Monday, September 29, 2008

Live through Volatility

The newspaper headlines today were quite predictable, one screamed

"Halal Street ", and the other said “Trillion Rupee Crash” and so on after the mayhem on the stock markets yesterday.

Many investors are shaken up, and, obviously the 'first time' investors i.e. the recent converts to equity are wondering whether it was a wise thing to 'ditch' RBI Bonds, Post Office, Bank FDs' & PPF at all?  Should they revert to the old asset allocation plan of being in 'safe fixed income investments' and not take any risks at all?

Is all that 'glitters still gold?" i.e. is the 'good old gold' better than stocks & equity funds?

There will be endless analysis about 'FII taxation', 'rise in US interest rates', 'oil prices', ' fall in world equity markets' , inflation and so on. 

I can bet that there will be discussions about who was the big seller, which FIIs sold etc. 

So what does a sincere long term buy & hold investor do?

All the above-mentioned analysis & discussions about FII taxation, interest rates etc, are of academic interest to a genuine long term buying & hold investor.

I thought the best thing to do was check my own SIP investment, see the return of my own equity MF portfolio, whether it had survived the earth-quake of this magnitude on the bourses?

After all the proof of the pudding is in eating it.

So after saying my prayers twice this morning, taking a deep breath, gathering courage- I hesitantly punched the 'pale looking Navs’ of 18th May 2006, into the spreadsheet.

In the microseconds that the spreadsheet was calculating, I said my prayers once again and then slowly opened my eyes.

I looked at the XIRR of my diversified fund SIP that I have been doing over the past 4 years. The figure stood at a 'low of 52%'.  It stood reduced to 52% from app. 59% the day before! 

I looked at the spreadsheet in disbelief to see my portfolio return at 52% XIRR after the greatest market crash in history. Was my PC playing tricks with me?

I hope not I thought, so I punched the keys frantically & fed the 'pale looking NAV' again.... it gave the same number, 52% XIRR.

I looked around with a smile on my face, but immediately became serious when I saw the others in a sombre mood. 

I called my wife and whispered into the phone, "We are still above the poverty line”! 

Although the above piece has been written with a touch of humor, there are some serious inferences from it:

* A buy & hold strategy for equity investments is the only logical method of investing as validated by experts like Warren Buffet, Jack Bogle, and many others like them for decades. 

* As repeatedly warned by Jack Bogle, a short-term investor / trader follows 'rent-a-stock' strategy as opposed to the 'own-a-stock’ method of a genuine long term buy & hold investor.

Therefore when one does 'rent-a-stock’, you have to be prepared for events like May 18th and bear those consequences.

For the 'own-a-stock' guy there is no worry because he is by default part owner in a business enterprise as represented by that stock and therefore aware that volatility is a part and parcel of the process of creating wealth in the long term.

If one owned a business like say a manufacturing unit or a shop, that business would have both good & bad days and time periods during its long existence.

One wouldn’t normally sell a factory or the shop during a bad time; one would just stay 'invested' and continue with the business.

* Equity investments are for long-term goals; therefore the holding period has to be genuinely long term i.e. at least 5 years or more.  And this long-term wealth creation process is going to be accompanied by intermittent volatility.

Take it or leave it. Period!   There is no free lunch in life and you cannot have your cake and eat it too.

* If one does not have the expertise of direct equity investments.... as many don’t, it is better to invest via broadly diversified equity mutual funds, invest systematically, and stay invested till one's long term goals or objectives are met.

A lump sum investor also creates wealth if the time period is sufficient to iron out intermediate volatility.

* I have given the example of my portfolio just as an illustration of a 'buy and hold investor' surviving the stock market slaughter, investors should follow their own asset allocation plan, financial objectives / goals, time period of investment, and assess their own risk profile.

Saturday, September 27, 2008

Safe & Steady way to returns

Investors have just become a lot poorer!

