Momentum Investing | Portfolio Yoga

The True Contrarian Strategy – Momentum

Contrarian investing is described as buying when no one wants to buy and selling when no one wants to sell. Much of value investing in many ways is contrarian investing.

In the book, Contrarian Investing, the Authors say that any stock that fulfills 2 out of the following 4 criteria can be considered as a buy

A PE Ratio less than12
A Price to Free Cash Flow ratio less than 10
A Price to Sales ratio of less than 1
A price to book value ratio less than 1

Not too different from a Value Investors screener for choosing stocks. When you search for Mutual Funds whose fund names have “Contra”, on ValueResearch, they are bundled with Value Funds.

Talking about the Berkshire Annual General Meeting, Morgan Housel wrote this,

It’s 40,000 people, all of whom consider themselves contrarians. People show up at 4 am to wait in line with thousands of other people to tell each other about their lifelong commitment to not following the crowd. Pluralistic ignorance at its finest.

Being contrarian is doing something that goes against the grain of logical thinking. Much of investing is not really contrarian. This is not to say Contrarian investing is not possible. Investing in a sector when it’s facing bad times for instance is often seen as contrarian investing.

I myself have done this more than a couple of times, the last being

https://twitter.com/Prashanth_Krish/status/1396742870321664000

I think investing against the herd gives off the zing that doesn’t come with normal investing. Here is the comparison chart of Nifty Realty with Nifty 50 and my own personal Momentum PF.

Lot of times, Contra Investing can also overlap with Distress investing. Wanna buy Pakistan Bonds?

https://twitter.com/AAHSoomro/status/1624677330575654912

The biggest issue with Contrarian investing is position sizing. Bet too small and even if right, it may not move the needle. Bet too much and if things go wrong, your returns shall never make it to the benchmark for years.

But there is a certain fascination / ego to say one is a contrarian for it suggests that one is better than the herd. But we are in more ways than one always part of the herd.

Recently I finished reading “Samurai William: The Adventurer Who Unlocked Japan”. It’s an impressive book that looks at the first Europeans who landed in Japan. But what the discovery (for Europeans for Asians had trade relations with the country going back centuries) was the fact that this was financed by risk talking gentlemen sitting in London.

In a similar vein, I think in today’s world, the true contrarian investors are “Angel Investors”. Unlike PE funds or VC funds, Angel Investors are risking their own money in investments most of which they very well know shall fail.

In the secondary market, I think one of the most hated strategies has to be Momentum. BAAP takes the limelight because of just one fund manager there to be bashed.

When one speaks about Momentum, most confuse Discretionary Momentum Trading and Systematic Momentum Investing. While both try to buy stocks that are going up, the key difference is in risk management. Systematic has a set of rules to ensure that when things don’t work out, and they don’t 50% of the time, we have an exit to end the agony.

In discretion, we are left to our own devices and given our behavioral biases and heuristics, the probability of cutting down when things aren’t working out is much tougher. Many traders for instance have a concept called “Mental Stop Loss”. Rather than placing the order on the terminal, the idea is to have the same in the mind and execute when it’s triggered.

Most of the time, stop loss means that the trade is already at a loss. The probability that the trader will actually go ahead with the trade is less than 100%. Most of the time this leads to bigger losses but once in a while, the trade rebounds to profit and the mind registers this as a reason to not place the order.

At the end of March 2020, my portfolio had been devastated by the markets. On 1st April, my strategy told me to sell 25 of the 30 stocks I held and buy 10 as replacement (50% went to Cash due to paucity of stocks to buy).

Despite practicing Systematic Investing for nearly 3 years and Systematic Trading for more than a decade by then, my first instinct was to override. Why not hold onto the stocks given my view that the worst could be over. Being overweight in financials, a few of my investments were down 40% and more – not easy to book losses of that nature especially when the holding period was just a month or two for many.

Thankfully I choose to follow the system. Thankful because as I wrote in my previous post, The Itch”, the cost isn’t just about money. In this case, in hindsight, sticking to the system gave a better return than if I had just stuck with the stocks even though many did recover in time.

The toughest issue with Momentum Investing is not just behavioral. Buying at highs and selling many a time at what seems to be the low point is tough. Tougher is the lack of a convincing argument on why the action needs to be performed.

Jim Simons had started to taste success in his fund. But that did not stop him from trying to influence what trades to make. Thanks to his team, he was not allowed to mess up the system.

Snapshot from the book, The Man who Solved the Market by Gregory Zukerman.

There is this misconception that systematic trading or investing is easy when in my own experience it’s not. The reason is that a system asks you to jettison all your own thoughts, views and just follow the machine. But we are not machines.

Systematic strategies are easy to follow when the going is good. The utopia of making money, even if it’s inline with the market allows the mind to feel it’s in control. But the trouble starts when one has a losing streak and regardless of systems, every system shall have its downtime.

Mulvaney Capital runs a systematic trend following program. It has had a blockbuster 2022 with a return of 89% for the year. Since its inception in 1999, it has generated a CAGR of 14% vs 4.50% for S&P 500. A fabulous outperformance indeed.

But long term returns can hide short term pains and it’s the same here too. The fund had a fantastic 10 years since its inception. 2000 to 2010, it generated a CAGR of 19% vs a negative return of 1.4% by the S&P 500.

