Notice: Function _load_textdomain_just_in_time was called incorrectly. Translation loading for the nimble-builder domain was triggered too early. This is usually an indicator for some code in the plugin or theme running too early. Translations should be loaded at the init action or later. Please see Debugging in WordPress for more information. (This message was added in version 6.7.0.) in /home1/portfol1/public_html/wp/wp-includes/functions.php on line 6131

Notice: Function _load_textdomain_just_in_time was called incorrectly. Translation loading for the restrict-user-access domain was triggered too early. This is usually an indicator for some code in the plugin or theme running too early. Translations should be loaded at the init action or later. Please see Debugging in WordPress for more information. (This message was added in version 6.7.0.) in /home1/portfol1/public_html/wp/wp-includes/functions.php on line 6131

Deprecated: preg_split(): Passing null to parameter #3 ($limit) of type int is deprecated in /home1/portfol1/public_html/wp/wp-content/plugins/add-meta-tags/metadata/amt_basic.php on line 118
Portfolio Yoga - Part 22
Deprecated: Function WP_Dependencies->add_data() was called with an argument that is deprecated since version 6.9.0! IE conditional comments are ignored by all supported browsers. in /home1/portfol1/public_html/wp/wp-includes/functions.php on line 6131

Deprecated: Function WP_Dependencies->add_data() was called with an argument that is deprecated since version 6.9.0! IE conditional comments are ignored by all supported browsers. in /home1/portfol1/public_html/wp/wp-includes/functions.php on line 6131

How to plan for your Retirement if you don’t have One Crore Rupees

The other day I was reading a blog post where the author claimed that even 1 Crore in savings is not enough to sustain a good life (assumption being monthly expenses of 50K per month). But how many (I am sure that if you are reading this, you have already reached the 1 Cr mark in savings or sure you will) folks in India can really save that kind of money. 

In ways more than one, we live in our own bubbles. Unlike the West, we have very little to speak off when it comes to Social Safety Net. Costs are ballooning even as opportunities for income become weaker by the day.

In the last couple of years, explosion of ecommerce has meant there has resulted in a huge number of low pay jobs. While it was easy to make fun of Pakoda making as being an Industry, being part of the gig economy is worse for you learn no real skills no matter how long you work nor build any brand identity. 

Retiring at 60

When we talk about Retirement, most instantly think about  their job ending when they come to 60 years of age. But why 60 and what is the history behind Retirement.

Retirement is a very recent phenomenon thanks to 1. Growing population that meant you had more people available for work 2. Longer life expectancy and 3. Changes in technology which meant the older generation had to constantly keep learning new tricks 

Frederick Hoffman argued in 1906 that a country’s productive potential could be maximized if people ceased working at age 65. While we are mentally as active at 70 as maybe at 60, the physical abilities deteriorate over time and unless one is in the knowledge based industry, its rare to see active senior workmen on the floor of any factory.

Life Expectancy in India

India’s life expectancy has been trending higher and given both the advances in healthcare and quality of lifestyle means that should expect the average to move higher. 

Unemployment has always been India’s bane though for few periods of time, we have had the kind of growth that made it seem that maybe finally we were able to come to grips. 

Social Security is a major source of retirement income for a large swath of Americans, but in India, one is left to their own. This means that if you stumble during your earning years, it tough if not impossible to build a retirement nest that can last your lifespan.

By 2050, the United Nations estimates that one out of every six people—or 1.6 billion—will be over the age of 65. In Japan, a country which is rapidly ageing, 59% of men ages 65 to 69 are still working. 

Aging across Countries

A year ago, I had an acquaintance ask for my help in figuring out if he was on the right track. This Gentleman had 3 Crore plus in savings but had a pretty hefty monthly requirement. He had gone with a very large wealth management firm a year before that and was seemingly not sure he they were guiding him right. 

The portfolio he showed me had the following funds with his funds split across them.

In addition, he had just been switched out of 3 funds and into 3 others. Thanks to the switches, in addition to getting ripped off in Dividend Tax, he was paying Income Tax on top of it as well.

So much for having some-one plan your finances. Of course, he wasn’t alone as data for flows into Balanced Funds showcased. Investors were sold the concept of being able to get monthly dividend even as the overall value of their holdings increased over time, a win-win situation. The only winners were those who sold thanks to the nice commissions.

I have this friend who has worked for a while and been an entrepreneur for another length of time and currently if he goes by the hippie slang, he is between jobs. He recently came to me asking for advice on how to go about investing the money he has while ensuing some kind of security for old age.

While I am not a Certified Advisor, given the bad experiences I have come across plus the fact that his corpus was way too small for most advisors to make it work commercially, decided to create a plan that allowed him to get a monthly income.

But was I on the right track, did I miss anything. Thoughts of these made me tweet to get reactions from those who follow me on Twitter.

