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Investment Objectives & Advice

The most critical part of investment journey!

let me share a story, I have come across recently, to set the tone of today’s topic.

Jack Bogle was talking about “Buy & Hold” to some investment advisers, and one adviser complained, “I tell my investors to do this, and the next year, they ask what should they do, and I say, do nothing, and the third year, I say do nothing. The investor says, ‘Every year, you tell me to do nothing. What do I need you for?’ And I told them ‘You need me to keep you from doing anything.'”

Over the years, I have shared cases and my pertinent advise to specific queries. One such case was in 2019, I wrote my view and analysis for the Aditya Birla Sun Life Pure value fund. After the discussion, the investor has paused his SIPs in the fund and moved the new money to a better risk aligned fund for himself. As I suggested him to not sell off the current investments at the bottom of the cycle. He held on and today after 2 more years of wait, they fund has delivered a great return (Details below). He is happy now and Ok for him to make the exit as well.

Source: Morningstar India as of Aug 31, 2021

In a similar instance, last year lot of people hit me with the questions about the future of ICICI Prudential Equity & Debt fund. They tried to pick me on this fund for its underperformance as the fund category (Aggressive Hybrid Fund) is widely recommended by me and this specific fund was also part of my shortlist of funds to be in my portfolio (When I replaced my HDFC Hybrid Equity Fund after 10+ years of holding). One year since then, The fund has came back with roaring returns and my two cents of analysis are vindicated again. In below table, You will see that the fund has +10% outperformance vs the Category & ~20% outperformance vs the Index on YTD basis.

Source: Morningstar India as of Aug 31, 2021

The reason, I brought these two cases back to light due to my recent conversation with a friend about “What should he do for his underperforming fund?“. I have often given the specific advise but realized that a generic checklist would be a better solution and can be applied by the wider population. If the fund has been underperforming, Analyze the reason of the underperformance:

  1. Is it driven by the style or category being out of favor? or
  2. There has been any change in the fundamental attributes of the fund? or
  3. The fund manager has been changed and causing the rejig of portfolio? or
  4. etc.. etc..

If the change is cyclical in nature, you might be better of waiting for cycle to turn and then move out at the top of the cycle. Though when fund starts to perform back, you might forget that you wanted to move out of this fund therefore make a record of it for a 6monthly review. If the changes are permanent in nature, like heavy loss of AUM, loss of star fund manager or substantial increase of TER etc. You should plan your exit in optimal manner, check the exit load implications as well as the tax treatment of the accumulated capital gains. If you can not determine the reason of underperformance, do not hesitate and speak with a competent financial advisor who can help you with the process. Any good advisor would be worth the fee they would charge.

Lastly, If you hate the periods of underperformance than it is an apt situation to explore the passive funds to get the closer to index performance. This would not only eliminate the anxiety of the underperformance but also take away the effort in fund review/ selection. Let me leave you with these lines from the Netflix series “THE CROWN” as it reflects the most critical part of investment journey “Buy & Do nothing” unless the reason to sell is one from the list.

To do nothing is the hardest job of all. And it will take every ounce of energy that you have. To be impartial is not natural, not human.

Happy Investing!

Mutual Fund

ICICI Prudential Nasdaq 100 Index Fund: What you should know!

Recently, ICICI Prudential has come up with the NFO for their new Index fund mimicking the US based Nasdaq composite Index. The media has been buzzing and the number of articles about why you should invest in the fund are available in abundance. This is probably the 3rd or 4th fund which enables the Indian investor to take exposure to Nasdaq Index [Other options are via Motilal Oswal & Kotak AMCs]. To save time of mine as well as yours, I’m not going to talk about what this fund is all about & it’s benefits. You can refer to the literature produced by the AMC in their presentation[Link]. We will try to discuss few specific points, that should enable you to decide, if you should add this fund in your portfolio or not. The fund is quite attractive from the perspective of potential ownership of the Big Tech names and next gen Innovative companies. Though as usual, I can not predict the future but I can look for the longer historical track record to make some reasonable expectations. We will try to look through the lenses of Risk & Return and it’s benefit to overall portfolio.

Caveats: Before we jump into the detailed numbers/ charts, Let’s understand that data I used is from the google finance for Nifty 50 Index, Nasdaq 100 index and Currency values. As the market operations differ in both countries, I tried to take the base as Nifty 50 & everything is calculated in the INR terms. The dividends are not included as it’s not the TRI data.