But in the next 10 years (2011 Jan to December 2020) yielded a CAGR of just 2.88% vs a return by S&P 500 of 11.55%. Talk about underperformance. Two short years later, the CAGR since 2011 Jan is now greater than S&P 500.

Most CTA’s have low assets under management with the management most of the time having their own money greater than the rest of clients combined. The pressure the fund manager faces during those trying times is unmeasurable.

Momentum strategies will have similar periods of no returns too. In the back-test, we saw that the 2008 peak was not comprehensively taken out till late 2013. The returns were inline with Nifty 50 but that is of little help to someone who has to keep managing the portfolio (Weekly / Monthly as the model maybe).

As a contrarian fund manager says in the book, Contrarian Investing,

Compatibility between investor and investment style is one of the most overlooked concepts in the investing field. What works very well for one investor may be disastrous for another. I think that’s why a lot of investors fail. They may have a good investment strategy or technique, but they’re not comfortable with it because it’s not compatible with their natures. The result: they don’t stick with it.

Much better to temper enthusiasm when things are good and develop enthusiasm when things look bleak. This is what contrarians do and it helps them stay the course.

All good investing is Value Investing, says Charlie Munger. I would add that all good investing is Contrarian in nature.

PS: As I was writing this post, I was also listening to songs from the Telugu Movie Shankarabharanam. In many ways, the movie was a contrarian. It featured a debutant for the key role while also allowing a newbie singer, SPB, to sing the fabulous songs. The movie broke records and is seen as one of the best Telugu movies ever. Risk many a time can pay off very well.

Roundup of Five Years of Momentum Investing

While everyone wants to take the road not taken, safety lies in the road everyone takes. Fund managers would rather be called out as closet managers than be criticized or worse fired for striking a new road which unfortunately did not lead to expected returns.

Momentum has been around for a long time if you were to consider evidence from the world of Technical Analysis and yet other than in recent times, there was no real interest in pushing this as a way of investing.

In most parts of the world, Momentum Investing is seen as buying stocks where one is looking at Momentum in Earnings. In India, much of Momentum Investing is basically betting randomly on stocks that are going up. While both strategies have their positives and negatives, the one that got me interested was more with respect to price based momentum but where rules are defined.

The biggest advantage of quantitative momentum lies in the simplicity – both in the approach as well as in execution. While the original rule has been slightly tweaked, the strategy that was worked out 5 years back is still working fine as a fiddle.

With the rebalancing being monthly, what this means is a lot less stress. While shorter rebalance periods have their advantages, one that really showed its worth in the month of March 2020, the trade off is a lot more churn and impact costs that add up over time.

Evaluating a Strategy

At the beginning of 2018, a fund manager who was practicing a strategy that was not inline with what most investors believe was having a gala time. His 5 year CAGR was a mind blowing 43%. A 40% return will have you owning the entire stock market in ~60 years (Link)

It’s been 4 more years since then and the calculations seem to suggest that the high of 2017 is yet to be broken. The 9 year CAGR is now 20% – not bad but only if one had invested in 2013. An investor from 2017 would be barely breaking even.

So, what is a reasonable time to evaluate a strategy that goes against the grain of thought? Meb Faber says it should be a minimum of 10, better 20.

9. A reasonable time frame to evaluate a manager or strategy is 10, maybe 20 years.
— Meb Faber (@MebFaber) March 19, 2019

Or take this view expressed by Jim O’Shaughnessy in his Masterclass book, What works on Wall Street

Short Periods are Valueless

Consider the “Soaring Sixties.” The go-go growth managers of the era switched stocks so fast they were called gunslingers. Performance was the name of the game, and buying stocks with outstanding earnings growth was the way to get it.
In hindsight, look at how misleading a five-year period can be. Between December 31, 1963 and December 31, 1968, $10,000 invested in a portfolio that annually bought the 50 stocks in the Compustat database with the best one-year earnings-per-share percentage gains soared to almost $35,000 in value, a compound return of more than 28 percent per year. That more than doubled the S&P 500’s 10.16 percent annual return, which saw $10,000 grow to just over $16,000. Unfortunately, the strategy didn’t fare so well over the next five years. It went on to lose over half its value between 1968 and 1973, compared to a gain of 2 percent for the S&P 500.
More recently, the mania of the late 1990s provided yet another exam- ple of people extrapolating shorter term results well into the future. Here, it wasn’t “gunslingers” pouring money into just the stocks with the highest gain in earnings, but rather new-era disciples pouring money into Internet compa- nies that in many instances had little more than a PowerPoint presentation and a naïve belief that they were going to revolutionize the economy. In both cases, things ended very badly.

The oldest Momentum ETF in the USA is Invesco DWA Momentum ETF which started off in March 2007. The performance though has been severely disappointing with the fund being beaten by its chosen benchmark literally every year in the last 10 years

iShares which launched its own Momentum ETF in 2013 has done slightly better but still underperforms Russell 1000 Growth since Inception.

AQR Large Cap Momentum Fund has underperformed the same benchmark since inception though last year the fund did slightly better vs the Index.

On the other hand, the recently launched UTI Momentum 30 Index Fund has more than comfortably beaten Nifty 200 (which is a good benchmark to compare against).

Does this mean that Momentum works better in India than in the US?

