market meltdown like we saw in March of this year, markets are losing momentum. As on date just 43% of stocks that we monitor are bullish. This was 61% on that day in August.

Volume demand exceeds Volume Supply (10 day average to smoothen out the daily noise). This is positive for now and we shall track any negative crossovers which accompanied by market divergence can have negative bearing.

The biggest positive for the markets currently is that all the broader indices are trading well above their 200 day EMA’s. As long as reactions are contained well above the 200 day EMA, we feel that we won’t need to change our strategy of rebalancing once a month. The only other reason this could change is if we see very heavy volatility in the coming days.

There is one change in the Multi Cap Portfolio. We exit ~~Globus Spirits~~ and replace it with ~~Astec Life Sciences~~. The same is also recorded in the Monthly Rebalance Information Sheet.

Finally, Novembers have generally been positive. Hope this November is one such November.

PS: Work on our Large Cap Momentum Portfolio is on track and we expect to release the same in November. In addition, we are also working on a Sector Portfolio which is not Systematic but one we believe holds a great deal of promise. More of it later.

Wish to Subscribe? Check out our Philosophy and the Charge here
https://www.portfolioyoga.com/wp/philosophy-services/

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