Category: Your Money

Economists’ Hypothetical Time versus Real Market Time

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Kim Asger Olsen, an investment manager, has a succinct way of looking at the timeframes in which different people live. People active in the financial markets – traders, investment managers – live in the Real Market Time (RMT). It is rather different from Economist’s Hypothetical Time (EHT) or even Newspaper Headline Time (NHT).

The ability to figure out what matters and what doesn’t is key to living in the RMT. Bloggers, on the other hand, tend to work in EHT (they dwell for too long on what already belongs in the past in RMT). And by the time it hits the Hindu (NHT) it doesn’t matter any more.

In RMT, if the can can be kicked down the road, it will be, and its good enough. People like Nouriel Roubini, David Rosenberg, etc live in the EHT – EHTers look at Greece, Portugal, Italy, China and think it spells the end of the world. The fact of the matter is that you will never have all the data you need to make decisions in real-time. Leave it to EHTers and the Hindu to be the Monday morning quarterback.

Read more here: http://economicsacloserlook.blogspot.in/2012/01/quotes-and-time-zones.html

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Airtel–dropped calls come back to bite

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The carnage in Airtel stock continues – down close to 10% since their results were announced. Their Revenue Per Minute (the amount they charged you) increased by 3.2% while minutes rose only 0.8% And the worst part is that Idea’s minutes grew 7.3% during the same period, in spite of those annoying Abhishek Bachan ads.

I am not sure which network traders are on, but having suffered through Airtel’s network for the better part of three years: no signal, dropped calls, annoying ring-tones, having to pay to talk to a customer service rep, being told that I had to buy a Rs. 20,000 “booster” to fix the lack of network around my house; it comes as no shock to me that people “used” less minutes. I have lost track of the number of times I’ve carried the rest of a conversation on Skype because Airtel dropped the call.

I guess all of those dropped calls finally translated to a disappointing quarter.

The stock is hovering around Rs. 350 now. It was around Rs. 320 in early Jan so I’m tempted to say that a correction was overdue and I’m actually warming up to a bull case here.

You can read all the news stories about Airtel here.

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Fees–the silent killer of investment returns

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My colleague Abhishek did an overview of how to look at investment returns (see here, here and here). Let me round out the series with a pet peeve of mine: fees.

Almost all packaged investments (mutual funds, ETFs, etc…) come with a built-in fee structure. Typically, passive ETFs have a lower fee (0.80% for NIFTYBEES, for example) and mutual funds average about 2% annually. So assume that you have a 10 year investment horizon. How do fees impact your total returns?

Lets assume that the market always goes up by 8% annually. So in 10 years, your IRR should be 8%, if you paid no fees. But it falls to 5.84% if you paid even 2% as an Expense Ratio. But the problem is that the market doesn’t go up every year but you will still pay that 2% to the bank.

Before 2008, fund companies estimated that the fees for closed-end funds averaged 6% of an investor’s return, the maximum by law for both types of funds, while the open-ended funds charged 1.75% on average.

The popularity of those high-fee funds back then shows that investors pay little attention to fees when they are amortized over the holding period. When it comes to assent management fees, fore-warned is fore-armed!

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Risk Adjusted Returns

Mutual fund

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In my intro to calculating returns I had touched upon how to compare returns on different investments, you need to first adjust it for risk. There are three such measures that I consider important: alpha, beta and the Sharpe Ratio.

Alpha measures the ability of an investor to beat the market, thereby generating returns in excess of what might be possible by taking the same amount of risk. Essentially, an investment manager should not only avoid losing money for the client and should make a certain amount of money, but in fact should make more money than the passive strategy of investing in everything equally. Basically, you are paying your mutual fund for the alpha, compared to just buying the Nifty50 ETF.

Beta is similar to correlation (see: The Reliance on Correlation.) An asset has a Beta of zero if its returns change independently of changes in the market’s returns. A positive beta means that the asset’s returns generally follow the market’s returns. By definition, the market itself has a beta of 1.0. A stock whose returns vary more than the market’s returns has a beta whose absolute value is greater than 1. A stock whose returns vary less than the market’s returns has a beta with an absolute value less than 1.

And finally, the Sharpe ratio. The Sharpe ratio tells us whether a portfolio’s returns are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio’s Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a risk-less asset would perform better than the security being analyzed.

Read More:
Sharpe: http://www.investopedia.com/terms/s/sharperatio.asp#ixzz1lmQd5BEB
Beta: http://en.wikipedia.org/wiki/Beta_(finance)
Alpha: http://en.wikipedia.org/wiki/Alpha_(investment)

Questions? Email me: abhi@stockviz.biz

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Real vs. Nominal Returns

The One Rupee Banknote.

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In my previous post about calculating returns, I briefly touched upon the notion of “risk adjusting” any projected returns to see if it makes sense compared to different investment options available. Today I’m going to discuss the biggest unavoidable risk of all: inflation.

Inflation is the erosion of value of money over time. i.e., as time progresses, the same Rupee buys less goods or services. We have all seen its effects first hand – I can’t think of single thing that has become cheaper over the years in India. So how does inflation affect investment decisions?

If you just took all your money and kept it in a vault, over a period of a year, you’ll get only 90% of it back. Where did the 10% go? Inflation took it (assuming a 10% annual inflation rate). Now imagine what happens if you socked away your money in a vault over a period of 10 years? How much will you get back then?

The rate of inflation plays a crucial role in calculating returns on investments. So important, in fact, that the way we calculated returns yesterday is called “nominal returns”. When you adjust nominal returns for inflation over the same period of time, you get “real returns.”

There are various measures of inflation depending on who it affects, but the most popular of them is the CPI – the Consumer Price Index. A good rule of thumb is to subtract nominal returns with the CPI to see how much you really end up making.

Different investments react differently to changes in inflation. For example, real assets, like real estate are supposed to be immune to inflation since their value is expected to rise along with it. Bonds perform poorly in an inflationary scenario because you get a fixed return. Stocks fall somewhere in between.

So its almost always a poor investment to keep cash in a vault. At the very least, your returns should at least match the rate of inflation.

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