Corey Hoffstein had this to say on why Momentum in US has lost its Mojo in recent times

At any given time, approximately 31% of our portfolio is allocated to a basket of high momentum U.S. equities. Within the context of the broader portfolio design, this sleeve seeks to generate alpha, particularly during bull markets. Unfortunately, since early 2021, it has dramatically underperformed the S&P 500
What makes momentum distinctive, as a factor, is that it is a chameleon. If quality stocks are doing well, it may buy quality. If expensive, junky stocks are doing well, it will buy expensive, junky stocks. If the stocks of companies who have CEOs that have red hair are doing particularly well, it may buy those stocks, no questions asked.

Momentum in India too will face the same issues at some point of time in the future. It’s a feature of momentum and not a bug.

While it’s too early to call, the fact remains that while Indices may showcase strong returns, the ability to replicate it without transmission costs (read as tracking error) is not yet fully tested. Recently Nifty Alpha 50 had included stocks that on the day of rebalance were frozen in upper circuit limiting the ability of the ETF’s that track it to buy the same. Misses such as these will overtime widen the difference between Index and the ETF.

Here is the yearly divergence in percentage terms of Nifty 200 Momentum 30 Index vs Nifty 50. While 2021 was an outlier, the Index has performed massively better over time with few exceptions.

Lets go a step further and add Nifty Small Cap 100 Index Returns (again, the difference and not the absolute returns).

Given that the philosophy and even the strategy is pretty similar, it’s doubtful that Indian stocks are better acclimatized with respect to Momentum vs in markets such as the US. What we are seeing especially in the case of UTI Momentum 30 fund for example could be a case of one off years that happened to be the first year of its existence too.

In almost all strategies, Size is a constraint and this can be a real killer for almost all strategies. From Warren Buffett to Peter Lynch, their Alpha deteriorated once the AUM started to go beyond a certain size.

Compared to Value strategies which have a low level of churn and hence higher allocations can be done over time, the same is not true for Momentum since the holding period can be quite short and one would want to enter and exit without either delay or moving the prices due to our own actions.

Take for instance a stock that has a daily trading value of 1 Crore (Shared traded multiplied by the Price) on any specific day. If one is a Momentum Investor, it’s unlikely that you can buy or sell anymore than 10 Lakhs at maximum without distorting the price.

So, how many stocks will fit the bill. Do note that the data is of current and current volumes as I shall show later on are much higher than what they used to be.

Assume you have a 20 Stock Portfolio with equal weights. So, at 1 Crore Capital, you will buy 5 Lakhs of a stock. If you want to buy no more than 1% of a stock’s daily volume (note that the delivered volumes are actually much lower), you have just 753 stocks to choose from. If you are willing to stretch that and buy say 10% of a stocks volume, this expands to 1373 stocks out of the total stocks of approximately 1800.

While Individual Investors have small capital, this doesn’t seem to be an issue. But if money is being managed, this can and is definitely an issue. The higher the AUM, the lower the number of stocks that are available.

This was an issue that was addressed even by Warren Buffet. His quote,

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
Warren Buffett

Of course, you can buy a greater quantity of a particular stock but as Bill Hwang experienced, at trading in large volumes on a given day – at percentages of more than 10% to 15% of the daily trading volume of a specific issuer – would create upward pressure on the share price and often result in the share price increasing.

The problem accelerates when it comes to selling for it works in reverse. You can always say, I shall sell over a period of time but remember, Momentum stocks are sold when they have lost Momentum. This means that the stock that one is exiting is generally weaker in the short term and a strong pressure of selling can topple it more than what it would have done without that gust of selling.

This is a problem that confounds not just Momentum players. ARK through its multiple ETFs has managed to accumulate a large percentage of equity of stocks that got pushed up because of their own buying. Now that money is on the way out and the only way to raise funds is to sell the same stocks for otherwise they will become too big a percentage of the portfolio, the same are now toppling back at double speed.

Advisories are able to get around this issue by just counting the model portfolio returns. Question though is, how much are the clients making? Given how many low liquid stocks make it to the portfolio and orders placed at market, my own guess is that it’s big enough to make a dent. In bull markets, these things are easy to ignore but can markets be bullish forever?

Smallcase recently changed the way it calculates returns and portfolio returns showcased suddenly saw a big spike down. One small case I tracked fell 25% in a day. But one wonders, is even that number a reality?

Slippage is an invisible killer. It doesn’t show up on your contract note but can damage more than Taxes and Fees put together.

Performance Data

On my personal account, I have been trading using Momentum for the last 5 years. What started as an experiment is now the whole and sole manager of my equity exposure. The figures, tables and charts below are based upon that data.

Monthly Returns

I have been posting personal monthly returns on Twitter since August 2019. The idea of posting came from the way CTA’s in the US post their monthly returns. A major reasoning though is to showcase that Systematic Momentum can deliver the goods. While we lack the narratives that accompany other strategies, the final arbiter being returns, I hope that a long term performance record inspires others

Rolling CAGR

In India, Motilal Oswal made famous the 10x in Years. To achieve this, one needs to compound on an average at 24% per year. Right now, we seem to be on the right path though who knows how the next 5 years shall pan out.

Drawdown from Peak – for the Momentum Portfolio vs Nifty 500

Drawdown in the years between 2018 to 2020 had been much higher than the drawdown that has been seen hence. My own expectation is that we should see a divergence once again in the future.

