Tag: returns

Volatility and Returns

shyam April 26, 2019 0

Indian mid-caps, represented by the NIFTY MIDCAP 100 TR index, has out-performed its large-cap peer, the NIFTY 50 TR index.

It has done so with higher volatility. Here is the rolling 200-week standard deviation of weekly returns of the two indices:

MIDCAP volatility has been persistently higher than NIFTY volatility in the past:

A portfolio of bonds and mid-caps should exhibit lower volatility than an all-equity portfolio. Here are the standard-deviation ratios for different allocations to bonds:

B05, for example, represents a portfolio of 5% short-term bonds and 95% MIDCAP index. As allocation to bonds increases, portfolio volatility decreases.

We see from the chart above that a 75% MIDCAP + 25% BOND portfolio has almost never seen volatility greater than an all NIFTY portfolio. So, what are we giving up in returns to reduce volatility? About 2% in returns:

Take-away

On an annualized basis, the allocation portfolio gives up about 2% in returns compared to all MIDCAP portfolio and is on par with NIFTY’s.
After taxes and transaction costs, expect the allocation portfolio to under-perform buy-and-hold NIFTY.
No pain. No gain.

Code and charts are on github.

Categories Investing Insight Tags returns, volatility

Are Stop-Losses Worth It?

shyam April 25, 2019 0

StockViz introduced Themes back in August 2013. We went live with two strategies: Momentum, rebalanced once a month, and Quality to Price, rebalanced once a quarter. The Modi bull market was just getting started and returns were spectacular in the beginning. Here is Momentum, from Jan-2014 through Dec-2015:

And then, in Jan-2016, the Chinese market crash rippled through world financial markets (WaPo). Momentum collapsed. This is the previous chart extended to June-2016:

Momentum investors clamored for a safety net. Enter stop-losses. We created a new set of Themes, called Momos, that had a 5% trailing stop loss at the position level. Positions hitting the stop loss were substituted with stocks that had favorable momentum and trend. The logic was that if the entire market crashed, the strategy would be in cash until stocks gained momentum. We introduced these Themes in June and they worked as advertised on the subsequent market correction in November that year. Idea validated? Here is a chart comparing the returns of Momentum (vanilla) vs. Momo (Relative) v1.1:

Momo trails its plain-vanilla counterpart over a ~3 year period. There has been plenty of volatility during that time – November 2016, August 2017 and January 2018 through now. And Momo traded a lot more than its plain-vanilla counterpart (the turnover charts are on the Theme pages linked above) through these bouts of volatility. And what was saved through stop-losses was paid for in taxes and transaction costs. Here is a chart that shows the Momo strategy with and without transaction costs:

So, are stop-losses worth it? Probably not. It is very difficult to de-risk a high-risk strategy intrinsically. It is better for investors to focus on asset allocation to bring down overall portfolio volatility to a level that they can bear. Think of it like trying to tame a tiger. You may very well succeed. But a tame tiger is a cat.

Categories Investing Insight Tags momentum, returns

Indian vs. US Mid-caps

shyam April 5, 2019 0

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:

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:

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.

It is time to have a chat about your portfolio. Get in touch with us now!

Further reading: Funding Your Dollar Dreams

Categories Investing Insight Tags diversification, returns

EM Bonds out-performed EM Equities the last decade

shyam March 4, 2019March 4, 2019 0

A recent article in WSJ had this to say about emerging market bonds:

Research on hard-currency bonds since Britain and Prussia defeated France at the Battle of Waterloo in 1815 shows that on average the return from lending to governments issuing external debt in sterling or dollars delivered a return close to U.S. stocks, with lower volatility.

EM bonds giving better returns than US stocks seems counter-intuitive. There is an ETF that tracks the bond index that the article talks about: EMB – iShares JP Morgan USD Emerging Markets Bond ETF. The ETF was launched on December 2007 (not during the Battle of Waterloo,) so we cannot really put that claim to test. However, here are the last 10-years for EMB, EEM (iShares MSCI Emerging Markets ETF) and SPY (SPDR S&P 500 ETF Trust):

EM bonds beat EM equities, but not US stocks (SPY). US mega-caps pretty much beat every other equity market. Here are the MSCI indices of USA, WORLD ex US and EM:

Can’t really single out EM for under-performance when everything trailed. Besides, if you look at performance since 1987, aggregate returns from EM have been on par with those of US with complementary periods:

So, should you ditch your EM equities portfolio and get into EM bonds and US stocks? Some analysts could look at a decade of EM equity under-performance, point to its valuation spread vs. US mega-caps, and conclude that EMs are a better place to be for the next decade. While others could point out that the US is the home to most of the world’s biggest tech monopolies so it deserves the out-performance. We will only know who is right once 2030 rolls in. Until then, diversify your portfolio and enjoy your life.

Code and annual return charts are on github.

Categories Investing Insight Tags bonds, ETF, returns

Strategy Capacity

shyam February 26, 2019 0

A recent Verdad Capital newsletter, Dan Rasmussen points out that it is impossible to scale value investing as defined in academia. Almost all of “value” ETFs and actively managed funds are completely avoiding the cheapest stocks (high book-to-market) while instead owning primarily stocks that are more expensive (low book-to-market).

And what explains this puzzle? Strategy capacity.

The cheapest stocks are disproportionately small in terms of size and volume. This means that an active manager looking to choose, say, the best 40 of these stocks would be unable to manage more than $200M or so. The average small value fund tracked by Morningstar has $1.3B of assets under management. It is close to impossible to deploy that amount of capital exclusively in the cheapest two deciles of the stock market.

This is true for Indian mutual funds as well. Most managers claim to be “value” investors while actually hugging the index with a GARP/momentum tilt. Given the size of most of these funds, there is no way they can invest in value.

Strategy capacity should be one of the questions investors should ask of their fund managers/advisers. Especially advisers of direct equity portfolios who do not know the aggregate exposure that their subscribers have across portfolios.

Categories Investing Insight Tags returns