Portfolio Yoga - Part 41

Missing the Obvious

The hot topic in last few days have been about SEBI and how they are killing the distributor by making it known to the investor, the fee he pays (indirectly). Much comparison was made as to how Insurance agents had a free run before Manoj Nagpal put out a tweet clarifying things a bit. He said and I quote

Life Insurance Cos already disclose commission. Benefit illustration – which has to be signed by client – has it (buried in lot of paper)

The human eye, its said doesn’t register / record everything. It instead takes snap shot and stitches to get a complete picture. Since the amount of data that is collected is huge, a lot of things are just zapped out unless we force ourselves to look at the same.

When we are driving, we see and observe traffic to make sure we don’t break laws (Signals) nor cause accidents. Yet, you cannot remember the colors or models of the last cars you overtook. Yet, the fact that we overtook them means that we did observe them for a while at the very least.

When we are making investments, what are we looking at? We are looking for major things like writing down the right information and selecting the right scheme. If we have already decided what to invest in, the least thing that the mind will focus on is commission that will get paid pursuant to our acceptance.

Just today, I fell for the same when I made a investment via online portal that allows one to invest directly. My focus was so much on registering and investing that I missed the fact that they charge a platform fee of Rs.948.00 per year. My whole idea of using the platform was to invest direct (and this fund by the way is not something they recommend either) yet I missed the obvious fact that I was paying them for just providing me with the ability to invest & monitor (something that I could have done a whole lot cheaper elsewhere).

I instantly wrote back to them and received a call wherein I was assured that since the transaction has been completed, they will make a special case and not levy (again, this levy is not auto-debit and I would have had to pay if I wanted to continue my usage of the portal) the fee.

A thousand bucks is not really expensive, but given the fact that most mutual funds provide you with the ability to invest online for free and monitoring is easy given once again the plethora of sites and apps (most being free), one needs to question what exactly he is paying for.

Of course, since the fee is fixed, once investments cross a certain barrier, the charges get diluted (as % of AUM). But if you are doing a one off lump-sum or a SIP, you still do not get the full advantage of the difference between the Direct and the Regular scheme even though you yourself would have done all the hard work.

In my own case, I learnt a valuable lesson that I thought I knew very well – nothing comes for Free

🙂

Transparency in Mutual Funds

On Friday, SEBI came out with a Circular detailing among other things

The amount of actual commission paid by AMCs/Mutual Funds (MFs) to distributors (in absolute terms) during the half-year period against the concerned investor’s total investments in each MF scheme. The term ‘commission’ here refers to all direct monetary payments and other payments made in the form of gifts / rewards, trips, event sponsorships etc. by AMCs/MFs to distributors.
The scheme’s average Total Expense Ratio (in percentage terms) for the half-year period, of both direct plan and regular plan, for each scheme where the concerned investor has invested in.

This has really set things abuzz among the IFA folks who believe that this spells death for many of them given the fact that now the customer is empowered with the knowledge of what he is paying for the advice he is receiving, he may not really be quite keen on continuation of the service as it stands.

Some time back, SEBI decided to differentiate between an Adviser and a Distributor. An Adviser while could charge a fee could not take advantage of the commission paid by the AMC. The basic idea here was to ensure that by de-linking the adviser’s income to products he sold, a adviser wouldn’t sell products not suitable for the investor. But given the fact that Distributors were given a free run where they could (and a leading site that enables investment in mutual funds) still claims and I quote “The smartest way to invest in Mutual Funds and more – For FREE!, it was a tough issue for any adviser to ask an investor to pay when he could supposedly get the same for free.

To overcome this, many a RIA just placed their distributor code under a different entity making it seem that they provided the advice for Free when it clearly was not happening since many of them did not even enable investors to invest in “Direct” rather than “Regular”.

