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Mutual Funds | Portfolio Yoga

The Contrarian Fund Manager – Prashant Jain

Peter Lynch is seen as one of the greatest fund managers even though the period where he managed real public money is of a time frame that is extremely short when one compares him with other great fellow investors.

Prashant Jain has been managing what today is known as HDFC Balanced Advantage Fund (but earlier known by other names) for what very few fund managers have managed historically. 1994 to 2022 is a very long period for an open ended mutual fund manager to be at the reins of any fund. The only person who I can name and one who has a phenomenal track record of his own is Anthony Bolton who managed  Fidelity Special Situations fund from December 1979 to December 2007.

If you wish to check out more about Anthony Bolton, do check out his book Investing Against the Tide: Lessons From a Life Running Money 

Do note that while he was part of the funds since the start (as Head of Equities), he wasn’t the CIO of the funds themselves until a much later time (2001 for HDFC Top 100, 2003 for HDFC  BAF and 2003 for HDFC Flexicap). But since he was involved in the decision making process, I am looking at the complete cycle vs only from when he assumed full control.

Note: While I shall use the current fund names, most of them went through different names and objectives in the past. 

How does one assess a fund manager whose timeframe of managing money is greater than what the average age of an investor is today. He started at a time when today’s dominant exchange, the National Stock Exchange, just about commenced operations. 

One of the complaints that most investors have with fund managers who manage funds, large or small, is that many of them are just closeted investors. In other words, they try to mimic the Index pretty closely and hence generate returns that are no different from the Index but for which one ends up paying a fee that is multiple times that.

Regardless of whether you are a believer in him or not, one thing that most won’t disagree with is that Prashant was less of a closet indexer even though as the size of his fund grew, it obviously would have placed a limitation on where he could invest.

He was lucky too. His bad bets, even with which he was able to closely generate Index returns, came after he had already made a name for himself. If the path had differed and he had made similar bets in the past when he was not really well known, it’s doubtful we ever would have heard of him.

Breaking down the Performance

Let’s start by looking at the yearly performance of the 3 funds he managed vs the Sensex returns. Do note that while Mutual Fund returns are Total Returns, I am using non Total Returns of Sensex since Total Returns data doesn’t go as long back as the 90’s

1999 (when he was not the fund manager) and 2003 (when he was) were blockbuster years for all their funds. The outperformance above the Index can be better seen in the following chart

The first 10 years sees some massive outperformance, the next 6 decent outperformance and finally the last 12 not so much. Geometric Average outperformance for the periods

HDFC Balanced Advantage Fund (then known as Zurich India Equity Fund but started out as Centurion Quantum ) was able to ride the bull in the Dot com bubble and then get off before it all crumbled down. As a result, it gave an incredibly good Alpha both in the years of the bubble and the years when the market fell. When markets rose once again from the Ashes in 2004, the fund was once again able to maximize.

But in the last 10 years or so, the outperformance is basically gone. Do note that I use non TRI to compare but am also using a Regular plan (where the bulk of the money I assume is invested anyways). While TRI is seen as the right benchmark, there is no way to get TRI Index returns and hence a better benchmark would be a Index Fund for that is the real alternative investors could have invested into.

When we are looking at long term trends, starting points can create substantial bias. One way to eliminate and smoothen out to see how a fund performed vs its peer / benchmark is to compare returns on a rolling scale.

Short term comparisons to me are meaningless since there is a lot of noise and factor of luck in the short term. Anything from 5 years and above starts providing good understanding. 

The first few years were incredible Alpha generators. Way better way to look at the excess returns would be by way of this chart

For investors upto 2014, the funds continued to produce Alpha. Post that, it declined with 5 year excess returns getting into negative territory.

One reason that is given for the decline is his bad picks (or rather contrarian picks). But the contrarian side was what saved the funds during the dot com bubble phase. So, in a way it evens out. 

