There seems to be no end to the current stock market crash.
Today, the Indian stock markets as represented by the BSE Sensex and the NSE Nifty-50 crashed by over 10%. Some stocks fell much harder...Unitech fell 50%! If you owned Unitech yesterday, you would be half as rich today on Unitech.
Current market conditions and the crash are truly unprecedented. A great change seems to be afoot. And in times of great change, there are obvious winners and losers. So far, the bears have been winning and the bulls have been losing big time.
Some battered bulls are now crying out for help. These are not the average investors but many are so called experts that you see so many times on business channels. Many such bulls have lost money and continue to lose money. It is obviously hurting. And hence these people are calling for help from all corners.
Some people cry for a ban on short selling.
Others want rate reductions and easier money.
Some want the government to do something, as if it were the job of the government to protect asset prices in some way.
Some want hte government to set up a market stabilisation fund to prop up the markets.
Some want a change in the way futures are settled on settlement day.
Some are angry that there is no level playing field between local investors and FIIs.
Some desperately seek any kind of silver lining in bad news.
People simply want the markets to go up again and for better times to return.
I was amused to see the remarks of one such celebrated fund manager and CIO of Reliance Mutual Fund, Madhu Kela. He seemed to have anguish in his voice complaining that mutual funds are not allowed to go short in any signficant manner while FIIs are allowed to do anything. He added that he would have loved to short the market as well given a choice. I found it quite amusing.
For one, a mutual fund is not a hedge fund. It is designed as a vehicle for the average investor to participate in the stock market. Short selling has a greater risk than long only buying and it requires greater skill. By not allowing short selling in any big way, the average investor is protected against incompetence of the fund manager, if any, to sell short.
Also, if someone finds stocks cheap, he/she should go ahead and buy. Reliance mutual fund is saying on the one hand that stocks are cheap and then stating on the other hand that they are waiting with a lot of money to buy when markets stop falling. By abstaining from buying, is Reliance Mutual fund not also contributing to the fall?
And assume if mutual funds were allowed to short sell as well? Would the markets have not gone down faster as mutual funds would have come around to shorting the markets instead of the buying that some have been doing?
And speaking generally, when the markets were going up, no one was complaining about anything. Everyone was happy when the markets went up 50% in 2-3 months in Sep-Nov 2007. Now that the markets are crashing, these experts are now crying for help and lamenting about how things are biased against them.
They are behaving like cry babies. Where is the personal accountability? Anyone who made a loss, made it because they chose to invest in the markets. They and they alone are responsible for their losses. Period! They lost money because they made a bad choice and were blind to extreme events occuring.
There is no point in cribbing and complaining. There is no point in whining. Yes, there might be genuine issues with the markets and all the problems that these experts talk about might be valid. But these have existed and are not something that have been thrust upon them overnight. They were aware of these issues when the markets were going up, and hence should not complain how these caused them losses.
Markets go up and markets go down. A downcycle is a way of cleaning out all excesses of the previous cycle. Just like a jungle fire, it cleans out all existing vegetation and new life begins. When people want to sell, they will sell regardless of external artificial measures. Interfering with natural processes create dislocations in other areas and create new problems to deal with.
Having said that, till very recently, I was arguing that markets were not cheap yet. Now the picture might have changed. The markets do look attractive now, based on traditional measures.
The BSE Sensex (8701) now trades at a PE of 10.63, Price to Book Value (PBV) of 2.25 and Dividend Yield of 2.12%.
The BSE Midcap index has the same values at 8.02, 1.46 and 2.46%
The BSE SmallCap index has the same values at 5.62, 0.91, 2.78%
Same is the case with NSE indices.
Historically, these are in line (by and large) with previous lows.
But before we jump ahead and buy, we don't know how future earnings would be. We dont know whether earnings will rise, fall or stay stagnant. If they rise, how much they would rise by? And what PE multiples would the markets give the markets? So even though stocks optically look attractive, this could be an illusion as earnings fall short of expectations. But, generally speaking, stocks might be worth buying into starting now...with a caveat that I could be wrong, earnings could disappoint, markets could go down...and hence you should invest in a manner that if you are wrong, you dont lose much.
Looking at the current picture, there is no hurry to buy anyways. The next few years could turn out to be an investor's delight. He would get stocks cheap, perhaps very cheap, and would not be in any hurry to buy. Keep cash handy.
Happy Investing!
Friday, October 24, 2008
Not protecting yourself
You buy motor insurance for your cars. That is mandatory by law.
You are wise and buy life insurance and medical insurance (If you don't, you should)
But what about investment insurance?
For most of our lives, things keep going along the same way they always do. Today is much like yesterday and tommorrow will be most like today. And we believe that the future will be like the past.
