Optimization vs. Maximization

The dog years of 2010, 2011, 2012 and 2013

According to AMFI, these are the 5 largest funds at the end of March-2015:

Scheme Name AUM (Cr.)
HDFC Equity Fund – Growth Option
1,280,287
HDFC Top 200 Fund – Growth Option
1,009,121
Reliance Equity Opportunities Fund-Growth Plan-Growth Option
764,383
HDFC MID-CAP OPPORTUNITIES FUND – Growth Option
715,865
ICICI Prudential Value Discovery Fund – Regular Plan – Growth
645,946

What this means is that there is at least one person in your immediate network who would have invested in one of these funds.

Now let’s take a walk down memory lane. 2010, 2011, 2012 and 2013 were the worst years for the Indian economy. The RBI had messed up monetary policy leading to high inflation (double digits), there was a currency panic (rupee went from 45 to a dollar to 65), a never-ending series of scams and a government hell bent on redistribution. The only two asset classes that were doing well at the time were gold and real estate. GOLDBEES, the gold ETF, returned 13.25% (IRR) during that period. Fixed deposits were yielding around 11%. How would a typical investor react if his actively managed equity investments gave the following returns?

Scheme Name IRR
HDFC Equity Fund – Growth Option
7.00%
HDFC Top 200 Fund – Growth Option
6.74%
Reliance Equity Opportunities Fund-Growth Plan-Growth Option
12.00%
HDFC MID-CAP OPPORTUNITIES FUND – Growth Option
13.24%
ICICI Prudential Value Discovery Fund – Regular Plan – Growth
11.09%

Here is Gold (in red) vs. HDFC Equity Fund (in black):

Needless to say, most investors who dipped their toes into the equity markets in 2010 gave up after a couple of years and still believe that the whole mutual fund business is a scam.

First half of 2015

We are supposed to be in a bull market. But let’s see how the first half worked out for the HDFC Equity Fund:

IRR of -2.39%. And bonds lost money too (in June.) Bull markets are not immune to prolonged periods of a “sideways” market.

Diversification across assets

A standard response to most investing problems in diversification. Invest a little into a variety of asset classes – equities, commodities, real-estate, gold, bonds – and you will be fine.

The problem with diversification is that it always feels wrong. For example, there are “balanced” funds that are supposed to allocate between both bonds and equities. They end up having lower draw-downs because of this. If you compare the ICICI Prudential Balanced Fund with HDFC Equity Fund between 2010-2013, the latter has an IRR of 11.38% vs. 7.00% of the former. But during the bull market of 2014, the balanced-fund gave an IRR of 45.47% vs. the equity fund’s 53.83%. So the lower draw-down comes at the expense of performance. It is a huge cognitive burden for investors to live with.

The kind of assets you pick for diversifying into also matters. For example, there was this big thing back in the day about the “commodity super-cycle.” About how the insatiable appetite for all sorts of commodities from China would keep growing to infinity. Plus, commodities were supposed to uncorrelated with equities. So great for diversification, right? Here’s how Mirae Global Commodity Equity Fund compares to the HDFC Equity Fund:

Commodity stocks did turn out to be uncorrelated but not in a way that you would like. And the commodities themselves are bouncing along multi-year lows right now.

What about bonds? Surely, they are safe. But let’s not forget that in 2009 and 2013, gilts drew-down double digits and their long-term IRRs are between 7% and 10%.

gilt drawdowns

Diversifying across geographies

What if you invested in international funds? After all, the rupee keeps going down, right? Depends on where you look. Between 2010 and 2013 (the dog years) the Birla Sun Life International Equity Fund – Plan A gave an IRR of 16.09% vs. HDFC Equity Fund’s 7%. But before you pat yourself on the back, between 2014 and now, the latter gave an IRR of 3.06% vs. 32.54% of the former. And Religare’s Pan European Equity Fund gave 1.50%.

Diversification means that your overall portfolio will trail behind the best performing asset class du jour. Psychologically, it is a very difficult thing to stick to.