How about the AUM growth? We unfortunately don’t have much data. Anand Gupta was kind enough to share data from 2012. Here is the growth of assets in the scheme over the last decade

But does the above picture reflect the real change? No. Remember, markets have gone up since 2012 and that organic growth would have moved the AUM higher even without any inflows. We need to remove the gains in assets which came in because of the markets to get a better understanding of the numbers. Removing the gains the fund made, here is the rebased chart

While HDFC Balanced Advantage shows strong growth, one aspect that is missing here is the impact of merger of other schemes into it. The other two have actually lost AUM though point to point AUM is higher thanks to the market’s growth.

80% of the Assets under Management come through Mutual Fund Distributors and the data seems to suggest that they were either moving away from the funds or dissuading inventors from adding more. Either way, its finally returns that are the key to continued investments by clients with even the famed Seth Klarman facing withdrawals after years of underperformance

Managing other people’s money is tough but what attracts the best of the minds is the financial incentives that accompany this endeavor. Higher the asset one manages, more the Income and in a way this creates an incentive to focus more on asset gathering than generating alpha for clients. 

It’s doubly tough to be a contrarian fund manager if one is an employee because the risk to one’s career is multifold. Most funds with a couple of decades of history generally have seen multiple fund managers getting the hot seat and then being removed based purely on performance. 

The risk of being contrary is that when things don’t work out the way one anticipates, everyone would pitch into say how stupid one had to be to invest and lose money in a stock that even a  man wouldn’t touch. 

In his most recent memo, Howard Marks talks about taking the path not taken. But the example he uses is of the one guy who took a non beaten path and emerged victorious. Those who take a path that is contrarian by nature and don’t succeed are those we never hear about. Remember, Abraham Wald and the Missing Bullet Holes

India hasn’t had a fund manager managing public equities for the length of time Prashant Jain has been at the helm. Nilesh Shah, CEO, Kotak Mahindra Mutual Fund compared him to Don Bradman of our times. 

If you look at his outperformance generated by the funds he was part of in the first ten years, he did have an average that no fund manager of today can match. But if you were to look at his recent ten year outperformance, it would be hard not to see him as Kohli, an incredibly talented batsmen but who currently has been out of form for a long time.

Outperforming the markets today is way tougher than it was two decades back as information arbitrages have dwindled down. Everyone has the same information as the next guy. Stray too far from the herd like what a few managers have tried and you shall be pilloried. This even if you actually end up being right. Only time this works is if you are right and the rest of the world is wrong in which case there will be some grudging acknowledgement. But even there, there are big ‘if’s”. And if they fail while trying to be different and generating excess returns? Remember Santhosh Kamath?

Overall, I would say Prashant will pass off as one of the great fund managers in India. While we can quibble on his value add over the last few years, the fact also remains that at no point of time was his portfolio seen as untouchable by other fund managers. Getting timing right with major trends is enormously tough and there is no shame in getting it wrong as long as his clients get a decent return. 

Finally I am reminded of the famous dialogue in the movie Ratatouille 

Some reading sources: 

2001 article on Zurich India Equity Fund

2010 article on Prashant Jain in Forbes

Contrarian Investing – Investing in China

In recent times, there has been a lot of talk about Global Investing with all kinds of narratives spun around to make it sound that if you are not investing globally you are missing out. Nothing could be further than the truth, but selling expensive products requires a good narrative and right now with US markets providing market-beating returns, a good excuse is all that is required.

Why to invest globally vs locally. The first time I heard about Global Investing was from experts in the United States. The United States, they said, being a mature country will grow around 3% while emerging giants such as China and India are growing close to double digits. Why confine to the United States alone they argued.

Over the last decade and more, anyone who followed their advice and invested in emerging nations underperformed the S&P 500. Diversification is good but mindless diversification adds no value.

In India, at last count, there are 56 Mutual Fund Schemes offering various themes and a few countries with 5 new offerings. But if one were to look at the Assets under Management, 5 funds and one fund of fund, all focussed on the US markets.

Axis and Kotak have global innovation funds but where majority of the underlying stocks are from US (65% and 80% respectively). A key attraction for investors has been the recent strong trends one has observed in the US markets.