140 plus responses were received and I am thankful to each of them for taking some time out to think and respond to a real problem that required a good solution.

Due to the nature of request – monthly income combined with fact that the person had too less money to work around, many responses were similar in nature.

Selected Tweets with my views on the same

An Interesting suggestion this was. IDFC First Bank offers 8% interest on 3 year deposits. At 20 Lakhs, this would generate what he wishes while the investment in Large Cap would enable a bit of compounding at a higher rate (hopefully). Even better would be buying ETF’s of Nifty 50 and Nifty Next 50 since tests have shown that they can generate as much return or sometimes even better than the best large cap fund.

https://twitter.com/iarm87/status/1172902709004910592

What is a Balanced Advantage Fund?

Balanced Advantage funds are funds that invest 65% into equities and 35% into debt. The advantage here is that since it has 65% into equities, its treated as Equity for tax purposes.

The disadvantage, since 65% is in Equity, 90% of its movements are correlated with Equity. Equity returns being chunky in nature, this is not the best instrument for having monthly returns.

This is a very interesting scheme and while my friend is not eligible since he is not yet 60, locking in 15 Lakhs with return of 9.60% (taxable) is something that is worth looking at for those above the age of 60.

https://twitter.com/reachanandl/status/1172881192334454784

Maximum number of suggestions were to invest everything at Bank and enjoy the fruits. The positive is that the monthly income for now would be more than what he requires enabling him to save and add to the principal

The negative is that there is Re-investment Risk. If interest rates are lower at the time of renewal, he would have to start cutting expenses which would have gone higher thanks to Inflation or start eating into the principal – not an enticing prospect.

This is something I actually discussed with my friend. While he too wants to be active and not just sit at home, the tough part is that very few skill sets have ability to generate an income without having to risk capital for he has none.

Have talked to him about a couple of areas where he could start off and while income may not be visible immediately, who knows what tomorrow holds. Fingers crossed for now.

https://twitter.com/anilbajpai/status/1172848258869153792

Another common suggestion was Reverse Mortgage. While I did’t explore this idea with him at current juncture, its something that hopefully shall catch on. SBI eligibility for Reverse Mortgage is 60 years and while his house being in the suburbs may not yield a great amount, its still something that can be accessed if circumstances so demand.

Cost of Healthcare is a real issue especially given that as one gets older, the risks get higher while premiums shoot up making it immensely tough to be insured.

Friend has Health Insurance for now, but bigger question is, how much is enough. Not an easy ask balancing the requirements with the cost of taking that hedge.

One of the interesting observations was that he retired early by choice. I wish not to go into the circumstances on why he is Retired before he has accumulated a Crore other than to say “shit happens”. Life doesn’t go according to one’s plans and wishes.

As much as the suggestion is valid, as one gets older, he wishes to stay close to his near and dear ones. After all, emotional security is as important as financial security.

Overall, diverse suggestions and once again, thanks for chipping in. Was especially moved by this tweet

Thank you Sridhar for your thoughts.

What I felt was missing was the concept of “Safe Withdrawal Rate”

While this is more applicable in countries where the government ensures that your ailments don’t need you to sell your house, even in India post a certain age, it makes sense to think about withdrawing from the Capital itself.

This especially if low interest rates have made it tough to meet ends. Risk though is that you run through your capital before life runs out.

The whole exercise has been interesting enough for me to wipe the dust off the CFP books I had ordered a while back. As for my friend, I think he will get along okay.

How we landed up here.

It was 2013, the Year of the Snake according to Chinese Zodiac. In India though, Investors were running away from the markets like they had seen a snake. Between mid 2009 when UPA came to power for the second time to October of 2013, Investors in total withdrew more than  37 thousand crores from Equity Mutual Funds.

Then again, why wouldn’t they. The government seem embroiled in scams that seem to be growing bigger than one’s own imagination of how large numbers can be. In Europe, countries were going through a meltdown with talk of countries may be forced to exit the Euro. 

Stocks were cheap, but you don’t buy when they are cheap for who knows, they can become even cheaper. Add to it, when your neighbour is buying properties like no tomorrow with prices on a never ending incline, why take the risk of buying a business that maybe there today, gone tomorrow.

Sentiments couldn’t have been more worse when the news started to trickle in that a messiah who had made his state proud was thinking of running the nation. In the United States, 17 of the 45 Presidents had served as Governors of state. 

In India, Morarji Desai was the first Prime Minister to take office post being Chief Minister of a state (State of Bombay), P.V Narasimha Rao and Deve Gowda being the other politicians who ascended the high office after being Chief Ministers of states.  

When one is drowning, even a tender grass offers hope and for the markets which were lacking any real hope, caught it like the savior it seemed to be. After a brief confrontation with the old war horses who refused to give space to the new, the preparations for the coronation began even before the voter had decided on whom they shall vote into power.

