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Portfolio Yoga - Part 11

Some Questions around Momentum Investing

Since my first blog post highlighting my own move to Momentum Investing, I keep getting queries by friends and acquaintances who wish to learn more about it. The number of queries have increased in recent times though many are in telephone calls and not shareable with others. Once in a way, I do receive very thoughtful questions that I think require more than a simple answer. Yesterday, I was asked one such set of questions by Prashant. 

I think these questions and my views on the same can add value to a better understanding and hence rather than it being a one to one conversation, am posting this here in the hope that it helps clear some doubts that others may have themselves.

1) First thing, would like to discuss about the conducive environment for momentum investing –

Many researchers and authors suggest keeping track of sentiment, be it breadth of the market or some kind of trend indicator (200/50 DMAs) for overall market trend. My point is one or other sector or stocks are always there which shows momentum even if broder market breadth is not good or range bound or even falling/downtrend, So is it a good idea to be invested all the time – based on backtest and purely from your experience ?

My View: In his book, Stocks on the Move, Andres Cleanow writes and I quote

I will declare the market to be bearish if the S&P 500 Index is below its 200 day moving average. That’s a very long term filter. Using such a simple approach, we immediately have a firm way to identify if the market is in a bear trend or not. Practically all equity portfolio strategies can be improved significantly by simply adding this one rule. If the index is in a bear market, just don’t buy stocks

Andres Cleanow

While theoretically this is sensible, there is an issue when you look at the data. For the Indian Markets, I shall use Nifty 500 as the Proxy. The issue is whipsaws. From 2010 to 2020, Nifty 500 has crossed below its 200 day moving average 40 times (average of 4 times a year). Using an envelope rather than the 200 average reduces the trade numbers but adds a bigger lag on either side. 

Even without bothering about Timing Luck which would impact this tremendously, this constant moving to cash and getting back to full position has a cost. Personally I don’t see value in adding this filter even though this could have gotten me partially out of the market in March of this year (I would be back fully only in August and hence lost quite a lot on the way down while losing the opportunity on the way up as well).

But when market breadth as measured through say % of stocks trading above their 200 day EMA is on the lower end, the performance of Momentum like any other market strategy will be below par.  Hence a better strategy will be to sit out when % of stocks trading above their 200 day EMA drops below a certain parameter and pick it up only when the broader trends are back in place.

Because it’s not as volatile as the 200 day EMA on a Index, this has a lower number of trade-offs. But trade-offs shall remain regardless for there is no Free Lunch.

Personally since I started, my portfolio has been completely invested but for one month (April 2020). I do keep working on new ideas and strategies and willing to change if evidence points to a better way to invest.

2) Second point is Exit, somewhat related to first point and of utmost importance –

Is it better to exit all positions when sentiment for the whole market turned bearish based on above trend criteria OR can follow stock specific checks be it fixed SL(5% or 10%) or Trailing SL or momentum ranking criteria (if it falls out of list lets say top 20 or 40 depending upon one’s strategy of ranking/sector allocation/volatility). What is the best practice given the kind of experience you have ?

My View: As outlined above, exits when we feel the market is bearish (based on quantitative measures) has its drawbacks. I don’t feel it compensates for what we are aiming for – lower drawdowns in any meaningful way other than once in a blue moon kind of event. 

Stocks are generally volatile and stocks that are making new highs (and hence generally tend to be part of the Momentum Portfolio) are more likely to be a bit more volatile. Having a fixed percentage stop is injurious to returns. Each stock has its own volatility and trying to force every stock to align with a single stop will guarantee bad returns.

I use WorstRankHeld as the criteria to decide whether to hold the stock or exit. This is not strictly speaking required – you can just exit any stock that moves past the portfolio size and replace it with others. But the reason I use is to limit churn in the portfolio. Churn has a very high cost (both visible and invisible) and lower the churn, lower the cost we pay. 

I don’t believe that a stock in momentum has to continuously rocket upwards all the time. Many a time stocks do move into a range before launching into another fresh rally. Constant checking and weeding out such stocks will only mean that you aren’t allowing much time for the stock to make its move.