The biggest concern among IFA’s is that this method (of not making the client know what the IFA is getting paid) was the best since we “Indians” supposedly do not wish to pay for advice. Yes, we would love to get things for free (who doesn’t), but if there is a way to evaluate and showcase why paying for advise maybe worth the investment, a lot of those who weren’t ready will have a change of heart. That doesn’t mean everyone will do, but who said changing opinions is easy.

Syms, an off-price clothing store in New York, says, “An educated consumer is our best customer.” I have friends who are happy to go with a distributor since he provides them with evidence backed data on what funds are good investments and what aren’t. If a distributor is providing value and has nothing to hide (after all, no one expects anyone to do anything for Free), I find no reason as to why should this new disclosure bother him. The only guys who would be stumped are those who were claiming to do a free service while riding piggy back on the commissions.

As to those who claim that without the distributor, Mutual Funds will not be able to penetrate in a big way, I would like to read this short story “The Old Lady of Somanahalli”

Buying the Low’s

On Twitter, Alokesh Phukan asked me a query on the difference in returns between buying at the high of the year every year vs buying at the low of the year .

Not sure if this study holds for our volatile mkts @Prashanth_Krish can find out l guess;) #PeterLynch #MarketTiming pic.twitter.com/tGr1Cs8rCi

— Alokesh Phukan (@greyfool) March 16, 2016

Now, who would not want to buy at the lows of the year but the sad truth is that we have a higher probability of getting hit by lightning than being able to buy at the low of the year, year after year for decades together. And all this for what?

The difference (XIRR returns) comes to 3.12% and while its big, do note that we are comparing against another operator which is non predictable. The easy thing to do would be to buy at the end of the year and the difference between the low and the close comes to just 1.83%.

Since objections were raised as to how every one percent additional returns can make a huge difference at the end, let me provide the figures.

Assuming one invests 1000 Rupees every year, the returns at end of 26 years (Investment of 26,000 Rupees) would be

Value if bought at Low: 2,01,739.00

Value if bought at High: 1,21,043.00

Value if bought at Close: 1,49,321.00

Given that there is no way we could have bought the low (buying the high is much more possible given our emotional state when everything looks good), the question is whether there is anything we can do to minimize the difference between buying at the low and buying at close.

If one wants to trade only once a year, there doesn’t exist much scope other than maybe split uniformly across the year and hope that the average is lower than the year-end closing. But if you are game to trading, there does exist a method where we could actually end up buying more cheaply than the Index (or Stock) was available to trade.

Trading Systems exist by the thousands though the few that are able to beat indices consistently would not be publicly available for trade. Any trading system that has positive expectancy is something that is worthwhile to bet on (if other tests prove it to be a able commander of money).

In simple words, Positive Expectancy is the points your system can make overall per trade (average). If your system trades say 1 trade a week (52 trades a month) and makes on a average 20 points per trade, at the end of the year, the average price of your stock would be (assuming you buy to hold at end of the year) Close Price – (20 * 52) = Close – 1040.

Of course, let me add that you cannot possibly hope to make 20 points in stocks such as ITC, but is entirely possible in Indices such as Nifty 50 or Nifty Bank. Another caveat is that there is no certainty that you shall have your 20 points year after year. Some years will be better than 20, some worse. But if that 20 holds on in the long term, you could actually have a negative price as your purchase price some years down the lane, something that is impossible if you just buy and hold.

Trading means more efforts (both in building systems as well as executing the trades) plus more in commissions / taxes. But if end of the day, you are liable to make a much larger gain without it being relative to how the market performs, its a fair deal in my opinion.

You will never be able to make that one good trade every year, but the law of large numbers will ensure that if your system is good, you could get a return way higher than what you could get by having a crystal ball provide you with the exact date and price of the low for the year.

True Lies

The other day Jim Rogers claimed that he foresaw a 100% probability of a U.S. Recession – a probability that gives him no room to escape, but then again, this is not the first nor the last time he has predicted the unpredictable. In his book, Clash of The Financial Pundits, Josh Brown writes about one such guy – Joe Granville and its a fascinating story to say the least.