Let’s talk about returns first, I would use the rolling returns data and not the point to point returns as most of the articles and presentations are sharing. I am also going to look thorough the returns for a longer time horizon, Since Jan 2000 to Today a good 20+ years of history. One thing that flags from that analysis is that the last decade has been dominated by Nasdaq vs Nifty 50, though 2000-2010 has Nifty as a winner. Both these returns are in INR terms and do not include impact of Dividends. Overall If we take the Geometric mean of all the 1year rolling returns, Nifty takes the lead with 11% vs 8.6% of Nasdaq. Therefore, If the recent outperformance of Nasdaq is luring you to this fund beware of the lure. Please note that this is based on historic data so we do not know if this would hold true for Future or not.

In terms of risk, The returns of Nifty as well as Nasdaq has been quite volatile. Nifty returns have ranged between +99.4% to -55.5% vs the Nasdaq returns range of +95.5% to -64.3%. In terms of Max drawdown during the analyze period, Nifty had the worst drawdown of -59.4% vs -75.5% for the Nasdaq. Yes, That’s correct the Nasdaq had lost 3/4th of It’s value during the Tech bubble burst in 2000-01 period. In terms of Standard deviation, Nasdaq is slightly better off with 21.9% vs 25.6% of Nifty. Based on these data points, Nasdaq is less volatile but has higher drawdowns & swings to negative.

This does not make a great case for investment in Nasdaq 100 index as the mean returns are lower and risk parameters are comparable if not worse. Though we should not stop here on our decision, As I flagged in my article on Modern Portfolio Theory even if the standalone assets are risky the combination might have the diversification benefits. For e.g. I made the case to have gold in your portfolio for diversification benefit. In 2020, when markets had large drawdowns the rally in gold has cushioned my portfolio a lot and gave me confidence to deploy more money in equities at that opportune time.

Risk (Std Dev) on x-axis & Returns (Mean of RR) on y-axis

I am in awe of the above chart as it’s shape matches with the efficient frontier we have learnt during academic years. replicating something similar with real data & example is a great experience 🙂.

In the above chart, I have plotted 11 portfolio combinations, P1 is 100% Nifty to P11 is 100% Nasdaq. As you move across the Portfolios, you would notice that we would keep on reducing the volatility with increasing mix to Nasdaq and sacrifice some returns in process. This characteristic appears due to lower correlation (approx. 0.5) between these indexes rolling returns over the analyzed period. P4 (70% Nifty : 30% Nasdaq) has a similar volatility to Nasdaq index but adds +180bps on the returns, This means the investors should have higher exposure to Nifty to get a better risk adjusted returns. In real life, the correlations are not constant but dynamic and the realized benefit might be lower than expected as per the above chart.

Based on the above data points, I would say that Nasdaq is a risky proposition as an individual investment with higher drawdowns & lower mean returns for Indian retail investors like me & you . It definitely provides the diversification benefits but that would need an exposure of 20%+, If you plan to invest couple of % points or say 5-10% then you can give it a skip. We might be better off with taking global diversification using other options like S&P 500 or Developed world Index funds, though I have not analyzed so not recommending that yet.

Don’t jump on all the NFOs hitting the market, Follow the broad thoughtful portfolio which needs less changes to be a successful investor over a long term. Happy Investing!

If you find the above information & analysis useful, Do like, subscribe and share the article with your friends. Write to us, if you want me to analyze any particular scenario & facilitate decision making based on the data.

Investment Objectives & Advice

Nifty, Sensex at all time high – Part II! What should you do?

The thoughts of others were light and fleeting, of lover’s meeting or luck or fame. Mine were of trouble and mine were steady, so I was ready when trouble came.”

– A. E. Housman

Last year in December 2020 about Nifty hitting all time high, since then we have seen ~200 days of trading and in more than 60 occasions Nifty have been hitting a new high. If I was asked to write about the same topic and advise on action to be taken for your portfolio each time, I would be required to write every-week and probably twice in certain weeks. Thankfully, I have no such obligations. Though in 10 months old blog, I tried to leave you with the message that To protect your downside, you need to let go some upsideas well as To win the race, you need to run/ participate.

Imagine, if you have completely moved out of the equity market and invested in debt funds at that time. In last 10 months equity have returned ~35%, while debt investments would have accrued <5% in the same period, the difference is of 7x. In other words you would need to wait for at least 6 more years to match the portfolio value you could have achieved in equity portfolio already. Now, Obviously it is easy for me to point this out in hindsight but in no way I could have predicted the same 10 months back.

