Invest Without Emotions
Is there a relationship between inflation and stock returns in India? A recent study that looked at monthly data between 1994 and 2014 shows that there is no significant pro-cyclical inter-dependency between inflation and stock returns.
However, the paper does not present the results of any statistical significance tests. This leaves the reader at the mercy of trying to interpret pretty pictures of wavelet transforms.
Investors often use the NIFTY 50 index as a benchmark while comparing investments. It is probably fair if you are making price comparisons. However, investment vehicles like mutual funds reinvest the dividends that they get on their holdings. So a more appropriate benchmark there is the NIFTY Total Return (NIFTY 50 TR) index.
The NIFTY 50 TR index is an index with the same constituents as the NIFTY 50 but with dividends reinvested back into the index.
To give you an idea of how dividends impact long-term returns, here’s a cumulative wealth chart of the NIFTY 50 TR Index vs. the Nifty 50 (Price) Index:
From the beginning of the year 2000 through to the end of August-2016, the Total Return was roughly 6x while the Price return was 4.5x. Here is how dividend reinvestment has boosted returns through the years:
A 1.6% dividend boost sounds trivial until you look at the cumulative effect of it over the years.
When you see mutual fund returns compared with “price” indices (all NIFTY indices are price indices unless they are explicitly mentioned to be total return,) you should handicap those returns by ~1.5-2% every year to get an idea of whether the fund actually outperformed the index.
It is tragic that the NSE has maintained a total return index only for the NIFTY 50. With the rising popularity of other asset classes and strategies, it makes sense to provide a Total Return index for every Price index that they publish. We briefly touched upon this while we looked at the MNC asset class. The NIFTY MNC Index, being a price index, missed a lot of performance information. We had to compare an MNC Fund to another Midcap Fund to get a better idea of relative performance. (Read the whole thing here: The MNC Fund Gravy Train, Part II)
Code for the above charts are on Github
We had discussed how MNCs listed in India have outperformed pretty much every benchmark (here, here.) However, there are are a few dark-spots in an otherwise solid long-term investment thesis that are worth discussing.
The NIFTY MNC benchmark index had two drawbacks:
For example, Unilever bought back more than $5 billion of HUL’s float [stockquote]HINDUNILVR[/stockquote] in 2013; OFSS [stockquote]OFSS[/stockquote] payed out Rs. 485 per share as dividend on September 2014. The stock was trading around Rs. 3960 at that time – a yield of ~12.25% that is not captured by the index.
If you compare just the NIFTY MNC index to other NIFTY indices, it doesn’t look so good:
Annual returns:
As you can see, all though the MIDCAP index is volatile, it offers returns an order of magnitude greater than the MNC index.
However, this is the index that we are talking about.
For a true apples-to-apples comparison between MNCs and Midcaps, we should look at the funds that reference them. This takes care of the dividend reinvestment and vanishing float problems of MNCs. But creates another problem of having to adjust for alpha, but we will ignore that for now.
Let’s compare the BSL MNC fund vs. BSL Midcap Fund:
On a cumulative basis, the MNC fund as beaten their Midcap fund… with shallower drawdowns to boot:
Given the past performance of the MNC asset class, we had recommended BSL’s and UTI’s MNC funds to investors. However, we had not considered a googly being bowled by the parent companies.
The biggest risk with MNCs is not quantitative but qualitative. Their parent companies do not want the hassle of going through listed India subsidiaries. It is easier to invest in new projects and expatriate profits if they did so through a wholly owned subsidiary rather than a listed one. Key examples:
It looks like minority shareholders are getting shafted by the parent. The listed companies are being ‘hollowed out’ and turned into mere marketing outfits that command a significantly lower valuation in the markets.
If you are an investor in MNCs as a distinct asset class, it is time to work these risks into your future return expectations.
The R source code for this analysis and charts can be found on GitHub.
Midcaps, proxied by the NIFTY MID100 FREE index, have given an annualized return of over 18% from 2001 through August-2016. That is a 12x return over 15 years. Sounds good when you say it that way, doesn’t it? Take a look at how Rs. 1 has grown over the years:
Now, zoom into the bottom-most chart – the drawdown chart:
The point-to-point drawdown chart is horrific enough. Investors saw a 70% loss during the Global Financial Crisis (GFC) in 2008/09. 30% drawdowns occur with regular frequency. Investors make it worse by looking at their investments too often.