Mutual funds are good generators of wealth in the long run if the markets where they are invested see a good growth. Every country has seen at least one big bull run which provides unprecedented gains to the investors.

As much as Technical Analysis is about basing the future on the way its past has been, its no advocate of blindly trusting that historical patterns will occur in the future as well. As Mark Twain eloquently wrote, History does not repeat itself, but it rhymes.

Some years back, in a moment of euphoria a Goldman Sach’s Analyst decided that the next big growth will come not from advanced countries like America or Europe but from 4 countries – Brazil Russia India and China and so came the acronym, BRIC which later on became BRICS thanks to the addition of South Africa to the list.

Over time, the bricks have been falling off to the extent that the lone man standing now is India. Brazil which showed so much promise has been done by the collapse of commodity prices, Russia in addition to getting hit by commodity prices also got hit due to its incursions in Ukraine, China – country whose stock market literally shook the world markets is someone whose numbers are always under question.

For a while, it was good with the worldwide growth washing away everyone’s sin’s of omission and commission but while investors may have a short term memory, markets remember.

In a recent article, I read about the last 150 years of innovation has been on lines that has never been seen in any other 150 years. So, when we look back on the markets of the last 15 years and think that that next 15 will be similar or even better, how realistic our assumptions really are?

My idea of critiquing investment methods / strategies is not to say that they aren’t worthwhile but to provide you with a perspective of things from a different view point. Anyone and everyone makes money (some by hard work, some by luck, some others by Inheritance) for money is the key essence to survive (forget thrive). But unlike say our grand father or his father before, we want to do a lot more – more travel, more entertainment, more outings with family. And then who doesn’t want a bigger home, better education for his kids among other wishes.

But life is costly and there aren’t short cuts to success. If you were to look at the Fortune 500, you shall see the list of men who risked big and survived. You shall not see a Vijay Mallya there since while he did risk big, the bets didn’t pay off and instead have taken their pound of flesh in terms of loss of existing wealth.

The reason investors are generally skeptical of equities is because of their inability to understand the risk component. Understanding that is the key to getting a better than average return. Everyone aspires for average returns, but for the average to be average, some will be above the average and some will be below the average. Where do you prefer to be?

Mutual Funds /Equity / Bonds / Cash all have their place in one’s portfolio provided you understand their pro’s and con’s before getting sold on what may or may not be ideal for you. To conclude, let me quote this from Howard Marks, a guy who has delivered returns which are closer to equity but by using bonds.

“If riskier investments could be counted on to produce higher returns, they wouldn’t be riskier. Misplaced reliance on the benefits of risk bearing has led investors to some very unpleasant surprises.”

Finance and the Treachery within

Of all the Industries, the one that is loathed despite its laudable achievements is the world of finance. If not for the inventions in finance, most of us would still be bartering stuff around and hoping that you have what I need and you need what I have.

While inventions in other industries are lauded, in the world of finance, invention in recent years has made one wonder as to whose good these instruments of finance really are.

At its simplest level, finance is all about money changing hands from one who has more than he wants (for now) to one who wants more than he has (for now). Every business is build on its ability to finance its investment from one source or the other.

Directly or Indirectly, most of us are participants of every nature of business there is. While investing in Equities or Bonds is a direct way, when you lend your money to the bank and they lend to a business, its a indirect way wherein your money is channeled to the business with the risk being spread across.

Mutual funds are one way of participating in the business with the main logic being that the fund manager knows better than others. But does he really know any better?

Every month, reports go out on what funds bought and sold and the list is large enough to wonder as to why fund managers need to trade so much even as they hold in disdain any form of short term trading / investing. HDFC Equity Fund for example (picked up at Random) has a turnover ratio of 34% which means that the whole portfolio is literally turned over every 3 years and yet, we have fund managers who shout from the roof tops the advantages of holding for the very long term.