But the same US markets saw a near 12 year period of Zero return between 2000 and 2011. Nasdaq was able to break above the high of 2000 only in 2016. In the same period of time, Indian Markets did phenomenally well.

Post the recent attack on Indian Troops, China evokes a very different sentiment than one we had before that. This is not limited to India alone as we have seen a severe spike in China being seen as unfavorable across much of the developed world.

Much of this is a result of not just trade disputes China has with others or the fact that CoronaVirus started out there but the aggressive Wolf Warrior Diplomacy that has been carried out with Ambassadors all but threatening the leaders of other nations for what China sees as errors of Omission or Commission. 

The biggest risk of investing in Autocratic countries is that they lack the rule of the law which allows for fair competition and pricing. This in a way pushes away prospective investors. This also means that such countries are generally cheap. They are of course cheap for the reason that your companies can get booted out of business without any compensation.

Take a look at the Cyclically Adjusted PE Ratio of major indices (end June 2021)

Anyone who has read Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice by Bill Browder knows how risky it can be to invest in such a country. While I loved reading the book, I did wonder, is there another side to the story? The problem for autocratic countries is that their Judiciary is seen as one sided, even if there is another side to the story, we may tend to not believe the same.

Countries such as China & Japan have a conviction rate of 99%. A very high conviction rate either means that the police is extremely efficient or the judiciary is compromised not to challenge the state. Either way, it’s an extremely risky proposition to invest in such countries directly.

China tech crackdown is India’s gain was a recent article pointing out how in this year, Venture capital funds have shifted funds to India due to the duress they are observing in China post the Alibaba incident. 

Excess returns are not possible by investing into companies or countries where everything is working out great. Decent returns, Yes but not Excess returns. Excess returns is the fee that the market pays the risk taker for buying something when no one wants. Value Investing 101 is all about investing in what everyone seems to think as risky. Markets are right a lot of times with risky companies going down the tube. But they are also wrong and that is where the opportunity lies.

Currently I am starting to see China as one such country which is out of favor, seems to carry risks that are opaque in nature but can blow up spectacularly and a country that is said to have peaked early.

Investing in China for outsiders is tough. This is a reason why Hong Kong for long has been the gateway for investing in China. In 2010, when there was little talk of International Investing, the Benchmark Asset Management Company brought out a HangSeng ETF. Motilal Oswal followed up with the N100 the very next year.

When compared with one another, the returns can be said to be Chalk & Cheese. The Nasdaq 100 ETF since its listing has delivered an absolute return of 884% vs 162% for the HangSeng Bees. Not surprisingly the Hang Seng Bees has a very small asset under management – just 100 Crores.

While Nasdaq has been an outperformer for a long time, the Assets themselves are fairly recent. As of end October 2019, the N100 ETF had an AUM of 242 Crores and its Fund of Fund an AUM of 98 Crores. Today (end October 2021), the AUM of the ETF is 5,703 Crores and the AUM for the FOF stands at 3,998 Crores.

The highest risk in investing is not going with the crowd but going with them when they are wrong which usually happens at peaks and bottoms. The best tech companies are no doubt in the United States, but when it comes to valuations, how many are priced to perfection and what happens if those predictions fail to come true.

When an asset management company starts a new fund, the general reasoning is that they are getting into the asset gathering mode. But what if a fund launches a fund that may not really get its asset base to swell. The launch of the Mirae Asset Hang Seng TECH ETF to be suggests that rather than it being another attempt to boost their assets (which crossed the magical figure of 10 Lakh Crore a few months ago), this is a attempt to provide a opportunity to invest in a market that is cheap, seems to have a decent future with a affordable product.

Another interesting NFO that is coming out is the Nippon India Taiwan Equity Fund. While much of Taiwan’s market is China, it’s tough to know how they can play out if China decides to start squeezing Taiwan economically. 

One of the reasons to avoid International country specific funds is we really know so little about them. Seven years ago if you had invested in the Franklin India Feeder – Templeton European Opportunities Fund, the value of investment would have grown by an awesomely obscene CAGR of 2.20%. This even as Europe has recovered from the crisis that was seen as the end of the European dream. Anyone remember the PIIGS and the doomsday that was pointed out then?

