Uncategorized | Portfolio Yoga

Meb Faber Timing Model on CNX Nifty

For a trader, its essential that any strategy he uses needs to at least in historical testing beat Buy & Hold returns (and since we assume a lot in our back-tests, higher the returns compared to B&H, the better). After all, the argument here is simple. If you spend time and effort in markets, the least you should be expected of doing is beating the guy on the street who may have just bought nifty bees and went into deep sleep.

Then again, that may not entirely essential to a investor whose idea is to get a return better than other asset classes and if one comes with lower risks, the better.

The biggest advantage of Buy & Hold on Nifty Bees is its simplicity. You buy it and you can forget all about it. X years later, your returns shall closely mimic the returns of the Index (some variations shall exist due to tracking error).

The biggest disadvantage is that when Index falls big, your investment gets hurt too. For example, a guy who invested into Nifty Bees 2006 would have seen his returns being absolutely zero if he had checked in late 2008 / early 2009. A FD on the other hand would have paid him much higher returns without a iota of risk.

The best way to beat the markets one is told is to buy good companies and hold on (forever). But here too, it comes down all to when you enter. Let me give a example. I doubt you shall be able to say that buying Warren Buffett’s Berkshire Hathaway is a stupid strategy.

This is what I tweeted a couple of days back

An investment into Berkshire Hathway ($BRK-A) at close of 1998 as of today would have yielded a CAGR of 7.66%.

I do not know whether a CAGR return of 7.66% for Americans is huge, but the fact that you could have bought a Treasury Bond (30 Year) which was yielding 5% returns at the same time (End 1998) says that the results aren’t way out of whack with the expectations that could have been made. But I am digressing from the agenda.

Beating the markets on long term is tough. The survivors we see today hide the huge lot of fund managers who have literally disappeared. And beating the markets without having similar draw-down is even more tough. Even the best managers go through tough draw-downs that can send a chill down any investors spine.

Meb Faber some time back talked about a simple strategy. Rather than repeat what he has to say, I would recommend you to head over and take a look – http://mebfaber.com/timing-model/

I tested this strategy on Nifty (using Nifty Total Returns Index to ensure that we account for Dividends which get missed when one uses only Spot Nifty). The results are outlined here;

Test Period: June 1999 till date (December 2014)

Total Raw Returns: 9162 Points (higher than CNX Nifty since it includes Dividends).
System Returns: 8288 Points.

Raw Draw-down: 48.81%
System Draw-down: 26.71%

Raw Holding Period: 173 Months
System Holding Period: 131 Months

Raw Number of Trades: 1
System Number of Trades: 12 (last one being Long from November 2013)

Buy Price & Sell Price = Opening price of the next bar (1st trading day of next month). No Transaction / Slippage charges used.

But the big issue with directly using above data is that you cannot buy Nifty Total Return Index. Instead, what if one uses Nifty Bees. Nifty Bees has a tracking error (bit outdated data) of around 0.20% and a cost of 0.50%. Compared to other options available, this is the best.

In my search on that issue, stumbled upon Kiran’s blog where he has provided some stats on the same out here

All in all, I think for some one who wants to invest directly into market (some Mutual funds have outperformed strongly, but too much of Survivor bias makes comparing them apples to oranges) and yet not get caught when markets drop like a hot potato, this simple strategy is worth a look.

Howard Marks critique of Technical Analysis

Technical Analysis is a nice punching bowl for most seasoned analysts and fund managers. Howard Marks in his book, “The Most Important Thing” suggests that its not a worthwhile strategy in not more than 300 words.

I myself despite being a follower of Technical Analysis for quite some time do not take at face value all the bull shit that goes by its name. Switch on any television channel and you shall be saturated with calls based on so called “Predictive Technical Analysis” with most analysts trying to predict where the markets / stocks may go from here on the short term.

And almost everyone who comes on TV espousing technical analysis is either working for a firm or runs his own tip providing company. When was the last time you saw a person who used Technical Analysis but was managing a fund?

What this has meant is that even Quantitative analysts (an area from which we derive a lot) look upon Technical Analysis as some sort of vodoo science fit to be ignored. But is there really any value in Technical Analysis or are we blindly following a belief that is not worthwhile?

