Random Ramblings

Human Mind is hardwired to lose money in Stock markets. There is a perpetual oscillation between greed and fear, that influences any buy/sell/hold decisions. (hold is also a decision , remember our late PM PV Narasimha Rao) I have attempted an illustration of the human mind while dealing with stocks. (pic 1)

Human Mind is hardwired to lose money in Stock markets.

If one is to succeed there is a need to detach human mind from our buy / sell decisions.

Another example of how an automated system is better suited to certain situations

You come back home tired , late at night and ask your Mom to wake you up early for an important meeting . Then you find in the morning you are late, having overslept. You ask your mom and she says sweetly, “you were sleeping so soundly that I didn’t have the heart to wake you up” … Ok , it would have been a different matter had you asked your wife. She would have taken it as a great opportunity to pour a bucket of cold water on your head ! Under the circumstances an alarm clock , set to multiple rings , would have solved the purpose wonderfully, sans emotions.

So we come to SIP or Systematic Investment Plan .

Many of us would have come across tables to illustrate how investing through a Systematic Investment plan is superior to investing a lump sum.

Two options are compared through the table; lump sum investment of Rs 12,000 at the beginning of a 12 month period and monthly investment of Rs 1000/- for 12 months. The SIP route has resulted in getting an addition unit of MF for the same cost price even though the amount invested is in installments.  You get more units when the market is down and less units when the market is up. It is also called Rupee Cost averaging.

A point to note is that this is not always the case.  In a bear market, SIP is more efficient and in a bull market SIP may actually result in getting less number of units. Ideally one should invest in a lump sum when the market has bottomed out. But the catch is that Nobody knows when the market has bottoms out. In 2008, No one knew , that the market was at its peak and in 2009 No one knew that it had bottomed out. If an investor had got out of the market in Jan 2008 and re-entered anytime between Oct 2008 and Mar 2009, he would be sitting on a huge fortune today. But that is hindsight. In reality most people sold out in mid 2008 at a loss after waiting for a reversal and were scared to re-enter till 2012 when the market was already up. Some are still keeping away and are just coming back in trickles in 2017-18 .

If an investor had got out of the market in Jan 2008 and re-entered anytime between Oct 2008 and Mar 2009, he would be sitting on a huge fortune today. But that is hindsight. In reality most people sold out in mid 2008 at a loss after a long painful wait for a reversal and were scared to re-enter till 2012 when the market was already up. Some are still keeping away and are just coming back in trickles in 2017-18 .

It’s like riding a roller-coaster ride blind-folded; you can’t brace yourself for the ups and downs.  For a deeper understanding  click here

More important than the arithmetic, it is the detachment of human mind that makes SIP great. When I first started regular investments in MF, it was during the bull run post 2004 elections. Then in 2006, there was a slump and every stock, every Mutual Fund started heading south. I had a tech heavy portfolio and these stocks lost wealth faster as dollar was depreciating against rupee. My first action was to redeem my MFs. Why should I actually pay someone to lose my money ?

More important than the arithmetic, it is the detachment of human mind that makes SIP great.

On hindsight , I had made two big mistakes. Firstly, I had compared the MF performance in absolute terms and not with its benchmark Index. These MFs were still losing money slower than their benchmark indices and so, were still performing great. The second mistake was that while I was prepared to invest at higher NAV while I was hesitating to do so at lower NAVs.

Stock market pundits would tell you that , 10 shares of Infosys bought at IPO at Rs 95/ per share (all of Rs 950/) in 1993 (it was under-subscribed) would now be worth over 50 lakhs. So is it with the wealth created by Wipro or Reliance. I wonder how many of us have met any person who have actually benefited from such an investment. On the contrary, prior to Harshad Mehta scam, the same shares Infosys and Wipro had reached astronomical prices with three figure PEs and many investors lost big-time as the bubble burst. I am sure we would have met some of these investors . In short, big losses are real while big profits are hypothetical and on hindsight.

In short, big losses are real while big profits are hypothetical and on hindsight.