Markets were enthused that this finally was the real deal they had been waiting for so long. Small Cap Index doubled in the space of 9 months. India was seemingly shining once again.

Much of the run-up was justified for the base was low and more importantly macro winds were flowing in India’s favor. While bull runs of the past was interrupted by violent reactions and this run was no different with markets going through much of 2015 in a steady state of decline.

Factors this time were not related only to India, Chinese markets were taking a beating too with talks of a global slowdown. Interesting side note, China as been the case with many other countries has never seen its index climb above the highs of 2008. 

In the meantime, Real Estate had begun to show signs of weakness and money destined there came to the stock markets. Equity Mutual Funds saw a reversal of flows with inflow of Rs.47,509 Crores in 2014 and Rs.84,697 in 2015.

For Equity Mutual Funds, 2016 was a bit of a dampener. They could collect only Forty Five thousand crores. So, in 2017, they came up with a brilliant campaign – Mutual Funds Sahi Hai. 

2018 marked the peak of the bull run for the majority of investors. While Nifty has continued to gallop higher, thanks to the steady inflow of funds (Mutual Funds collected an unprecedented 1.36 Lakh Crores in 2017, came close to beating it in 2018 when total equity mutual fund collections accumulated to 1.12 Lakh Crores. Year to date, Equity Mutual Funds have seen a inflow of 43 thousand crores.

Capital Markets are the bedrock of Capitalism for they allow money to be moved from small savers to companies on the lookout for funds. Yet, that model has been dead for a while. Mutual Funds having amassed thousands of crores have kept pumping the same into a few number of stocks.

This moved up valuations into territory which makes no sense if you were to think of buying a stock to be similar to buying a business. High valuations make sense when companies are growing rapidly and the valuations in a way showcase how investors perceive the future growth of the company.

Yet, Mutual Funds are hampered by the fact that Indian markets aren’t really deep. Almost all funds are concentrated in the top 400 stocks and continued flows has led to a frenzy in an attempt to deploy it without bothering about valuations.

Is this the new Normal?

In 2000, in the midst of the Dot Com bubble, select stocks achieved levels of valuations that seemed incomprehensible before and 20 years later, seems incomprehensible today. But at that point of time, you were either a player or not.

Depending on whom you ask, Nifty Price to Earnings Ratio is either an indicator of future returns or its not. But what most will agree is that this has been the first time in ages that we have remained at substantially elevated levels even as sector after sector seems to crumble beneath.

The markets is no longer in the aura of the messiah delivering the goods. It’s now more a question of whether he even wants the same thing as the markets want.

The Indian story wasn’t built on manufacturing for the world as China did or greasing the world’s engines as the Middle East did. Much of the story was about how the large population would enable us to sell more of the stuff to us than others.

India doesn’t have the kind of data that the US has, but based on larger trends it seems that people have either run out of money to spend or aren’t willing to spend and rather save for a rainy day.

Other than in a few countries, economic downturns haven’t been short-lived. The longer the economy spirals downwards, the more self-perpetuating it becomes. We prayed for low inflation and we got it, now we are praying for low interest rates and chances are we shall get that too. 

But low inflation and low interest rates don’t come in a silo, they impact on the economy in ways we may not have imagined. Low Inflation, much of which is due to flat trends in agricultural prices have impacted rural demand. While low interest rates helps companies that are heavy on debt, it impacts the other side of the balance sheet – savers who are now forced to save more to get the same income.

What history tells us though is that even this will pass. Yet, history conveniently ignores the collateral damage caused and moves on. No one today remembers those who lost their savings and homes in the 2008 financial crisis, for why would they. Markets have moved on, people unfortunately may not.

Prudential Asset Allocation

Few days back, this tweet by Muthukrishnan caught my eye.

While I have used the tweet of @muthuk, my views below are not with respect to him. I believe there are hundreds of such examples but not highlighted.

A genuine advisor starts investment counselling process by concentrating on the asset allocation mix. These days, the only advisors one hears about is those who start off by recommending what they believe is the best fund to invest in.

Asset Allocation is the foundation on which you build the structure. In good times, read as when markets are bullish, advisors would rather first build the structure and only then think about if any foundation is required.

Asset Allocation is personal – my allocation mix is suitable to me only. It’s not possible for others to coat tail or just copy. Being personal unfortunately works against for when we don’t even disclose all the details to our Doctor, providing our financial position to an adviser is an unknown concept.

This has meant that the advisor is working with data that is not full and hence liable to make mistakes. Assume for instance a client walks in and says that he wishes to invest in Equity, a distributor with little or no data on his other assets can only provide him a list of funds he believes are good investments.