Equity Curve

While the strategy seems to beat Nifty 500 by a fair distance, there have been funds that have in the same period delivered pretty excellent returns but there is always the question of whether (1) Could we identify them beforehand and (2) how much could we allocate to such a fund.

Point to Pont Returns of the best Mutual Funds (Excludes Sector & Thematic Funds. Direct Schemes)

As I have written in one of the past annual letters, my objective is to be in the top quartile if not the top. For now it seems to be accomplished thanks to the huge pushup given by small cap stocks since the Covid Crash. In fact, the returns for the Momentum Fund could have been easily obtained by just buying and holding a Small Cap Index Fund post the Corona Crash.

While much of the Alpha for Do it yourself Momentum I believe comes from exposure to small caps, the advantage of Momentum strategy is that when the small cap starts to break the trend, we scale down the positions as well. The chart below shows the exposure to Large Cap, Mid Cap and Small Cap at end of every quarter

As you can notice, exposure to small caps was just 21% at the time of the Corona Crash. This shot up to 77% in the second quarter of 2021 and has been falling steadily since then.

Exposure to small caps did increase volatility by a slight margin. Since the start, Volatility for the strategy is 15% vs 12% for Nifty 50 and 11.50% for Nifty 500

Unlike fundamental portfolios, the holding period of Momentum portfolio tends to be on the lower side. The median holding period came to around 3 months.

During the 5 years, have traded around 275+ stocks of which just 120 stocks had a profitable exit. In fact, the combined profit for the strategy (booked profits) came from just 22 stocks.

The biggest worry for investors is high churn. Momentum is a high churn strategy but as the table below shows, churn is pretty consistent other than for a few exceptions

One new test that started in 2021 was with buying a portfolio of Nano Cap stocks using Momentum. One year and bit more down the lane, the results aren’t something really outstanding given the amount of risk involved. But results being decent means that its worth studying.

Overall, for the amount of efforts required, the returns are more than decent and wile it maybe years before one can be sure that we made our money not due to luck, the trend seems to be good for now. Until next year..Adios.

Can Momentum Strategy Avoid Manipulated Stocks

The big fear for most investors is about getting caught on the wrong side of a stock that went up only due to manipulation and once the deed has been done, has lost all of its gains without providing investors an opportunity to exit.

I recently did a Twitter Spaces talk and this was one of the questions raised. While getting caught in manipulated stocks is possible regardless of the strategy one follows, the lack of narrative and fundamental reasoning for Momentum leaves us particularly exposed.

Pump and Dump is something that is not new but one that has been evident from the time we had stock markets. The oldest example of that would be in the South Sea Bubble.

There are basically two kinds of Pump and Dump that happens. One involves manipulating the accounts so as to suggest the company is doing way better than it is really doing while the other involves just squeezing the price higher without fundamental triggers.

Cases like Satyam Computers, Vakrangee among others belonged to the first group. The accounts were not a true reflection of what the reality was and this enabled the price to shoot higher.

Cases of pure Pump and Dump of stock prices are dime a dozen. Stocks seem to go higher and higher for no reason and with very little volumes before a reversal happens and all the gains are lost.

The pure price based pump and dump is actually easy to evade for Momentum Investors. Have a high enough bar of how much value a stock should trade on a normal day (for a long enough period) and voila, 99% of such stocks will get automatically rejected. Pump and Dumps that don’t have a fundamental backing generally are operated by a small coterie and are not really well traded.

The fundamental driven frauds are much tougher in that sense. When Vakrangee for instance was going up, it was accompanied by positive spin. Some positive tweets / articles of those times

How Vakrangee turned from a penny stock into a Rs 37,000 crore firm.https://t.co/mlbURrgJWs pic.twitter.com/agIzLpxN0H
— NDTV Profit (@NDTVProfitIndia) November 25, 2017

#BuzzingStock: Vakrangee jumps 7% as firm becomes debt free https://t.co/lDaA6uK6lu
— ETMarkets (@ETMarkets) June 1, 2017

Maybank initiates on Vakrangee pic.twitter.com/Iq2ZUjcZyL
— Darshan Mehta (@darshanvmehta1) December 8, 2017

Heck, the stock even made it to MSCI Largecap Index. Not that everyone was gung ho on it, Nooresh Merani and Amit Mantri were among the few to question it

But there was not a single tweet I could find that had the words Vakrangee and Fraud. Of course calling out Fraud on even Fraud companies in India is Risky and one would rather not be invested than question companies that have connections which can result in midnight calls or even sent to jail.

I got caught in my personal account in Vakrangee. While I did interact with very many intelligent folks, I decided to hold onto the stock since selling would be essentially breaking the cardinal rule of Systematic Investing – adding the discretionary element that one hopes to eliminate.

I was lucky in the sense that when the stock made its top, my return from the stock was at 100% and when I got the ability to exit, it was back at my entry price. So, even after a 50% fall, I got out at cost with the only loss being opportunity cost.

I was not having a Momentum Investing strategy when Satyam Crashed but the crash unlike that of Vakrangee took place at the high point. Rather, the stock was down 78% from it’s all time high and down 67% from its 52 week high. Momentum strategies would have long ignored this stock and would have had no impact whatsoever.

Yet, there is no saying the next stock that may be part of a Momentum Strategy and turn out to be a fraud. Or for that matter, stocks can fall big time within the timeframe of a rebalance without there being any fraud.