Sundaram Finance undertook an exercise to identify the beneficiaries of one of its top performing MFs Sundaram Select Midcap Fund. The idea was to honour these people in their AGM to highlight the importance of long term view on investments. It had given 5400% returns in 15 years since launch. After a lot of digging into their databases they could physically identify only a handful of investors. Half of these were dead and the others were not aware that they were holding these valuable assets. They were the only people who created wealth through long term investment ; the dead and the duds. So, if you want to make money through stock markets, after investing, be dead to the market or just be unaware, forget about the market; easier said than done.

the only people who created wealth through long term investment ; the dead and the duds. So, if you want to make money through stock markets, after investing, be dead to the market or just be unaware, forget about the market; easier said than done.

More than anything, an SIP ensures that you are not affected by the swings in the stock market .  It goes like the steady tick-tick of a grandfather’s clock even though a storm may be raging all around. I’ll conclude with my personal experience on the effectiveness of SIP.

Most of us are used to the monthly subscription we make to some kind of provident fund , partly to avoid paying higher income tax. Provident Fund gives about 8 % returns and there is a tax rebate. After retirement in 2012, I started investing in ELSS (Equity Linked Saving Schemes) through SIP. Last year I had invested in Axis Long Term Equty Fund . I get the same tax rebate as someone who invests in PPF, and the returns given by the MFs are about 12-18% annualized. Since there is a lock-in period of three years , it is a forced long term investment. Pic

Note that there is no growth for the first year and a half but it is made up subsequently. Normally , a human mind is susceptible to intervene in such situations, often to a disastrous effect.

The only thing which is always true in a MF brochure is the mandatory disclaimer :  Mutual Funds are subject to market risks ; …. Past performance of a Fund is no guarantee for future returns.

We know from the historical data that Market rewards long term investors. We also know from anecdotal evidence that most people buy high and sell low.  It is not the people , but their emotions , greed and fear that make the buy / sell decisions.  Detach the emotions from investment decisions and you have SIP.

Next we see how individual MFs are evaluated.

Every brokerage firm wants to sell , sell and sell. So they just want you to buy ,buy and buy.  Advertisement for a financial product is just as for any other product in the market. However, there is one big difference; In a financial product, there is no tyre to kick; there is no hardware. Then there is the disclaimer “Mutual Funds are subject to market risks blah blah blah” . So, it is very easy to mis-sell Schemes with fancy names like Guaranteed Income Scheme. How can you expect any guarantee when “ Mutual Funds are subject to market risks …..” ?

In the MF industry , there are three main players; AMC, Distributors and investors. The Distributors are paid by the AMCs commission for every unit of a Scheme sold and the investors bear these costs irrespective of profit or loss they incur. Who bears the cost of running the AMCs ? It is investors again. How do the AMCs charge  after all Investors don’t write out a cheque, as fees? The charges are deducted from the NAV (Net asset value) of a unit in the name of expense ratio , the charges for running a MF . An innocuous looking 1.5 % expense ratio can make a significant dent in your returns. For example, Rs 1 lakh over 10 years at the rate of 15 per cent will grow to Rs 4.05 lakh. But if we consider an expense ratio of 1.5 per cent, your actual total returns would be Rs 3.55 lakh, nearly 14 per cent less than what would have been achieved without any expense charge.

  An innocuous looking 1.5 % expense ratio can make a significant dent in your returns. For example, Rs 1 lakh over 10 years at the rate of 15 per cent will grow to Rs 4.05 lakh. But if we consider an expense ratio of 1.5 per cent, your actual total returns would be Rs 3.55 lakh, nearly 14 per cent less than what would have been achieved without any expense charge.

An equity MF can charge upto 2.5 % and a debt fund can charge upto 2.25 %. In effect , once a product is sold, for a distributor an one time  return is guaranteed and for an AMC, an annual return is guaranteed and only the investors return is subject to market risks !!

With assured outgo of 1 – 2.5 % per annum from your investment, wouldn’t it be prudent to do some check before buying ?

The Net is a boon as well as a bane.