As an analogy, think about going to a Chemist shop and asking for tablet for fever. In all likelihood, he would disburse you with a strip of paracetamol. But what if you are experiencing fever accompanied by shivers. That would require a different approach since shivers come for specific reasons that paracetamol alone won’t help.

In India, main stay for Mutual funds are distributors who are by SEBI disallowed from advising on asset allocation. They can only give incidental advice and this is restricted to selecting MF schemes for investment. In other words, they are more of a Chemist than a Doctor who can diagnose the issue properly and provide the treatment necessary.

If you are not invested in equities, its seen as if you are missing out. Fear of Missing Out happens even more in bull markets, but not everyone requires equity exposure in the first place. Let me take a couple of examples where you maybe better off with Debt than Equity.

If you are a business owner, you are already upto your neck in equity – just that its your own firm’s equity that is most of the time pretty illiquid. Business fail all the time and while I don’t have data, I think there is a very high correlation between failure and the state of the economy.

When things are good, your investments are good, your business is good, life is great. When things turn rough in the market, market goes down, your business goes down and your life suddenly sees a different trajectory.

Being a Chemist and Druggist is a wonderful business. It comes with certain moats that have made it tough to disrupt in the way other businesses have been disrupted. Yet, disruption is always round the corner for who knows what the future holds. 

A chemist I know has invested in savings in buying a commercial complex that yields a sizeable rent. This has ensured that even if tomorrow his business is somehow disrupted, his life can go on as usual thanks to the continuous cash flow.

In other words, he has invested in what can be compared to Dividend Yielding stocks that may not give much capital appreciation, but can provide good cash flows over time. While Real Estate is looked negatively from the angle of asset allocation for being a dead asset, for him this is as good as equity with only draw-back being it is illiquid in nature.

Buying a house these days invariably means taking a loan with monthly EMI’s eating substantially into ones earnings. Thanks to the tax treatment, it may seem to make sense to take loans these days than save and pay by cash. Yet, how do you treat the loan has large implications when times are bad.

The biggest fear than most young employees express is the risk of layoff’s since many are burdened with staggering amount of loans – from Mobile Phone to Cars to Homes and what not. 

In 2006 / 2007, Americans had bought homes on loans. While the focus for long has been about loans offered to people who had no credit history or even ability to pay back, a lot of loans were also to people with steady jobs.

When the financial crisis erupted, it not only brought down housing prices but also meant loss of jobs. Take a look at the change in Unemployed Rates during that period

If one was invested in addition in equities, he saw his portfolio cut by 50%. Its easy to ridicule those who sold equities near the bottom, but if one had lost his job and his house at risk of being possessed for not making the monthly payment, better something than losing everything.

A friend of mine was recently asking about how he should treat his house in his asset allocation mix. Thinking on the same, I believe that if there is a loan repayable, you are better off treating it as equity than as fixed asset which is what it is.

Advisors to Fund Managers use the Warren Buffett quote 

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

While we can summarize the quote as one about how long term is rewarding in equities, another way of looking at is that if you need money over the next 10 years, equities may not be the best bet.

That doesn’t mean that you need to have zero exposure to equities, but given the fact that India is one of the few countries where you can get real positive returns on Debt, its unwise to load up on Equities if the objective of the investment is to help you in times of distress.

Have a prudent asset allocation plan that plans for worst case scenarios. Debt while not seeming sexy as equities can actually deliver better results if you face volatility in your career.

Assets can be temporary, Liabilities are permanent. Stress test your allocation to ensure that a quotation loss doesn’t become a permanent loss. As a quote goes,

A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain. 

You don’t want to be without an umbrella when it starts to rain.

Uncertainty – The life of an Entrepreneur

I never met V G Siddhartha even though I stay close to his home, was a member of Bangalore Stock Exchange where he started off initially and one I had been part of for more than 2 decades and more importantly, started my journey into markets as a Primary Broker under Sivan & Co, his company that is now known as Way2Wealth.

Twitter is filled with comments & opinions on what pushed him to kill himself – after all, he wasn’t a nobody. While it’s easy to point fingers at his debt as being the reason for the untimely demise, few companies other than Infotech companies are able to grow without resorting to debt at some point or the other.

Entrepreneur’s are attracted to risk as a moth to flame. They know that its risky, but is there a way out is the question that is frequently tossed about. For every dozen failures, there is always one rags to riches story that spurs one to leave the comfort of a job that pays a monthly salary towards a journey where he could end up lower than where he started off at.

For the better part of my life, I personally have been an Entrepreneur and yet, lack of good advise aided in no better part by my own stupidity and inability to think big soured all my journeys. 

What hurts an entrepreneur most is the lack of empathy when one is facing setbacks in business. Everyone and their chacha are happy to throw a few more stones saying, I told you so.