Investing as a whole is always risky. All we can do is attempt to address the risks as efficiently as we can while also hoping that our thesis is not extraordinarily wrong. 

Nothing Works all the Time

Collective2 is a US website where you can sell a strategy that trades / invests on markets or if you are an investor, track and invest along with the strategy. Think of it like the smallcase in India but without the hassles of having to go for SEBI registrations and as such you can build a model, launch it on the site and if it works as you think it will, keep collecting the subscription fee from your users. 

As a free subscriber, I get newsletters sent weekly showcasing the “Trading Strategy of the Week”.

If you notice, there is no single strategy that repeats itself. While this could be to market different strategies, the general reason is that you don’t want to flaunt something that worked earlier but not working now. In fact, since I have a hoard of their letters, I went back to strategies that were recommended to be checked out a couple of years ago. 9 out 10 had vanished showing how low the chances of success is.

In markets, you continuously see some industries that dominate only to wither off over time and some other industries take the leadership. Currently it is Pharma that is dominating the news but a few months back, it would have been Quality and a bit before that it was Large cap and even before that it was Small Cap. 

The other day, a fund completed 10 years of successful investing. While the fund returns have been fantastic, the article pointed out how just 911 investors were invested throughout the journey. Clients were to blame 

It reminded me of an old blog post about Fidelity where it said that the clients that did the best were the ones who were dead.  The second best performing set of clients forgot they had Fidelity accounts.

It’s not the case with every investor of course. I have had my family invest in Mutual Fund Offer for Sale in the late 90’s and we hold many of them till date. One of the better investments I can claim to be invested since day one of the fund is Franklin India Technology Fund. The return since inception is 18% – wonderful right. Should have really boosted our family’s net-worth.

Unfortunately, nope and the reason is twofold. One is of course how much we invested in 1998 when it was first launched – we invested a measly 5000 bucks (the minimum investment if I remember right). That was a very small part of our family’s net-worth as on that date. So, it was just one another investment – not THE investment.

Second reason is that we did not add to it over time. This meant that what was already a small percentage over time became a rounding off error in a sense. So, while the 18% looks great, its value as part the total net-worth is negligible.

It was based on the thought process, I asked this question to my dear followers on Twitter 

https://twitter.com/Prashanth_Krish/status/1284552707005534208

The answers were as usual very interesting, but most were against the principle of investing all of one’s money other than maybe in the Index. This is not surprising especially in light of recent events such as Franklin Templeton’s debt funds – it’s bad to have a small holding, think about if this was the only investment. 

As I write, a mailer from Motilal has landed in my Inbox. Motial is launching a new Multi Asset Fund with the title, Different asset classes outperform each other at different times. What is different for a Multi Asset Fund from a Multicap Fund? In both, the fund manager has the ability to move assets towards sectors or caps where he believes lies the greatest opportunity. The only difference though is that while a Multicap fund would essentially buy only stocks, a Multi Asset Fund is more of a Fund of Fund and one that invests basically in other funds (mostly from their own house as far as possible).

These days, passive investing is seen as the key for data shows that 90% or more fund managers are unable to outperform the same. Passive investing hasn’t grown as much as the hype we see on Twitter though for the simple reason that the monetary gains to be gained by selling a client and servicing him are nothing compared to active funds. 

But how much of that is the genuine belief that no manager can out-perform the top 50 or 100 stocks of India in the long term vs recency bias due to current better performance by the large cap indices vs say the small and mid cap indices. This applies for even N100 or PPFAS which is suddenly being seen as the cool investment to be invested into

But back to my question – why is it so tough to make a choice when it comes to a fund. The reason is simple – we are afraid to take a call which in hindsight may look foolish. For all the talk about Fund Manager, Process, etc, our focus is extremely short term and looks back at the returns – nothing wrong in that perse, but that also means we lack the confidence in both our own approach as well as the approach of the fund manager.

