Category: Investing Insight

Investing insight to make you a better investor.

Nifty Cash-Futures Basis

Fair value

Equity futures have a ‘fair-value’:

Futures Price = Cash Price [1+r (x/360)] – Dividends;
where x = days to expiration of the futures contract

Fair value is the theoretical assumption of where a futures contract should be priced given such things as the current index level, index dividends, days to expiration and interest rates. The actual futures price will not necessarily trade at the theoretical price, as short-term supply and demand will cause price to fluctuate around fair value. Price discrepancies above or below fair value should cause arbitrageurs to return the market closer to its fair value. – CME

Cash-futures Basis

You can see this in action when you plot the NIFTY index value with its futures:

nifty-cash-futures-basis

Initially, x/360 is large, so futures’ trade rich to cash. As expiry approaches, futures and cash prices converge. This is the natural order of things.

Interest Rate

You can go one step further and back out the interest rate baked into these prices:

nifty-cash-futures-interest-rate

r is usually within a tight band; roughly around where short-term rates are.

So if you ever wondered why futures are trading higher than cash, now you know!

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The Golden Straitjacket

One of Thomas Friedman‘s theses states that individual countries must sacrifice some degree of economic sovereignty to global institutions, a situation he has termed the “golden straitjacket.”

From his book, The Lexus and the Olive Tree:

To fit into the Golden Straitjacket a country must either adopt, or be seen as moving toward, the following golden rules:

  1. making the private sector the primary engine of its economic growth,
  2. maintaining a low rate of inflation and price stability,
  3. shrinking the size of its state bureaucracy,
  4. maintaining as close to a balanced budget as possible, if not a surplus,
  5. eliminating and lowering tariffs on imported goods,
  6. removing restrictions on foreign investment,
  7. getting rid of quotas and domestic monopolies,
  8. increasing exports,
  9. privatizing state-owned industries and utilities,
  10. deregulating capital markets,
  11. making its currency convertible,
  12. opening its industries, stock and bond markets to direct foreign ownership and investment,
  13. deregulating its economy to promote as much domestic competition as possible,
  14. eliminating government corruption, subsidies and kickbacks as much as possible,
  15. opening its banking and telecommunications systems to private ownership and competition, and
  16. allowing its citizens to choose from an array of competing pension options and foreign-run pension and mutual funds.

When you stitch all of these pieces together you have the Golden Straitjacket.

As your country puts on the Golden Straitjacket, two things tend to happen: your economy grows and your politics shrinks. That is, on the economic front the Golden Straitjacket usually fosters more growth and higher average incomes — through more trade, foreign investment, privatization and more efficient use of resources under the pressure of global competition. But on the political front, the Golden Straitjacket narrows the political and economic policy choices of those in power to relatively tight parameters. Governments — be they led by Democrats or Republicans, Conservatives or Labourites, Gaullists or Socialists, Christian Democrats or Social Democrats — that deviate too far from the core rules will see their investors stampede away, interest rates rise and stock market valuations fall.

Will the Modi-Jaitley duo make this budget the budget of the Golden Straitjacket? Or are they going to stick to the UPA/Congress playbook of rent extraction? Fingers crossed…

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Mid N Small vs. Value Discovery

Sometimes, when you are comparing funds from different AMCs, you stumble across a pair of them that are so similar that it becomes a tough call choosing between them. For example, Religare Invesco MID N SMALL CAP Fund and ICICI Prudential Value Discovery Fund are right on top of each other. Try to spot the difference here (Jan-2012 through Jan-2015):

religare.icici

Between 2012-01-02 and 2015-01-07, Religare Invesco MID N SMALL CAP Fund has returned a cumulative 172.88% with an IRR of 39.49% vs. ICICI Prudential Value Discovery Fund’s cumulative return of 170.32% and an IRR of 39.05%.

Their drawdowns are similar as well. And since the NAV is quoted after all expenses, Religare’s expense ratio of 2.97% vs. ICICI’s 2.34% is factored into the returns.

religare.icici.metrics

In terms of metrics, Religare is marginally better than ICICI. However, there is nothing there to swing the decision one way or the other.

Run the FundCompare tool and have a look for yourself.

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Strategies that rocked in 2014

WHAT IS A “THEME”?

A StockViz Investment Theme is a portfolio of stocks that follows a particular strategy. It is a convenient way for you to:

  1. stick to a strategy
  2. follow a preset rebalancing schedule
  3. think in terms of your portfolio strategy rather than individual stocks
  4. avoid common behavioral pitfalls
  5. systematically track your P&L and strategy performance

WHAT IS AN INVESTMENT STRATEGY?

An investment strategy is a specific way of going about the process of investing. It identifies specific variables that define a stock. Variables can be anything: risk, style, sector, balance-sheet items, etc..

By mapping specific Themes to your account, you ensure that you stay pure to your strategy allocation. And that there is no “flying by the seat of your pants” investing.

HOW HAVE YOUR THEMES PERFORMED?

We started 2014 with eight investment strategies. Here is how they performed:

Momentum 200 +90.30%
Balance-sheet Strength +83.23%
Financial Strength Value +79.53%
Magic Formula Investing +75.54%
Quality to Price +69.65%
Market Elephants +44.69%
Enterprise Yield +43.54%
Market Fliers +32.68%
It was one of those rare years when both momentum and value performed at the same time. The Modi-rally coincided nicely with the bottoming of the cycle.

Passive buy-and-hold

Implementing a strategy involves churn. For die-hard fans of the passive buy-and-hold clan, here’s how 2014 looked like:

PSUBNKBEES +71.37%
BANKBEES +64.94%
JUNIORBEES +43.70%
NIFTYBEES +31.57%
INFRABEES +25.83%
GOLDBEES -9.32%
Gold was a money loser and public-sector banks, in spite of all the bad loans and scams, out-performed the rest of the market by a mile.

WHAT SHOULD I DO NEXT?

You should open a demat account with StockViz and invest through our Themes.

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Choices: Large-cap Investing

While looking at investing in large-cap stocks, investors have quite a few options available to them.

Mutual Funds

Previously, we discussed ‘Top 100’ funds — funds that invest in the largest market-cap stocks. This is one way to go about adding large-cap exposure to your portfolio. However, the expense ratios of more than 2% will eat into your returns. Remember, returns are not predictable, but fees are forever.

Passive ETFs

You can buy an equal proportion of the NIFTYBEES and the JUNIORBEES ETFs. Since these are exchange traded, you don’t have to go through the hassle of “surrendering” your mutual fund “units” and keeping track of exit-loads etc. Besides, NIFTYBEES’ expense ratio is 0.5% and JUNIORBEES’ 1%. Overall, you pay 0.75% to Goldman Sachs to manage the ETFs.

Not a bad deal, considering that you end up tracking the CNX 100 index which represents the top 100 stocks by market cap.

Active ETFs

We have a Theme that takes a tactical route when it comes to tracking the CNX 100 index. Its called the CNX 100 50-Day Tactical Theme. The basic idea is to switch between (NIFTYBEES + JUNIORBEES) and LIQUIDBEES depending on whether the CNX 100 index is trading above or below its 50-day moving average. Details of the strategy can be found here.

The drawback is that in flat markets, you end up getting whipsawed a lot. But if you have the discipline to stick with it for over 5-years, it has the ability to deliver superior risk-adjusted returns.

Conclusion

Each of the approaches described above have their advantages and disadvantages. With mutual funds, you have a brand-name manager who is working for you. With the passive route, you save on fees. The tactical route will probably lessen drawdowns during a market crash and preserve capital.

What you end up investing in finally boils down to whatever sails your boat.

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