In March 2020 for instance, one of my PF constituents was AU Bank. The stock was bought on the 1st trading day of the month at around 1150 and by the end of the month was at 500. A 57% fall in one of the stocks can be fatal to any Portfolio and my was not immune especially since I was having a significant weight to financials which bore the brunt of the damage.

What saved me though was that I have always felt that since we are dealing with a lot of unknowns, a good amount of diversification while reducing the returns slightly can enhance from the risk management angle. In a 30 stock portfolio, each stock has a weight of just 3.33% (approximately) and even if a stock was to go down 50% before you can exit, the damage (assuming the rest of the stock overall did not fall like a pack of cards), the damage to the portfolio is just 1.67% – something that is honestly very much bearable.

Other risk management techniques that can be used are trailing stops, stops based on either the equity curve or based on moving average on a benchmark index among others. The risk of trying to manage risk though in a way can actually enhance the volatility since there would be more stocks in motion (going in and out).

While four years is too short a time frame to judge a strategy – Meb Faber recently tweeted that he believed that to clearly judge a strategy as being good or bad required 20 years of data – my experience tells me that with a good set of filters and maybe once in a way allowing the luxury of not entering a stock even if it tops the momentum list (I did it with Adani Green, Tanla among others), risk of getting into stocks that you don’t have a easy exit can be vastly avoided.

At Portfolio Yoga, our aim is not to maximize reward but to maximize the ability to deploy a larger capital. A 20% gain that comes via a risky portfolio is worse than a 15% gain that can come through a lower risk (there is nothing like no risk) portfolio but one where you can confidently deploy a much larger percentage of your money.

On that note, let me leave you with this post from Seth Godin – Optimized or maximized?

4th year of Momentum Investing – Getting Rich

In the world of Momentum Investing, our belief is that the probability of past winners continuing to be a winner in the future is high. In some ways, this is the same logic of Growth Investing (which is not a factor based strategy as such). Here instead of looking at price, the idea is to look at the business and try to figure out if the past growth can continue into the future.

Compared to Momentum Investing, Growth (at a fair value for Buffett fans) Investing is something that allows a much larger capital to be deployed since the average holding time is measured in years vs months for Momentum.

But this is true across the financial spectrum. Angel Investing can be hugely beneficial if you strike it big, Angel investor Garry Tan for instance invested $300,000 into Coinbase and one which was worth $2.4 billion at its listing. Forget even bothering to calculate the CAGR

I funded Coinbase in 2012. 6000x on my best startup investment yet.https://t.co/95aHoWTkBg pic.twitter.com/N5wC72SzTa
— Garry Tan (@garrytan) April 14, 2021

But Angel Investing is not dominated by big money but by small Individual actors who are willing to risk their personal money (not other people’s money) on ventures they feel holds promise. Big money on the other hand is attracted to PE funds which come into play at a much later time frame in the company and at a much higher valuation.

In many ways Momentum Investing I think can be compared with Micro Cap Investing. Once again, Microcap investing is a do-it-yourself model with investors investing in companies that have very little or no coverage at all. Most small cap funds don’t go below 5000 Crores in Market Cap while there are 1700+ companies that are having a market cap of 1000 Crores or less and are profitable.

Momentum in recent times has attracted superlative interest thanks to the strong returns that have been generated. But this is not really out of the ordinary. As the saying goes, every dog has its day so is the same with factors.

Nothing comes easy. Not Momentum, Not Value, Not Quality and Not Micro Caps. But each of them have made people rich (mostly those who have managed funds for others but also a few investors who have stuck to the thesis).

Recently there has been extreme clamour for DIY momentum portfolios. With the ability to execute with just a single click, this has made it easy for even those with no understanding of markets let alone factors to try and ride the trend.

Fascinating years for most markets are generally followed by dull years when the markets tend to go nowhere and the only thing you can do is stick to the strategy and hope for the best. From my own Momentum Backest for instance, the high of 2008 was broken by the strategy only in 2014. How many will have the willpower to go through such a long period of literally Zero returns I wonder.

The returns from investing in Mutual funds for the same period would not have been any different but at least you had no decision or action to execute every week or month. Yet, Mutual Funds on a whole saw outflow of funds from 2008 to 2013 (cumulative). The outcome for the investor in essence will not be based on the strategy but his own behavior and how he would be able to overcome the same during the tough times.

Concentration or Diversification – the age old question

“There is one other rule you ought to keep in mind and that is to concentrate, and not only in the Zen sense. Sweet are the uses of diversity, but only if you want to end up in the middle of an average.” Adam Smith, The Money Game

Other than in my early years, I have for most part been a concentrated investor / trader. For a long time, my only positions were in Nifty (leveraged). Concentration I firmly believe is the key to wealth but as it happened in my own case, the risk is that if it doesn’t work out, you are doomed to failure.

While not all great investors of time have been concentrated investors, they have whenever opportunity came forth for a great trade were willing to go way beyond what they would generally be comfortable with.

Check out this article on famed “Value Investor” Bill Miller for instance

Bill Miller's personal portfolio is 83% Amazon, and a lot of Bitcoin, which he started buying at $200.