But there comes a time when the world changes upon us, at least in the investing world. The future is hardly like the past.
When such incidences occur, past experiences do not count. Asset prices crash and crash hard. A collosal amount of wealth is lost. This has happened in the past and will continue to happen in the future...one such time is now. A massive wealth destruction has occured in the almost all asset markets, especially in the stock markets.
While we are never able to predict such events, their timing or their magnitude. But we can stay awake to the possibility of such events occuring...and have a plan to protect our wealth when they do occur.
Else, paper gains do not take time to erode into huge losses...and into horror stories.
Look at the kind of damage many bluechip stocks (all are Nifty 50 stocks) have had over this year from their highs, and especially this month (data as on 23 Oct 2008 market closing):
Stock---------Fall
ABB Ltd.------64%
BHEL---------59%
Bharti---------45%
DLF-----------78%
Grasim--------70%
Hindalco-------71%
ICICI Bank----75%
Idea-----------74%
Infosys--------46%
L&T-----------63%
Ranbaxy------62%
Rel Comm-----72%
Rel Infra------83%
Rel Petro------67%
SAIL----------71%
Siemens-------73%
Sterlite--------78%
Suzlon---------83%
Tata Motors---78%
Tata Steel-----78%
TCS-----------59%
Unitech-------89%
And falling....
Not to mention many smaller companies that have seen greater damage.
Clearly, the need to protect your investment is never more clear than in the current environment. Of course, protection should have been deployed much earlier.
Wise investors manage risk and protect themselves when things go bad. There are many ways to minimise losses. One is to risk small. The other is to stay out of large downtrends (recognise it first naturally) by either staying with cash or using derivatives as hedges.
Regardless of which method an investor chooses to use, every investor should learn how to protect his/her portfolio...and learn not to live in hope and blind optimism.
You are wise and buy life insurance and medical insurance (If you don't, you should)
But what about investment insurance?
For most of our lives, things keep going along the same way they always do. Today is much like yesterday and tommorrow will be most like today. And we believe that the future will be like the past.
But there comes a time when the world changes upon us, at least in the investing world. The future is hardly like the past.
When such incidences occur, past experiences do not count. Asset prices crash and crash hard. A collosal amount of wealth is lost. This has happened in the past and will continue to happen in the future...one such time is now. A massive wealth destruction has occured in the almost all asset markets, especially in the stock markets.
While we are never able to predict such events, their timing or their magnitude. But we can stay awake to the possibility of such events occuring...and have a plan to protect our wealth when they do occur.
Else, paper gains do not take time to erode into huge losses...and into horror stories.
Look at the kind of damage many bluechip stocks (all are Nifty 50 stocks) have had over this year from their highs, and especially this month (data as on 23 Oct 2008 market closing):
Stock---------Fall
ABB Ltd.------64%
BHEL---------59%
Bharti---------45%
DLF-----------78%
Grasim--------70%
Hindalco-------71%
ICICI Bank----75%
Idea-----------74%
Infosys--------46%
L&T-----------63%
Ranbaxy------62%
Rel Comm-----72%
Rel Infra------83%
Rel Petro------67%
SAIL----------71%
Siemens-------73%
Sterlite--------78%
Suzlon---------83%
Tata Motors---78%
Tata Steel-----78%
TCS-----------59%
Unitech-------89%
And falling....
Not to mention many smaller companies that have seen greater damage.
Clearly, the need to protect your investment is never more clear than in the current environment. Of course, protection should have been deployed much earlier.
Wise investors manage risk and protect themselves when things go bad. There are many ways to minimise losses. One is to risk small. The other is to stay out of large downtrends (recognise it first naturally) by either staying with cash or using derivatives as hedges.
Regardless of which method an investor chooses to use, every investor should learn how to protect his/her portfolio...and learn not to live in hope and blind optimism.
Tuesday, October 14, 2008
Obsessed with bottoms
Have we hit the bottom in the stock markets?
These days people seem to be obsessed about finding bottoms. Television anchors keep asking so called experts about whether we have hit rock bottom and whether prices will now stop falling.
Some think that we made market bottom last friday. Others think that the bottom is not yet made. So far, the no-sayers are winning the battle as markets have kept going down.
Bottom seekers live with the hope that if the market bottom has been identified, they can start buying again and avoid losses.
But I have a few things to say.
First, bottoms can only be identified in hindsight. Much later than today, when we look back at what happened, we should be able to say whether markets did make a bottom on 10th October 2008 or not. Sitting in the present, it is impossible to call a bottom except by pure luck.
No one can spot a bottom except in hindsight, after it has been formed. Trying to find bottoms is a meaningless exercise, an exercise in futility.
