Tag: mutual funds

Optimization vs. Maximization

The dog years of 2010, 2011, 2012 and 2013

According to AMFI, these are the 5 largest funds at the end of March-2015:

Scheme Name AUM (Cr.)
HDFC Equity Fund – Growth Option
1,280,287
HDFC Top 200 Fund – Growth Option
1,009,121
Reliance Equity Opportunities Fund-Growth Plan-Growth Option
764,383
HDFC MID-CAP OPPORTUNITIES FUND – Growth Option
715,865
ICICI Prudential Value Discovery Fund – Regular Plan – Growth
645,946

What this means is that there is at least one person in your immediate network who would have invested in one of these funds.

Now let’s take a walk down memory lane. 2010, 2011, 2012 and 2013 were the worst years for the Indian economy. The RBI had messed up monetary policy leading to high inflation (double digits), there was a currency panic (rupee went from 45 to a dollar to 65), a never-ending series of scams and a government hell bent on redistribution. The only two asset classes that were doing well at the time were gold and real estate. GOLDBEES, the gold ETF, returned 13.25% (IRR) during that period. Fixed deposits were yielding around 11%. How would a typical investor react if his actively managed equity investments gave the following returns?

Scheme Name IRR
HDFC Equity Fund – Growth Option
7.00%
HDFC Top 200 Fund – Growth Option
6.74%
Reliance Equity Opportunities Fund-Growth Plan-Growth Option
12.00%
HDFC MID-CAP OPPORTUNITIES FUND – Growth Option
13.24%
ICICI Prudential Value Discovery Fund – Regular Plan – Growth
11.09%

Here is Gold (in red) vs. HDFC Equity Fund (in black):

Needless to say, most investors who dipped their toes into the equity markets in 2010 gave up after a couple of years and still believe that the whole mutual fund business is a scam.

First half of 2015

We are supposed to be in a bull market. But let’s see how the first half worked out for the HDFC Equity Fund:

IRR of -2.39%. And bonds lost money too (in June.) Bull markets are not immune to prolonged periods of a “sideways” market.

Diversification across assets

A standard response to most investing problems in diversification. Invest a little into a variety of asset classes – equities, commodities, real-estate, gold, bonds – and you will be fine.

The problem with diversification is that it always feels wrong. For example, there are “balanced” funds that are supposed to allocate between both bonds and equities. They end up having lower draw-downs because of this. If you compare the ICICI Prudential Balanced Fund with HDFC Equity Fund between 2010-2013, the latter has an IRR of 11.38% vs. 7.00% of the former. But during the bull market of 2014, the balanced-fund gave an IRR of 45.47% vs. the equity fund’s 53.83%. So the lower draw-down comes at the expense of performance. It is a huge cognitive burden for investors to live with.

The kind of assets you pick for diversifying into also matters. For example, there was this big thing back in the day about the “commodity super-cycle.” About how the insatiable appetite for all sorts of commodities from China would keep growing to infinity. Plus, commodities were supposed to uncorrelated with equities. So great for diversification, right? Here’s how Mirae Global Commodity Equity Fund compares to the HDFC Equity Fund:

Commodity stocks did turn out to be uncorrelated but not in a way that you would like. And the commodities themselves are bouncing along multi-year lows right now.

What about bonds? Surely, they are safe. But let’s not forget that in 2009 and 2013, gilts drew-down double digits and their long-term IRRs are between 7% and 10%.

gilt drawdowns

Diversifying across geographies

What if you invested in international funds? After all, the rupee keeps going down, right? Depends on where you look. Between 2010 and 2013 (the dog years) the Birla Sun Life International Equity Fund – Plan A gave an IRR of 16.09% vs. HDFC Equity Fund’s 7%. But before you pat yourself on the back, between 2014 and now, the latter gave an IRR of 3.06% vs. 32.54% of the former. And Religare’s Pan European Equity Fund gave 1.50%.

Diversification means that your overall portfolio will trail behind the best performing asset class du jour. Psychologically, it is a very difficult thing to stick to.

