Invest Without Emotions
The iShares MSCI India ETF (INDA) tracks the MSCI India Total Return Index, representing about 85% of the Indian stock market. As a follow up to our earlier post on the historical volatility of the NIFTY 
, we thought we’ll compare the volatilities of INDA and SPY, the S&P 500 ETF.
10-day volatility:
50-day volatility:
As expected, a dollar denominated emerging market ETF is more volatile than the S&P. File this away in your brain attic.
Here’s a density plot of NIFTY volatility across 10-, 20-, 30-, and 50-day periods:
And here’s how it was in 2004 (10-years ago):
For those of who argue that the introduction of the pre-open auction call in 2010 skews these results, here’s how 2011 looked like:
The unprecedented absence of a second “hump” in the volatility density plot for 2014 should give pause to investors looking for a repeat of 2014 anytime soon.
If you look at the 50-day volatility over different time-periods, you can observe how volatile volatility is:
This year’s observed volatility is closer to last-year’s than to its long-term mean. Here’s how 2015 has panned out so far:
We should expect higher volatility as the initial bull-run wears off and volatility reverts. This will have a ripple effect on pretty much every investment/trading strategy.
Year-wise NIFTY volatility density plots (pdf)
Came across an interesting paper: Will My Risk Parity Strategy Outperform? Robert M. Anderson, Stephen W. Bianchi, CFA, and Lisa R. Goldberg. Even though they discuss risk parity, they make some pretty interesting points that relate to all investment strategies.
Before index ETFs, there was no cost-effective way of replicating an index. For example, NIFTYBEES was listed in 2002 and came with an expense ratio of 0.80% while retail brokerage charges were in the 0.5-1.0% range. Replicating the NIFTY index before NIFTYBEES came around was expensive. So any backtest before 2002 that that tries to argue the benefits of buying-and-holding an index ETF is likely bogus. Similarly, today’s active management strategies available to a select few hedge-fund investors are tomorrow’s “smart beta” ETFs that will be available to anybody with a demat account.
There are periods when banks pull their lines of credit based on macro factors that has nothing to do with your strategy. For example, during the 2008 financial crisis, your bank/broker would have pulled your credit lines forcing you to sell near the bottom and preventing you from buying the bounce. Any strategy that uses leverage – risk-parity, for example – should factor this risk.
Besides, most strategies have a rebalancing frequency – once a month, once a year, and so on. The specific day you choose to rebalance can have a material impact on your strategy. For example, rebalancing during options expiry, corporate events, etc… can meaningfully skew your risk/returns.
There is huge execution risk involved in strategies that requires shorting of shares. Given the regulations surrounding SLBS – lending/borrowing allowed only on those securities that are listed in F&O and that too only in increments of lot-sizes – the friction involved in shorting stocks are prohibitive.
There is likely going to be a big difference between model execution prices and actual execution prices. For example, when we rebalance our Themes, we use the latest available price in our database. These prices themselves could be stale by over 10 minutes. These changes then have to percolate down to investors who execute them in the market. From start to finish, there could be a price gap of over 20 minutes – a significant source of drift between the ideal P&L and actual P&L.
Investors should have a deployment checklist for their strategies that addresses the issues raised above. What we have found is that most strategies that look good on a simple backtest don’t look that great when costs, variable periods, drift and half-lives are factored in.
| MINTs | |
|---|---|
| JCI(IDN) | -5.43% |
| INMEX(MEX) | -2.18% |
| NGSEINDX(NGA) | +5.16% |
| XU030(TUR) | -1.22% |
| BRICS | |
|---|---|
| IBOV(BRA) | -3.23% |
| SHCOMP(CHN) | -4.78% |
| NIFTY(IND) | +0.24% |
| INDEXCF(RUS) | -5.20% |
| TOP40(ZAF) | +1.20% |
| Energy | |
|---|---|
| Brent Crude Oil | -8.90% |
| Ethanol | +4.85% |
| Natural Gas | -5.45% |
| RBOB Gasoline | -15.74% |
| WTI Crude Oil | -5.77% |
| Heating Oil | -7.15% |
| Metals | |
|---|---|
| Gold 100oz | -1.51% |
| Platinum | -9.61% |
| Copper | +2.15% |
| Silver 5000oz | -0.68% |
| Palladium | +8.89% |
| MINTs | |
|---|---|
| USDIDR(IDN) | +4.31% |
| USDMXN(MEX) | +1.02% |
| USDNGN(NGA) | +0.17% |
| USDTRY(TUR) | +3.91% |
| BRICS | |
|---|---|
| USDBRL(BRA) | +8.66% |
| USDCNY(CHN) | -0.34% |
| USDINR(IND) | -1.38% |
| USDRUB(RUS) | +2.21% |
| USDZAR(ZAF) | +4.24% |
| Agricultural | |
|---|---|
| Coffee (Arabica) | +0.21% |
| Wheat | +6.04% |
| Coffee (Robusta) | -1.52% |
| Orange Juice | -18.53% |
| Soybean Meal | -4.62% |
| White Sugar | +8.38% |
| Cattle | -13.66% |
| Lumber | -3.66% |
| Soybeans | -0.61% |
| Cocoa | +2.59% |
| Corn | +5.98% |
| Cotton | -7.19% |
| Feeder Cattle | -11.86% |
| Lean Hogs | +7.97% |
| Sugar #11 | +20.58% |
| Index | Change |
|---|---|
| Markit CDX EM | -2.28% |
| Markit CDX NA HY | -2.05% |
| Markit CDX NA IG | +7.87% |
| Markit iTraxx Asia ex-Japan IG | +2.50% |
| Markit iTraxx Australia | +9.68% |
| Markit iTraxx Europe | +13.38% |
| Markit iTraxx Europe Crossover | +66.06% |
| Markit iTraxx Japan | +5.91% |
| Markit iTraxx SovX Western Europe | -2.27% |
| Markit LCDX (Loan CDS) | +0.00% |
| Markit MCDX (Municipal CDS) | +0.97% |
This gives you an idea of how widespread the carnage was. India was one of the few markets that managed to end September in the green.
