Quality | Portfolio Yoga

Value vs Quality vs Momentum

I got introduced to Technical Analysis by way of an accident during the time of the Dot Com bubble and I fell in love with it. I loved it for both the simplicity and the fact that the answers were binary in nature with very little between.

Pure Technical Analysis though is as discretionary as with any other strategy. Buy if the stock doesn’t break below 100 but if it breaks 100, expect the stock to go down to 80. Good Luck trying to invest or trade based on such analysis.

Loving the method is not enough, one needs to be a constant cheerleader for how else will the world know that my method is the best. The ability to spread the word during the early part of this century wasn’t easy – no Twitter or Whatsapp or Telegram. So, I did what I could do – started a Yahoo group and given that I still believed myself to be more of an investor than a Trader named it Technical-Investor.

While I may or may not have learnt anything from the group, I did make quite a few friends for life. In a way, my scribbles on the group were also responsible for my first real job when I got a job with Dr. C.K. Narayan. This was kind of a midwife to me for enabling me to meet “Captain Hindsight”, someone who has influenced me and continues to do so .

Technical Analysis for me still is the bedrock for understanding markets. If prices move based on Demand and Supply, it can be only gauged by data.

A reason for me sticking with it is also because of the fact that I was barely able to forecast my own businesses let alone dream of being able to forecast the business run by others.

Not for lack of trying though. I have read most of Buffett’s writing as well as have books written by many well known authors on Value Investing. While I understand the rationale, I doubt my ability to muster enough courage to bet on companies based on the understanding.

Quality is something I have grown to like with a lot of credit for it owed to Saurabh Mukherjea. While most analysts try to showcase quality by way of narrative, SM to me was the first to backtest a simple idea and showcase its ability to generate above market returns for any investor willing to invest for the long run.

To me Value, Quality and Momentum are many sides of the same coin. One cannot exist without the other. In fact, I was recently said that my returns suggested that my portfolio was more of Quality stocks and less of Momentum even though my selection criteria has nothing to do with fundamental aspects of the stock itself

Thanks to @rajanraju26, Attribution Analysis (via Factors) of my personal Momentum Portfolio (last 3 year returns) pic.twitter.com/l4JAPf5tkj
— Prashanth (@Prashanth_Krish) June 27, 2022

Financial Advisors tell you that the risk you should take should not disturb your sleep. In many ways, the method you follow is something that you can sleep with. Every strategy has its positives and negatives. I have in the past tried to showcase the negatives of Momentum Investing for example. Same risk exits for Value / Quality or any other strategy that exits.

There are no free lunches anywhere.

Introducing a Quality Portfolio

To maximize return, the focus of any investor should be on a single factor, be it Momentum, Value or Quality. But the risk of a single factor is high in the sense that one can go through long periods of under-performance before seeing the light of the day.

Internationally, the accepted norm for advisors is to minimize that risk by having a multi factor approach. More diversified the portfolio is, the smoother the returns will be. For large accounts, advisors recommended exposure to more investments such as Gold or Trend Following to reduce the net volatility of the portfolio.

Of course, nothing is free and the cost of spreading across does mean a slightly lower return but if that comes at the cost of a better sleep, it’s any day better than losing sleep but ultimately getting a high return especially if you are not prepared mentally for the risks.

When we started off with Momentum Portfolio, we made a promise that in addition to Momentum at some point of time we would be providing a Coffee Can style high quality stock portfolio. Today we are delivering on the said promise.

The concept of Coffee Can Strategy goes back to 1984 when Robert Kirby wrote a paper titled The Journal of Portfolio Management. Yet, in India, we owe the familiarity of the strategy to Saurabh Mukherjea when he first wrote the book The Unusual Billionaires in 2016.

Since then, Saurabh has been a strong supporter of the said strategy while laid down very simply asks you to build a portfolio of stocks that carry two characteristics. As he writes in his book and I quote,

Thus, my stock-selection filters are companies that deliver revenue growth of 10 per cent and ROCE of 15 per cent every year for the past ten years.

When I first stumbled upon the strategy thanks to the book, I was impressed because here lay a simple strategy that had in the past delivered a return better than a benchmark but also one that seemed logically sound.

Most Analysts and Fund Managers try to make it seem like their process is ultra complex. From trying to figure out the management quality to understanding the company better than the company’s own management.

It’s not that there is no value in trying to determine how good or bad a management is but it’s easy to get misled for we are finally humans and gullible in nature. The reason guys like Madoff or Ramalinga Raju were able to do what they did for so long has more to do with not their own abilities as sales guys but also the fact that most of us want to look at things from a positive spirit.

Buying good companies and holding them for long is the long and short of the Coffee Can Strategy. In many ways, if you were to read between the lines of any fund manager, this is what the aim ultimately is.

While most retail investors try to chase the next best thing, fund managers continue to bet on what worked in the past in anticipation of them working in the future as well. HDFC Bank was a well known wealth generator in 2010 which at that point of time its 10 year returns were to the tune of 20% at the beginning of that year. Today, its 10 year return stands at 20%.

Yet, most investors will rather chase the next HDFC Bank (the current fancy being IDFC Bank) than buy HDFC Bank. As Charlie Munger says,

Avoiding Stupidity is Easier than Seeking Brilliance

and yet, we seek brilliance by attempting to find the next best stock. Not that it really matters when it comes to final returns for very few will wish to bet on the next best stock a substantial amount of money, but always nice to claim as having identified it – maybe even before the promoters knew about it themselves.