The Net is teeming with analysts and advisors on Mutual Funds. I am wary of clichés like “There’s no free lunch”. Actually in the digital world , there is free lunch with dessert included provided one is careful about his surfing habits and sources. I don’t mean piracy, but legitimate sources of information and data. Generally there is no dearth of places for Gyaan starting from the American “Investopaedia” to our own start up from Bengaluru zerodha . They are excellent free sources if only one is prepared to read. But who wants to read. ? We often hear “yeh sab chhod , batao kaunsa fund thik hai” . People just want the proceeds rather than the process. Just give me a list of stocks or funds to invest in.  That’s understandable; perfectly okay. There are places to get such lists also.

Though most of the brokerages publish their general recommendations and bring out free newsletters, the specific recommendations are restricted to paid subscribers. So, to begin with one should study the website of your own brokerage company thoroughly.

Here , I am giving some screen-shots from ICICI Direct Brokerage . I hope it is not an infringement on IP  rights. Most of it is in public domain anyway.

Then there is outlook money magazine which brings out a list of Funds every year as OLM 50. Here’s a snap shot .

After investing , unlike Stocks, there is no need to monitor on daily basis as that is what the Fund manager and his team are paid for. However, at-least every quarter one should have a look at the portfolio to decide on ” buy , hold or sell”. If due diligence  is done before buying, there would be no need to churn the portfolio too often.

The least one should do is the have a look at the last column of portfolio details on the web site . You won’t be very wrong even if you just follow the recommendations in the remarks columns.

To summarize, firstly, one should avoid falling prey to mis-selling by distributors . Secondly, a little bit of study will help to build a balanced portfolio for growth and stability.

SIP will require a separate post by itself.

A list of links to study for Mutual Funds Pick

Traditionally , Indians invest in real estate , gold and fixed deposits and it is only in the recent years that Equities and Mutual Funds have attracted the investors’ attention. Our pension funds have just started investing in the Stock Market. Still there is a long way to go before every investor has a stake in some mutual fund or the other, directly or indirectly.

Year after year MF AUM (Asset Under Management) is increasing 20-30 percent. I am not an expert on Investments or Mutual Funds but I am trying to learn the ropes as I go along , over the past 10-12 years. This just an attempt to share my experiences for investors starting out now; a primer in Mutual Fund Investing.

Why Mutual Funds

Everybody hears stories of people having got excellent returns from investment in the share markets. But unfortunately they also hear stories of the big crashes in the stock markets and crores of rupees being wiped out in a day. There are people whose life times savings have shrunk to one fifth or one sixth of the original capital. Is it worth the risk ? Investing in mutual funds helps to mitigate the risks involved in direct investment in equities.

If you need to cross a lake, you may just  put on a life jacket , pack something to eat and drink , and set about to “row row , row the boat ,gently down the lake” . But if you need to go into a sea , where there are too many unknowns and too many risks like winds and waves, hurricanes and Icebergs , it is better to look for a ship equipped to negotiate through all kinds of obstacles. Also you need an astute Skipper and a navigator.

While an investor can easily understand financial instruments like fixed deposits and bonds to invest on their own , Equity is a different kettle of fish. If one is not careful, a financial tsunami can wipe out the entire capital. So you need a qualified fund manager backed up by a battery of research assistants with all technical and tactical tools they can muster.

So, if you want to undertake a voyage you need to find a good ship and a good skipper. The Mutual Fund Scheme is the Ship and the Fund manager is the captain of that ship and there is a qualified and experienced crew to assist him.

Next question is how do you select one or two out of the myriad number of schemes in the market. Every day there are new schemes and offers announced to attract investors. Here, we need to understand the idea of risk reward chart.

Higher the risk, higher the reward. Debt funds are like open ended fixed deposits . They give a low return but always a positive one. The Debt / Liquid MFs invest in Govt bonds and such instruments which give fixed returns.

The next in order is Hybrid Funds that invest in Equities and Bonds in a fixed ratio. Depending on the ratio they could be equity heavy or Bonds heavy. Suffice to say that equity oriented Hybrid funds carry higher risks and they also offer higher rewards.