US rate hike jitters has pushed precious metals down for most of this year. With 2010’s hyper-inflation fears morphing into 2015’s deflation, gold has seen a massive sell-off…
Saudi’s kept the pump running, hoping to drive US shale operators out of business. But slowing global growth and an appreciating US Dollar might have had a bigger impact on oil prices…
| Decile | Mkt. Cap. | Adv/Decl |
|---|---|---|
| 1 (micro) | -1.65% | 68/63 |
| 2 | -0.57% | 71/59 |
| 3 | -1.01% | 61/69 |
| 4 | +0.97% | 64/67 |
| 5 | +0.84% | 68/62 |
| 6 | -2.22% | 60/71 |
| 7 | -1.06% | 63/68 |
| 8 | +1.48% | 62/68 |
| 9 | +0.03% | 67/64 |
| 10 (mega) | -2.04% | 64/67 |
| SRTRANSFIN | +13.78% |
| RPOWER | +14.67% |
| RELCAPITAL | +19.59% |
| MOTHERSUMI | -24.10% |
| BHARATFORG | -22.29% |
| BOSCHLTD | -16.47% |
| BANKBEES | +0.16% |
| NIFTYBEES | -0.82% |
| GOLDBEES | -1.82% |
| JUNIORBEES | -2.38% |
| CPSEETF | -3.21% |
| PSUBNKBEES | -4.22% |
| INFRABEES | -6.32% |
| Sub Index | Change in YTM | Total Return(%) |
|---|---|---|
| 0 5 | -0.28 | +1.35% |
| 5 10 | -0.23 | +1.85% |
| 10 15 | -0.15 | +1.77% |
| 15 20 | -0.21 | +2.54% |
| 20 30 | -0.20 | +2.77% |
| ADAG stocks | +12.21% |
| Momentum | +3.94% |
| High Beta | +3.69% |
| CNX 100 Enterprise Yield | +1.53% |
| Magic Formula | +1.26% |
| Quality to Price | +0.77% |
| Balance Sheet Strength | -0.63% |
| Financial Strength Value | -0.91% |
| PPFAS Long Term Value | -0.94% |
| The RBI Restricted List | -1.07% |
| Tactical CNX 100 | -1.58% |
| ASK Life | -3.01% |
| Low Volatility | -3.71% |
| Next Trillion | -6.57% |
There are four types of investment returns:
Look at the long-term history of great investors, and you’ll find they occupy the third category.
Source: Good Investing Hurts
Dynamic P/E funds use the market Price-to-Equity ratio to decide on allocation. If the P/E ratio is deemed too high, they allocate more to bonds or arbitrage strategies and if the P/E ratio is low, they allocate more towards equities. This logic sounds good on paper. However,
It is a solution looking for a problem.
We thank Franklin Templeton for running the Dynamic PE Ratio Fund Of Funds to perform our analysis. This is probably the only fund where a true apples-to-apples comparison can be made between a pure-play equity fund, a pure-play bond fund and a dynamic PE fund.
The Dynamic PE fund invests x% in the Franklin India Short Term Income Plan and 100-x% in the Franklin India Bluechip Fund based on the P/E ratio. All we have to do is look at how a buy-and-hold strategy of the components compare to the Dynamic PE fund to gauge the effectiveness of the strategy.
Between 2007-01-02 and 2015-09-23, Franklin India Dynamic PE Ratio Fund of Funds-Growth’s IRR was 10.93% vs. Franklin India Bluechip Fund-Growth’s IRR of 11.53%
Similar returns. Lesser drawdowns. Lump-sum investors will probably be fine with these returns.
First, let’s compare the Dynamic PE fund to the Short Term Income Plan.
Between 2007-01-02 and 2015-09-23, Dynamic PE Ratio had an IRR of 10.93% vs. Short-Term Income Plan’s IRR of 9.49%
For investors worried about drawdowns, just investing in the liquid fund would have given similar returns with a lot less risk. A 35% drawdown is a lot for a fund that gives bond-like returns.
A bond fund like the Birla Sun Life Dynamic Bond Fund, for example, had an IRR of 9.65% over the same time period
Using the P/E ratio for asset allocation is a bad idea. Investors would have experienced similar returns but with smaller drawdowns if they had invested in a regular bond fund instead.
Related: Dynamic PE Funds