Investing fads and broker recommendations

Of all the poor choices that investors can make, the worst is giving into investing fads. Back in 2004, there was this whole “India shining” marketing slogan. And now there is “make in India”, “smart cities”, “digital India”, etc. And almost every single time, fund houses come out with new schemes that tag along the slogan du jour. Here are some examples:

Morgan Stanley came out with their stock picks if Modi won (Theme created Dec 6, 2013):
morgan stanley strong election result

Here’s one on the Rail Budget (Theme, created Feb 26, 2015)
rail budget 2015 theme

So much for betting on rate-sensitive stocks (Theme, created Feb 3, 2015):
rate sensitive 2015 theme

You can browse through all these recommendations and lists under the “Broker Recommendations” section of our Themes page. We call it Doodh Ka Doodh Pani ka Pani.

Optimization vs. Maximization

The above examples highlight the problems of trying to maximize returns. There will always be an asset class, mutual fund or stock that is doing better than what you own. And there is an entire industry of tip-sheets, newsletter writers and subscription services that promise to pick the next winner.

However, we see investing as an optimization problem. We believe that drawdowns are an inseparable part of investing. Instead, we focus on getting the right mix of assets and strategies based on your risk appetite. And we make it supremely easy to stick to a plan.

For direct equity investors, this means getting Value and Momentum right. We have created Themes based on different approaches to value and momentum investing. Investors can then map our Themes to gain exposure to a specific set of strategies.

For mutual fund investors, this means getting portfolio risk right. We have created Themes based on the risk of the overall portfolio. Investors can now tune out the noise and focus on achieving their life goals.

Investing is not easy, but your journey as an investor will be so much more smoother with us. Get in touch with us now!

Investing in European Equities

Why Now?

Here are the top 5 reasons why investors should look at European equities:

  1. The ECB’s $1.1 trillion bond-buying program is beginning to kick in.
  2. The slide in the euro’s value against the dollar has also made European exports more competitive.
  3. Valuations appear attractive.
  4. Eurozone corporates are less leveraged, and their profitability has remained resilient.
  5. Greece is a source of uncertainty. Investing during uncertain times bears outsized returns.

How?

Unless you have a foreign equities trading account, the only way you can invest in European equities are through feeder funds or international funds. Feeder funds are just a wrapper around another fund. One such fund is the Religare Invesco Pan European Equity Fund. It feeds into the Invesco Pan European Equity Fund (MorningStar.)

It can be argued that investing in a narrow geographic is riskier compared to investing in a broad international fund. We had highlighted one such fund, the Birla Sun Life International Equity Fund Plan A, in our post about investing in non-rupee assets. If you compare the two, between 2014-03-03 and 2015-06-25, Religare’s fund gave an IRR of 1.27% vs. Birla’s 7.14%download Although this blows when compared to the CNX Midcap (IRR of 48.41% in the same period), remember that investing is all about prospective returns.

Risks

There is always the risk that Greece will blowup and drag Italy down with it, causing the Eurozone to implode. Tack on the risk of active management and currency risk (the rupee might appreciate against the euro), it becomes a pretty scary proposition. But remember, investing during uncertain times bears outsized returns.

Call us to discuss whether this fund is right for you.

Mutual Fund Performance Chasing

Introduction

Mutual fund sales brochures and distributors often highlight past performance. Why? Because performance sells. The disclaimer that “past performance is not an indicator of future returns” is buried in small-print at the back of the book.

To see how bad a predictor past performance is of future returns, we came up with a novel idea. We used the Relative Strength Spread that we wrote about recently and applied it to mutual fund returns. This gave us three things:

  1. Normalized returns with respect to CNX 500 irrespective of the fund’s benchmark.
  2. A visualization of the performance gap between the best and the worst funds. And,
  3. A parade of top-10 and bottom-10 funds across different periods of time.

Relative Performance

Here’s how the spread between the top and bottom-decile looks like with a 100-day lookback:
CNX 500.mf.relative-spread-index.100

And with a 365-day lookback:
CNX 500.mf.relative-spread-index.365

When the broad markets go up, the performance gap between the best and the worst funds widen. Some managers wring more out the markets than the others. However, during the bear phase, the relative performance between different funds compress. If the market is bad, they all look beige.