To give a recent example – Birla Soft got into my portfolio in October 2020 (a tad too late maybe). Stock decided to drop right after my entry. But in the ranks, did not go below the WorstRank held and this ensured that the stock wasn’t dropped like a hot potato. The next month (November 2020), it moved up enough to get back to my purchase price. It was only in  late December that the stock finally made its move. Without a worst rank held, this would have gone out. There is always a chance that the replacement could have done better, but could have done worse as well.

I have tested for both and find it kind of a yin and yang. Sometimes cutting off once it drops below 30 works better than Worst Rank Held while some other times, it works bad. But overall, I have seen that the difference it makes isn’t too huge and if I can get the returns without too much of a churn, I am game for that.

3) Third point is allocation –

There are quite a few theories related to this: few researchers suggest equal weight portfolio while few suggest volatility based using

20 ATR and start allocating funds from rank 1 based on volatility of stock till the fund exhausts.

Sectoral allocation – Some suggest keeping sectors in check but some suggest to invest even if all the stocks come out from only one sector. 

What’s your point of view ?

My View: This is a very good question.

Let’s start with portfolio construction. Equal Weight, Weight based on Trend Strength, Inverse Volatility weights, Market Cap based weights are among the one’s generally used. I have tested for Volatility and Equal weight and found not much of a difference in returns. Bigger difference and volatility happens due to Portfolio Size. Equal weight is simple and easy to adjust when one is adding new capital and hence my preferred choice.

Sector Allocation can be controversial. In August, I made this tweet 

Not much has changed since then. Pharma remains the highest weight in the current portfolio. Is this Risky – of course it’s Risky. But sectors and industries don’t generally fall off the cliff so as to speak with little time to adjust one’s position.  

In early 2018, 80% of my portfolio was in Small and Mid Caps which had just then made a high that is yet to be broken. But in the course of a couple of months, the portfolio switched out to Large Cap Stocks. But this 80% exposure was what gave me 60% returns in the period between May 2017 to December 2017. While some of it was given back, a large part was retained. 

Rather than an overweight in a sector, I am more concerned with being overweight in a single stock. This is because stock level risk is always much higher and hence my willingness to cut down stocks that have gone above a certain weight in the portfolio. Reversals in Individual stocks can be nasty with very little time to adjust one’s positions. 

Sector concentration risk is also a reason I choose to go with 30 stocks even though it may not be the most optimal. It’s unlikely to find the top 30 stocks all belonging to the same sector. But this is entirely possible if you are buying just 10 stocks for instance. 

4) Fourth point is Momentum/Ranking and about entry –

Have read many articles ranging from simple strategies like

(a) simple rate of change(max gains) to

(b) 90 days linear regression kind of complex strategies to

(c) Again rate of change over 3,6,9,12 months period.

My point of view while deciding the rank/momentum to give more weightage to short timeframe gainers – e.g.,

let’s say I want to rank on the basis of 12 months return but weighted kind of formula while ranking want to take care of all 3,6,9,12 months returns and apply some kind of function which gives more weightage to 3M returns than 6M returns than 9M returns than 12 returns and assign ranking for my universe of stocks. For one stock, I want to consider all four (3,6,9,12 M returns) timeframe in weighted terms.

Any suggestions on this ?

My View: Keep it simple. 

Currently the trend is with a lookback of 6 months, previously it was with 9 months and before that it was 12 months. But the shorter the lookback, more the churn and more the volatility. Trying to optimize on everything I feel is a fool’s errand. Rather go for one that allows the maximum amount of capital to be deployed. It doesn’t matter how great your system is if you can only risk say 10% vs a lower yield system but one where you can live with a 70% exposure.

Adding too many constraints in backtests opens up risks in terms of data mining and curve fitting. There are a lot of assumptions already built into any backtest, you don’t want to load them up even further.

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.

Bull Market Gurus

Every Bull market gives rise to a set of Gurus who can do nothing wrong. They are aggressive in terms of stock selection and for a while anything they touch seems to become Gold. While before the advent of Social Media and 24 hour business channels, it was tough to amplify one’s message beyond one’s own circles, today, we have Gurus who are able to dominate both the Social Media and the Television networks enabling them to reach millions.