Secondly, we invest to make money, not to not lose money. While not losing a part of the game, the basic idea is to make money.
So the key issue is whether we should be able to make money regardless of whether a bottom is made or not, identified or not. Even if we are able to call a bottom correctly, if prices do not go up after we buy, we are not going to make money. In fact, we would pay an opportunity cost of not having deployed the same money into other investments like say fixed deposits (which currently are offering 10-11% returns).
What we as investors should focus on is the prospects of gains rather than finding bottoms. If we think that prices are not headed up, it does not make sense to buy even if we buy at the bottom.
Look at the prospects of gains in preference to finding market bottoms. Keep observing the market with an open mind and look for signs that the markets are headed higher.
It is better to wait for a bottom and then let the markets tell you that it is possibily going up. This is an easier task and more profitable one than trying to find bottoms.
These days people seem to be obsessed about finding bottoms. Television anchors keep asking so called experts about whether we have hit rock bottom and whether prices will now stop falling.
Some think that we made market bottom last friday. Others think that the bottom is not yet made. So far, the no-sayers are winning the battle as markets have kept going down.
Bottom seekers live with the hope that if the market bottom has been identified, they can start buying again and avoid losses.
But I have a few things to say.
First, bottoms can only be identified in hindsight. Much later than today, when we look back at what happened, we should be able to say whether markets did make a bottom on 10th October 2008 or not. Sitting in the present, it is impossible to call a bottom except by pure luck.
No one can spot a bottom except in hindsight, after it has been formed. Trying to find bottoms is a meaningless exercise, an exercise in futility.
Secondly, we invest to make money, not to not lose money. While not losing a part of the game, the basic idea is to make money.
So the key issue is whether we should be able to make money regardless of whether a bottom is made or not, identified or not. Even if we are able to call a bottom correctly, if prices do not go up after we buy, we are not going to make money. In fact, we would pay an opportunity cost of not having deployed the same money into other investments like say fixed deposits (which currently are offering 10-11% returns).
What we as investors should focus on is the prospects of gains rather than finding bottoms. If we think that prices are not headed up, it does not make sense to buy even if we buy at the bottom.
Look at the prospects of gains in preference to finding market bottoms. Keep observing the market with an open mind and look for signs that the markets are headed higher.
It is better to wait for a bottom and then let the markets tell you that it is possibily going up. This is an easier task and more profitable one than trying to find bottoms.
Sunday, October 12, 2008
A few lessons from the crash
The stock markets have crashed big time. I dont think we have ever seen such dramatic collapses in the Indian markets. This is highlighted by the worst ever weekly performance ending this week. And the week had only 4 trading days!
But first, let me apologise for what I am going to say next. I almost am tempted to say, "I told you so". Readers would have noticed the very cautious slant in my previous blogs and mails since March of this year. Of course, I never dreamt of such intensity, but I had sounded caution. So an apology is in order if I sound self-congratulatory here.
But what lessons can we, as investors, derive out of the current crisis? While there are many and I would like to highlight a few ones.
(1). The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings.
(William Shakespeare - Julius Caesar I.ii.)
No one has the ability to totally comprehend our economic world. The world is far too complex and has unimaginable linkages for us to get an idea of how one parameter would change what others and by how much. What started as a country specific (USA) problem in one sector of the economy (housing) has now become a world wide credit crisis that threatens to undermine the entire financial system of the world. First it was housing prices, then investment banks, then mortgage lenders to commercial banks to now trade financing (the latest is on letters of credit or LCs). All assets are getting decimated, stocks, commodities, real estate...except the US dollar and precious metals like Gold. Seemingly insulated countries like India are witnessing high linkages via capital flows.
The lesson to draw is that unexpected things do happen in the world, things that so beyond the ordinary that they change the future. While no one can really predict what and how intense such changes would be, it a wise idea to be aware that they can happen and more importantly, be prepared to protect your wealth or create wealth for yourself when such events occur.
The typical market expert has a standard advise. Hold stocks for the long run, or use a SIP to invest, etc. Such advise of ok in normal times. In extraordinary times, such advise causes a lot of pain and hardship. Investors should learn how to avoid such large losses when unprecedented events occur. Avoiding large losses in bad times is good both for our financial and physical health.
(2.) Common sense is not so common afterall.