Longevity of returns

Is the out-performance sustainable? If you picked the best performing fund this year, will it retain its position the next? Click to embiggen:

mutual fund relative performance decile

None of the top performers in 2010 retained their spot in 2011; same as in 2013 vs. 2014. There were a few cases where funds in the top-decile slipped to the bottom decile the next year. It is a total crap-shoot.

Conclusion

There is absolutely no connection between past performance and future returns. If fund managers require a broad-based rally in the markets to out-perform, then they are in effect, chasing momentum.

Investing in Non-Rupee Assets

Introduction

Indian investors have a significant home bias – we tend to hold a high proportion of our portfolio, sometimes 100%, in Indian assets. However, if you look at how the rupee has behaved vis-a-vis the US Dollar, the advantage of international diversification becomes obvious.

USDINR has been a one-way trade

Historically, the rupee has only depreciated against the dollar. It is the price we pay for being a socialist democracy with poor fiscal responsibility and an unaccountable central bank.

Depreciation quantified

Nifty investors have seen an IRR of 821% since 1991 and today. However, in dollar terms, the IRR is 286%. The difference of 535% is because of rupee depreciation – even if you had held on to a non-productive dollar asset, you would have made that much in rupee terms.

nifty.vs.defty.1991

Diversification benefit

By being long only Indian assets, your fate is tied to the vagaries of the local market participants, regulators and politicians. In a country where most people have dual-SIM phones, it is surprising that most investors are willing to hitch their ride to that pony.

One of the oldest international funds is from Birla Sun Life, let us see how that fared since the financial crisis:

Between 2008-01-01 and 2015-06-15, Birla Sun Life International Equity Fund Plan A- Growth has returned a cumulative 69.99% with an IRR of 7.37% vs. CNX Midcap’s cumulative return of 32.36% and an IRR of 3.83%. It has a beta of only 0.12825 vs. the Midcap index. (MorningStar)

Caveats

The biggest problem with investing in international funds is manager competence. All the reasons we highlighted in our post, Funds that (also) invest in foreign markets, apply. At the end of the day, you are still investing in equities and equity markets are (loosely) correlated. However, investors are better off choosing a pure international equity fund rather than one where the “international” part is a hobby.

The second problem is that there are some funds that invest in emerging Asia or frontier markets. These funds are not really long the dollar. Investors should pay attention to this detail.

Conclusion

Investing in international funds makes sense from a depreciation and diversification point of view. In our Aggressive Fund portfolio, we assign 30% of investor allocation to international funds.

Mutual Fund Performance in Bear Markets

Introduction

During our discussion on Relative Strength Spread, we saw how the relative performance between winners and losers were compressed in the bear markets of 2011, 2012 and 2013. During these doldrums, most active investment strategies fail to outperform their benchmarks. Since most mutual fund investments span multiple bull and bear markets, it makes sense to have a look at how funds performed in the most recent bear market.

For our analysis, we took funds that had more than 90% allocated in equities and ignored sector and international funds. We then applied the same benchmark, the CNX Midcap Index, to make sure that we had an apples-to-apples comparison. A total of 200 funds were analyzed.

The 10 worst funds

Information Ratio

Sharpe Ratio

Beta

Bear Beta

Draw down depth

Draw down length

The 10 best funds

Information Ratio

Sharpe Ratio

Beta

Bear Beta

Draw down depth

Draw down length

Conclusion

The Birla MNC fund stands out as one having the most points in its favour: low and shallow drawdown, better sharpe and higher returns. The next stand outs were the Axis Long-term equity fund and the Mirae Asset Emerging Bluechip Fund.

In terms of the worst funds, HSBC Progressive Themes was definitely regressive to your wealth. JM Basic and Sundram SMILE funds also laid a deuce.

Mutual funds are marketed as wealth builders. However, the truth is that most of them struggle. At last count, there were more than 5300 different schemes that you could choose from.

Are you getting the right advise? Get in touch with us if you are looking to invest! Call us or Whatsapp us at +918026650232