The weakening of the crude along with the 20% upswing of the equities from the lows of July 2008 has made investors doubt the sustainability of the up move! The worry is whether the upbeat seen in the corporate profits in Q1FY09 can be sustained in the Q2 FY09 or not?

Equity markets are supposed to be a place to invest your extra money for the long term. A steady and patient investor in the Indian stock markets would have made nearly 20% every year for the past about 28 years. The steady investor would have made about 160 times his initial investment over this 28-year time period that has seen Indian politics head from bad to worse. India’s GDP has had an average growth of about 6.20% per annum. One of the best rates of growth of any country in the world.

The long term potential for the growth of the Indian economy has not changed. The long term potential for making your extra money earn more money while you go about your daily work has not changed. What has changed is the greed of the gambling crowds. The greed which was evident until December 2007 has now turned to a panic like fear.

Underlying Strength 

The oil prices have increased. Food prices have zoomed. And the cost of borrowing money has increased. To top it all, we have election coming up. All of these will cause some slow down and some pain. But a lot of these factors are cyclical—their importance tends to shine or fade over time. We have had elections before –in fact 7 elections between the 1980 & 2008 time period. We are still around and relatively more prosperous as a country. Why should things be different after the next election? 

As an investment manager, the challenge is not figuring whether FIIs will come again to invest in India or whether India has a future or not, rather, to identify companies and managements that can build solid long term businesses.  The idea is to prepare ourselves for the times (the last 6 months) when the investors – both large and retail—scramble out and head for the exit in panic. Profits are made when there is a difference between perception and reality. Today, people perceive stock market as the worst place to invest. 

The reality is that there are many companies that will do well over the next few years whose share prices have been hammered. These are great stocks to buy because of the underlying strength of their businesses. So as the short term investors sell the stocks, we should be happily buying the businesses that those underlying stocks represent.



Friday, September 26, 2008

Rational for investing in Mutual Funds II

Somehow we always know what we should have done in the past with our investments. But when it comes to taking action now, we are clueless. We think for example that we must have booked some profits when the stock market was at its peak in January. We did not know it then, but know it surely now. We ignore that we have the benefit of hindsight, and almost believe that there has to be a way to figure out what seems so obvious. The truth is that there is no such nice little way to make money, and investors will quarrel with this known wisdom, as they use past data and show how money could have been made.

It is useful to think about ways and means of keeping the level of the market from swaying our investment decisions completely. If your favourite restaurant runs a discount on its Mexican menu, you may not choose to have it for breakfast, lunch and dinner, only because it is cheap, isn’t it? You would surely think that whether you are hungry, and whether you like Mexican cuisine are more important than the rock bottom price. Importantly, your choice of what you will eat will be driven by you, rather than what is on offer. We need to bring that common sense principle into investing as well. To an investor who hates any loss in the value of his portfolio, equity markets are a no-no even if the index is at a very attractive level. Just as my father will refuse to have pizzas for dinner, and my daughter will cringe at porridge. Therefore step one is to ask whether we like to be in the markets at all, and understand why we want to be there. If we figured that what we do with our investments has to stand on its own, driven by our needs and preferences, half the battle is won.

Sadly, just as we sneak in a samosa even as we are working out the fat, we find it so tough to actually implement what is good for us. There are well known behavioral traits that we have, which come in the way. Many of them bias our judgment and our decision. We may like to invest some money into equity at the current levels, having seen that corporate profits are healthy and fundamentals are good. But we will be worried about the fall in price that we have seen. It is so important to see some rise in price, before we buy, because we are led by our recent experiences. We are enthusiastic buyers when markets have moved up, and when everyone else seems to be buying. We seldom buy cheap. Somehow we think it has to be a good thing to do, if many people are doing so. Then, we like what we buy and refuse to accept that we could have a loser on hand. When we see prices falling, we convince ourselves that prices will somehow recover to our price. We are very clued to our price, that it becomes some kind of mental benchmark. But the market does not know this and is unlikely to care. So we tend to keep losers, and refuse to reckon the loss. If we bought at Rs. 100 and the price fell to Rs. 20, we lost 80%. When we continue to hold what we bought, and hope it will go back to Rs. 100, we are expecting a 400% increase – not realistic isn’t it? At every decision to buy or sell, we need to fight the bias to implement what is good for us, and many of us find it tough to do so.