As an Investor, you really are at your peak when you start to think like a Fund Manager – which is what one is essentially with the only difference being that rather than other people’s money we are dealing with our own money. Every decision has to be seen in the light of what it brings to the table when relative to the rest of what you hold. Once you get an understanding of it, the choices in front of you become very easy to make.

The objective of this post is not to hold a gun to your head and make you choose a single fund but to provide a perspective that more may not indeed be better. The better we understand what we are invested into, the easier it is to navigate during tough times as it is during the good times. 

Active vs Passive debate rolls on

Aarti Krishnan of Prime Investor posted today an article titled “What are the Risks in Index Funds”. 

Basically she boils it down to 

  1. They do not protect you from market volatility
  2. They may have concentrated portfolios
  3. They don’t shield you from business or governance risks
  4. They do not guarantee superior returns

I believe that the above reasons aren’t in themselves reasons that make Index funds Risky in any way compared to the alternatives (Active Mutual Funds). My views on the points raised and my thoughts on what is the better approach.

They do not protect you from market volatility

While there are various ways to measure volatility, for me the choice is to look at maximum draw-down. Draw-down is the percentage change the instrument has suffered from the time it hit its peak. 

For example, Nifty 50 hit a high of 6357 in January 2008. By March of next year, it was down to 2600 levels. In other words the Index had declined by nearly 60%. If you had invested in a passive fund or ETF, this is the draw-down you would have seen since the fund mimics the Index, nothing more nothing less.

On the other hand, Active Mutual funds have a fund manager to look after the portfolio and hence your interests. It’s the very reason you pay 2.5% yearly. They wouldn’t have done so badly, right?

Here is the chart depicting the draw-down faced by various mutual funds. Do note that some of these funds weren’t large cap at that time.

Large Cap Mutual Fund draw-down from Peak

As you can see, Mutual Fund’s did not shine themselves too well. But that is excusable as long as they deliver alpha – or gain more than the Index gains itself you may say which is true. As long as a fund manager delivers a higher return than the Index after fees, his fee is none of the concern unless you believe that you can do better than him.

The following table from S&P shows 6 out of 10 funds have failed to beat the Index. This presents an issue – Can you select the better fund 10 years ahead of time. In the last three years, just one or two funds out of 10 have outperformed. 

Maybe this can reverse, Maybe it won’t. But purely based on Data, Active funds carry the same risks as passive while not really delivering big, at least when it comes to Large Cap Funds.

They may have concentrated portfolios

Since Indices are free float market weighted, sectors that are the current favorite have a higher degree of concentration than the one’s that have fallen out of favor. With the current favorite being financials, it no wonder that it dominates the Index. But this has always been the case. If you remember in 2007, Index weight was dominated by Infrastructure & Ambani companies. 

Concentrated Portfolio in itself isn’t wrong. The key is to have conviction in the stock and bet on the same. A diversified portfolio is good when conviction in the stocks is low and one reason my own Momentum Portfolio has a 30 stock portfolio.

If you look at the portfolio’s of most funds and compare them to the benchmark index, you can see very little differentiation out there. Its as if they are closet index funds with a pinch of active.

They don’t shield you from business or governance risks

Indices that are fundamental agnostic do once in a way add a stock that carries significant risks. But that risk is carried by even active funds. When Manpasand fells on questions of Corporate Governance, more than a few funds were found to be holding the same. Everyone makes mistakes, Active or not, you cannot avoid such risks completely.

They do not guarantee superior returns

I think this point was the focus of the article going the replies in response to a tweet. Index funds actually underperform the Index to the extent of their fees and slippages. But with fees for ETF’s (different from Index funds) as low as 0.07%, one wonders should one be concerned.

Does all the above info mean that it makes no sense to go active and instead one should buy the cheapest ETF or Index traded fund? 

I disagree. Mutual Funds have their use case, but it’s more of an active strategy than a passive one of just Buy and Hold for a lifetime. If your use case if Buy and Forget, I think there is more benefit buying a Multi Cap fund than buying an Index which buys the top 100 stocks of today.