Its a question that has been asked several times by several eminent folks and the answer I have found is that while there is merit in some forms of technical analysis, it does not mean that all the non-sense that is peddled in its name has value.

To me, any logic that is based on some sort of mathematics and can be created using a system has value. This is because by using a systematic logical process, one is able to over-ride our inherent difficulty that comes to pass as several biases showcase.

The very fact that there are hundreds of successful CTA’s who use one or the other form of Technical Analysis (Trendfollowing based) again tells me that the science is not Vodoo as many seem to think it is.

Do take a look at the performance numbers of a few of such folks here (Link) and tell me how could they achieve those returns if the market is random in nature.

Coming back to the book I am reading, Howard Mark says and I quote

Another form of relying on past stock price movements to tell you something is so- called momentum investing. It, too, exists in contravention of the random walk hypothesis. I’m unlikely to do it justice. But as I see it, investors who practice this approach operate under the assumption
that they can tell when something that has been rising will continue to rise.

Momentum investing might enable you to participate in a bull market that continues upward, but I see a lot of drawbacks. One is based on economist Herb Stein’s wry observation that “if something cannot go on forever, it will stop.” What happens to momentum investors then? How will this approach help them sell in time to avoid a decline? And what will it have them do in falling markets?

I am yet to read his latest book, but I do hope that he has in the mean time seen the evidence that has come out to showcase the fact that momentum trading has some value to it. (Link for a search).

And as to getting out when the bull market stops? Is it not as simple as just using the reverse analogy of the buy to get out. Should not be too hard, ain’t it?

Like any other form of investing, Technical Analysis is not easy too. The ease at which it captures trends seems great in hind-sight, but without putting the effort required to understand and apply the same, the ability to do that in real time is pretty low.

Technical Analysis like any other form of Analysis asks for thinking out of the box. Just like the probability of gains is low that you shall gain just because a stock is cheap, so is with most known ways of using Technical Analysis to identify entry / exit points.

So, ignore the pundits on TV and put some work to understand the nature of the markets and how you can apply a theory that enables you to capture as much of it as possible without having to take the risks that come with a pure Buy & Hope strategy.

Random thoughts on a volatile market day

We are all familiar with Notional Loss and Permanent Loss but what about Opportunity Loss (Cost). Compared to the other two, this is not painful since Ignorance is Bliss. But then again, while the other two losses are something that has occurred due to action, opportunity cost is one which takes place due to inaction.

For Investors, the cost of opportunity is not being able to en-cash the gains in their portfolio. Warren Buffet says that he loves to hold stocks to infinity (speaking in a literal sense). But how plausible it is for a ordinary investor who has invested his money not to make wealth for the next generation but to achieve certain targets in his own lifetime.

A portfolio of IT stocks would have skyrocketed in value when the 2000 IT boom happened. Once it burst, the portfolio could have never recovered even though its been 14 long years. Even a Index (which has the advantage of being able to jettison weak stocks and add new stocks instead) like the Nasdaq Composite has not been able to conquer its 2000 peak. If you consider the impact of Inflation, the break-even cost will be even higher.

A portfolio which was heavy on Infrastructure / Energy would have seen it soaring in value in the years between 2005 – 2007 (in India). But how long before they come back to their highs (and will many of them even survive in the interim).

Some stocks though have never bothered to look back too much. But the question that you need to ask yourself is, how likely do you think that your portfolio consists of such stocks and hopefully everything bought at prices which are not tested when the larger trend reverses?

Some Small caps move onto Mid Caps and later on become Large Caps. The question though is, what is the % of stocks that advance such. On the other hand, what is the % of stock that move the other way round.

Index stocks are seen as the bluest of the blue-chips. But 20 yeas later, how many companies have survived and thrived. If you had bought (for equal amounts / stock) all Sensex stocks in 1994 and looked at your portfolio today, the CAGR gains you would have seen is somewhere around 12% (Of the 30 stocks, 29 are in existence with Philips India being the only company that got de-listed).

If you were to think that maybe investing in Mutual Funds would have given you a better return, think again. While you would have gained handsomely if you had invested in Kothari Templeton Prima Plus, your investment (adjusted for Inflation) would have wiped out if you had instead invested in CRB Mutual Fund (and both were launched in the same year, 1994).