The moral of the story is, we may have a nice little strategy of investment, but if it is driven only by the level of the market, and not by our needs, there is a risk. That risk becomes higher, when our decisions about the markets are biased and our thinking about the market and the way we make our decisions are far from optimal. When we combine the craving for the right time to buy into the market, with the biases that we suffer, we could put our investments in danger.

There are two things we could do, if we accept that this is a problem, and that we need to do something about it. One – we have a plan that we implement, without caring about where the market went. Two – we let professionals manage our money, so the call on markets is not biased. The mutual fund choice is sensible, because it enables us to implement disciplined investing in our own way, leaving the "market watch" to the fund managers. And having the fund managers to watch your money is a nice way to side step the bias. A fund manager is bound by investment processes and risk controls that take care of bias we will suffer when we deal with our own money.

 Have you noticed that your kids, who cringe about writing one-page of handwriting practice during the holidays, happily do 7 subjects a day in school? There is something about organization, process and discipline that make a job which is complex for you, simple for others, and makes implementation a breeze. Free your investments from bias. 

Thursday, September 25, 2008

Rationale for investing in Mutual Funds

It was a year since we got the car. After a disastrous stint at the driving school, which made me feel as if the clutch was the most important part of the car, and driving lessons on Sunday, which disturbed the tranquility of my holiday, I took the simple decision - driving was not for me. I hated the thought of not being able to drive. I sat in the car and looked longingly at men who zipped past. My friends disbelieved that an otherwise confident me, was refusing to drive for the fear of the road. Sitting in the front seat of a car has the ability to increase the fears of people like me - every situation looks risky and every maneuver of fellow drivers very skillful, that I simply cant get it.
Then came my dear friend Babaji, our new driver. Babaji was excellent behind the wheels and loved his job. He loved speed, but was safe to be with. After 6-months of being driven around by him, I asked tentatively, if he could teach me to drive. I told him that I am scared of the roads and worried about accidents. He talks very little, but on this issue, he went on a mini-lecture. He told me that I have to know few rules, exercise judgment and that’s it. Trust me; he got me to drive on the main roads, 2 days after our practice sessions in the deserted roads of Navi Mumbai. It is 3 years now, and I can’t thank Babaji enough, for making me confident to take the driver’s seat.
Now it was my turn to do something for Babaji. So I asked that I teach him what I know – investing. Babaji was not ready for this. He was not able to save much, and did not want to risk his small savings in markets. He reads a lot of newspapers, and told me that there it looks so complex and that he does not want to take any risk. We were on the way to office when I was convincing him, and there was big traffic jam in front of us. Babaji exercised patience as he switched from first gear to second and back. Soon as the road cleared, he sped to save time, overtaking vehicles and using every little space he got. I told him, investing is exactly like driving the road. You have to exercise judgment, you have to assess the scenario and decide, and that’s it. If I can drive, Babaji can surely invest!
The financial markets have many investment options, some are slow some are fast, just like vehicles on the road. There are regulators, licenses and signals in the markets, just as it is in the roads. Before anyone can collect money from investors, regulators have to approve the products and information given to the investors. Babaji quickly pointed out to me, that it does not always work. I told him that it does not always work on the roads either. There could be a truck driver without a license, who is learning to drive on the road. There could be vehicles that have not been serviced. The road itself may have potholes, or even be closed for repairs. Just as you cannot have a perfect road with perfect cars and drivers, you can’t have perfect markets; you have to figure out the way and exercise judgment.
To those who find this tough, there are buses and trains. Public transport that takes you at designated time, from one place to another for a fixed price. That’s what mutual funds do in the financial markets. They offer you specific products at specific prices. You can conveniently choose what you like, at the cost you can pay, and go to the destination you want. I told Babaji that investors tend to be confused on what they want. They get to the market not knowing where they want to go; they get into a bus and expect it to speed like a taxi, and they get off the bus if they find there is a jam, not realizing that they have to take another bus to go to their destination If investors used the same judgment Babaji used on roads, they will be safe in a market that has risks. The logic is the same. The financial markets also have rear view mirrors, maps and most importantly, brakes. So you only have to choose what you want to do and how. Babaji is not fully convinced and remains worried, but overtakes another truck. When I tell him that I find it so risky, he tells me that he knows what he is doing and I must not worry. That’s what it is, you need to find a trustworthy driver like Babaji (for your car and AIMS for your investments), who drives safely and skillfully, has a license and will reach you to your destination, every day, day after day. It is not even required that you learn to drive. If you do, it is an added skill you can use, when there is a need. But some choices ask that you hire and use the skills of others. After all you do not have to own a plane to be able to take a holiday!