If we can not predict the future accurately, what should we be doing? As John C. Bogle said in his April 2000 speech that “When reward is at its pinnacle, risk is near at hand“. If I use that as a guideline, The recent rally should prompt us for prudent risk management. Since the number of successful rides on motor bike should not determine the need of helmet because it might take just one accident to change the life of yours and your family forever. Similarly in portfolio management, returns should not be the only factor in designing your portfolio. Alas! 99% of the general investors follow return based approach. I rarely find people being aware of the risk measurements of their portfolio. People are aware that equity is risky, debt is safe in general but I am yet to find the person with answer for “How risky is their portfolio?“. There are various ways of measuring the risk, we can always debate about the limitations of each method, though volatility (standard deviation) and max draw down continues to be the relevant and efficient way to manage risk of the portfolio.

Volatility is the measure of the dispersion of your returns, higher volatility would mean that the returns can swing a lot in either directions. In our Indian Mutual Fund landscape, Overnight funds have the volatility of ~0.2% and typically termed as least risky while the Equity small caps have the volatility ~20%+. The decision of having certain volatility in your portfolio should be based on factors like time horizon for your investments, your saving capacity and your own risk profile. I personally put myself in risk averse category so I hate having volatility of >4% in my portfolio. Before you go for the tune “high risk means high returns & low risks mean low returns”, let me flag that even with <4% volatility my portfolio has been clocking double digit returns for more than a decade. Similarly, the portfolio of my parents in retirement has <2% volatility and clocking 8.5%+ returns in current low return environment for last 5years. Therefore, be mindful of the volatility in your portfolio and ask if that is justified.

{The volatility would keep on changing as per various market conditions for different time frames and There could be high volatility clusters during any large risk off events.}

Max Draw Down measures the maximum observed loss from the peak portfolio value. Higher max draw down values mean the potential loss based on historic trend. In our Indian Mutual Fund landscape, Overnight funds have shorter history with negligible drawdowns of ~0% and Equity smallcap funds have witnessed the draw downs of 60% or more. Though the %draw down factor is less relevant to manage the risk, I personally use the term I call as drawdown delay.

Drawdown delay = Portfolio Value x Historical Draw down estimate / Monthly saving rate

for e.g. If the portfolio size is INR 6mm built by monthly savings of 20k and historical max draw down comes to be 20%, then the Drawdown delay would be 60 months as below. This basically means you have lost your 5 years worth of savings in this scenario.

(6,000,000 x 20%) / 20,000 = 60 months or 5 years

Typically when you start savings, you would have the lower drawdown delay as your savings/ principal would be small in your 1st phase of wealth cycle. As you progress in your investment journey, your monthly savings would be a smaller part of the growth in your overall portfolio and the drawdown delays would range in years. Specially people in retirement would have almost zero new savings, therefore they are advised to keep most investments in the least risky options while managing for longevity risk. In Mar 2020, during the market corrections the max drawdown for the Nifty 50 was ~38% and it was accompanied by the turbulence in the debt markets. Even in that scenario, the MDD for my parents’ portfolio was <3%. For myself, it is bit higher but still in single digit so that drawdown delay is <1yr in general.

I have not found any tool in my experience to give us these metrics for overall mutual fund portfolio. Those few tools which give the portfolio volatility, does that by providing simple weighted volatility and completely ignores the correlation impact between asset classes. Therefore, I had build it for myself in our favorite tool MS excel which can be tailor made to one’s portfolio. write to us if you are interested to check these parameters for your overall portfolio.

Now, The important part is not to just know these parameters but understand their impact to your portfolio health and align them to your risk profile. In current scenario, if the rise in market gives you the sleepless nights than below are the few remedies to improve the resilience of your portfolio.

  • You can reduce the volatility of portfolio, without reducing the exposure to the broad asset class like debt/ gold/ equity etc. by moving the portfolio from high risk products like Small/ Mid cap to Large or Multi cap scenario. Look for stocks with consistent and stable dividends with low beta
  • You can diversify the portfolio for better geographical diversification, Not all countries market will fail at the same time. In short run they might but money would move from risky locations to safer locations and global diversification would help you protect from the country specific risks
  • Light up the exposure from risky assets, for e.g. move money from pure equity funds to hybrid or Balanced advantage funds or to debt funds

Most of these remedies can be used and are used by investors in general, though problem lies in shooting blindly in hope of hitting the enemy vs making targeted changes. If you can measure the risk, you can also measure the impact of your action on the risk mitigation. let me leave you with the quote arguably attributed to Peter Drucker: “If you can’t measure it, you can not manage it.

Happy Investing!