Category: Investing Insight

Investing insight to make you a better investor.

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.

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Further reading: Funding Your Dollar Dreams

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Food: A problem of plenty?

fertilizer and food price chart

fertilizer, cereal, rice and wheat indices

Legend
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.

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Chart: Number of stocks going up

We often hear market commentators croaking about the number of stocks going up vs. those going down. There is even an advance/decline line filed under technical “analysis.” However, have a look at the statistical distribution of stocks going up in any given month and see for yourself if it makes any sense paying attention to it:
NIFTY100.gainers

It is, at best, a historical artifact… something that is nice to lookup when someone says that they had a great/crappy month. When a lot of stocks have gone up, it presents a target rich environment for long-only traders. So a random selection of stocks would out-perform the index in that scenario. But good luck using it for market timing.

Code and chart are on github.

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Long-term averages are still being made

Value investing in the US has been under pressure recently, having underperformed growth and momentum over the last decade. The most popular explanations given for this are:

  1. Price-to-book, the most popular metric of value investors, stopped being a good measure of value.
  2. Value, as a strategy, got crowded after putting in a strong performance the prior decade.
  3. The value effect is the strongest in small- and micro-caps but scale prevents investment managers from being able to access it. Making large-cap value an over-fished pond.
  4. All anomalies, including value and momentum, have their ups and downs. Investors chase performance, thus preserving the anomaly.
  5. This time is different.

From a quantitative point of view, “value” is a way of ranking the universe of stocks and applying a cut-off on them. The cut-off is based on historical averages. But the problem with historical averages is that history is still being made. This point is driven home in newer markets, like India’s, where we cannot lean on 100-year back-tests but have to depend on data-sets that are, at best, 10- or 15-years old. And here’s how that last 10-year price-to-book of different indices looks like:
PB ratio

The averages are being made as we speak. This presents a moving target for value investors because value is all about mean-reversion. And something similar could be happening in the US – maybe a few decades from now, a test looking back at today will reveal that the high PB stocks were unusually cheap.

Related: Index Valuations

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Momentum vs. Low Volatility

Is the low-volatility anomaly overrated?

momentum vs. min-volatility

momentum vs. min-volatility

Investors may be giving up on the significantly higher returns of a momentum strategy in favor of slightly lower drawdowns of a low-volatility strategy. They maybe better off managing overall portfolio risk through a bond allocation rather than tilting away from momentum.

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