Ask any stock broker / Analyst and he shall be happy to share the huge gains that could have been made by investing right and sitting tight. Heck, as the list below compiled by friend Girish showcases, your returns would beat the hell out of any other asset classes

Of the list, I have been into a couple of stocks. But then again, like any other investor, I have not held to-date and missed a pretty nice opportunity. But then again, I do hold a couple of stocks which have given me 100x returns (UTI Bank / Indocount), but since my quantity of purchase is small, even though the percentage returns seems awesome, the amount is pretty meager. A lakh of Rupees 10 years back is not the same 10 Lakhs now.

In fact, its not about identifying a 100x opportunity but ability to buy it big is the key to making wealth in markets. But how many have the confidence to buy a stock and invest say 10 / 20 or even 30% of their networth into it?

Recently I was reading a tweet by a Mutual Fund manager where he professed as to how investors would have made handsome returns by investing in markets and as an example showcased how Sensex has grown to 27,000 from 100 in 1979. What he forgets is that 100 was the base price and secondly, there was no way to invest into Sensex / Nifty till 2002 when Benchmark Nifty Bees came into the picture. So, when people talk about the long term returns of market, do take with a few kilo of Salt.

Over the last few days, Russian Markets have literally imploded. Things have come to such a pass that one is hearing that people are buying iPhones to hedge their currency risk. What is the probability that we may get hit with something similar and what is the plan of action if that does indeed happen. How hedged is one’s portfolio to international moves that we may have no control.

Without a plan, most of us move with the herd making it easy for the hunters to cull us. But how many have financial plans in the first place. Today youngsters take loans which they repay for most of their lives to buy asset such as Land / Appartments. While that has worked well in last 15 / 20 / 30 years, what is the probability of it working in the next 30 years?

We are happy to see advent of Flipkart / Uber / Zerodha among other disruptive companies. But what if the next disruption makes us jobless with our domain expertise not worth the price we deem its worth. What is the plan of action?

Writing this blog is a way for me to express my inner thoughts and if its boring, I apologize. But think deep, do we have a plan to achieve our goals if the Plan A bombs. How many have a Plan B or even a Plan C to take care of us when shit hits the fan?

A couple of interesting recent reads that may have influenced some of the thoughts above;

On the Shortness of Life

How Adam Smith Can Change Your Life: An Unexpected Guide to Human Nature and Happiness

Hand to Mouth: Living in Bootstrap America

Do check out the books above. Deeply inspiring to say the least. Made me think of what Warren Buffet calls the Ovarian Lottery and how lucky we are (regardless of the challenges we face).

This has been one hell of random writing. Thanks for reading. Hope its worth your time

sayonara 🙂

Is the oil fall a black swan event?

Nassim Taleb describes a black swan as : A BLAC K SWA N is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was.

Lets look at Oil and check whether it fits the definition.

Was the steep fall in oil something that was predicted: No. I know of no study that suggested oil prices will fall and fall so steeply.

Is it something that shall have a massive impact elsewhere: Yes, oil is the main currency of many countries. While many are small, we do have a entire sub-continent in Middle East which depend on oil for most of their revenues. We also have Russia which has huge dependency on Oil to balance its budget.

While there is a direct benefit to countries such as India since we pay a lower price for oil, we will get impacted too as a large part of our foreign exchange earnings comes from Indians working in Middle East and repatriating a major part of their earnings. If that is impacted, it will have an impact on the Rupee – USD which in itself will then impact on a whole lot of other industries.

And finally, are we able to con-cot a explanation for the fall: Yep, blame the shale oil for the fall say the experts. Yes, a surge in production in US may indeed have had an impact, but why was that impact not a slower process than one we have seen.

Well before oil fell, Coal prices were falling at a pretty steep pace. But interestingly that was not seen as damaging (other than for countries such as Australia / Brazil among others). The question though is, was it a fore-bearer to the crisis that is coming?

Collateral damage is pretty hard to predict. Russia is going through a crisis that seems to show no signs of ending. In 1997, they defaulted on their own currency bonds and hell broke out in most markets though India being more closed was relatively safer. But if we were to see a repeat of something on that scale, what would be the probable impact?

