Mutual Fund

Offense wins games… Defense wins championships!!!

Most people think that offense is what wins the game but when ESPN flashed that Defense wins the NFL championships; it was not an easy fact to digest that 38 (out of 45) Super Bowls have been won by a top 10 defense and 22 have been won by a top three defense. This is very true for investing if not anything else. Before I get into the details, I want to first take you guys through few more financial jargon after all we need to keep learning:

Alpha: Most of you might already be familiar with this term but no harm in quick definition. Alpha is the amount of extra return that your investment has generated over the return on index/ benchmark. For e.g. if you are investing to generate returns in mid-cap segment than your portfolio return vs the Nifty Mid-cap index return is known as alpha. More can be read at Alpha

Upside & Downside Capture: Upside and Downside capture ratios are relatively new terms and very few people are aware of this metrics at present. It measures the tendency of your portfolio vs. the tendency of the index in simple words, when index value is increasing at what rate your portfolio increases. For e.g. if index value has increased by 20% over a period of time and your portfolio is increased by 19% then the upside capture ratio will be called as 19/20 = 95% or It the market falls by 10% and your portfolio gets down by 8% only then the downside capture is 8/10 = 80%

Max Draw-down: Max Draw-down is basically the maximum fall of the portfolio value in the given period on a forward looking basis. The calculation of this is not very simple as you need to compare the value of portfolio to all it’s values to find the largest negative decline. The idea of this measurement is to measure the worst possible fall you should expect from your portfolio/ investment. MD

The reason I wanted to walk you guys through this is show and elaborate that how to spot a great fund. General perception is that you buy the right companies and outperform the markets during rally is how you beat the index returns, though this is not true in most cases for mutual funds. Most of the funds outperform the index returns by limiting the downside during the market sell offs. Recently economic times published the Top funds in each category to invest (Link). We quickly check some facts for these best funds:

  1. Axis Blue-Chip fund Alpha 2.2% | Upside Capture 92% | Downside Capture 74%
  2. Canara Robeco Bluechip Alpha 0.2% | Upside Capture 96% | Downside Capture 94%
  3. Kotak Standard Multicap Alpha 2.9% | Upside Capture 100% | Downside Capture 82%
  4. Mirae Asset India Equity Alpha 2.5% | Upside Capture 105% | Downside Capture 91%
  5. Invesco India Midcap Alpha 4.1% | Upside Capture 95% | Downside Capture 76%
  6. L&T Midcap fund Alpha 5.5%| Upside Capture 97% | Downside Capture 73%  

You can look for the similar stats for the other funds, though what I want to flag can be illustrated with these examples itself which are available at morning star’s website (Link) under risk & return metrics for the given fund. The attention I want to attract to is the downside capture and Alpha, You can notice that higher the Alpha, lower is the downside capture in each combination (Large Cap 1&2 or Multi Cap 3&4 or Mid Cap 5&6). This should be enough to illustrate that if you have a great defence you should be confident to have great returns.

Even if your goal keeper is the best defender and always stops the opposition to score, you still can’t win the game unless your team scores the goal. Therefore it is important to not only look for defence but a better than average offence as well. It is ok if your fund not able to have upside capture of >100% but it has to be more than the downside capture else you won’t be able to generate the Alpha. If I have to choose a fund, I will list the upside & downside capture ratios of the portfolio and calculate the upside capture per downside capture and pick the fund with higher ratio.

Now if you are wondering; why did I talk about the max draw-down? That is because we are humans. Whatever our experience, theory as well as brain says we will still be under the influence of our amygdala and heart. Most of us know that equity return beats the other asset classes over a long run. In certain periods they can give negative returns but due to losses in portfolio, we often end up selling to cut the further loss or stop investing. (We have discussed about remediation of negative equity returns through asset allocation & time diversification.) The only remedy to not commit that mistake is by avoiding the deep dark red returns in our portfolio. Therefore, the fund with minimal max draw down should keep me emotionally in check and help us to tide the period of volatility without large losses. The secret recipe of successful investing is to avoid letting your heart make decision and stay rational in all cases greed or fear.