He's now a billionaire. https://t.co/sSpGamQ0rX
— Michael Batnick (@michaelbatnick) April 25, 2021

While investors get to make a lot of noise when Rakesh Jhunjunwala picks up stocks, 50% of his portfolio is just Titan. I on the other hand get antsy when a stock in my portfolio breaches the 6% mark.

In the world of Portfolio Management Services (something I try to track closely), most portfolio managers believe in concentration with portfolio size being around 20 stocks. There are of course outliers on both sides. From a 5 stock portfolio to a 50+ stock portfolio.

I don’t know how many clients of PMS firms have become rich thanks to the astute investments by the fund manager but the biggest gainer generally happens to be the fund manager. This is because of two reasons

One: Most PMS firms have a performance fee (in addition or in lieu to management fee). What this does is provide for the fund manager kind of leverage that most of us cannot fathom.

As an example, think of a fund manager who has 1 Crore of his own funds invested into his own fund which also happens to have 100 Crore of Client money. Assume a 10% performance fee. In a year like the one just gone by (FY 2020-21) where the Index itself doubled (nearly), the performance fee would be 10 Crores.

While his own investment too would have yielded him a Crore of Rupees in Profit, it’s the Performance Fee that takes his own return to one that is 10 times others. It’s as good as if he had taken a 10 Crore Position using his 1 Crore as Capital (10x Leverage). Bill Hwang, the ill famed fund manager was leveraged 5 times on his capital but unlike with management of other people’s money, the downside belonged to him only (and hence his meltdown of sorts)

While the first reason is the one most advisors would want to become a fund manager but something outside the scope of most of us, the Second reason is what we as investors can coattail.

Two: Most fund managers have total skin in the game. Most of them have much of their net worth invested in the same stocks / portfolio that they are advising to clients. This is real concentration – concentration in a single strategy / fund. The risk is of course if the fund manager doesn’t perform (in which case the question that needs to be asked is, why is he managing other people’s money).

If the objective is to try and achieve a return of around 18%, this cannot be achieved by investing across PMS / Mutual Funds / Advisory Portfolio’s. If the objective is to achieve a return of around 12%, you don’t need anything other than a simple Index Fund that tracks the Nifty 50. A mix would hopefully provide a return that comes close to the middle – 15%.

My own objective is to achieve the best returns possible. Risk as I have come to understand is part and parcel regardless of the methodology or factor or strategy you invest into. As long as you can keep behavior under control, you should be fine.

When I started my Journey into the world of Momentum Investing, I had no real goals as such other than wanting to be invested in a strategy that gave me confidence both during the good times and the bad. 4 Years later, I think the conviction if anything has only grown.

Some Numbers:

Compounded Annual Growth Rate since Inception stands at 28.21%. This is way too high and not possible to continue for long.

NAV with Benchmark: There are essentially two benchmarks I use.

Nifty 500 for comparison with a passive market Index.

Second is to seek to beat the best Mutual Fund performance for the same period (my Inception to date). Since this is forward looking, the Mutual Funds generally keep changing over time. Last year it was Axis Bluechip Fund while this year it was Parag Parikh Flexicap Fund (if I used the filter for only Flexicap funds) or Quant Active Fund.

Since the Investment was not a lumpsum but added over time, XIRR is a way to compare with a passive benchmark which can be invested into. I used Nifty Next 50 since in 2017 when I started this, that was the hot index everyone was recommending to invest into

If you were to observe, you can see that outperformance has been strong at times and other times the performance is more or less equal to that of the fund. I was checking for a longer period (using the back-test data) and saw the same happen over and over again.

Momentum vs Nifty 50 Ratio chart pic.twitter.com/p3iDpXlBH9
— Prashanth (@Prashanth_Krish) May 2, 2021

What this showcases I feel is that while Momentum can provide for strong out-performance in the long run, this can only be achieved if you were also willing to stay through the periods when the returns are either in line or sub-par.

Drawdown:

While risk can be measured in various ways, drawdown is the most visible. Last year when I wrote, I had just experienced the worst drawdown since I had started this portfolio. The portfolio was able to hit the all time high only in November of 2020. The last time NAV had seen an all time high before this was in January 2018. While it was painful not to have a new high for all these times, it was helpful in the sense that it provided me enough time to boost up the capital invested. Capital deployed increased by 335% and hence while in absolute terms the return is still just around 87%, in monetary terms, it has been pretty big.

Monthly Returns

Just as sort of record keeping, I have been posting the monthly returns on Twitter. Provides a context with respect to how the market and the model is behaving.

Overall, I feel comfortable with the strategy and its performance. While I am sure that I shall see the Yin and Yangs in terms of performance, I feel the strategy as a whole should hold up over the years and decades to come.

Given the social circumstances outside, this has been an astonishingly good year from the investment perspective. Until next year ..Be Good. Be Safe

Year One: Momentum Investing – An Experiment with Real Money

Year Two: 2 Years of Momentum Investing – An Overview

Year Three: 3 Years of Momentum Investing

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

The biggest risk with strategies such as Momentum – Sector Concentration. My own portfolio as of today's close for instance pic.twitter.com/Szp4WgsFxc
— Prashanth (@Prashanth_Krish) August 3, 2020

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.

3 Years of Momentum Investing

When 2020 started, I had this strong belief that both career wise and portfolio wise, this decade will be the standout in my life. For the first time after being in markets for more than 2 decades as an investor and trader, I was finally comfortable investing based on a strategy that not just appealed to me, was accepted academically and also delivered the goods.