After 5 years (2003-2007) of a boom, people started taking things for granted: that India will keep growing at 9% for the next 50 years, that capital will keep flowing in forever because our country is so great, that stocks will keep returning 25% per annum ad infinitum. Guess what? Trees dont grow to the skies. In the big boom, the GDP expanded at higher than historic rates, EPS bases became bigger. Inflation set in and interest rates rose higher. Common sense mandated that the future would not be anything like the past. Common sense mandated that growth will slow down and earnings growth will slow down. But who cares for acquiring common sense when dreams and hopes abound? And when past experience suggested that good times would stay forever. The person who acted with common sense would have been able to protect his/her wealth better than the others, including many experts who are not feeling all that rich anymore.
(3). The lesson we learn from history is that we learn nothing.
How many of us have seen past debacles? At least we have heard about them or read about them, if not experienced them. Be it the bull market in 1985 (VP Singh cut direct taxes), Harshad Mehta time in 1992, FII driven optimism (1994) or the technology bubble in 2000, large rises over short periods are unsustainable. In each bust, stock markets fell 50% or more. That is the very nature of capitalism. Sudden booms bring in their own problems which invariably lead to a reverse cycle. But in each boom we feel it is different. There are always very plausible and logical sounding reasons for why it is different each time. In reality, it never is different. Capitalism makes super-normal returns disappear in no time. To think otherwise is a folly.
While we can never exactly say when the cycle will reverse, we can say with confidence that it will. While I do believe that the Indian stock markets are in a secular bull phase, cyclical downturns are to be expected (unless there is a systemic collapse, in which case all bets are off) and one should be prepared for such.
So, in closing I would like to state a few things:
-Seek competant advise, not the advise that is dished out to the masses. If every expert gives the same advise, how many among them would truly be competant?
-Learn to sell. Selling is the key to outperformance
-Get real. Expect the unexpected and have a plan to deal with it if the unexpected comes about. Do not live in denial
-Above all, have a plan. Period! Much pain comes because people do not have an investing plan, but rather invest haphazardly.
Happy investing!
But first, let me apologise for what I am going to say next. I almost am tempted to say, "I told you so". Readers would have noticed the very cautious slant in my previous blogs and mails since March of this year. Of course, I never dreamt of such intensity, but I had sounded caution. So an apology is in order if I sound self-congratulatory here.
But what lessons can we, as investors, derive out of the current crisis? While there are many and I would like to highlight a few ones.
(1). The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings.
(William Shakespeare - Julius Caesar I.ii.)
No one has the ability to totally comprehend our economic world. The world is far too complex and has unimaginable linkages for us to get an idea of how one parameter would change what others and by how much. What started as a country specific (USA) problem in one sector of the economy (housing) has now become a world wide credit crisis that threatens to undermine the entire financial system of the world. First it was housing prices, then investment banks, then mortgage lenders to commercial banks to now trade financing (the latest is on letters of credit or LCs). All assets are getting decimated, stocks, commodities, real estate...except the US dollar and precious metals like Gold. Seemingly insulated countries like India are witnessing high linkages via capital flows.
The lesson to draw is that unexpected things do happen in the world, things that so beyond the ordinary that they change the future. While no one can really predict what and how intense such changes would be, it a wise idea to be aware that they can happen and more importantly, be prepared to protect your wealth or create wealth for yourself when such events occur.
The typical market expert has a standard advise. Hold stocks for the long run, or use a SIP to invest, etc. Such advise of ok in normal times. In extraordinary times, such advise causes a lot of pain and hardship. Investors should learn how to avoid such large losses when unprecedented events occur. Avoiding large losses in bad times is good both for our financial and physical health.
(2.) Common sense is not so common afterall.
After 5 years (2003-2007) of a boom, people started taking things for granted: that India will keep growing at 9% for the next 50 years, that capital will keep flowing in forever because our country is so great, that stocks will keep returning 25% per annum ad infinitum. Guess what? Trees dont grow to the skies. In the big boom, the GDP expanded at higher than historic rates, EPS bases became bigger. Inflation set in and interest rates rose higher. Common sense mandated that the future would not be anything like the past. Common sense mandated that growth will slow down and earnings growth will slow down. But who cares for acquiring common sense when dreams and hopes abound? And when past experience suggested that good times would stay forever. The person who acted with common sense would have been able to protect his/her wealth better than the others, including many experts who are not feeling all that rich anymore.
(3). The lesson we learn from history is that we learn nothing.
How many of us have seen past debacles? At least we have heard about them or read about them, if not experienced them. Be it the bull market in 1985 (VP Singh cut direct taxes), Harshad Mehta time in 1992, FII driven optimism (1994) or the technology bubble in 2000, large rises over short periods are unsustainable. In each bust, stock markets fell 50% or more. That is the very nature of capitalism. Sudden booms bring in their own problems which invariably lead to a reverse cycle. But in each boom we feel it is different. There are always very plausible and logical sounding reasons for why it is different each time. In reality, it never is different. Capitalism makes super-normal returns disappear in no time. To think otherwise is a folly.