When I started off in this business, there were no business channels. The first channel that I remember devoted to the stock markets was called “Money TV”. It did not have any programs but instead more or less spent the whole time broadcasting stock prices. Think about having only data and no noise – it was a lovely period.

When we talk about the 1992 bubble and crash, we name it after Harshad Mehta. The Dot com bubble which was not unique to India was driven by Ketan Parekh though his name is not as associated as HM with the rise and fall.

The bull and bear markets post 2000 have no real guru’s with everyone using the generic names for the crash “Financial Crisis / Housing Crisis”, but that did not mean there weren’t any big guns who strongly believed that India was finally shining and it’s time had finally come. 

Compared to India, America which has had a higher participation by retail has been enchanted by various Gurus over time. The only non guru guru to have survived are Warren Buffett and Charlie Munger combination with most others have fallen by the wayside. A list of some of the big names of the past can be read here (Link) 

While the ultimate losers are the retail who follow these gurus, the gurus themselves use their moment under the Sun to make a tidy bundle. With public memory being short, it’s amazing to see previously failed forecasters coming back to the limelight once the conditions are good.

The only way to become a guru is to reject the old and embrace a new style that the guru has discovered. For instance in 2017, the rejection was with the traditional thought process of giving weight to management and its reputation and instead we were extolled to buy into companies with bad management. It worked for a while and the guru was able to amass a massive sum under his belt. While today he is no longer highlighted, I am pretty sure his day in the Sun will be back sooner than one assumes to be.

In 2019, a new guru emerged who discarded the fancy theories of not buying stocks at high valuations. Valuations don’t matter, he roared and for now he has been proven correct as a company with single digit growth trade at triple digit valuations. If Tesla can be valued at 1200 times its earnings, why should not the best of Coffee Cans be valued at high multiples. 

This year has belonged to the new emerging club of Pharma Experts. While there have been value investors who started nibbling to pharma in the last few years, the last few months have belonged to twitter warriors who seem to have a better understanding of Pharma than the Pharma companies themselves. 

Personally, I have nothing to complain about, Pharma has been the biggest driver of my own returns even though Pharma is nowhere close to my circle of competence. The fear though is that while I know I can make a quick exit, not everyone will be able to do so. We have seen this when the Dot com bubble crashed in 2000 as well as the crash of the Infrastructure / Real estate led boom in 2007/08. 

While I don’t believe that gurus themselves are frauds, the fact lies that many have no fiduciary duty and many a time get carried away by the market sentiment attracting audiences who have no business to follow the gurus footsteps.

As much as we would wish, there is no easy path to success in markets. If you don’t have the time and ability to learn the skills required, you are better off investing in just a Index fund and hoping the country in the long run does a good job.

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

  1. 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.
  1. 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.

Advise is Cheap, Advisory is Not

Twitter for the financial community has been a fine place for exchange of ideas and thoughts. While the #fintwit community is not very large, it’s decent enough to generate interesting conversations around the world of finance.

For all the talk of we not being part of a herd, if you were to just scroll around with an open mind, you would see that talk is cheap and action is missing. The bigger the number of followers, the rarer he or she will openly challenge a fellow fintwit. let sleeping dogs lie as the Iodim goes.

While we laugh at others who we feel are stupid enough not to recognize the reality, Once in a while I feel if we are in a echo chamber ourselves. We have our strong beliefs and no matter the evidence we will continue to stick with our beliefs while either ignoring facts that challenge our assumptions or worse show us to be wrong.

One of the fantastic writers I have come across in the Indian fintwit community is @PassiveFool. I love reading his long newsletter filled with thoughts most of which I agree with or make sense. But once in a way, he takes the logic way too far and one that makes no sense at least from where I come from. His latest tweet thread was one example and I retweeted disagreeing with him.

One of the negatives of twitter is the limitation of words, so let me break down why I think he is wrong in the long form here

The first tweet has two numbers – one the amount of money HDFC makes from Prashant Jain funds and second the under-performance in the same period vs the Large Cap Index. Both these numbers are correct I believe but yet provide the wrong context.