While India aims to be a 5 Trillion Dollar Economy, we still don’t have Personal Bankruptcy laws that ensure that if you fail, you can clean up and start afresh. Rather, most business failures I have seen have ended up with the businessman being cleaned off everything.

Starting a business requires funds and funds are hard to come by. Bank Loans require right connections or pledge of property but smaller loans are actually even tougher. At the City Market in Bangalore, money is lent to vegetable vendors in the morning at what is called “meter baddi”. Basically, they are given 90 Rupees in the morning and need to pay back 100 Rupees in the evening.

Go up a small level higher – say you want to start a grocery store and suddenly you find that there are no real avenues for raising debt at rates that make business sense. Commercial rents are generally high in most parts of the town and just the advance needed to stock up on the essential items can set one back by a few lakhs.

From Personal Loans to Pawn Lenders, most small entrepreneurs have running debits and one that while providing them with a chance robs them of the future for the high interest rate rarely enables them to meet ends meet.

If you wish to start something that requires a corporate setup, you have your first taste of government regulations as they start adding up to your bill even before you have given a name for your firm. Then onwards, its a steady stream of filing things and paying the Auditor, the Company Secretary, the Government among thousand others. 

Starting a business is a pain – from the start when you have trouble convincing your parents that you are better off on your own versus joining the herd for a safe salaried income. Once you cross that hurdle, from the Banks to the Government, everyone wants to trip you up even before your competitor has a chance.

If you somehow are able to sail through those, you are like the fish that finally comes out of the river to face the ocean. By the end of the first year, most fishes are spent force and look back at how their life would have turned out if they had just gone along with what their college mates and took up a 7 to 9 job.

When I started going to the Bangalore Stock Exchange, we occupied 3 floors with over 250 active members. This even though NSE had started off a few years back. In the 15 years I spent out there, I saw member after member basically either running themselves out because they took one risk too many or decided to fold before they were forced by circumstances and took up jobs in the booming brokerage industry elsewhere.

Today, I don’t think there are more than 25 brokers with enough business to afford paying their office rents. The surprising thing for me has been the fact that very few of the next generation of these brokers, many of whom have been associated with markets for decades have shown interest with most of them preferring to join the herd in search of a suitable job than take the risk of running a business where compliance costs have been slowly and steadily creeping up even as the brokerage dried up like many of the Bangalore lakes.

In India, failure is not seen as part and parcel of one’s journey but rather the end of ones’ journey. Failure is a stigma that refuses to go away unless you succeed beyond their beliefs and more importantly show that you have succeeded  – this generally by way of a Grand Wedding or buying a top of the range car.

One of the key issues facing the nation today is said to be unemployment. Yet, with the stigma of having been seen as a failure if they try and fail, few want to risk anything at all. Its time we started embracing the culture of taking risks by allowing those who fall to rise back up again without having to be ashamed at having failed. They failed because they tried.

As the son in law of a former chief minister, Siddhartha could have easily taken up the line of politics like other relatives of major politicians. Instead, he took upon a risk that worked for a while but ultimately burdened by facts that we barely know took his own life. Let’s remember for what he achieved rather than wondering what he could have done different.

As my favorite poem by Robert Frost ends,

Two roads diverged in a wood, and I took the one less traveled by, And that has made all the difference.

Stop Playing the Blame Game

If Investing is a Journey, 90% of such journey’s are left mid-way. Every co-passenger you meet on the journey seems to know what his final destination is – unlimited riches. Financial freedom alone doesn’t cut it for what is freedom without recognition as being a great investor / trader.

Markets move in cycles and we all know what goes up most of the time comes down – may not back to square one but definitely deep into recess before the next up cycle begins. Yet, the euphoria of a bull makes one forget that all these can and shall end one day.

While fundamentals provide the true value for a stock, its sentiments that drive much of the demand and supply. In 2014, news of the incoming government’s intention to launch GST provided a strong fillip to logistic companies.

While logistic is a simple business with very little of a moat to speak about, stocks got re-rated crazily. Companies like GATI which were trading at 10 times their trailing earnings suddenly were traded well north of 50 times. Its as if GST would revolutionize the Industry and boost their earnings significantly.

Well, there is a reason for old proverbs such as “If wishes were horses, beggars would ride”. Markets had just overestimated the impact and when results didn’t showcase any such boom, stock started to climb back from the peaks to the base-camp from where it had all started. The stock is today down 80% from its peak and yet its actually more than double from where it started off.

Sector after Sector has followed a similar pattern with stocks being sold at valuations that defy gravity and logic. Yet, with markets showing no weakness, like Chuck Prince many an advisor and fund manager felt that this was the new normal. Afterall, why is it abnormal to pay Non Banking Finance Companies which depend upon Banks for their own funding a price to book and price to earnings that is multiples of banks that have cheaper cost of deposits.