When we invest in funds, we are betting on the fund philosophy / fund manager. That being the case, why should you limit him to buying only from the top 100 stocks or stocks ranked from 100 to 250 for instance.

Multicap funds allow the fund manager to take a call on where he feels value is there in the current market scenario and bet on those segment regardless whether its from the large cap or small cap.

Another style of funds that is worth being in active vs passive is from the Small Cap and Thematic funds. But here too some amount of timing is required unless you can stomach draw-downs of 70%+ that few funds saw in 2008 / 09 for instance and one that took years to reclaim.

The biggest risk of Index investing is that Indices can go flat for a long time. India has limited data. I hence calculated the % of time, your investment could have yielded negative returns even post holding for 10 years. For the S&P 500 where data goes back to 1950, that comes to 8% of the time. Not high, but something that you should bear in mind.

The best use case for ETF’s that track Indices is to have a tactical allocation strategy. Be long when the trend is in favor of you and be out when its not. Right now the trend in large cap is hot and strong and a good time to be invested. But there will come a time when its out of favor and it makes no sense to go through the pain. 

Investing for Long Term is not possible without building Conviction

When it comes to financial advise, everyone knows what is best for others even though one may not be qualified to handle their own money let alone other people’s money. From Fund Managers to your corner uncle who sells Mutual Funds, everyone believes that investing in real estate is a waste. Gold bugs believe that the doom is just around the corner and if you don’t hold gold and that too in Physical, you are doomed.

Insurance agents believe that investing in Insurance is not a hedge against something (Life / Health, etc) but a way to save money. Then again, if I am paid 20% of what you invest, I don’t think I would be complaining about it either.

On the equity side, we have fund managers who believe in different philosophies and refuse to accept that there is more than one way to skin the cat. So, while some vouch by value, some others vouch by quality. Some believe investing in small cap stocks is the way forward while others believe that you are better off with only large cap stocks.

For a long time now, Gold and Real Estate have been the chief investment products for a large majority of Indians. While it’s easy to decry and laugh at their stupidity in investing in assets, the fact remains that financial advisors generally do not have a clue as to why they do what they do.

Let’s take Real Estate for instance. I recently heard about a person who took a house on rent for a monthly rental that is 6 figures. I was wonder stuck as to why anyone would pay that kind of money till it dawned or rather was educated that despite the high rent, the annual rental was less than 1% of the property’s current worth. Add taxes and the real rental is a pittance on the current value of the asset.

On one hand, that looks stupid, but one also has to admire the conviction of holding onto the asset in a period when there is neither a capital gain nor rental yields. Which of course, brings the question back to market?

Since 1981, Apple has delivered a compounded return of 18% till date. But that kind of return comes with its own pain points. Below is the draw-down from its peak the stock has seen over time.

While draw-downs are one thing, the real killer is the time a stock spends in the draw-down. For instance, Apple hit a new all-time high in 1991, a high that wasn’t crossed till mid 1999 during the Infotech boom.

We have similar examples out here in India as well, from Hindustan Lever to Reliance Industries which have spent lots of time post hitting of a new high before the stock could go back to another new high.

What does it all point to?

For me, it just showcases that investing is not a simple affair where buying a good company can provide you great results. Good strategy can survive but only if you also understand the risk of the strategy in the first place.

Thanks to the enormous weight of FAANG stocks in S&P 500, Value Strategy has been an under-performer in US for a very long time. But should one even compare with S&P 500 if one is trading a strategy that is widely different to the underlying Index?

Would you race a dog and a horse and declare one to be the winner since both have similar body shapes and four legs.

In the world of factor investing, one of the major factors is the “Size Factor”. Size factor is calculated by taking the average return of small cap stocks and subtracting the average return of large cap stocks.

From 1927 through 2015, the US size premium was 3.3%. In other words, if you held a small cap portfolio from 1927, your return would have been higher by 3.3% compared to someone held a large cap portfolio in the same period.

Of course, the very fact that they out-perform doesn’t meant they do it all the time. In the same period of time, the probability of your portfolio under-performing a large cap portfolio after 10 years of being invested was to the tune of 23%.