The 700 Crores HDFC makes is not because of various reasons including the fact that they have been able to build a very strong distributorship who are willing to side with the fund manager despite the bad days he is seeing currently.

But here is the thing – what if you looked at the same data in 2015 (5 years comparison vs Nifty Total Returns). To compare, I shall use HDFC Top 200 fund – the fund that is no more in existence today but the prima donna for HDFC for a really long time and one Prashant has been managing

While Nifty delivered (including reinvestment of Dividends) a absolute return of 70%, HDFC Top 200 outperformed it by delivering 92%. In other words, if the same question was asked at the beginning of 2015, there would not be a tweet saying that HDFC was earning despite underperformance. Lets move to the next tweet that gathered my attention

https://twitter.com/passivefool/status/1333300261717110786

Again, the data is correct. 80% or so of the Assets that are coming into the asset management firms are coming from distributors but are they getting scammed? Scam to me is a word that is better used when investments are suggested where there is low probability of getting the principal back, let alone interest.

I don’t know if mutual funds calculate the total returns they have generated across clients – kind of Lifetime Customer Value – but if they do, I am pretty sure it’s strongly positive. Investors have made more money compared to what they have invested. 

Cost is a very relative term. Active funds are expensive compared to Passive Funds. But are they the only choices investors have when they wish to decide where to invest their excess savings?

Regular funds are expensive because there is a cost involved with having a research team and the support around it compared to copying the Index where the research is outsourced. A Portfolio Management Service company for example needs to have a AUM of at least 100 Crore to breakeven. The breakeven for Mutual Funds is way higher. Someone has to pay.

https://twitter.com/passivefool/status/1333300263612866560

I am in complete agreement here and have written it multiple times as well. But Cost is just one part of the equation – the other part being service. I have blogged about how I started out as a Fixed Deposit Canvasser when I first started testing the financial services business. I got sidetracked by the Secondary markets and did not go the Mutual Fund Distributor route.

But a MFD is not someone who just tweets about the good things you can achieve by investing. Most MFD’s are literally putting their neck on the line for the meager commissions they get for the work they put in. What work you may wonder does a MFD do – all he needs to do is select the best performing fund and have his client invest and voila, its done.

The reality though is quite different. Most clients expect the advisor to be available and not just on a telephone call but physically at least in the beginning when the relationship is still getting built and trust getting established.

Since Portfolio Yoga started its advisory services, I have talked to a lot of prospective clients. Some felt that the service was worth the price, some did not. But everyone had their share of questions which they wanted answers for. Investing is not like buying potatoes where the worst thing that can happen is that you bought rotten potatoes. 

The trend towards passive in the United States has been gathering steam enormously in recent times. But is it even right to compare what advisors are able to do there versus advisors here. Let’s take a look. 

The guys at Ritholtz have been great proponents of Passive in their various blog posts and books. They offer to their clients investment advisory services through Comprehensive Portfolio Management. With more than a Million followers, the CEO is a star on his own. So, who do they serve and how much do they charge? 

Their minimum for getting started is $1,000,000. Not much different from what our Portfolio Management Firms though here it’s because of SEBI mandate and there it is not. In other words, if you are not having that much money to give them to manage, they aren’t really interested in you. 

But if you think about it, this makes sense. It’s all nice to talk about the small investor, but who will bear the cost of helping him reach his goals and provide him the pep talk he requires when markets melt down like it did in March. 

The fee they charge for the Financial Planning & Consulting (and one they are able to auto-debit) ranges from  1.25% to 0.35% based on the Investment Amount (higher the Investment, lower the scale). The asset weighted fee for Regular Mutual Funds in India is around 2%. This is higher than 1.25% but on the other hand, you can invest a small amount and still call up your advisor distributor whenever you feel overburdened by everything that is happening around the world and want to change your fund.

For long I was in the same camp of Passive – why are guys so stupid I have felt and many a time verablly blurted out. But the problem as I see is that I was seeing from where I stand – me being someone who is in the Industry for 20+ years and understands it much more than someone whose only financial investment before this was a Fixed Deposit (or a LIC scheme his Uncle sold him).