While we can never exactly say when the cycle will reverse, we can say with confidence that it will. While I do believe that the Indian stock markets are in a secular bull phase, cyclical downturns are to be expected (unless there is a systemic collapse, in which case all bets are off) and one should be prepared for such.
So, in closing I would like to state a few things:
-Seek competant advise, not the advise that is dished out to the masses. If every expert gives the same advise, how many among them would truly be competant?
-Learn to sell. Selling is the key to outperformance
-Get real. Expect the unexpected and have a plan to deal with it if the unexpected comes about. Do not live in denial
-Above all, have a plan. Period! Much pain comes because people do not have an investing plan, but rather invest haphazardly.
Happy investing!
Thursday, September 18, 2008
Black Swan
Nassim Nicolas Taleb writes about 'Black Swans' in his book "The Black Swan".
For most of humanity people thought all swans were white in colour...till a black coloured swan was discovered in Australia.
Black swans, Taleb says, are low-probability high-impact events that are very consequential.
They are high impact events that cause a major shock, either positive or negative.
Black swans are inherently unpredictable. Our limited understanding on the world means we cannot predict when or where such events would take place. Of course, when they occur, in hindsight, they look so obvious that we wonder why no one thought them earlier.
For most days, the sacrificial lamb is well fed and looked after. The lamb continues to expect the future to be like the past. For most days this is true...until till the day the lamb is sacrificed. Most investors and experts alike expect the future to be more or less like the past. Till one day there is a black swan event that changes the course of the future.
Black Swan events can be positive as well as negative. A positive black swan is the internet. No body planned for the internet, we did not know what internet was before it came up, we did not know where or when the internet would develop and did not know how it would transform the world. A negative black swan was the world war 1 or the Great Depression in the 1930s.
What we are witnessing in the financial markets today in the USA is a black swan event. A huge negative black swan event that is changing the investment landscape, perhaps permanently, with huge implications for all world markets. Icons on Wall Street are going bust virtually every week. Stock markets are tumbling like nine pins and there is blood on the streets.
What does it mean for the Indian stock market?
1.) Generally, the current turmoil would mean a lot less money coming into countries like India. Maybe money would keep going out. Every rise might be sold into. Valuations for stocks are likely to to go down and stocks might get lower PE ratios in general.
2.) Investors should be prepared towards the possibility of black swans (both positive and negative). In terms of downsides, invest with protection. We have our cars insured, we buy life insurance, but most retail investors dont think about investment insurance or how to protect capital from major declines.
3.) Do not fall into the 'value' trap. The market is the final arbiter of value and in such an environment, there is no hurry to get in. Remember the time period from 2000-2002/3. The markets really tested the patience of investors while giving no returns.
4.) Return expectations from stocks will need to be reduced significantly. The fancy returns from stocks that we saw over the last 5 years are a thing of the past. There is still a lot of 'buy-on-dips' optimism out there.
5.) Do not think that India's great fundamentals will automatically mean good stock market performance in the longer run. Most analysts opine that fundamentals are great. This might be the case, or fundamentals might detoriate. In any event, the economy needs liquidity to grow, stocks need liquidity to perform. Foreign capital is in doubt. No athlete, however capable, can perform in an oxygen deficient environment.
Here is wishing you wise investing!
For most of humanity people thought all swans were white in colour...till a black coloured swan was discovered in Australia.
Black swans, Taleb says, are low-probability high-impact events that are very consequential.
They are high impact events that cause a major shock, either positive or negative.
Black swans are inherently unpredictable. Our limited understanding on the world means we cannot predict when or where such events would take place. Of course, when they occur, in hindsight, they look so obvious that we wonder why no one thought them earlier.
For most days, the sacrificial lamb is well fed and looked after. The lamb continues to expect the future to be like the past. For most days this is true...until till the day the lamb is sacrificed. Most investors and experts alike expect the future to be more or less like the past. Till one day there is a black swan event that changes the course of the future.
Black Swan events can be positive as well as negative. A positive black swan is the internet. No body planned for the internet, we did not know what internet was before it came up, we did not know where or when the internet would develop and did not know how it would transform the world. A negative black swan was the world war 1 or the Great Depression in the 1930s.
What we are witnessing in the financial markets today in the USA is a black swan event. A huge negative black swan event that is changing the investment landscape, perhaps permanently, with huge implications for all world markets. Icons on Wall Street are going bust virtually every week. Stock markets are tumbling like nine pins and there is blood on the streets.
What does it mean for the Indian stock market?