For example, if an investor saw the returns of his portfolio once every 1000 days (4-5 years,) he would not have seen more than 35 drawdowns during the period. Move the observation to every 200 days (about a year,) and the number ticks up to 138. The more you check your portfolio, more the number of losses that you see:
New investors have rightfully taken the SIP route to saving in equities. However, they would be doing themselves a disservice if they expect a fixed-deposit like consistency in equity returns.
For the quant inclined, code for this analysis can be found on Github.
Related: Definition: Drawdown
Analysts, brokers and pundits often appear on financial media with a ready list of stocks that investors should buy. Some of them are collated into lists by the Economic Times, Money Control, etc. We turn these lists into equally weighted portfolios and track them. We call them Doodh Ka Doodh Pani ka Pani.
We look at 260 trading days worth of returns of these portfolios and compare them with NIFTY and MIDCAP 100 FREE returns during the same time period. 260 trading days approximates to one calendar year — a tax-free holding period and an upper limit of an average retail investor’s patience with investment tips.
| Analyst Theme | Created | # stocks | Nifty Returns | MidCap Returns | Analyst Returns | Out perf. Wrt. MidCap |
|---|---|---|---|---|---|---|
| CS Midcap 28-Aug-2013 |
2013Aug29
|
10
|
50.61
|
78.67
|
126.56
|
47.88
|
| Exporters – ET 2013-09-04 |
2013Sep04
|
10
|
46.27
|
70.81
|
71.65
|
0.84
|
| Prabhudas Lilladher Midcap 10-Sept-2013 |
2013Sep10
|
8
|
34.74
|
65.09
|
105.12
|
40.02
|
| Prabhudas Lilladher Largecap 13-Sept-2013 |
2013Sep13
|
15
|
36.06
|
63.04
|
41.15
|
-21.89
|
| Bharat |
2013Oct07
|
13
|
41.18
|
66.12
|
47.48
|
-18.65
|
| Microsec’s Diwali picks – 2013 |
2013Nov01
|
9
|
35.16
|
63.66
|
45.71
|
-17.95
|
| Globe’s Diwali picks – 2013 |
2013Nov01
|
10
|
35.16
|
63.66
|
44.51
|
-19.14
|
| Prabhudas Lilladher’s Diwali picks – 2013 |
2013Nov02
|
5
|
36.53
|
64.02
|
61.71
|
-2.31
|
| Kotak’s Diwali picks – 2013 |
2013Nov04
|
11
|
36.53
|
64.02
|
63.41
|
-0.61
|
| Emkay 2013-11-12 |
2013Nov12
|
9
|
38.59
|
65.21
|
119.78
|
54.57
|
| Ashwani Gujral 2013-11-12 |
2013Nov12
|
5
|
38.59
|
65.21
|
173.85
|
108.64
|
| Sharekhan 15-Nov-2013 |
2013Nov15
|
11
|
32.88
|
60.08
|
30.37
|
-29.71
|
| UBS 2013-12-04 |
2013Dec04
|
9
|
34.44
|
64.19
|
94.21
|
30.03
|
| Morgan Stanley Fragmented Election 2013-12 |
2013Dec06
|
12
|
34.11
|
63.52
|
33.24
|
-30.28
|
| Morgan Stanley Strong Election 2013-12 |
2013Dec06
|
13
|
34.11
|
63.52
|
29.55
|
-33.97
|
| Merrill 2014 |
2013Dec12
|
10
|
33.50
|
65.36
|
122.21
|
56.85
|
| Espirito Santo Silver Bullets 2013-12-26 |
2013Dec26
|
7
|
38.49
|
62.25
|
54.96
|
-7.28
|
| IIFL Micaps for 2014 2013-12-27 |
2013Dec27
|
10
|
38.26
|
61.32
|
86.04
|
24.72
|
| SMC 2013-12-28 |
2013Dec28
|
10
|
39.27
|
62.15
|
59.22
|
-2.93
|
| Religare Top 4 for 2014 |
2014Jan01
|
4
|
41.40
|
61.99
|
58.37
|
-3.62
|
| Macquarie – Midcaps 2014-01-21 |
2014Jan21
|
5
|
39.53
|
67.20
|
97.08
|
29.88
|
| Mitesh Thacker Midcaps 2014-1-30 |