Investing fads and broker recommendations

Of all the poor choices that investors can make, the worst is giving into investing fads. Back in 2004, there was this whole “India shining” marketing slogan. And now there is “make in India”, “smart cities”, “digital India”, etc. And almost every single time, fund houses come out with new schemes that tag along the slogan du jour. Here are some examples:

Morgan Stanley came out with their stock picks if Modi won (Theme created Dec 6, 2013):
morgan stanley strong election result

Here’s one on the Rail Budget (Theme, created Feb 26, 2015)
rail budget 2015 theme

So much for betting on rate-sensitive stocks (Theme, created Feb 3, 2015):
rate sensitive 2015 theme

You can browse through all these recommendations and lists under the “Broker Recommendations” section of our Themes page. We call it Doodh Ka Doodh Pani ka Pani.

Optimization vs. Maximization

The above examples highlight the problems of trying to maximize returns. There will always be an asset class, mutual fund or stock that is doing better than what you own. And there is an entire industry of tip-sheets, newsletter writers and subscription services that promise to pick the next winner.

However, we see investing as an optimization problem. We believe that drawdowns are an inseparable part of investing. Instead, we focus on getting the right mix of assets and strategies based on your risk appetite. And we make it supremely easy to stick to a plan.

For direct equity investors, this means getting Value and Momentum right. We have created Themes based on different approaches to value and momentum investing. Investors can then map our Themes to gain exposure to a specific set of strategies.

For mutual fund investors, this means getting portfolio risk right. We have created Themes based on the risk of the overall portfolio. Investors can now tune out the noise and focus on achieving their life goals.

Investing is not easy, but your journey as an investor will be so much more smoother with us. Get in touch with us now!

Weekly Recap: Illusion of Insight

world.2015-06-26.2015-07-03

Equities

Major
DAX(DEU) -3.78%
CAC(FRA) -4.96%
UKX(GBR) -2.49%
NKY(JPN) -0.80%
SPX(USA) -1.07%
MINTs
JCI(IDN) +1.22%
INMEX(MEX) -1.33%
NGSEINDX(NGA) -0.96%
XU030(TUR) -3.24%
BRICS
IBOV(BRA) -2.42%
SHCOMP(CHN) -12.07%
NIFTY(IND) +1.24%
INDEXCF(RUS) -0.78%
TOP40(ZAF) -1.49%

Commodities

Energy
Brent Crude Oil -4.66%
Ethanol +3.10%
Natural Gas +0.18%
WTI Crude Oil -6.97%
Heating Oil -3.60%
RBOB Gasoline -2.01%
Metals
Copper -1.13%
Palladium +0.78%
Platinum +0.21%
Gold 100oz -0.29%
Silver 5000oz -0.64%

Currencies

USDEUR:+0.51% USDJPY:-0.86%

MINTs
USDIDR(IDN) +0.09%
USDMXN(MEX) +0.96%
USDNGN(NGA) -0.03%
USDTRY(TUR) +0.95%
BRICS
USDBRL(BRA) +0.25%
USDCNY(CHN) -0.06%
USDINR(IND) -0.32%
USDRUB(RUS) +1.83%
USDZAR(ZAF) +0.82%
Agricultural
Corn +9.16%
Feeder Cattle +0.15%
Lean Hogs +4.63%
Lumber -1.60%
Cattle +2.02%
Cocoa -0.23%
Coffee (Arabica) -4.07%
Cotton +1.26%
Coffee (Robusta) -2.48%
Orange Juice -2.44%
Soybean Meal +4.91%
Soybeans +4.58%
Sugar #11 +6.14%
Wheat +4.59%
White Sugar +3.31%

Credit Indices

Index Change
Markit CDX EM -0.19%
Markit CDX NA HY +0.10%
Markit CDX NA IG +1.32%
Markit iTraxx Asia ex-Japan IG +5.12%
Markit iTraxx Australia +5.77%
Markit iTraxx Europe +6.41%
Markit iTraxx Europe Crossover +27.25%
Markit iTraxx Japan +0.68%
Markit iTraxx SovX Western Europe +2.22%
Markit LCDX (Loan CDS) -0.04%
Markit MCDX (Municipal CDS) +4.16%
The Nifty was one of the few global indices that ended this week in the green. Pretty much all markets were buffetted by the Greece drama. Shanghai had one of the worst weeks ever – Chinese regulators have allowed pretty much anything to be posted as collateral, the only thing that remains to be tried is outlawing falling stock prices.