This is not the first time nor the last. The only difference is the sector / stocks in play and the players themselves. Old wine in new bottle as they say.

The question is what next. There will be another bull run but that doesn’t mean that your stocks will participate. In 2000, anything that had a name that included Infotech shot up. When the dust settled, the only survivors were barely a dozen at best.

Similar was the play in 2008 when Infra companies toppled. 11 years hence there has been very few if any companies that are trading above their 2008 high. 

In 2008, one of the top performing mutual fund was DSP BlackRock Micro Cap Fund, a fund focussed on small cap stocks. When the trend turned, the fund dropped like a rock falling 75% from the peak. But come 2017 and the fund was once again in focus with inflows to the extent that the fund actually stopped taking in fresh monies.

From the 2008 high, the NAV at the beginning of 2017 was up by 200% – the high of 2008, not the low of 2009. This even as the Nifty Smallcap 100 had barely recovered to its high of 2008. 

This did not come through by sitting on their old portfolio but by removing weak companies which were replaced by better companies. This ongoing process cuts out the weeds and ensures that the future performance is better than the immediate past. 

From advisors to fund managers, 2014 to 2017 was a time when most of them got carried away by the relentless bull rally. Momentum investing, especially price based momentum investing isn’t bad as regular readers of this blog know by now.

My own Momentum Portfolio was 80% of small cap stocks in January 2018. Today though, the portfolio is more in the Large to Mid Cap universe. While that in itself hasn’t helped me in limiting the draw-down (currently around 20% mark), the thought process is that when the markets bottom and the next bull rally takes off, the portfolio will be in the forefront of gainers.

If I had held the same portfolio that I had in January 2008, the portfolio would have been down by more than 60%. Cutting the losers and holding onto the winners has helped restrain the overall draw-down though given the deep cuts we have seen.  

If in this market, you have been caught with stocks that are down, you have two choices – one – hold onto the existing portfolio with the hope being that when the trend turns, the stocks too will recover.

Or better, shift out from the weak to the strong for when the market climbs back up again, the strong stocks of today have a greater possibility of generating better returns than the weakest of today.

In a way, the current situation for many is similar to the Monty Hall problem. Rather than me explaining the same, this video should do the trick.

Every rise and fall in markets is accompanied by narratives as to why the markets have moved as such. Currently the narrative is to blame the fall on the government policies. While government policies do influence stock price movements to a great extent, the fact remains that overpaying for future earnings does take a toll in future growth prospects of the firms as well.

Infosys was growing faster in 2000 than anytime in the future, but overpaying for that future earnings meant that the high of 2000 was seen once again only in 2006. Then again, investors in Infosys were lucky, same couldn’t be said for the hundreds and thousands of investors in companies such as DSQ Software, Silverline, Pentafour Software among others. All they hold today is worthless paper.

You can blame anyone for the mess but the impact is felt only by you. Everyone of us makes mistakes, but the way out is to first accept the mistake and learn the lessons it offers. Blaming can only take one so far and you are far better not investing with people who blame things on everything but themselves.

Asset Allocation & Models

In 2015, I wrote a small post introducing the Portfolio-Yoga Asset Allocator.

Introducing Portfolio Yoga – Asset Allocator

While the model in itself has undergone a change once, given the dichotomy with the current allocation and the market trends, I felt that a post was required to help better understand the model and how to use it as a guide for your investments.

I am a strong believer in systematic rule based models for these enable one to test out the nature of the idea before committing money or time on the same. Yet, the single point of failure for most models lies in the developer of the model himself. Models are build in two ways – one by way of data mining the past and coming up the optimal combination that seems to generate the best possible return.

The risk of such models is that the future is not a repeat of the past. As a wonderful quote goes, “History doesn’t repeat itself but it often rhymes,”. While human behaviour will ensure that we never really run out boom and bust cycles, the length of cycle will keep differing making even the most data oriented model but one that was trained on a different cycle length go repeatedly wrong.

Asset Allocation models aren’t really different – at the core, the philosophy is that you get the best “Risk adjusted Return”. That doesn’t mean one never goes wrong, but when one goes wrong, its better to err on the side of caution that on the side of Risk.

The model offered here is contaminated by the bias I bring to the table. While in my own investing, I was never conservative, owing to the experiences of self and clients, I have come to believe that its better to be safe than sorry.

The simplest asset allocation split is 60:40 in favour of equities. But when you adjust it for risk, you are actually looking at 90:10 and to me, that requires tremendous will power and experience to be able to row through a tough time with such a massive tilt.

Much of the literature on Asset Allocation comes from the United States but one that is uniquely different from the Indian markets. Interest rates in US have been low for a very long period of time and given the rising cost of living, especially Education and Healthcare, Investors are forced to risk more than what they should or rather would want to risk.