Since 2013, markets had a tremendous run, more so for the small cap than large cap stocks. While the data showcases an outperformance of just around 3% per year, in this case, we had something like a 3x returns.

This was very well known not to stretch to infinity and beyond though every time it seemed like the rally would end it sprung a surprise. In February I wrote in my post, The Rout – What Now? And I quote

“By the time, the bear market got over, a lot of stocks had seen draw-downs from peak of 35 – 55%, a huge difference from the current falls of between 15 – 25%.”

Among stocks that trade on the National Stock Exchange, around 36% of stocks have fallen greater than 50% from their peaks, another 42% have fallen between 35% and 50%. In other words, nearly 80% of the market is now down from their peaks by more than 25%.

But as I tweeted out the other day, this way of looking at markets has issues. When a stock has risen from say 100 to 1000 and falls to 500, it has suffered a 50% draw-down yet is up 400% from the starting point. A case of Glass being half empty of half full.

Valuation is a better way to look at where markets are compared to where they started from. It’s been nearly 5 years since this rally started and one way to figure out whether markets are cheap or not is by looking at valuations.

The rally from 2013 happened due to two reasons – Reasonable valuation and Trigger of a shift in power from Congress to BJP which was till recently seen as the center of right party. The 2018 fall that has started has started with similar reasons – Unreasonable valuations and Trigger of a shift in power from BJP to who knows whom.

To add to worries we have the US Fed hiking interest rates and swapping up liquidity from the markets. Even here in India, growth of M3 as % of GDP has slumped sharply.

So, let’s move back to our original thesis – why do investors prefer Gold / Real Estate over Equity even though they are not fools to know that it won’t go up in a straight line? Why are they able to stay the course when it comes to Real Estate and Gold while the same person behaves differently when it comes to financial assets like Equity.

The answer in my opinion lies in conviction – they believe they understand better about Real Estate and Gold. This conviction didn’t come from seeing advertisements but from either experience of self and close friends.

AMFI has been funding big time advertising the merits of Mutual Funds under the “Mutual Fund Sahi Hai” campaign and I would give it a lot of credit for the shift we have seen in recent times. But what really helped the campaign was not just that the other asset classes were showing weakness even as equity was delivering.

At best, to me this is borrowed conviction and one that is not easy to sustain if the market undergoes a long and painful correction. At Capitalmind we recently wrote about Insurance and one chart was deeply troubling – more than 50% of the policies closed out by the end of the 5th year.

Once again, massively misselling means that while its easy to get people in, sustaining them is pretty tough. Would equity mutual funds turn out to be any different?

My guess is as good as yours though I believe that the only people who shall stay is who aren’t swayed by the advertisements but have understood the importance of having equity in their asset allocation matrix.

Finding the edge that works for you is not an easy task and one that can years and decades. But once conviction is build, its easier to deal with stuff like draw-downs and volatility. Till that time, one keeps jumping from one queue to another since one’s queue always seems to be not moving.

                

Investing in Markets – Ways and Means

We have hundreds if not more number of studies that has shown that over the long term, the best growth is delivered only by equities. While in India, Real Estate has also proven to be a bonafide wealth generator, I strongly believe that growth over the next decade or two will more likely come in Equity with Real Estate more or less providing sub-optimal returns.

So, how does one go about in investing into the markets. For a lay man, there lies there options of investing his savings into the markets

1. Investing via a Mutual Fund

Theoretically speaking, this is the easiest way to gain exposure to the markets. But then again, not all Mutual Funds are the same and hence some amount of research is necessary to ensure that we invest in the funds that have showcased long term growth vs chasing funds that have made a mark in the very near past.

While most mutual funds in United States haven’t been able to beat the benchmark consistently, in India, we have hordes of fund managers who have beaten the benchmark returns year after year. Whether this is due to they being Genuis or whether its because of the fact that the benchmarks are not really that good a criteria to compare against is a story for another time.