Much of the rise in markets has been due to the continuous flow of funds by FII’s. How much of the funds are coming from countries (sovereign funds) or funds that have exposure to oil (directly or indirectly). Last week saw them selling though the net impact was +ve due to the sale of shares by Infosys promoters. If one removes that trade, net flow is -ve. If oil is really a positive to India, why are FII’s starting to pull out now?

One of the key reasons for the sudden crash in ASEAN countries was the over-leverage by corporates and countries since the currency rate being fixed, the assumption was that it was a zero risk venture. How many of our big caps have un-heged overseas exposure that may come back to haunt them in case Rupee takes a tumble?

Of course, all is not lost as of now. Nifty trailing four quarters PE is not exactly in bubble territory. But that said, we aren’t cheap and unless we grow, even these levels aren’t sustainable.

The last time we fell from a similar PE level was in 2004 and while we did recover, the Draw-down in that year was 30% from the peak. At current Nifty, that would mean a fall to 6000, something that was seen way before the “Acche din affect”.

In one of my earlier posts, I had provided the future returns based on current Nifty PE and at 21.5 (where we were a few days ago), we were coming close to a point where we had a average gain of a few percentage points over the next three years.

I don’t believe that the way forward is by trying to predict, especially using macro views. After all, the housing bubble that was the reason for 2008 began not in 2007 but in 2005 and by 2006, it was seen as spreading like a wild weed. Markets take their own sweet time to react to events and it makes zero sense to try and trade on that. Instead, what we need is a plan, a plan on what will one do if our portfolio drops X% and what they shall do when it drops X-10%.

Every crisis is a opportunity if only you can survive the crisis in the first place. Opportunities come once in a while and only early preparation can help one not only to tide over the crisis but take advantage of the same. So, write down your plan and more importantly, stick to it.

Concentrated or Diversified Portfolio.

Depending on how you use it, Twitter can be Good / Bad or Ugly. For me, it has been an interesting minefield of information on a variety of subjects that hold my interest. One of things I keep stumbling about is when a guy says, ABC share has returned 5X returns in Y years. A secondary thing I keep hearing is that equities have given great returns – this is generally calculated by using 1979 as the base and calculating the CAGR returns from that point of time.

Both in a way are bandied about as to why Equity is the best place to invest. While I agree, one should invest in equities, there are several issues with the above statements which I want to explore more via this post.

There are two ways of building a portfolio

1. A Concentrated Portfolio of a few select stocks (or more stocks but with one or two having unequally high weight).

2. A well diversified portfolio of a large number of stocks

Both come with its advantages and disadvantages. Lets first deal with the Pro’s and Con’s of a Concentrated Portfolio

Lets start with this cheesy quote by the Oracle of Omaha

If you have a harem of 40 women, you never get to know any of them very well – Warren Buffett

The advantage of holding a concentrated portfolio is that you have a very low number of stocks / industries you need to understand. We all have our limitations, both in terms of time and knowledge and its impossible for any one person to know everything that is needed to know about every industry / sector / company that is listed.

The second advantage of having a concentrated portfolio is that even if 1 or 2 stocks click big, the out-sized position size means that the net affect on the overall portfolio will be pretty huge.

Peter Lynch made his name managing the Fidelity Magellan Fund. Over the 13 years he managed, he grew (both in terms of AUM & Net Returns) exponentially. The number of stocks he had when he exited the fund as the manager – 1400+ (Yep, One thousand Four Hundred) (Source: http://bit.ly/169mypw ).

The biggest advantage of having a large portfolio – no one or two stocks can damage the portfolio badly .But on the other hand, even if a stock goes 5x from your purchase price, the net impact on the portfolio may be very negligible.

The larger the portfolio, lower is the volatility of returns. A large enough diversified portfolio more or less starts to mimic the Indices both in terms of returns and risk.

So, what is better?

I believe that the final call on what approach is best is dependent on how much of confidence you have in your ability to pick stocks as well as your ability to absorb the pain that comes in with it.

