Author: shyam

Book Review: The Behavioral Investor

The Behavioral Investor (Amazon,) by Daniel Crosby had me nodding in agreement at every page. It is one of those books that produces your thoughts in print.

You are not built to be happy or to make good investment choices, you are built to survive and reproduce. Asking someone built for short-term survival to become a long-term investor is a bit like trying to paint a room with a hammer. You can do it, but it’s not pretty.

Successful investing is hard. It has more to do with controlling one’s own emotions than finding a superior strategy. Being mindful of our decision making process is half the battle won. The book has some good ideas on how we can be aware of when we are making poor decisions so that we can take a pause and reconsider.

Recommendation: Read it now!

Volatility and Returns

Indian mid-caps, represented by the NIFTY MIDCAP 100 TR index, has out-performed its large-cap peer, the NIFTY 50 TR index.

It has done so with higher volatility. Here is the rolling 200-week standard deviation of weekly returns of the two indices:
standard deviation of weekly returns

MIDCAP volatility has been persistently higher than NIFTY volatility in the past:
ratio of standard deviations

A portfolio of bonds and mid-caps should exhibit lower volatility than an all-equity portfolio. Here are the standard-deviation ratios for different allocations to bonds:
standard deviation ratios of different bond allocations
B05, for example, represents a portfolio of 5% short-term bonds and 95% MIDCAP index. As allocation to bonds increases, portfolio volatility decreases.

We see from the chart above that a 75% MIDCAP + 25% BOND portfolio has almost never seen volatility greater than an all NIFTY portfolio. So, what are we giving up in returns to reduce volatility? About 2% in returns:

75% MIDCAP + 25% BOND returns


  1. On an annualized basis, the allocation portfolio gives up about 2% in returns compared to all MIDCAP portfolio and is on par with NIFTY’s.
  2. After taxes and transaction costs, expect the allocation portfolio to under-perform buy-and-hold NIFTY.
  3. No pain. No gain.

Code and charts are on github.

Are Stop-Losses Worth It?

StockViz introduced Themes back in August 2013. We went live with two strategies: Momentum, rebalanced once a month, and Quality to Price, rebalanced once a quarter. The Modi bull market was just getting started and returns were spectacular in the beginning. Here is Momentum, from Jan-2014 through Dec-2015:
Momentum Jan-2014 through Dec-2015

And then, in Jan-2016, the Chinese market crash rippled through world financial markets (WaPo). Momentum collapsed. This is the previous chart extended to June-2016:
Momentum Jan-2014 through June-2016

Momentum investors clamored for a safety net. Enter stop-losses. We created a new set of Themes, called Momos, that had a 5% trailing stop loss at the position level. Positions hitting the stop loss were substituted with stocks that had favorable momentum and trend. The logic was that if the entire market crashed, the strategy would be in cash until stocks gained momentum. We introduced these Themes in June and they worked as advertised on the subsequent market correction in November that year. Idea validated? Here is a chart comparing the returns of Momentum (vanilla) vs. Momo (Relative) v1.1:
Momentum (vanilla) vs. Momo

Momo trails its plain-vanilla counterpart over a ~3 year period. There has been plenty of volatility during that time – November 2016, August 2017 and January 2018 through now. And Momo traded a lot more than its plain-vanilla counterpart (the turnover charts are on the Theme pages linked above) through these bouts of volatility. And what was saved through stop-losses was paid for in taxes and transaction costs. Here is a chart that shows the Momo strategy with and without transaction costs:

So, are stop-losses worth it? Probably not. It is very difficult to de-risk a high-risk strategy intrinsically. It is better for investors to focus on asset allocation to bring down overall portfolio volatility to a level that they can bear. Think of it like trying to tame a tiger. You may very well succeed. But a tame tiger is a cat.

Indian vs. US Mid-caps

There used to be a time when getting your kids through college was the final act before kicking them out of the house. But kids these days want their parents to fund their US education as well. And how about a gap year to travel through Europe? You can roll your eyes all that you want but 15-20 years from now, this will be the new normal for middle-class Indians. What can we do? We have always been an aspirational lot and it is bound to rub off on our kids. As much as we like our kids to be financially independent when they grow up, we also don’t want them to start their lives with a ton of student loans. However, given the potentially large dollar liabilities in the future, most Indian investors continue to keep all their eggs in the Indian rupee basket. If you think your Indian mid-cap mutual fund alone is going to fund your kid’s grad school, think again.

Not only have Indian Mid-caps trailed US Mid-caps over the last 25 years, they have done so with steeper and longer drawdowns.

Over the last 25 years or so, US mid-caps have out-performed Indian mid-caps. Indian asset managers would have you believe that “east or west, India is the best” but that is not what the numbers say. Here are the cumulative and annual returns of the MSCI India MC and MSCI USA MC indices:
MSCI India vs. US mid-cap indices
MSCI India vs. US mid-cap indices

Living in India, it is easy to get carried away with stories about how Indian equities present big opportunities. However, historical returns show that investors were not compensated for the additional risk that they took by investing in India. Also, the US equity market cap is 50% of the total world equity market cap. So even if you have bonds, gold etc in your portfolio, being 100% invested in India is not true diversification. Besides, the Indian rupee keeps depreciating, making your future dollar liabilities that much larger when priced in local assets.

We ran through different allocations between Indian and US mid-caps to get an idea of what the potential returns could look like:
Allocating between MSCI India vs. US mid-cap indices

Assuming a monthly rebalance, the 50/50 portfolio beats the “all in” 100/0 and 0/100 portfolios. And it does so with shallower drawdowns. So both from a diversification and returns point of view, it makes sense to allocate towards US mid-caps.

It is time to have a chat about your portfolio. Get in touch with us now!

Further reading: Funding Your Dollar Dreams

Food: A problem of plenty?

fertilizer and food price chart

fertilizer, cereal, rice and wheat indices

PFERT: Primary Commodity Prices, Fertilizer
PCERE: Primary Commodity Prices, Cereal index
PRICENPQ: Primary Commodity Prices, Rice, Thailand
PWHEAMT: Primary Commodity Prices, Wheat
PFOOD: Primary Commodity Prices, Food index

If I am reading this chart right, when prices of food commodities (cereals, rice, wheat) go up, fertilizer prices go up. But when food prices come down, fertilizer’s stay up? Wheat prices are more-or-less where they were back in the 90’s. The rest have barely budged. No wonder I’ve spent most of my adult life hearing about farm distress.

Code and charts are on github.