1.) Generally, the current turmoil would mean a lot less money coming into countries like India. Maybe money would keep going out. Every rise might be sold into. Valuations for stocks are likely to to go down and stocks might get lower PE ratios in general.
2.) Investors should be prepared towards the possibility of black swans (both positive and negative). In terms of downsides, invest with protection. We have our cars insured, we buy life insurance, but most retail investors dont think about investment insurance or how to protect capital from major declines.
3.) Do not fall into the 'value' trap. The market is the final arbiter of value and in such an environment, there is no hurry to get in. Remember the time period from 2000-2002/3. The markets really tested the patience of investors while giving no returns.
4.) Return expectations from stocks will need to be reduced significantly. The fancy returns from stocks that we saw over the last 5 years are a thing of the past. There is still a lot of 'buy-on-dips' optimism out there.
5.) Do not think that India's great fundamentals will automatically mean good stock market performance in the longer run. Most analysts opine that fundamentals are great. This might be the case, or fundamentals might detoriate. In any event, the economy needs liquidity to grow, stocks need liquidity to perform. Foreign capital is in doubt. No athlete, however capable, can perform in an oxygen deficient environment.
Here is wishing you wise investing!
Monday, September 8, 2008
Are we in an watershed moment?
Those who have been following the developments in the economies and the financial markets of the developed world, especially USA, would not fail to recognise that such developments might actually be some kind of watershed events. Some might even say that we are at an epochal moment in the investment world, just like the period after the Great Depression (1929), or the secular fall in interest rates (1982). These were events that changed the entire landscape of investing and meant new things for investments and returns therefrom.
The bursting of the housing bubble and the credit cruch, the boom in commodities and the ramifications it has for prices and inflation, the impact of the credit crunch on interest rates and on countries in need of (preferably cheap) capital (like India), the impacts of events such as these would need to be understood carefully as they unfold. There has been a confluence of a number of factors that threaten to change the characteristics of financial markets and our expectations from them.
We humans have our limitations. We rarely are able to see such changes while being a part of them. We cannot see a dislocation while being subject to it. For example, in 1930, no one expected the Great Depression to take place. In the early 1980s, the general expectation in the USA was that interest rates would remain high and stocks were a dead investment. By 2000, we thought that technology would revolutionise the world and technology stocks were cheap by any yardstick. By 2003, we were not able to see how a surge in liquidity would innundate asset markets worldover and bring about a boom in stocks, real estate, commodities, and other assets. Most people miss change as it occurs. It takes time for people to realise that change has occured.
We base our expectations of the future based on our experience of the past. So we assume, often linearly, that past trends will more or less continue into the future, sometimes naively, into the indefinate future. The world seldom works in a linear fashion. High impact transformational events happen unexpectedly to create a very different future. And major changes have occured in the developed world which would have serious impacts on the developing world.
What could it mean for The Indian stock market?
First, the era of cheap and easily available capital is over. India's GDP had shown what in my opinion was an above-potential growth of 9% over the last few years, on the back of copius amounts of foreign money flowing into the country (topping USD 110 billion, about 11% of our GDP in 2007). In the absence of such sums, growth is very likely to be lower than the lowered expectations of many people. A lower demand would mean a lower PE multiple for the stock markets.
People think that high interest rates will bite. They sure will. Add to that a much lower capital inflow will mean lower money available for projects and higher cost of capital and hence lower profits, especially for companies that require capital for growth. Earnings into the future would not be anywhere near what we have witnessed over the past few years.
Secondly, the currency weakening would mean more expensive imports and cheaper exports. While cheaper exports would mean a good thing, one should consider the slowing demand situation in the developed world which could nullify the advantage of cheaper exports.
Take into account the fact that stock valuations in general are not cheap though optimism for stocks for a longer period abounds. I still hear many voices saying how stocks will give good returns over 12 months plus time horizon. I would be vary since stocks would probably correct more than what we expect to make them cheap again. This could occur either by markets going down, or remaining sideways for a long period or both. There will not be that momentum money to drive our markets higher and higher even though at lower levels support might come in.
Many advisors are, in my opinion, guilty of forecasting past trends into the future. There have been instances in the past where returns from stocks for substantial periods ranging upto 3 years have been negative. Reasons were various, but the end result was that investors lost money. The current phase could just be one.
Optimism is good, but blind optimism with no regard to potential risks is foolish. Blindly relying on India's fundamentals and India's story is not sound investing. Blindly believing that stocks would give supernormal returns in your retirement account is being unrealistic.
The unfolding of current events leaves the future quite unclear. I do not know how it would unfold. Maybe the end game would make me look foolish and markets might do well. Or maybe not! In any event, I think it is better to wait and watch how the picture develops.