It takes enormous efforts to help him understand the nuances of finance and how over the long term, it can help build a reasonable nest for himself. The alternative as I wrote to Regular Funds is not Index Funds but Fixed Deposits or Real Estate or anything else where he either understands the product or is sold the product by someone who is angling for a fat commission. If anything, selling Mutual Funds is one of the toughest jobs and one that really doesn’t pay well either.

Index funds are great – but you reach that stage of Nirvana after having exhausted every other path. Most don’t get to reach that stage of enlightenment right at the start unless they are really fascinated by the world of finance and investing.

Bull Market – Are we in One

The first bull market I participated in was the Dot Com Bubble. It was where I made my first 10 baggers and 100 baggers even though to be honest I was as clueless as the next person around – or maybe not that much for I was able to squirrel away a bit of the profits and one that came in handy when I decided to become a stock broker a couple of years later.

Since then we have had two glorious bull markets – the first being from 2003 to 2008 and the next from 2013 to 2018. Five year bull markets are rare and offer great opportunities to really up the game and yet looking back, I more or less made barely anything. 

While my first million was made due to lack of knowledge, the reason I could not participate in the next two bull markets which were actually more broader and much longer was because I had moved from being a novice to a expert and one who clearly felt that there was something wrong with this market and it was doomed to fail. Thanks to the company I kept during those days, any doubts were quickly dispelled by those who seemed to be more bearish than me and who have even better convincing answers than what I could offer.

There is this story I remember having read that talked about how Churchill when the tide of the War (the Second World War) had shifted to the side of the Allies changed his experienced Generals for they were experienced in Defense while what he required that point was Offense even if it came at a cost and one that only a much naiver General would agree to. I don’t know how true this story is or not but it has struck a chord with me in terms of how to think in Bull Markets and how to think in Bear Markets.

In Edwin Lefèvre’s evergreen book, Reminiscences of a Stock Operator there is a particular paragraph that is constantly quoted around as if it is the Holy Bible itself and yet quoting is one thing and executing is quite another. The paragraph in question,

What old Mr. Partridge said did not mean much to me until I began to think about my own numerous failures to make as much money as I ought to when I was so right on the general market. The more I studied the more I realized how wise that old chap was. He had evidently suffered from the same defect in his young days and knew his own human weaknesses. He would not lay himself open to a temptation that experience had taught him was hard to resist and had always proved expensive to him, as it was to me.

I think it was a long step forward in my trading education when I realized at last that when old Mr. Partridge kept on telling the other customers, “Well, you know this is a bull market!” he really meant to tell them that the big money was not in the individual fluctuations but in the main movements that is, not in reading the tape but in sizing up the entire market and its trend.

There is another famous quote by John Templeton 

“Bull markets are born on PESSIMISM, grow on SKEPTICISM, mature on OPTIMISM and die on EUPHORIA.”

But how does one identify a bull market and how would one know it has ended. Being wrong in identifying correctly the start of a bull market would mean a loss of opportunity while being unable to identify the end of a bull market would mean a substantial correction not only to one’s net worth but also the beliefs we hold to be true.

Timing is Impossible say the experts while themselves timing every other day in a variety of ways. Or maybe they believe that they have better skill sets than the ordinary guy on the street and hence feel that What’s good for the goose is not good for the gander.

If you take the best textbook in economics by Mankiw, he says intelligent people make decisions based on opportunity costs – in other words, it’s your alternatives that matter. That’s how we make all our decisions – Charlie Munger

Quote Source: The Joys of Compounding

The only reason to play the game of the stock market is simple – the alternative is worse off – either in terms of returns or in terms of liquidity or in terms of size of the market itself. So, once we have decided to play, the question is how to ensure that the odds favor us.

The markets these days are on a tear. On an average, we are seeing 50+ stocks hitting a new 52 week high every single day. But are markets up unreasonably? 

Let’s assume for a moment that we did not have the health crisis we have on our hands due to Covid. Would you have assumed that the markets were irrational in making a new all time high? My guess is that you wouldn’t have. 