Since 2000 if not earlier, there has been reports of how monkey’s have been able to beat professional money managers (at least the vast majority of them). While there is no monkey out there with ability to pick the best stocks, the reason behind their success lies in the fact that markets being random, everyone has a chance at hitting the jackpot once in a while.

Some time back, the book 100 to 1 in the Stock Market: A Distinguished Security Analyst Tells How to Make More of Your Investment Opportunities by Thomas William Phelps started to make waves in the financial circles. I myself have not been able to read it though thanks to the world of Blogs, was able to get detailed reviews of it.

The thing is that no one, not me, not you, not the hot fund manager right now or the wise wizard next door has a clue about which business will click and provide tremendous gains over the next 10 / 20 / 30 years and which won’t. This means that one really cannot buy a few selective number of stocks and hope for the best.

In fact, right from Warren Buffet to the value investor down the road prefer to reduce risk of the portfolio by diversifying the same. Mutual fund advisers advise one to invest into not just 1 fund but 4 – 5 funds to reap the benefits. But if you were to total up the stocks, you may very well find that you own nearly 70 – 80% of market capitalization ranked stocks.

Much of the financial world is made of monkey’s who offer to provide the service of sharing their cake. As you would know the story by now, its the monkey who stood to gain from the cat’s misfortune. There is literature after literature, all backed by data going back decades and even centuries about investing in a simple index fund being way better than in any mutual fund. But we are told that India is different and Indian fund managers are really able to generate Alpha – something that even Warren Buffet is finding difficult to achieve these days.

The solution to every problem and goal you have in mind is now easily achievable by doing a Systematic Investment Plan we are told. No amount of words or data seems to change the beliefs of the non believers, so let me try and tackle the issue in another way.

What are the Primary reasons for Investors to invest using SIP. Based on my discussions, I could come up with the following

Unlike in the past, we are told that youngsters these days don’t save much even as they draw mouth watering salaries. Unless some part is taken off and invested, they may not have much by the time retirement comes calling. Also since they are butter fingered when it comes to money, they cannot accumulate money to buy when markets are cheap.
Most investors have no clue about investing and aren’t prepared to make efforts to learn the same. Hence investing directly in stocks is too risky for them since they cannot understand the difference between say a Jet Airways and a Kingfisher.
By investing every month regardless of valuation (which they cannot perceive anyway), they can hope to benefit by long term averaging (in fact, the other word for SIP is Dollar Cost Averaging).

So, any alternative to Systematic Investing has to be one where no grey matter is strained and its simple enough for execution.

One of the ways to generate wealth on the stock markets is to buy Good companies and hope that they continue to grow for decades to come. Easier said than done as evidence has shown that even companies that are part of Indices can come to naught.

Buying the blue-chip of today may provide you with a decent return but nothing extraordinary while if you can buy a stock before market start to believe in it, you may have a real wealth generator out there. Its similar to investing say in Kohli before he started notching up his Centuries. His price (even say in case of Sponsorship) would have been way lower than what after market recognized his abilities.

But identifying such companies is not easy – not even for fund managers who prefer to buy the safe stock than risk (and rightly so) on companies that may emerge to be the next big thing. Most mutual fund portfolio’s are hence full of stocks that are similar in nature (and hence more the funds, more the over lapping).

What if instead of putting X amount of money per month into a scheme you invested the same into a random stock. A stock that was chosen by anything but skill, how do you think that would play out?

Well, I tested out the same. Using a survivor free database, I selected stocks every month randomly and assumed to have bought the stock for the money I was investing (10K per month). Every month all I did was throw a dart and buy the stock it picked.

The negative of the strategies would be

You will have a lot of bad apples. After all, not every company will thrive on the long run.
Your demat statement will run into pages after a few years as you keep adding more and more companies over time.