When times are tough and the environment uncertain, it is wise to risk little. You may walk through a jungle infested with wild animals and come out unharmed. Yet that very act is stupid. The downside to investing now is that you would lose money, much more than you could think. And at least lose the opportunity cost of 10-11% you can get on debt.
So trade by all means if you can trade. But for investing, the risk:reward ratio is not attractive.
PS: No analysis of the investing world can incorporate all data or make correct judgements all the time. Needless to say that my analysis could be wrong. You could make your own call.
The bursting of the housing bubble and the credit cruch, the boom in commodities and the ramifications it has for prices and inflation, the impact of the credit crunch on interest rates and on countries in need of (preferably cheap) capital (like India), the impacts of events such as these would need to be understood carefully as they unfold. There has been a confluence of a number of factors that threaten to change the characteristics of financial markets and our expectations from them.
We humans have our limitations. We rarely are able to see such changes while being a part of them. We cannot see a dislocation while being subject to it. For example, in 1930, no one expected the Great Depression to take place. In the early 1980s, the general expectation in the USA was that interest rates would remain high and stocks were a dead investment. By 2000, we thought that technology would revolutionise the world and technology stocks were cheap by any yardstick. By 2003, we were not able to see how a surge in liquidity would innundate asset markets worldover and bring about a boom in stocks, real estate, commodities, and other assets. Most people miss change as it occurs. It takes time for people to realise that change has occured.
We base our expectations of the future based on our experience of the past. So we assume, often linearly, that past trends will more or less continue into the future, sometimes naively, into the indefinate future. The world seldom works in a linear fashion. High impact transformational events happen unexpectedly to create a very different future. And major changes have occured in the developed world which would have serious impacts on the developing world.
What could it mean for The Indian stock market?
First, the era of cheap and easily available capital is over. India's GDP had shown what in my opinion was an above-potential growth of 9% over the last few years, on the back of copius amounts of foreign money flowing into the country (topping USD 110 billion, about 11% of our GDP in 2007). In the absence of such sums, growth is very likely to be lower than the lowered expectations of many people. A lower demand would mean a lower PE multiple for the stock markets.
People think that high interest rates will bite. They sure will. Add to that a much lower capital inflow will mean lower money available for projects and higher cost of capital and hence lower profits, especially for companies that require capital for growth. Earnings into the future would not be anywhere near what we have witnessed over the past few years.
Secondly, the currency weakening would mean more expensive imports and cheaper exports. While cheaper exports would mean a good thing, one should consider the slowing demand situation in the developed world which could nullify the advantage of cheaper exports.
Take into account the fact that stock valuations in general are not cheap though optimism for stocks for a longer period abounds. I still hear many voices saying how stocks will give good returns over 12 months plus time horizon. I would be vary since stocks would probably correct more than what we expect to make them cheap again. This could occur either by markets going down, or remaining sideways for a long period or both. There will not be that momentum money to drive our markets higher and higher even though at lower levels support might come in.
Many advisors are, in my opinion, guilty of forecasting past trends into the future. There have been instances in the past where returns from stocks for substantial periods ranging upto 3 years have been negative. Reasons were various, but the end result was that investors lost money. The current phase could just be one.
Optimism is good, but blind optimism with no regard to potential risks is foolish. Blindly relying on India's fundamentals and India's story is not sound investing. Blindly believing that stocks would give supernormal returns in your retirement account is being unrealistic.
The unfolding of current events leaves the future quite unclear. I do not know how it would unfold. Maybe the end game would make me look foolish and markets might do well. Or maybe not! In any event, I think it is better to wait and watch how the picture develops.
When times are tough and the environment uncertain, it is wise to risk little. You may walk through a jungle infested with wild animals and come out unharmed. Yet that very act is stupid. The downside to investing now is that you would lose money, much more than you could think. And at least lose the opportunity cost of 10-11% you can get on debt.
So trade by all means if you can trade. But for investing, the risk:reward ratio is not attractive.
PS: No analysis of the investing world can incorporate all data or make correct judgements all the time. Needless to say that my analysis could be wrong. You could make your own call.
Tuesday, August 26, 2008
Does investing in actively managed mutual funds make sense?
Actively managed mutual funds are supposed to beat their benchmark indices. If the index returns 10%, an actively managed mutual fund should return more than 10%. Similarly if the index loses 10%, the fund should lose less than 10%. You pay a small management fee to the mutual fund for managing your money and outperforming a benchmark index. Else why them money for their services; you could well buy an index fund which is passively managed.
For the uninitiated, in an actively managed fund, the fund manager creates a portfolio and buys and sells stocks depending upon his/her judgement, experience, ability and skill. In contrast, in a passive fund, the portfolio mimics a particular index, the stocks and the percentages in the portfolio are the same as those in the benchmarked index.