2014Jan30
|
10
|
42.97
|
74.34
|
55.54
|
-18.80
|
| Dolat Capital’s 10 Hidden Gems 2014-02 |
2014Feb27
|
10
|
32.90
|
63.58
|
43.24
|
-20.34
|
| Prabhudas Lilladher’s LargeCap Picks 2014-03 |
2014Mar21
|
10
|
30.11
|
58.61
|
30.01
|
-28.60
|
| ET Top Midcap 2014-03 |
2014Mar21
|
10
|
30.11
|
58.61
|
77.74
|
19.13
|
| ET 2014-04 |
2014Apr10
|
10
|
20.53
|
41.41
|
47.66
|
6.24
|
| Religare Retail Lucky 13 mid-cap redux |
2014May06
|
13
|
23.88
|
47.47
|
48.49
|
1.02
|
| Nomura 2014-04 |
2014May06
|
11
|
23.88
|
47.47
|
52.66
|
5.18
|
| Religare Retail Lucky 13 mid-cap redux |
2014May06
|
13
|
23.88
|
47.47
|
71.38
|
23.91
|
| Sharekhan 20 midcaps 2014-05 |
2014May21
|
20
|
10.06
|
23.15
|
24.99
|
1.83
|
| Microsec Agri 2014-06 |
2014Jun30
|
10
|
13.43
|
23.13
|
27.99
|
4.86
|
| Lucky 13 2014-07 |
2014Jul02
|
16
|
10.31
|
19.73
|
24.04
|
4.30
|
| Hidden Gems 2014-08 |
2014Aug25
|
7
|
-0.43
|
16.06
|
48.18
|
32.12
|
| Globe Diwali Picks 2014 |
2014Oct22
|
11
|
-2.66
|
12.41
|
-17.22
|
-29.63
|
| Kotak Diwali Picks 2014 |
2014Oct22
|
9
|
-2.66
|
12.41
|
14.36
|
1.95
|
| ET Diwali Picks 2014 |
2014Oct22
|
10
|
-2.66
|
12.41
|
-1.88
|
-14.29
|
| SPA stock bets 2014-11 |
2014Nov24
|
16
|
-10.07
|
5.64
|
-23.78
|
-29.42
|
| ET Top 10 Dec-2014 |
2014Dec22
|
10
|
-8.68
|
8.03
|
-6.34
|
-14.37
|
| Beg Borrow Steal |
2015Jan06
|
7
|
-8.67
|
-0.85
|
-33.05
|
-32.20
|
| CLSA 9 for 2015 |
2015Jan06
|
8
|
-8.67
|
-0.85
|
-14.13
|
-13.28
|
| Midcaps for 2015 |
2015Jan06
|
16
|
-8.67
|
-0.85
|
15.93
|
16.78
|
| Espirito Santos Silver bullets Jan-2015 |
2015Jan12
|
8
|
-9.12
|
-1.37
|
-6.87
|
-5.49
|
| Mixed bag 2015-01 |
2015Jan20
|
9
|
-15.05
|
-4.53
|
-29.21
|
-24.68
|
| Rate Sensitive 2015-Jan |
2015Feb03
|
15
|
-17.07
|
-8.89
|
-23.66
|
-14.77
|
| Rail Budget 2015 |
2015Feb26
|
17
|
-14.09
|
-4.67
|
-26.97
|
-22.31
|
| Sharekhan Top 12 April-2015 |
2015Apr06
|
12
|
-8.05
|
0.03
|
-2.88
|
-2.91
|
| Smart City Stocks ET April-2015 |
2015Apr30
|
15
|
-4.87
|
2.75
|
9.00
|
6.25
|
Of the 47 lists we analyzed, the average out-performance was about +1.5% (vs. the MidCap index.)
We created two Themes out of the stocks in ‘Religare Retail Lucky 13 mid-cap redux.’ One was a minimum variance portfolio and the other one was an equal-weighted portfolio. The minimum variance portfolio out-performed the equal-weighted one. Food for thought.
Morgan Stanley had come out with two lists before the General Elections – one was supposed to do very well if Modi got elected and the other if he didn’t. Ironically, ‘Morgan Stanley Fragmented Election 2013-12’ out-performed ‘Morgan Stanley Strong Election 2013-12’ but both under-performed the Midcap Index.
Espirito Santos Silver bullets turned out to be blanks.
Kotak should do a better job with their Diwali picks.
We hope that these guys continue to put out lists so that we can track them. We admit that 47 is too small a sample to draw any conclusions. If you come across any such lists that are ‘subscription only’, i.e., not available on the ET or MC websites, please send them to info@stockviz.biz. We would love to track them all.