But having said that, its a fact that top funds keep changing over time. Prashant Jain is a much acclaimed fund manager, but lets face the facts – his top fund, HDFC Top 200 has generated a CAGR return of 13.36% DSP BlackRock Micro Cap Fund which over the same period has seen a CAGR return of 24.5%.

What I have done above is known as Selection bias. I have selected the DSP fund not by foresight but by using  current returns. In 2008 and 2009, the best large cap fund (5 year returns) was Reliance Growth Fund. Over the last 5 years, this fund has provided a CAGR return of 12.8%.

Over a similar period Nifty Total Return Index has shown a CAGR growth of 11.68%. While one can still argue about there being a alpha out there in funds such as HDFC Top 200 and Reliance Growth, we need to also consider the fact that they hold stocks outside of Nifty constituents and in essence, comparing the performance to Nifty is erroneous.

Personally my family is invested into multiple funds across the spectrum and overall, returns have been decent enough. As Warren Buffet once said, diversification is the only free lunch and this applies to Mutual funds as well.

A step above Mutual Funds comes a more personalized investment vehicle.

Portfolio Management Scheme (PMS for short):

Those who follow me on Twitter know that I am a very strong skeptic of PMS as a investment vehicle. My main objection comes from the fact that for most brokerage led PMS, this is not something where the objective is to generate above market returns for the client but is a nice way to churn the portfolio as much as possible in an attempt to garner as much brokerage as can be culled from the account.

In fact, it is a surprise that Assets under Management of PMS has growth substantially over the years despite most of them not even providing decent returns (let alone market beating) and worse of all, hiding the facts from the potential investors.

AUM

I do not have the break-down as which firm manages what amount, but just as a simple exercise, lets review the performances of top names in this business

Coming up first would be Sharekhan (Link)

AUM: Around 32 Crores

Sharekhan

What surprises me is not the under-performance but the fact that NSE Nifty returns are shown as having given different returns when compared with different products.

India Infoline (Link)

AUM: 4600 Crores

India Infoline runs a multitude of funds

IIFL-1

IIFL-2

Motilal Oswal (Link)

AUM: 1400 Crores

Moti

One of the few which has beaten their benchmarks. But then again, these are 1. Weighted Returns (and not everyone would get the same) and 2. Am not sure if these are after fees or before fees (Fees are substantial in nature, refer to page 14 of the document).

There are at least another 25 – 30 firms offering PMS, but I do hope you get the idea. PMS is not a ideal vehicle to ride the markets. In fact, one PMS firm actually managed to lose money when the markets were going up and lost money when the markets were coming down. The fund manager is now a star investment advisor 🙂

Last but not the least

Direct Investments into Equity:

Directly investing into equities is one of the most risky ways to put savings to work if you are neither willing to work hard nor have a clue about how markets work. Too many folks have burnt their hands in equity investing to swear off anything related to equity (Direct or not). But having said that, the only way to beat the returns generated elsewhere can be found here.

But if you are willing to put in the hours required to learn and understand the various way to analyze the markets, its a effort that can provide for worthwhile returns with total control in your hand.

But a caveat first – International evidence has shown that the average equity investor under-performs the markets very badly. In fact, many would have been better off just putting the cash under their pillow than investing into markets

InvestorReturns

While the above data comes from Mutual Fund investments and redemption by individual investors, with human psyche being the same, direct returns by investors would not be too different.

Investing (no matter how large or small your investments is) is a full time endeavor. Unless you are willing to devote a substantial amount of time, this is definitely not a area to dabble in since not only would the returns be below par, but the time spent could have been better utilized elsewhere.

To fill this gap, we have many a person offering to advise (Newsletter based generally) for a small fee. But with the vast majority of them being pure snake oil sellers, I would generally avoid all such stuff unless they have proof of their pudding (Audited returns of their own funds which in turn should be substantial portion of their net worth)

To conclude, while its true that some funds have shown ability to beat the markets, I recommend novice investors to distribute between a few select funds and a few ETF’s that track the index (Index funds). Invest regularly and you would turn out fine regardless of the gyrations we see in markets.