Since , Interest Rates in the United States have hovered close to the 0% mark and this means that Debt (Short Term Bond Funds) have yielded just around 3% for the end saver. Equity on the other hand has been in one of its longest bull runs with CAGR since the start of the rally in 2009 being to the tune of 17.75% {Total Returns}.

In India, Debt has yielded around 8% versus 16% for the similar period. Equity does deliver more, but that is also more a function of where we started at. If we had moved it back to just a few months back, January 2008, the Equity returns falls to 5% while Debt would be barely change much.

Investing in Equities is a game of timing. Invest in a good time and returns shine while on the other hand, investing in bad times can result in long periods of under-performance and even long term persistence may not change the end result by a great deal.

The highest correlation between factors of today and returns of tomorrow lies with Valuation which is a key input for most asset allocating algorithms. One of the better known valuation model is Robert Shiller’s Cyclically Adjusted Price to Earnings Ratio which tries to use a longer average of returns and hence avoid pitfalls of short term variation in yearly numbers.

The logic behind the Asset Allocator I update here is similar in approach. Since valuation is relative in the time space continuum, I use historical data to try and smoothen the curve. This ensures that the model is not binary in output.

Using the Asset Allocator Model

Asset allocation at its basic is about two things – Time and Return, Return being a product of time and valuation / growth. Both of these factors are hence the bulwark of the model.

Regardless of where valuation is, if you don’t have time on your hands, it make sense to have a Conservative Asset Allocation. For example, assume your kid will go to College in 3 year from now – would you want to risk the ability to pay his fees on the state of the market?

Conservative is also for folks who aren’t able to get through a major draw-down in their Networth without it impacting their way of life. Loss affect each one of us in different ways, but if loss – even we anticipate it to be temporary will make you worry, you are better suited to a Conservative allocation – it will provide a much lower return, but at least, you aren’t losing sleep over it.

Between the short term goals and long term goals, you will encounter what are medium term commitments – something which is at least 3 – 6 years away.  Here, you can take a bit more risk than with short term for you have a bit more time on your hands.

Finally there is the Aggressive – Aggressive is a mode for those risk takers who understand what they are doing as also applicable for those whose goals are years away – Retirement for example.

One of the primary complaints has been that the Asset model even at the Aggressive mode is way too Conservative. Currently for instance, this stands at 20% Equity and 80% Debt. As a friend who is ultraconservative recently commented, even he had more equity exposure than what the model seemed to argue for.

In software parlance, this is not a bug but a feature. When the going is good, it’s easy to mistake luck for skill and be overly aggressive in allocation versus what one is comfortable with. Those who haven’t yet seen a bear cycle fall into such traps for long bull markets make even the ordinary investor seem extra-ordinary when you look at his returns.

Historical Allocation and Draw-Down’s

Old timers remember how the markets fell post the Harshad Mehta scam. Yet, the bigger draw-down came in 2008. The fall of 2008 means that any model needs to account for a probability of 65% fall in the future. Accounting for a high level of draw-down has a direct impact on returns too given the correlation most models have with regard to Valuation, Return and Draw-downs.

Nifty is currently down just 5% from the peak. Assume that 2019 turns out to be similar to 2008 and Nifty goes down 65%. With a 20% allocation, you have the possibility of seeing a maximum draw-down of 16%.

The chart below showcases the average draw-down and maximum draw-down you could experience at various levels of exposure.

The above chart is based on the historical data of Nifty 50 from 1991 to 2019. The maximum is the same as what we saw in October of 2008. The deficiency if one can call if of the chart is that its path dependent.

Standard Deviation is close to the average, so you can at most times expect anywhere between double the average or close to new highs.

Finally, the model is for Investors who aren’t experienced the markets and would like to have an understanding of how much to risk at the current juncture. As you gain experience and go through cycles, you begin to get a better understanding of how much to bet on equity.

For sake of simplicity, I am ignoring all other asset classes out here. I don’t believe that given our fascination for Gold, it makes sense to bet even more by buying Gold backed financial assets.

Asset Allocation isn’t a one size fits all. Each person needs to evaluate his own requirements, his time frame of thought, his risk temperament among others. If you think you aren’t really capable of doing all that and there is no harm or shame in asking for outside help – preferably a qualified Financial Planner.

But do note that it’s finally your money and it’s very important you understand the risks and rewards for the weakest link in any strategy is bound to be you. Even the best advisor cannot be of help if you aren’t prepared to take his advise.

When Funds Run Riot – The DHFL Hungama

Multiple times in the past I have tweeted that one shouldn’t try to generate Alpha through Debt. Debt is for Capital Preservation, Equity is for Growth. Yet, when one is full time involved in finance, we understate our own limits.