But Corona and the impact it has had on the economy makes up question the new reality. When the financial crisis erupted in the US, it had an enormous impact on the general population of the United States. Out here in India, it barely logged other than those who were directly in the line of fire such as the Stock Markets.

Corona has been different – the impact was felt not just among the small population that invests in the market but the general population at large. The impact is very much visible – from the empty restaurants (though they are now getting back to normalcy) to businesses we touch base in the course of our daily life and have suffered.

The impact makes it tough for us to acknowledge why the markets are shooting up right now when news all around seems to be more bearish. In the United States, the markets are rocketing higher even as the number of Corona Cases per day has crossed the Lakh mark per day. 

In March, just a couple of days before we made the final low, I wrote this post

Mayhem in Markets. Will it End | Portfolio Yoga

Markets have  historically bottomed well before the trumpet of victory was sounded. This time it has not been different. Markets and Life itself has moved even though we are yet to fully conquer the disease. 

In the summer of 2003, after having suffered through a gruelling bear market, markets suddenly started to rise. In the space of less than a year, Nifty doubled and made its first all time high since the peak of 2000. While that victory was short-lived thanks to the fall of the NDA government, it was in hindsight the start of the biggest bull market India had seen. 

Markets have this ability to surprise us in both ways – on the upside when things seem to be wrong all around and on the downside when things are supposedly going all too well. 

One of the ways I have found helps in participating is having the tools that provide you with a perspective on what works and what doesn’t. Personally I favor tools that look at the breadth of the market and try to determine how they behaved in similar situations of the past. 

One such indicator I look out for is the % of stocks that are trading above their 200 day EMA. When they have crossed the 60% mark (after earlier having dropped below the 20% mark), Markets on an average have moved up 50%. This was triggered in August of this year and we are up 15% as of date, so who knows. 

One thing I believe in though is that markets are not in the Euphoric stage even though on the outside it appears so. For example at the beginning of 2004, 90% of the stocks that were trading were having positive momentum (in a way I define it) vs today’s number of 55%. 

One simple definition of the start of a bull market comes from Barry Ritholtz who holds that the Bull Market starts not at the bottom of the last Bear Market but at the breakout above the high of the previous bull market. In that sense, the journey has just started. Too early to fail?

Another would be the 200 day EMA on the Index heralding a bull market. Nifty crossed over that barrier in July and currently sitting 23% above it. 

The future is unknown though. This post may after all be the final nail in the coffin or maybe not. I for one am happy to have finally been able to participate in the bull market with as much exposure as I can afford. Like Mr. Partridge, I have come to accept that while there are a lot of reasons for markets not to move higher, there is nothing worse than staying out of a trend which could in hindsight be one of a longish phase.

Introducing Portfolio Yoga Large Cap Momentum Portfolio

If you were to analyze Mutual Fund assets under management, you shall find it dominated by essentially two styles – the Multicap which now thanks to new rules is changing over to Flexi Cap and Large Cap. 

This isn’t much different from what we have seen elsewhere in the word. Large Cap is basically preferred for its lower volatility and ability to be able to absorb a larger pool of capital vs the small and midcap category.  The Multicap is where the bet is on the fund manager more than the category.

The Portfolio Yoga Large Cap Momentum runs the same algorithm that drives the Portfolio Yoga Multi Cap Portfolio with the only difference being in the Universe of selection. Rather than have the entire market as the Universe as is the case with Multi Cap, with the Large Cap, we restrict ourselves to the 100 largest market capitalization companies.

The NIFTY 100 Index represents about 76.8% of the free float market capitalization of the stocks listed on NSE as on March 29, 2019. Our Portfolio will select stocks from this Universe while applying the same filters and logic as we apply elsewhere.

The Portfolio is a Equal Weight Portfolio of 20 stocks that shall be rebalanced Monthly. We estimate a low churn compared to the Multicap Momentum Portfolio. While one can invest a lower sum that what we recommend, we recommend you invest a minimum of Rs.2 Lakhs in the fund.