Next we have diversified , large caps followed by diversified mid cap funds. There are also multicap mutual funds which fall somewhere in between. Lastly, we have the sector specific mutual funds. There are times when investors are bullish on a particular sector like technology, pharma or say banking , AMCs(Asset management Companies) launch sector specific schemes to take advantage. But when the tide turns, these happen to be the most affected schemes. To give an example, in 2005-6 bull run, IT funds gave more than 100 % returns in a year and in the crash of 2008, it is the power and infrastructure MFs which saw a huge downturn. You can see the chart of reliance power and infrastructure MF. The scheme was sold with a lot of promise in 2008 and crashed with every dip in the market. An investor who had entered in 2008 would have hardly seen any gain till 2016. This may be compared to the performance of a typical diversified equity MF. HDFC top 100. It can be seen from the chart that from Rs 10/ in 1998, it has steadily rose to Rs 540 in 2018; a return of 50 times in 20 years.

It doesn’t mean that sector funds are to be avoided altogether. The risk must be understood correctly and a small percentage of the total capital , say 10% can be invested in such schemes.

How is MF Scheme judged ?

Primarily , a scheme is nothing but the composition of underlying equity assets. A  scheme buying risky equities is risky and one buying stocks of a solid company like blue chips are safer.  The performance of a Scheme is judged against its bench mark index . It could be Nifty 50 or BSE 100 or banking Index etc. That’s why a Scheme is said to be performing well even when it gives negative returns. It may have given a return of -5 % when its bench mark index , say Nifty 50 has given -10%. So if you are buying  a Pharma  MF, you should compare it with the NSE Pharma Index to track it’s performance.

New Fund Offers (NFOs)

Earlier the new schemes were called IPOs. People went for these “IPOs” as they cost only rs 10/ per unit compared to older schemes which cost anything like 500-600 rs per unit. The irony is that people never seem to understand that 10 X 500 and 500 X 10 gives the same result. If anything, the Rs 500 per unit scheme just shows that it has multiplied 50 times since inception. Now they are called NFOs as per directions of SEBI.

Why do AMCs come up with NFOs ? There may be a genuine reason or a necessity to exploit some opportunity in the stock market like arbitrage Fund. But mostly NFOs are ploys to attract more investors. Sometimes an AMC has to float a scheme just to match the competitors who have launched a new thematic fund. Theoretically, there are enough schemes in the market to cater for all kinds of investors. Before going for an NFO, one should be aware that the company is planning to start building his “ship” only with the money collected from the investors like you. Then it takes time to deploy the money. So, initially the Rs 10/ will dip to 9.xx before any gains. It is always better to wait for a Scheme to deploy the money and see how the underlying stocks perform.

Steps to Invest in MF.

How to identifies the schemes most suitable to you. Here I make an assumption that the money set aside for investment should be locked in for atleast three years if not more. Unlike premature withdrwal of Fds, premature selling of MFs can prove very costly.

Top Down Approach

Supposing we have 10 L for investment, it would be a good idea to decide how the risk / reard is to be spread. It would depend on your own temperament and appetite for risk. Normally midcaps and sector funds provide growth to the portfolio while balanced MFs and bluechip MFs provide stability. The debt/liquid funds are equally important. Liquid funds are used for temporary parking of money and also as a reserve to be deployed during market downturns. The ratio could be as under :

Sector Funds – 10%

Midcap Funds – 30%

Largecap diversified funds – 30%

balanced funds – 15 %

Liquid funds – 15%

Bottom up Approach

There are a number of organizations that evaluates the MFs and rate them as three star, five star etc. The details are also available on their web sites. Some of these sites are valueresearch org , mutual funds of india etc. They  can be accessed at my web site  under the menu Money —> Investments.

Of course , one gets lots of tips from people dealing in MFs.  But one has to be aware of the fact that there is more mis-selling than genuine ,free, financial advice. So, it is worth checking back from a second source.

Whichever way , first individual Schemes can be  picked and a portfolio be built , keeping in mind the aspect of Risk – Reward.

In the next part , we’ll go about on-line platforms and SIP mode for investments.