At the end of 2019, the CAGR for my portfolio since inception was nearly 17% and we had already seen 2 years where the majority of the stocks entered bear markets while my portfolio stood back up after every knock, what could really go wrong I wondered. Wuhan challenged that belief like nothing else has.

The key to winning in the arena of investment management comes down to two things – returns and allocation. You may have an asset that generated a great return, but if the allocation was poor, it may not be life changing even though you would get fulfillment in having correctly identified it early. On the other hand, if you had a large allocation and the investment turned out bad, it can set you back by years.

The way out is to diversify, say experts. But diversification as practiced by the majority of investors doesn’t really add value other than enabling them to somehow feel better. What difference would it make to be invested in 3 large cap funds versus one large cap index fund. The final results may turn out to be the same, yet there is a greater comfort with the advisor who asks you to buy 2 funds of each category (Large, Mid, Small, International, Sector) than with an advisor who will recommend that your entire equity allocation should go into not more than 2 funds.

One of the toughest problems that most investors face is staying true to the factor or philosophy they started out with. As humans, we love confirmation of our beliefs to the extent that confirmation bias is a cognitive dissonance. From Value Investing to Quality to Momentum, every strategy has its good times and bad. In the last couple of years, the only one to hold fort has been Quality. This has been especially troublesome for many especially for those on the Value front for while great value stocks seem to be getting killed, stocks with low or even negative growth are standing strong at valuations that most stocks can only dream about.

Passive is now becoming the new active what with every fund house trying to get a foot inside the door of what they think would not click but one they would not want to miss if at all the segment takes off. So, today you have Passive funds for the Large Caps, the Semi Large Caps, the Mid Caps, the Small Caps, International Funds and even a passive bond fund. It’s another matter though that without guidance and one that doesn’t come for free other than from Twitter, Investors are falling prey to recency bias and one that generally doesn’t end well.

Unlike Value or even Quality, Systematic Momentum has very few ardent believers. Buying stocks when it’s making new highs and selling some of them as they come crashing down isn’t something that investors love doing. It’s very unsettling and not comfortable for most.

I recently did a short term course by NYU Professor Scott Galloway and one attribute he says that is common across all successful companies is “Storytelling”. In the world of Systematic Investing, this is completely missing. It’s as if there is no story to be told and the only stories we hear are about Algo firms that went bust – so much for the positivity one hopes to hear.

Coming to allocation part, this is my only portfolio and comprises my total exposure to markets other than for the ELSS funds which anyways are locked in removing any ability on my side to mess things up.

One of my observations during the time when I was a stock broker and even today is that most do it yourself investors don’t really measure their portfolio growth. While many do know the stocks that made them big money and a few stocks that lost them big time, on an overall basis, they find it tough if not impossible to know whether they are doing better than the Indices or Mutual funds or not.

The reason to measure in my opinion goes further than just knowing how we are doing. Data leads to Knowledge and Knowledge leads to Wisdom. While earlier it was tough to measure, thanks to technology, that has become easy today and one I believe every investor should cultivate.

But, enough of banter. What has been the performance and what are the learnings.

A key reason for these posts is to be transparent to the reader while hopefully helping me become a better investor myself.

First off, CAGR since Inception

Was quietly plodding around the 18 to 20% mark before it got infected and reduced to a wreck. Stands at 8% currently – not bad in light of what is happening but that is small solace when I look at the drawdown chart.

But performance needs to be monitored against a benchmark. The strategy has despite the setback performed well in line and as per my own expectation. Among non sector mutual funds, the only fund to have performed better is Axis Bluechip Fund with a CAGR of 8.35% over the same period. On a side note, 4 out of the best 7 active funds belong to Axis. The fund house has been on an excellent run in recent times.

The static benchmark I have used is Nifty 500 since the majority of the stocks that I have bought over time has been from this benchmark even though I don’t filter stocks to be from the Nifty 500 Index only.

The out-performance that started in late 2017 has sustained through and through. Unfortunately over time I have continuously added money (Sipping though not every month) and this means that while the strategy itself is positive, on an absolute basis I am currently slightly negative.

What can I say, No Pain, No Gain or No Mercy, No Malice as Scott Galloway sees it. The only silver lining to my bruised ego is the fact that unlike in 2018 and 2019, my drawdown is now in line with overall markets. That should count for something. 🙂

The Escape from Covid

Friends of mine who practise slightly different versions of Momentum but have two things that are different than mine are

Going into cash during market weakness.
Weekly Rotation vs Monthly Rotation

Thanks to the availability of their daily NAV, I wanted to compare my strategy with theirs to see if that made sense. Chart comparing on such strategy with mine

The differential as I can see was not much just before Covid happened showcasing the similar end points despite the different paths taken.Post Covid, I am down approximately 14% versus their strategy.

During the last few weeks, I have spent a long time thinking on whether I should have had a market filter to reduce drawdowns but the evidence has been that other than in market falls of 2008 and 2020, such moves to cash have not added value. I continue to tinker with allocation methodology to see if I could get better returns by not selling any stock but having a tactical allocation strategy. A work in progress I would say for now.