The positives of the strategy are

Since you invest only a small sum every month, the maximum risk would be losing one month of investment. On the other hand, if you can over time get even a single 100 bagger, it would ensure that 99 other bad apples are taken care of
Cost is small for executing this strategy. These days with brokerage firms offering Zero brokerage for Cash Delivery, the net cost would be way smaller than any other comparable investment (even Vanguard is beaten).

So, how did my test turn out?

I selected 120 stocks from Jan – 2005 to Dec 2014 and invested 10,000 into them. I did not add for Dividends which over time can turn out to be a good enough amount and one that will take care of the costs (Demat / Exchange costs) and more.

So, how did it turn out? A 10K investment per month for 120 months meant a principal investment of 12,00,000. At the closing prices of Friday, the current sum would have been 74,13,875.35 and since the investment was monthly, our XIRR return comes to 29.40%.

Of course, this is just one streak of many (given the randomness) and you may actually end up either better or worse than the above number. The intention of this post is to provide you a view on how you can build a large kitty without having to wonder if you have picked up the right fund manager and if the fund manager is making the right bets.

Much of the finance industry is about making grandiose statement without providing the data to back them up. They say that if you SIP for say 10 years, you returns would be great, but is there is no possibility of having a loss after 10 years? Not even 1%, Zilch? Really??

Hundreds of thousands of Crores change hands from investors to those with the ability to market themselves as being the savior of your savings with no one being the wiser. As a adage goes, “The fool and his money are soon parted”.

When the financial crisis hit in 2007 / 08. thousands of investors lost money, many bankrupted. As to those who sold them such products in the first place? Well, most of them are well off and many are in a better position than during those turbulent times.

As I repeatedly emphasize, every one is after you money and its up-to you to safeguard the same. If you fail, you cannot have anyone to blame but yourself.

Being Right or Making Money

First off, the Title is a Rip off of a very interesting book by Ned Davis that I read and recommend you read it if you are interested in looking at market in different ways. Of course, not all the charts that are provided in the book can be easily re-created, but at the very least it will give you a idea on what to look at.

Yesterday, Bloomberg carried a report on Khmelnitsky, an analyst at Veritas Investment Research Corp being the only Analyst to issue a Sell call even as hedge funds piled in. While he now turns out to be right, in the interim, the stock had doubled (from time of his Sell call). In fact, its still yet to reach the price where he called “Buyer’s Beware”. Chart from Bloomberg below (article link)

On Social Media / Television, Analysts keep calling for either a strong fall or a strong rise (new Low or new High in their lingo) even as much of the time, market seems to do the opposite of what they are calling for. But markets being markets, they do get it right at some point of time. The question as in case of VRX above is, does getting it right after being very wrong for a large period of time makes enough amends?

As one very well knows, Being Right is easy, making money, well that is a problem that sometimes seems absolutely insurmountable. But to make money, one needs to be right in the first place and right in the right time frame. There is no point in being right but being unable to make money due to the pains that the position caused first.

Investing / Trading is all about timing and positioning (size). If you get the timing wrong, you will end up taking substantial losses (Notional or Real) whereas if you get positioning wrong, you either end with too small a profit to bother about or too large a loss to be never able to trade again.

The reason Systematic Investment Planning (SIP) is most preferred is because rather than doing the hard work (of both timing and sizing), one hopes that over a long time, everything will average down and provide a better return than what one time lump-sum can provide (a thesis that can be easily tested).

Yet, its surprising that the very same people who argue for SIP argue against a Exchange Traded Fund claiming that since some funds (remember, Survivor Bias makes the whole testing meaningless) have given true alpha and hence in the Indian context Mutual Funds are better than Exchange Traded Funds. If timing is not possible, how can you really hope to pick up the right funds (average return of funds are generally lower than their bench-mark which means that there are a lot of funds that under-perform) all the time?

But I am digressing, this post is not for or against SIP. This post is about whether it makes sense to even follow Analysts / Fund Managers who claim to be right. Today morning for example, a famous PMS fund manager posted about how he hoped investors took advantage of his bullish tweets and invested in the market. But guess what, I scrolled through the gentleman’s twitter feed and he has tried to call markets bottom at every major level.