While the basic idea for the portfolio has been borrowed from the Coffee Can strategy laid out by Saurabh, it’s not the same implementation. I have made some slight changes based on my understanding of the strategy as also the portfolio being more diverse than what is generally advertised. As the above Charlie Munger quote says, we are here not to seek Brilliance but avoiding stupidity and a diversified portfolio is a hedge against our stupidity in ways more than one.

Not every stock out there would be a winner but I strongly believe that the portfolio as a whole would give decent long term returns to the investor.

The portfolio has no cap on Individual sector weights though it is nicely spread across with a larger weight in two focus sectors – Tech and Pharma.

We expect very little churn in the portfolio in line with the basic strategy of Coffee Can which is to buy and hold for a decade. Yet, this is not a copy of the Marcellus Portfolio {last time they disclosed the same, these were the constituents}. Do note that there is a slight amount of discretion in the portfolio that can be alluded to us.

https://twitter.com/Prashanth_Krish/status/1365903371790520323

For a while, Quality stocks have been richly valued compared to peers. The premium for quality is not going to go out even though we may see a period of flat returns which generally allow for the excess valuations to dissipate.

The risk at the current stage as far as my observation and understanding goes is with respect to flat returns. But most of these companies have showcased excellent growth in the past and the business model is sufficient tuned to continue to grow in the future as well

The portfolio comes at no additional cost to existing or new subscribers. If you have any questions, do mail me or DM me on Twitter

What is your Philosophy when it comes to Investing?

For a long time, I was a drifter when it came to investing philosophy. Value today, Quality tomorrow and Momentum the third day. The disadvantage of being a drifter is that one never is able to convince himself that when the chips are down, the strategy is still as valid today as it was yesterday.

Out goes the baby with the bathwater in search of a new medicine that can soothe these wounds and seem to be the perfect match until it hits its own roadblock that makes one once again shift gears.

We understand that everyone cannot be an expert on everything and yet somehow exclude ourselves from that limitation with the belief that we can somehow traverse the diverse fields with the agility that can lay Usain Bolt to shame.

When investors select mutual funds to invest into, the key criteria many look for is the short term returns of the fund. Higher returns from known funds have generally meant an enhanced flow of funds.

Higher the amount under management, higher the incentives for those at the top and that itself is generally enough to motivate fund managers to switch philosophies based on the flavour of the day. While this in itself isn’t wrong, what it means that the investor has nothing other than performance to back-up his investments rationale.

Churn is a factor that is dependent on the strategy being deployed. My own momentum strategy requires a much higher churn than a value strategy where churns are much lower. But when you look at the mutual fund turnover ratio’s, they tell a different story altogether.

While some funds do have a very low churn ratio, many a fund which either in name or through brochures and advertisement claim to be followers of one sort of philosophy have a turnover that is replica of another.

It hence isn’t surprising to see that investors keep getting returns lower than the fund returns for the whole logic of investment was based on returns and when returns fail, they are unable to understand the reasoning and would rather abandon ship than take the risk of sailing through the stormy seas.

Momentum, Value, Quality and Size are well known factors with tons of documentary evidence that point out to its longevity. But in such long periods are periods where the strategy under-performs other strategies and the market as a whole.

Small Cap stocks have been under the weather in India for nearly 10 months now. While last Diwali picks by experts were more in the Small and Micro cap space, this time around, most of the recommendations are in the large cap space.

But has Small Cap really been a disaster like everyone loves to point out. Here is a relative comparison chart that compares Nifty 50, the large cap Index with Nifty Small Cap 100, the small cap Index.

As you can see, from the chart, while the path has been varied, the results have been the same. A small investor would have been the object of envy of the large cap investor for a long time but once the crack came in, the large cap investor feels vindicated that his style was the better choice.

Momentum Strategy can be applied on any subset of the market. For my personal investment, I am agnostic to market capitalization which means that the choice of stocks is based on the flavour of the moment. Yet, despite the churn, the portfolio has seen a draw-down – one that will be a long time from getting back to all time high.

In earlier days, like the experts of today, I would have loved to shift to a strategy that offered more robustness in these times. Maybe Quality for the Nifty Quality Index is still making new highs even as the rest of the market seems to be immersed in its own poo.

But many a Quality stock is even today more expensive that it ever has been historically been. This means that while they could be resilient for now, their future returns will not be in-line with others as and when the market recovers – and the market always recovers.

Success in markets doesn’t require one to follow the herd when it comes to the most popular style or strategy. Success instead comes when we are able to stay the course even as the airplane hits a air pocket and there is turbulence all around.

If the current market behaviour is making you clamour to change your path, my humble advise would be to step back and see your portfolio for what it aims to be rather than what you want it to be.

Stocks, Sectors, Industries, Countries all move in cycles – sometimes in favour, sometimes out of favour. As long as you understand that, investing becomes much easier since changes are not driven by the heat of the moment but an in depth understanding of the strategy itself.

Whatever you do, Wishing you all the Success in the coming year. Wishing you a Happy & Prosperous year ahead. Happy Deepavali.

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