The drawdown is a trade-off that I had anticipated based on the backest though when reality hits, it hurts a lot more than just a few numbers on the spreadsheet which is what backtest finally comes down to. Despite the setback, I am still not convinced about the idea of going into cash on every market dip – the costs alone can set you back big time not to mention the feeling of constant churn that has an impact on one’s behaviors.

A superior way would have been to take Insurance to limit the loss as Bill Ackman did with his fund. Then again, that’s why he manages Billions. Who am I kidding. On the other hand, one could start the year by buying Insurance for such an eventuality and roll it up or down every year. I got caught flat footed this time around and I do hope I am better prepared the next time around. This has been a key learning for me and one that hopefully shall add value over time.

They say, Learning never Ends and so is the case when it comes to the world of finance. From the Franklin debacle to the Covid meltdown, there are always things to learn even if some of them come at a personal cost. Then again. who said Learning was Free 🙂

Previous Posts;

1st Year

2nd Year

Market Timing Luck – When should you Rebalance

Luck plays a large role in many a person’s life regardless of whether they choose to accept it or not starting right from the family they were born to. Luck is like the catalyst in a chemical reaction – small in proportion to the other chemicals out there but large in the role to play.

When one is building a trading system, one way to check out whether the trading system has real value is by subjecting the results of the back-test to Bootstrapping and Monte Carlo. This provides for one to analyze a system without being held hostage to its path dependency of the past.

Systematic Momentum investing has not gained much followership even though the majority of investors are in the camp of Momentum Investing. In Momentum Investing there is an element of luck that is introduced in various ways – one way that is of great interest to me ever since I started to focus on it has been around the question of when to rebalance one’s portfolio.

The best interval for rebalancing is for Daily with the worst being Yearly. This is because as close as you are to the daily changes, the better the ability to enter a stock as soon as it starts showing momentum and vice versa for exit.

On the other hand, the longer your holding time frame before rebalance, the higher the probability of mean reversion kicking in and eating a chunk of your returns before the reset happens. While there is no optimal time frame, higher transactions lead to higher levels of transactions and taxes.

I rotate my portfolio once a month. While academic evidence has pointed to monthly being a pretty optimal (not the most), the choice was dictated by other reasons including the fact that when I started with Momentum Investing, I was working with Capitalmind and there we already had a Qualitative Momentum strategy that rotated once a month.

There is a great deal of Literature around Timing Luck. To learn more about this, do read this post by Corey Hoffstein

The Dumb (Timing) Luck of Smart Beta

Also check out

Strategic Rebalancing

My own rebalance happens on the first day of the month. Idea has been to keep it simple and one that when I was working synchronized with my Salary being credited enabling me to add to the portfolio if I so wished.

It shall be in a few days 3 years since I started and the results while not fantastic has been way better than what I could have achieved by investing in any other Long only product. That was until March 2020.

When the Corona Virus first started making news, I tried to study the possible impact on markets given my own large exposure to them. From what I could study about previous epidemics,I figured that the worst case scenario was one that I could digest without having to deviate from my current plan and strategy. Man, was I wrong.

As a trader before and investor today, losing money I have understood is part and parcel of the process. What I wish to understand more was whether the path I had chosen had hidden risks that got exposed in such times. In case of Momentum Investing, the question was whether my performance would have been better if I had stuck to a mid month rebalance vs a start of the month rebalance.

While I have thought about going down to Weekly, I have found little evidence of it having a better risk management for the additional trouble and costs I need to pay. Same goes for a fortnightly rebalance as well. In hindsight, the only way I could have saved a lot of grief this time around without panicking and exiting my portfolio was by way of buying Puts. But given how much of the markets which is where my portfolio comes from had deviated from Nifty, this would have cost me in the last two years even as the portfolio had suffered.

March 2020 was different though. I calculated that if I had rebalanced (not exited) the portfolio at the middle of the month, I could have saved a whopping 10% vs what I lost by rebalancing at the end of the month.

But was this a one off or does rebalancing mid month does add value {Remember, the time period difference between two rebalances continues to be a month} was what I wanted to test and hence I set out to test the strategy of rebalancing mid-month.

When I got the results, it blew me off. It’s not that the mid-month was better, it’s just how bad that was and how Lucky I was to have chosen a start of the month rebalance instead. Here is the over-all comparison on a Net Asset Value basis

I broke this down in monthly terms

What I find fascinating is that the mid-month strategy works better in bear markets than in bull, but because in the last 15 years, the testing period, bull markets have been the dominating factor, small differences have added to a substantial outperformance.

The question that needs to be asked is Why? Why does a mid-month rebalance suffer so much versus a beginning of the month rebalance. The honest answer is I don’t know but I do think, rather, I can speculate that this may have something to do with how large investors deploy.

To me, this fall has been more educative with the cost much more bearable than all the other market crashes I had participated in the past (going right back to the Dot Com bubble crash). The answers I come across confound my own beliefs, but that is why one needs to keep testing alternatives so as to be sure that one is not mistaking good luck for great strategy. It’s a real thin line out there in the world of finance.

End Note: We are starting to build some Momentum in the Slack Channel. It’s a network effect and hence should take more time to build the environment that enables people to share and discuss views and strategies, but believe we will be there.

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Evaluating a Strategy

Performance Data

Monthly Returns

Rolling CAGR

Drawdown from Peak – for the Momentum Portfolio vs Nifty 500

Equity Curve

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Some Numbers:

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The Escape from Covid

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