Warren Buffett in the past has talked about Quotation Loss and Permanent Loss. If you invested in 2018 in a small or mid cap mutual fund, you may currently be finding yourself in hot waters with the NAV being lower than what you had purchased. But give it time and you should at some point of time make up for the loss and start gaining on your investment.

But, if you were invested in a stock, the probability of recovery is slimmer for the return is dependent on the company bouncing back from troubled times. Some do, majority don’t.

Tuesday was a market holiday and yet FinTwit was fully active thanks to the deep cuts seen by many funds. While it’s one thing to see Credit Risk funds get hit when companies they bet go down the drain, what was surprising but one that we now should have got used to was the number of Ultra Short Term and Low Duration funds that got hit.

Image Courtesy: @NagpalManoj

What is interesting is how sharply things have deteriorated. At the end of January, DHFL was an AAA rated company. Just 4 months later, its gone to CARE D. In other words, the company has lost 13 notches – something that showcases how quick things can turn bad.

Here is the Chart of one such fund which has been affected by the Crisis – UTI Treasury Advantage Fund.

In August of 2018, just before shit hit the fan for DHFL, the scheme was managing a corpus of Rs. 11,630 Crores. By end of May 2019, this had dropped to Rs.4,554 as investors tuned to the portfolio and the risks preferred to exit the scheme than take a chance of DHFL paying off the interests and the Principals which is due in 2021.

Once shit hit the fan for DHFL and the company stopped disbursing any fresh housing loans and instead preferring to pay back its debt, its end was written for one and all to see. Bonds traded in the secondary market showed the panic as Yields shot up to 30%+.

If you were a Mutual Fund Manager with a large dosage of the company’s bonds, the problem here was that you had literally no buyers, especially given the size of investment you would have had in DHFL.

Smart Investors quitting the scheme though had to be paid back and this was paid back by selling other bonds and holdings which were good. The interesting thing is that DHFL as % of the AUM barely moved. It was 6.74% of NAV in August 2018 and 6.78% – this despite a 50%+ fall in AUM.

Yet, the NAV over the last two days have fallen by 11.20% over the last two days. This shows that either the weights have changed over the period for which we don’t have data or there have been some other funds that have gone bad either. I would imagine the former than the later.

UTI has now written down 100% of its exposure to DHFL – in other words, it doesn’t expect to be paid back. This is good accounting practise since the NAV is now more or less fair. What isn’t fair to existing investors and this is not just for UTI funds is that other than Tata AMC, no other fund house has closed the fund to new investors to allow for side pocketing.

What is Side Pocketing?

Side Pocketing is a term used to denote the practice when a mutual fund separates the bad paper from the rest of the portfolio while rest of the investment continue to remain in the fund.

You have a fund with, say, 5% of Zee promoter paper, and the NAV is 100. Zee promoter paper defaults. The fund decides to side-pocket. So your NAV will fall to 95 on the fund. You will get another fund with an NAV equivalent to the remaining 5. The second fund is the side pocket – you can’t buy or sell units, but you will get money as and when the fund recovers money.

What this does is ensure that the fund need not close the fund to eliminate risk of arbitrage seeking hot money flow while at the same time ensuing that those who were invested in the fund and suffered due to the impact of the bad paper have an ability to claw back any monies that could be available in the future. {Source: Capitalmind.in}

What now?

Mutual Funds for long attracted Corporate Investors who were able to generate a small return for funds that instead would have been idling in their current accounts. In recent years though, Retail has become a major player thanks to the huge push by way of #MutualSahiHai and the arbitrage created by the government thanks to the differential way it treats income from Debt via MF’s versus Fixed Deposits.

While we have seen big mishaps in the past, what is different this time around is the number of fund houses that have been affected. Almost every other fund house manager seemed to be on a path to maximize returns without regard to risks.

It’s easy today to lay the blame squarely at the Credit Rating Agencies, but that misses the point that you are paying a full time fund manager who is supposed to know what he is getting into. A 20% cut in an Equity Mutual Fund is something that can recover, a 10% cut in Debt funds on the other hand is literally non recoverable.

In my last post, I wrote that one should stay away from Fixed Maturity Plans – yes, the past has been beautiful, but we don’t know how the future will unfold. Now, I am coming to the clear conclusion that unless you are good at understanding companies, their financial situations, monitor mutual fund portfolio’s every month and so on, you are better off with funds that invest in short term government securities.

Long Term GSec funds carry their own set of Risks and hence not advisable to any one other than those who understand Interest Rate Cycles and are able to know when to get in and when to get out.

From my limited review of Mutual Funds, only Quantum Liquid Fund and PPFAS Liquid Fund make the cut in terms of having a portfolio with close to Zero Risk of default eating up not just your interest but also your principal as we have seen in multiple funds featured above.