Wednesday, September 24, 2008

Market Turmoil

Some Wealth Inspiring thoughts
Ø Timing is vital. It is much more important to buy cheap than to sell dear.
Ø Time in the market is more important than timing the market.
Ø It is never your thinking that makes big money, it is sitting.
Ø Success in market usually comes to those, who are too busy to be looking for it.
Ø Managing money requires more skill than making it.

Wealth as they say is like old wine. The more time it takes the longer it stays for you to savor it!!
Stock Market is generally feared by all! And may be rightly so!! Investors usually see – or rather made to see—the short term fluctuations rather than the long term upside potential which comes steadily but without much of an announcement! It’s the short term upheavals are talked about in every newspaper—much to the contrary!!!

Your would not find many investors talking about say Tata Steel moving up from a level of Rs. 530/- a year back to Rs. 745/--- a cool 40% gain! Rather you will come across many investors crying hoarse about the price of Tata Steel having gone down from Rs. 900/- on 29/10/2007 to present day price of Rs. Rs. 745/- -- a fall of 17% in just 8 months!
We at AIMS have always believed that time in the market is more important than timing the market! A 40% gains over a single year easily drowns in the din of 17-20% fall in a matter of months!
What is true for Tata Steel is true for any investment even for a Mutual Fund. We believe that Mutual Fund is the route for retail investors! It is not that we despise or discourage direct equity—direct equity is preferable only if you have the habit of digesting the fluctuations and also have the time to do your research because investing without research is like playing poker without looking at the cards.
Another compelling reason for investing in Mutual Funds is highlighted in the last wealth inspiring thoughts as stated above—managing money requires more skill than making it!
There are very few options currently where the real returns -- returns in excess of the inflation—are positive. Hence investments in PPF, Post Office; RBI Bonds or bank deposits tend to depreciate your corpus rather than appreciate. They will in all likelihood not see you through your retirement or even be able to fund your child’s higher education! Only Equity has the power to give you inflation adjusted returns!! Consider this :- a monthly investment of Rs. 1,000/- in DSP Merrill Lynch Equity Fund from 02/05/1997 till date would have grown from Rs. 1,33,000 to about Rs. 8,46,000/- -- a compounded annual growth of 20.32% (Source DSP Merrill Lynch Mutual Fund). AND THAT TOO TAX FREE!! This in spite of Dot Com meltdowns, Kargil, 9/11 etc.
The thought now looming in your mind is “What Now”? “Where will the market stabilize”? Whether this is the right time to invest or not??
We must admit frankly that we are unable to forecast the index level from where the markets would start climbing up! No body in this world – not even the legendary Warren Buffet—will be able to predict the index level!
As for “WHAT NOW” – we can only say that the India story is very much alive and with a heavy discount sale currently on – GRAB IT—before it’s too late!!
At the end we would only repeat what Lord Krishna said to Arjun during Mahabharata – tum karm karo, phal ki chinta mat karo (Do not worry about the results, just do your duty!)

Investing is your duty TODAY!

Happy Investing!!