So do actively managed funds actually beat their respective indices?
Consider the Nifty-50 index that comprises 50 large cap stocks.
Over the last 3 years, the Nifty has risen at 23% compounded (as on 22 August 2008 day end).
Over the same period, only 22 out of 108 diversified equity funds that have existed for more than 3 years have given a return higher than 23%!
86 out of 108 funds have not been able to beat the Nifty index.
That's 80% of all such funds!
So why should the management fee be paid for managing money?
The percentage is similar for returns over 1 year. 82% (152 out of 184) diversified equity funds could not even garner a return of 5.1% given by the Nifty.
There are reasons for such underperformance. But the end result is, that over the last 3 years, 80% actively managed diversified mutual funds have not been able to beat the common index.
A similar trend exists in developed markets as well. For example, in the USA, 80% funds fail to beat their benchmark indices.
Mutual funds often become victims of their own success. When a particular fund outperforms, a lot of fresh money flows into it, chasing past performance. With larger assets under management, maintaining the same level of performance becomes difficult.
When mutual funds as an industry becomes too big, they tend to become a sizeable portion of the markets themselves. It then becomes difficult to beat the market since mutual funds start representing, in a very significant manner, the market itself!
Add to that the management fees and transaction costs. That takes away a little from the returns. At least in India, management fees are small. In the USA, this is not always the case.
The famous investor, John Bogle, an ardent advocate of index funds and does not think actively managed mutual funds can outperform an index over a long period of time.
In India, over the longer run, actively managed mutual funds have indeed beated the Nifty and the Sensex. For example, over the last 5 years, 41 out of 61 funds beat the Nifty returns. But one has to understand that mutual funds have proliferated in the last 3-4 years. There are only a handful of funds that have existed for over 10 years! Mutual funds that have a long history have been much smaller in size earlier. It is easier to beat an index with lesser capital under management. Size often becomes a hinderance for success.
For the uninitiated, in an actively managed fund, the fund manager creates a portfolio and buys and sells stocks depending upon his/her judgement, experience, ability and skill. In contrast, in a passive fund, the portfolio mimics a particular index, the stocks and the percentages in the portfolio are the same as those in the benchmarked index.
So do actively managed funds actually beat their respective indices?
Consider the Nifty-50 index that comprises 50 large cap stocks.
Over the last 3 years, the Nifty has risen at 23% compounded (as on 22 August 2008 day end).
Over the same period, only 22 out of 108 diversified equity funds that have existed for more than 3 years have given a return higher than 23%!
86 out of 108 funds have not been able to beat the Nifty index.
That's 80% of all such funds!
So why should the management fee be paid for managing money?
The percentage is similar for returns over 1 year. 82% (152 out of 184) diversified equity funds could not even garner a return of 5.1% given by the Nifty.
There are reasons for such underperformance. But the end result is, that over the last 3 years, 80% actively managed diversified mutual funds have not been able to beat the common index.
A similar trend exists in developed markets as well. For example, in the USA, 80% funds fail to beat their benchmark indices.
Mutual funds often become victims of their own success. When a particular fund outperforms, a lot of fresh money flows into it, chasing past performance. With larger assets under management, maintaining the same level of performance becomes difficult.
When mutual funds as an industry becomes too big, they tend to become a sizeable portion of the markets themselves. It then becomes difficult to beat the market since mutual funds start representing, in a very significant manner, the market itself!
Add to that the management fees and transaction costs. That takes away a little from the returns. At least in India, management fees are small. In the USA, this is not always the case.
The famous investor, John Bogle, an ardent advocate of index funds and does not think actively managed mutual funds can outperform an index over a long period of time.
In India, over the longer run, actively managed mutual funds have indeed beated the Nifty and the Sensex. For example, over the last 5 years, 41 out of 61 funds beat the Nifty returns. But one has to understand that mutual funds have proliferated in the last 3-4 years. There are only a handful of funds that have existed for over 10 years! Mutual funds that have a long history have been much smaller in size earlier. It is easier to beat an index with lesser capital under management. Size often becomes a hinderance for success.
Also, over the last 5 years, till 2005, midcap stocks that go seriously undervalued during the period 2000-2003, gained more than largecap stocks. Moreover, an economic upturn helps the performance of smaller companies more than those of larger companies.
Consequently, most funds outperformed the Nifty during the period 2003-2005.
Three years ago, actively managed mutual funds could easily have been declared superior to index fund investing. But in view of their recent underperformance compared to index investing, the jury on whether investing in actively managed mutual funds is better than passive index funds investing, is still out.
Only time will be the judge!
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