But if you believe that you do not posses the skill set to identify stocks and bet big on it (Concentrated), you may actually be better off investing into a diversified Mutual fund while concentrating your efforts on understanding the larger picture so that you know when you should be Sipping (in other words, following a Systematic Investment Plan) and when you should be Whipping (Systematic Withdrawal Plan).

And before I conclude, just remember that there is no Free lunch in markets. Its all about give and take. Knowing what you are willing to give will also give you a idea on what you can take 🙂

Rationalizing todays market move

Pundits (be on Television or Newspaper) have a way to rationalize everything that happens. Every market move is due to some or the other news. When markets are bullish, all reasons are bullish in nature and even those that aren’t turned around to mean as such.

So, if the markets are up despite there being a bad IIP nos, its explained away as Investors / Traders betting on a Interest rate cut. If it falls, of course IIP no’s were the culprit. One day the markets rise is explained by what happened in China while the next day, China does not even matter since market action was due to the downgrade of ______ (Fill up the country of your choice).

People love rationalizing. Period. Every move has to be explained by some event or the other. So, yesterday’s move down in our markets were due to selling of shares by the Ex-Promoters of Infosys while for today’s move, we have China to blame.

The interesting thing about China is that, much of the world did not even know that there existed a stock exchange in Shanghai until it started rallying in recent weeks. Today’s one day fall in the market has in a way stuck a match for the others with markets around the world falling in sync. Incidentally, Shanghai Index is way way below its 2008 highs. The relative performance chart of Shanghai vs Sensex showcases how despite being up 38% up in this year, the performance is nowhere comparable to our performance.

As in the past, China will be quickly forgotten as soon as the markets have something else to bother with. Not too long ago was Cyprus / PIIGS a big problem for the market. Right now, most cannot even remember what the issue was about in the first place.

To conclude, I am reminded of Judy Croome’s quote “Today’s news is tomorrow’s history.”. The only way to win in the markets is by sticking with a plan. News neither makes nor breaks the markets. So, stop rationalizing 🙂

Circle of Competence

Most of the top investors subscribe in one way or the other to the Charlie Munger concept of investing in stocks that one can understand. Of course, its quite another thing that most of us have literally no clue regarding how a company makes profits (other than that its products are popular and hence its making profits).

Lets take a simple Example. Bata India. Its the largest shoe company in India and at one time or the other, most of us would have bought for our-self or for family a shoe or a slipper from a Bata Store. But is the business really simple to understand. I doubt that most investors can really understand a company enough to risk serious money on the company (or any company for that matter).

I am more of a subscribe to Technical Analysis as a much simpler and better way to place our bets (we are after all, knowingly or un-knowingly betting on certain outcomes) but even here, I wonder how many a trader really digs deep enough.

Lets take a simple RSI for instance. Since it comes installed as a default indicator in most technical analysis software, most traders who use charts would have encountered the same in one way or the other. But how many really understand how the RSI is calculate, how many understand why the default number is 14, how many understand what a divergence in RSI and Price is really showcasing, how many know why 30 and 70 are seen as barriers (at least in the default version).

The other day, a friend of mine looking at a chart of Nifty with Stoch said that markets are overbought and shall fall. Of course, he is falling into the classic trap of mistaking overbought as a signal to sell. But I would not blame him since he is least bothered with what the indicator is all about as long as it provides a signal or a view to support his bias.

While reading a article today, I learnt that 42% of Americans do not read another book after they have completed their studies. With a average life expectancy of 78 years and assuming one finishes his education by the year 22 / 23, that is really a long period of no structured learning.

In the markets, it does not matter what approach you choose as long you are willing to learn everything and anything that concerns it. So, if Trend following is your poison of choice, learn all about the strategy, learn and understand what are the risks in using that strategy, what are the limitations of using trend following strategy in stocks vs using them on Indices and finally what is the reward for pursuing the strategy.

As Henry Ford says,

Anyone who stops learning is old, whether at twenty or eighty. Anyone who keeps learning stays young.

Learning about your system will help you in times when the seas are rough and the mind says that the best way forward is to abandon the ship. It can be a tremendous moral booster when the ride turns rough since once you understand the nature of your system and the reason for its current volatility, you will be much more prepared to take the next trade rather than worrying whether it makes sense to abandon the strategy in favor of another that is seeming to have succeeded during these tough times.

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