Hope you have identified the funds matching this criteria, if not review your selections and re-balance it accordingly. Happy Investing!!

Investment Objectives & Advice

Time Diversification: Lump Sum vs In Parts

There is an ongoing debate for many years about investing in lump sum or in Parts over 6 to 12 months. I have met and heard people from both the camps and they have a pretty strong view on their own philosophy. Though in reality the answer always in between and depends on individual. Personal finance is always about personal choices and you should chose the option after understanding the options correctly vs just making decision based on perception. Today, I will try to put my perspective on the same topic but let us first understand the concept of XIRR, a method to calculate returns for intermittent investing in parts.

Rate of return is a simple concept, for a years if you invest INR 12,000 and after a year if you get INR 13,800 your rate of return is “(13800 / 12000) – 1” = 0.15 or 15%. Though if i invest the amount in a monthly fashion INR 1,000 every month, this creates a problem. In this scenario the money invested in first month stays invested for full 12 months and the money invested in second month stays invested for 11 months, similarly the money invested in 12th month stay invested for a month only. Therefore returns on each investments differ due to different period of investment.

Return on 1st installment = 1000 x 15% x 12/12 = 150; Return on 2nd installment = 1000 x 15% x 11/12 = 137.5; Return on 3rd installment = 1000 x 15% x 10/12 = 125; ..Return on 12th Installment = 1000 x 15% x 1/12 = 12.5. Overall Return = 150 + 137.5 + 125 + … + 12.5 = 860, So for same 15% return in this case the amount received will be INR 12,860. The absolute return here on overall investment is “(12860/12000)-1” = 0.072 or 7.2% but mathematically the true rate of return is 15%.

Now let’s come back to the original quest to understand “Should we invest lump sum or in Parts?”. To understand this, I ran the analysis on Nifty 50 TRI from Jan 2000 to Mar 2019 data. Case 1: when we invest INR 12,000 in one go and measured the returns over the first year, Case 2: when we invest INR 1,000 in 12 parts monthly and measure the returns after the first year in XIRR as well as Absolute terms. Why just 1st year returns, because after first year you will be 100% invested so any returns post that will be same in both scenario.

Lumpsum vs in Parts

If you look at the first two bars that the Lump sum returns as well as XIRR returns are having similar distribution in each buckets for example 35% times the returns of lump sum investing is in range of 0% – 20% and so is for in parts investing in terms of XIRR. Therefore, there is no major difference of investing in lump sum or in Parts if you compare on XIRR. Though when you look in terms of absolute the story is quite different, there is only 4% chance to get <-15% returns vs 10% chance in terms of lump sum investing. This comes at the cost of giving up upside potential of generating returns >50% in lump sum 10% chance vs 0% chance to get such absolute returns while investing in parts.

What it means is that if you are having a aggressive risk profile and you do not need downside protection, then yes please go ahead to invest lump sum. Or you are an expert investor who can predict the market more accurately by active investing, then you can invest in lump sum and avoid the downside by predicting the market movements. For all other investors who do not know about market moves and are prudent to avoid downside, It is always suggest to invest your lump sum money over 6-12 monthly parts.

Please note this do not highlight that you should not do SIPs or regular monthly investing. This analysis is to be used only for your large sums like your Bonuses or withdrawal from insurance policies, PPFs/EPFs etc where the investment amount is quite high vs your regular monthly saving. The analysis here is for 100% equity investing using Nifty so you can still think of lump sum investing in funds where fund manager keeps juggling between asset classes like Multi Asset fund or Balanced advantage funds.

Lastly invest in the method you like, just understand the consequences and be ready for results as the gain as well as loss will be yours. You will be sad if loose more money but you will also be sad when your returns will be lower than the returns of lump sum investing. What will make you less sad, should be the correct and first question for yourself to finally decide about lump sum or investing in parts. Just don’t avoid investing.

Happy Investing!!

Also Read, Benefits of Diversification.