Backtest of the Large Cap Portfolio

When backtesting a portfolio that takes all stocks as the Universe, the only requirement is to ensure that dead stocks of today are available for selection in the day when selection is made. But when dealing with a subset of the data – an Index for example, not only should the data exist but also one should pick up only stocks that fulfill the criteria as on that day.

Idea for example is today close to a penny stock. But back in its heyday not only was it one of the top 100 stocks but also the top momentum stock. The constituents of most Index go through changes twice a year. Thankfully NSE provides the complete list of stocks that were part of the Index in historical times making it possible to recreate the Index as on those dates.

Creating and backtesting is a painstaking process but one that is absolutely necessary. The difference between testing on the current set of stocks that constitute the Index and the historical can boost up historical returns by a factor of nearly 2 times the return you would generate if you used the correct constituents.

The above chart showcases the equity curve if you used the Current Nifty 100 constituents vs using the Constituents available at the time when rebalancing was carried out. As you can see, Survivor Biased trumps Survivor Free. If only we had an Almanac to the future 🙂 

 Beating the Index is tough – this applies for Mutual Funds as much as much as Individual Investors if the portfolio sticks 100% to the Index itself. For large parts of the time as is seen currently a few stocks are able to move up the Index higher without the active participation of other stocks.

If beating the markets is tough if not impossible, why should one bother investing in the portfolio would be a question that can crop up in your mind. Why not go with a simple Index Fund where the tax is advantageous and the work much lower.

The answer lies in the fact that while the strategy will always outperform the Index, it has its moments when it does and does in a big way. Of the 189 months for which we have conducted a back-test, the Strategy wins nearly half the months while the other half is won by the Index. But if you look at the complete performance over the entire cycle, you shall see that the Strategy outperformed the Index comprehensively.

Long Term Charts are used everywhere for a reason – they hide the short term glitches that abound. Same is the case with the above chart as well. Rather than just stop with a one chart that contains 15 years of data, let’s break it down to rolling return charts. The back-test data file has the charts and the data backing it up.

Observe closely the 3 year rolling returns. For most part, the Strategy has outperformed all the other available Indices but the difference is not major in recent times.

But if you move to the 5 year rolling returns chart or the 7 or even the 10 year rolling returns chart, the outperformance is pretty evident. 

What this means is that while the strategy may not outperform the underlying in the short duration but as you extend the duration, the outperformance starts to showcase itself. While the portfolio can be invested by anyone, I believe that it holds a great value to investors who are new to the concept of Momentum Investing. Investing in well known stocks is mentally easier than investing in stocks that have great momentum but are unknown. 

The entire data set is available here {Link}. Do let me know if you have any questions in this regard.

The current open positions of the portfolio is available on the Google Spreadsheet shared with you. The first rebalance will come up at the end of this month. 

Finally the BIG Question I think which will crop up in many minds. Should I have both the Portfolios?

My Answer is No. 

The underlying strategy being the same, the correlation between the two portfolios will be high. The Large Cap Momentum will have a lower churn compared to the Multi Cap. It from the back-test also has a lower Volatility. Max Draw-down similarly is lower for the Large Cap Portfolio vs the Multi Cap Portfolio. Sector Concentration is lower for most of the time in the Large Cap Portfolio.

All these benefits come with a trade off that the returns will be lower. The backtest CAGR over the 15 years for Multi Cap comes to 24% while its 18% for the Large Cap Portfolio. 

The Multicap Universe benefits from its ability to move into the Mid and Small Cap universe and hence take advantage of the Size Factor (which is basically Beta). The downside is that we will have a few bummers on the way that could even make one question the thesis as a whole.

If you are comfortable with allocating money to stocks that are lower down the pecking order in terms of market capitalization and also willing to suffer a higher churn ratio, go for the Multicap Portfolio. On the other hand, if you want to be invested in the best of the Indian Companies and have a lower churn ratio, go for the Large Cap Portfolio.

Either way, we believe that to really showcase the advantages of an approach such as Momentum, you will need to be invested for at least 3 to 5 years. Please mail me if you have any questions with regard to either portfolios.