Nifty Heatmap

CNX NIFTY.2015-06-26.2015-07-03

Index Returns

For a deeper dive into indices, check out our weekly Index Update.
index.performance.2015-06-26.2015-07-03

Sector Performance

sector performance.2015-06-26.2015-07-03

Market Cap Decile Performance

Decile Mkt. Cap. Adv/Decl
1 (micro) +2.10% 64/67
2 +2.76% 71/59
3 +3.02% 72/59
4 +2.47% 68/62
5 +3.80% 76/55
6 +2.73% 67/63
7 +1.58% 69/62
8 +1.35% 67/63
9 +1.52% 63/68
10 (mega) +0.81% 72/59
Midcaps outperformed large-caps. Is this a sign of the market turning around?

Top Winners and Losers

AMBUJACEM +6.76%
BAJAJFINSV +12.09%
UBL +13.80%
TECHM -9.62%
HINDALCO -5.47%
BHARATFORG -3.67%
Who would’ve thunk that a cement stock can go up more than 6% in a week?

ETF Performance

BANKBEES +1.72%
JUNIORBEES +1.70%
PSUBNKBEES +1.02%
NIFTYBEES +0.88%
CPSEETF +0.56%
INFRABEES +0.36%
GOLDBEES -1.07%
Banks caught a bid. Gold sank.

Yield Curve

yield Curve.2015-06-26.2015-07-03

Bond Indices

Sub Index Change in YTM Total Return(%)
GSEC TB -0.14 +0.12%
GSEC SUB 1-3 +0.16 -0.10%
GSEC SUB 3-8 +0.32 -1.27%
GSEC SUB 8 +0.19 -1.32%
The long end of the curve got creamed…

Investment Theme Performance

Equity Mutual Funds

Bond Mutual Funds

Thought for the weekend

People were more confident that they knew the answers — had the information in their heads — if they had access to [internet] search. It’s more like thinking you know how to fix a car if you have access to a mechanic.

Plus, searching the internet is almost effortless, and it’s almost always accessible. You never face your ignorance when it’s there. Because we’re so deeply plugged into it, we misattribute the connection to knowledge to actually having the knowledge ourselves.

Emotional investments can give people the illusion of insight.

Source: The Internet Makes You Think You’re Smarter Than You Are

Implied Volatility around Earnings Announcements

Introduction

There is a common belief that option implied volatility, which is high before earnings announcements, quickly dissipates after the event. So sell options before the event to profit from the fall in IV. We decided to put this theory to test by observing at-the-money IVs 5-days before earnings announcements and their subsequent behavior.

It is not what you expect.

ATM IVs

Here are the at-the-money implied vols 5-days before and the day after announcements:

atm iv announcement

In our study, IV falls only 44% of the time. So the blanket statement fails. IV dissipation is not guaranteed. There are a lot of other things that affect IV and earnings alone is not sufficient to predict the outcome.

However, if the IV was more the 50, then IV dissipates 70% of the time. However, these odds could be similar to those without earnings announcements as well (all things equal.) So further research is required.

Conclusion

Don’t go around selling options thinking that IV will dissipate after earnings announcements. Know your odds.

Opening Bell 02.07.2015

Your world at 9am

world.2015-07-02

Equities

Major
DAX(DEU) +2.15%
CAC(FRA) +1.94%
UKX(GBR) +1.34%
NKY(JPN) +1.16%
SPX(USA) +0.69%
MINTs
JCI(IDN) +0.62%
INMEX(MEX) -0.17%
NGSEINDX(NGA) -1.77%
XU030(TUR) -0.98%
BRICS
IBOV(BRA) -0.61%
SHCOMP(CHN) -0.76%
NIFTY(IND) +1.01%
INDEXCF(RUS) -0.90%
TOP40(ZAF) +0.37%

