Author: shyam

On why passive investing is a risky strategy

If you are buying an investment fund, there are two main strategies you’ll encounter – active management and passive management. Passive investing is essentially the replication of an index or benchmark. For example, buying the NIFTYBEES ETF that replicates the Nifty 50 index. The aim of active investing is to deliver returns that are superior to the stock market that the companies sit within. An actively managed fund can offer you the potential for much higher returns than what a particular market is already providing. The debate as to which of these strategies is better has been raging on for the better part of the last 20 years. Whenever stock-market indices recover from a crash, the debate re-emerges.

The problem with passive investment is that passive management is only theoretically possible.

any evaluation of passive investment funds to be complete should include withdrawal activity during draw-downs, something that can be viewed as active management by the part of the investor imposed on the passive fund.

Also, most funds that call themselves “active” are actually “passive.”

the representation of closet index funds and traditional index funds have risen to the point where they now represent approximately 40% of the active universe—making the exercise of differentiating them from true active managers more important than ever.

Traditional passive investing, using indices weighted according to market capitalisation, works best in the kind of long bull markets that ignore fundamentals, because at the end of the day, you effectively end up buying high and selling low.

Investors should be careful of simplistic arguments and biased data while allocating capital. While I remain a fan of ETFs to get broad-market exposure, it is by no means the be-all-end-all of investment choices.

Sources:
Passive Investing in Stock Indices Involves Substantial Risks
Re-thinking the Active vs. Passive Debate

 

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52-Week High Investing

Investing in stocks that have hit 52-week highs is a form of momentum investing. The rationale is that traders are slow to react, or overreact, to good news. A stock whose price is at or near its 52-week high is a stock for which good news has recently arrived. This may be the time when biases in how traders react to news, and hence profits to momentum investing, are at their peaks. The psychological underpinning is traders’ reluctance to revise their reference point is price-level dependent.

Unlike straight-up momentum investing that looks at the top decile of stocks in terms of 200-day performance, the 52-week high model only gets activated when there are stocks hitting 52-week highs. In that sense, momentum investing is a continuous model whereas the 52-week high model is sporadic.

52-week high

How does this sporadic model compare during volatile markets? If you look at the Feb 2013 returns (above) that was picked right before volatility hit and the broad indices tanked, the model outperformed the CNX 100 by over 7 points. The out-performance is largely due to the immunity that these stocks enjoy in terms of positive news flow. It follows that this model is ideal for short- to medium-term investors who like to time their entry into the market. The image below is the performance of the portfolio picked on Feb 2012 to give you a longer-term perspective.

52-week high feb 2012

Check out our 52-Week High Theme and give us a call. Investing without emotions was never simpler.

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Quickie: RAJESHEXPO

Rajesh Exports [stockquote]RAJESHEXPO[/stockquote], for those of you who don’t follow the stock, is a Bangalore based company that manufactures gold & diamond jewellery for export as well as distribution to the domestic wholesale jewellery market. They also own a 75 outlet retail channel via Shubh Jewellers.

I find this stock interesting because it keeps oscillating between Rs. 120 and Rs. 150 levels. As you can see in the chart below, the stock has been sitting pretty in this channel for more than a year.

Rajesh Exports Analysis

This stock could be ideal for those who are looking for some trading action without adding on a lot of risk. With a beta of 0.72, there is not a ton of volatility here. RSI indicator is in the oversold area and the stock is testing its long-time support of Rs. 120.

From a fundamental point of view, the company has shown steady growth over the last three quarters. Gold price volatility has not been kind to the firm and there could be some impact due to that.

RAJESHEXPO - Rajesh Exports Limited - Quarterly Results

As I said earlier in the post, this could a quickie trade for investors trying to get some action that, going by the recent price action of the stock, appears low risk.

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Bull Beta / Bear Beta for Stock Picking

The Beta of a stock or portfolio is a number describing the correlated volatility in relation to the volatility of an index. By definition, the market itself has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the macro market. A stock with a beta of 2 has returns that change, on average, by twice the magnitude of the overall market’s returns; when the market’s return falls or rises by 3%, the stock’s return will fall or rise (respectively) by 6% on average.

The problem with a single measure of beta during all market conditions is that it might understand/overstate the risk of a stock during bull/bear phases. For example, FINPIPE [stockquote]FINPIPE[/stockquote] has a fairly benign beta of 0.68. So you would expect it to hold up pretty well during volatile markets, correct? However, with a bear beta of 1.17, it is going to tank more than the broader market and with a bull beta of just 0.007, it is not going to rise as much as the market either. So you get all of the downside without the upside. ASHOKLEY [stockquote]ASHOKLEY[/stockquote], on the other hand, has positive asymmetry with a bear beta of 0.90 and a bull beta of 1.16.

The bigger question is can this asymmetry be converted into a model for generating stock picks? Can investing in a portfolio of stocks with bull betas > 1.2 and a bear betas < 0.8 result in meaningful out-performance? We looked all the way back to Jan 2010 to pick out stocks that met this condition to see if a portfolio of these names can outperform the market. It seemed pretty legitimate at first, who wouldn’t want to own stocks that didn’t fall as much as the market when it went down but rose more than the market when it went up?

The results were a bit of a disappointment. First, the stock picks were extremely sparse. There were only 5 days during the entire period where there were more than 5 stocks that met the criteria. So there just weren’t enough data points to confirm or refute the thesis. It also didn’t help that these portfolio did not outperform the market in any meaningful way.

The Bull Beta / Bear Beta thesis needs to be further tested for different bull/bear thresholds. It is an interesting thesis and we are big fans of repeatable, verifiable and systematic portfolio strategies. Stay tuned for updates!

 

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The Great Rotation into Debt

It used be that news about increasing FII flows brought cheer to the markets. However, in spite of them bringing in close to $10.3 billion dollars since the beginning of this year, the market has been in an interminable funk.

FII Investments - IndiaMarket action doesn’t seem to concur with FII bullishness. Are FII faith misplaced? At first, the market expected a whiz-bang budget and capitulated once that turned out to be a damp squib. And now it appears that investors have latched on to the political goings on to feel depressed about.

CNX 500 Chart

Underneath it all is the exodus of domestic investors out of Equities. Since July 2012, Indian mutual funds pulled out more than $3.6 billion out of equities and piled into debt.

Domestic Investors - India

For every single month since July 2012, domestic investors have rotated out of equities and into debt to a grand total of $58.2 billion. Given the recent volatility in the stock market, it would be no surprise if domestic investors continue to herd into debt funds. The big question on my mind is how long will FII flows continue into equities if domestic investors continue to sell into them?

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