His target for Nifty (since Jan 2015) is 10,000 and I am sure he will be right. But how many have the ability to withstand the pain that came in between. Stocks, fancied or not have had a hell of a time in recent months with even marque names taking a substantial beating.

To me, timing is crucial – its easy in hindsight to say that, all you needed to do was sit tight, but sitting tight is not the answer most of the time unless you want to be like the average investor. But a average investor has no clue and does no home work, so why should your returns mirror his?

The future is unknown. Yes, we can make speculative / probability based guesses about it, but truth be told, no one has a clue of how it will unfold. The investors who have done big for themselves didn’t make it by taking small risks that will not hurt them if they got their Analysis wrong. Concentration was the key – it made some guys while broke many others.

As a parent, would you ask your ward to give his best (and hopefully come on top) or say, you know what – do as much as the average kid on the street. Why bother with hard work as Edgar Bergen says — ‘Hard work never killed anybody, but why take a chance?

Power & Responsibility

Of the major Superheroes – Batman, Spiderman and Superman, to me, Spiderman deserves a special place for unlike Batman, he is no Billionaire with a R&D team to conk out his villains nor has the Superpowers that Superman has. He is just a ordinary guy who gets ability to jump buildings. Maybe his humility also comes from his Uncle who provides with one of the great quotes ever

“With great power comes great responsibility”

Of course, that is not original and if you are a sticker for the truth, this link should help you find the source of similar sounding statements from history (Quote Source).

In the world of Finance, Experts / Fund Managers who come on Television and provide their views for one and all can be considered the super heroes for many a investor / trader. But do they exercise caution when asked to provide views / predictions on the future of a stock / market?

Fund Managers are generally bullish on markets and stocks for one, they understand the probabilities better in the sense that there is a much higher probability that markets can say double from here than halve from here (Current Nifty level being around 7K). But more than that, its always better to sell Greed when you are looking for funds from clients than spread Fear (more so if you are say a Long only PMS manager).

But this probability is not true at all times since when markets get into bubble territory, 50% fall is something we have seen happen. Dow Jones for instance has seen a 80% crack from its peak and while those times may not repeat, there is nothing like “will not happen” in markets.

A fan blog site which was pumping up all and sundry when mid & small caps were hitting the sky suddenly seems to have started believing that fund managers are clueless since their stocks have fallen a lot during the current bear market.

While Nifty is currently down 23% from its peak, a lot of stocks are way down. Here is the distribution chart of the same

60% of stocks that are trading on the National Stock Exchange of India are down 40% or more from their peaks (4.5 years look back). A substantial number would still be well above what they were a couple of years ago, but this fall is nothing to be laughed at.

I am not much of a fan of guys who sell subscription services since they carry / assume no risks and its all down to how they market themselves. Fund managers on the other hand have quite a skin in the game. Their performance numbers maybe tough to access (especially Hedge Fund Returns) but end of the day, they are answerable to their investors and bad news can spread fast as history clearly has shown us.

I was browsing through the twitter time line of one such fund manager who has not a single bearish / caution tweet right from beginning of 2015. Right from Jan 2015, his target for Nifty (even as he advises that unless you are of the time pass variety, you should be looking past Nifty) has been > 10K. I am sure, some day in the future, that 10K will arrive and he will claim to have “told you so”. But by then, a wave of investors who follow him since Television channels now sport him as “Market Guru” would have disappeared never to come back to the pits.

Thanks to experience of burning hands, I am aware of the risks of following such junkies, but when I entered the markets, this was the only way I knew how to buy / identify stocks. Even today, when people enter markets, it takes a few years before they start differentiating the good from the bad and the ugly. What I really hope is that people who come on television provide a bit more balanced view for as a Idiom says “What goes around, comes around”.

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