Commodities

Energy
WTI Crude Oil +0.11%
Heating Oil +0.52%
RBOB Gasoline +0.48%
Natural Gas +0.93%
Brent Crude Oil +0.39%
Ethanol +0.00%
Metals
Copper +0.15%
Silver 5000oz +0.00%
Gold 100oz -0.22%
Palladium +0.13%
Platinum -0.59%

Currencies

USDEUR:-0.17% USDJPY:+0.13%

MINTs
USDIDR(IDN) +0.08%
USDMXN(MEX) -0.00%
USDNGN(NGA) +0.13%
USDTRY(TUR) +0.02%
BRICS
USDBRL(BRA) +1.49%
USDCNY(CHN) +0.05%
USDINR(IND) +0.05%
USDRUB(RUS) -0.12%
USDZAR(ZAF) -0.00%
Agricultural
Cattle +0.00%
Cocoa +0.00%
Coffee (Arabica) -3.52%
Feeder Cattle +0.00%
Soybean Meal -0.22%
Soybeans -0.67%
Sugar #11 -0.48%
Wheat +0.64%
Orange Juice +0.09%
Coffee (Robusta) +0.00%
Corn +0.42%
Cotton +0.00%
Lean Hogs +0.00%
Lumber +0.00%
White Sugar +0.00%

Credit Indices

Index Change
Markit CDX EM +0.24%
Markit CDX NA HY -0.15%
Markit CDX NA IG -1.96%
Markit iTraxx Asia ex-Japan IG -0.70%
Markit iTraxx Australia -1.77%
Markit iTraxx Europe -1.46%
Markit iTraxx Europe Crossover -6.32%
Markit iTraxx Japan -2.42%
Markit iTraxx SovX Western Europe +0.27%
Markit LCDX (Loan CDS) +0.00%
Markit MCDX (Municipal CDS) +0.70%
Greece: nobody knows nothin’

Must reads

The National Optical Fibre Network is flailing amid right-of-way hurdles. What about broadband? But what about the farmers? Idea of India. (FE)

Domestic passenger vehicle sales lose momentum. However, Tata Motor’s sales momentum continued as the company reported the highest growth of 30 per cent among the PV makers. (Hindu) TATAMOTORS 433.55 -2.85 (-0.65%) MARUTI 4,005.00 11.60 (0.29%)

China discovers the pitfalls of fad based investing. “The country is promoting ‘internet plus’ so I bought some internet-themed stocks. Their results looked good. But then came a few days of limit-down. Now I’m stuck.” Sounds familiar to those “Make in India” themed portfolios, doesn’t it? (FT)

Most big-data projects: garbage in, garbage out. Not only do most of them actually not have Big Data in terms of data complexity or volume, but most of them actually have Crappy Data, and it’s probably hurting their business. (Techcrunch)

Engineers in Australia have created a fully working house-building machine that can create the brick framework of a property in just two days, working about 20 times faster than a human bricklayer. (Gizmag)

Good luck!

Macro Update June 2015

US TREASURIES VS. GILT SPREAD

The spread between 10yr US Treasuries and Indian Gilts remained within a tight range this month.

ust-ind-10yr-spread.2011-01-18

Long-term bond yields continued their ascent:

ust-yield-curve.2015-06-01

INSTITUTIONAL INVESTMENTS

FIIs came back to the debt market but took money out of equities…

fii-investments.2014-01-01.2015-06-30

… while DIIs gulped down debt as well.

dii-investments.2014-01-01.2015-06-30

Oil

Oil futures remained flat.

wti-brent.2011-01-18

Gold

If all the uncertainties cannot move gold up, I am not sure what will.

gold.usd

Copper

After a brief period of enthusiasm, it looks like copper has given up on industrial growth again.

copper.usd

Dollar Index

Looks like the dollar index (DXY) has found a range.

Outlook

Although the Indian markets have shrugged off Grexit for now, nobody really knows the extent to which the contagion can spread. It’s basically a known unknown at this point.

With the monsoon expected to be normal and earnings to begin in earnest only by the end of July, the first couple of weeks of July is going to be driven by optimism.