This week has been challenging for investors with constant flow of news about falling stock markets, raising crude oil prices, falling Indian Rupee and the stable interest rates etc. As reiterated last week by us here, 2018 continues to be volatile. The best thing for us to do as long-term investors, is to ignore the short-term noise and stay focused on the long-term goals.
While the logical part of our brain accepts the need to ignore short term signals, the emotional part is often in denial. This is wonderfully illustrated by Daniel Kahneman in his Nobel prize classic “Thinking Fast and Slow”. We are bombarded by news from social media, TV channels like CNBC, business newspapers, Whatsapp etc. How do we ignore all these short-term signals?
Today I would like to share a lesson from an IIM Ahmedabad professor. From personal experience, I can assure you that it is very useful. Harish Bhat, ex COO of Titan pays his tributes to his marketing guru – Prof Abhinandan Jain. Do read this moving note.
Prof Jain used to ask a simple question in class – “So?”It is the most powerful question we can ask!! Let us see why this is so relevant for us as Investors today.
Prof Jain was a teacher for 44 years at IIM Ahmedabad and he retired last month after guiding 40+ batches of CEO’s, IIM Directors in Marketing. One of his most powerful lessons was to teach students to think things through and not to be a “lazy thinker”.
The IIMs follow the case study methodology of teaching. The students would be given notes for a case study (e.g. how a company had to address a demand problem) prior to the class. The students are expected to read the case study and come prepared with their insights.
Typically, the class would be a discussion with inputs and views from students rather than a teacher reading out notes. The professor is more a facilitator who guides and shapes the thinking rather than reading out notes.
The Power of “So What?”
Whenever a student used to give an insight, Prof. Jain used to typically ask “So?”. I had a teacher from IIM Ahmedabad who used to ask a similar question, but he was more generous – he used to ask two words!! – “So What?” Whenever you are tempted to arrive at a conclusion based on a data point this will tempt you to think further towards a logical conclusion.
Let me give an example. Try applying this question to some of the recent news triggers
- Media and research analysts have opposite views – Morgan Stanley says that the Sensex will go to 42,000 by Sept 19 while Goldman Sachs downgradesIndian Equities – So What?
- The markets have fallen 10% in Sept 18. I have a notional loss of X lakhs – So What?
- Crude oil prices have increased 15 $ in the last quarter – So What?
- Rupee has depreciated 15% in the last quarter – So What?
This “So What” question will help us to think deeper than just reacting to the market movements.
- Have we not seen crude oil price raises and the falling Indian Rupee before?
- Have we not seen deep market corrections before?
- Have we not seen market recover from the lows?
- Have we not seen the Indian companies weathering these kind of storms before?
- Have we not seen the Indian companies grow their earnings over the last many years?
You will see that the logical chain of thoughts for each one of us should be as follows:
- Equity investments are a way to achieve long term goals (children’s education, retirement etc.). These are typically many years away
- Equity returns in the long run are driven by earnings growth of underlying stocks which are recovering and remain positive for Indian equities
- Equity investing will always have periods of volatility, like we are having now. We need to endure that to earn above average returns
- Continuing to invest in volatile times is rewarding and stopping investments now reduces your long-term returns.
We appreciate your patience in continuing your regular investments. In fact, this is the time for long term investments which will pay handsome dividends in the future. We would reiterate the importance of remaining invested. The bouts of volatility will cease after some time and the markets will move up from the current levels. But you should have remained invested in order to take advantage of the future price increases. Do remember that this mature investor behavior will give you the edge over other investors who are redeeming in panic. Correction is temporary, growth is permanent!!
When in doubt, always ask the magic question – So What? and stay calm and continue to invest!!
This week we have completed nine months in the calendar year – after a one way upward ride in 2017, we are now seeing significant volatility and valuation corrections in the equity markets.
Let us take a quick look at the market performance, the key events and what we should be doing.
Impact on the Equity Markets
The Indian equity markets saw a correction of 9% this month (we consider Nifty 500 to be more representative of the market than the Sensex or the nifty 50). This is the single largest monthly drop over the last ten years (from October 2008) onwards. Specific sectors were impacted in a significant manner
- From a sectoral viewpoint, the worst hit was banking and financial services (average fall of 14%), and Infrastructure (average fall of 11%). Pharma (down 4%) and Technology (down 1%) were relatively stable
- From a market cap viewpoint while the large cap (6.5% fall in the Nifty 50) corrected, the real fall was in the mid cap (down 13%) and small cap space (down 19%)
This correction has come after a steep rise in the past five years. Even now the Nifty small cap has five year annualized returns of 19% with several funds doing much better.
As always movements in the individual stocks are much more volatile. Various individual stocks have fallen between 35 to 50%( Dewan Housing Finance, Yes Bank, Infibeam, Indiabulls Real Estate, Jet Airways etc.).
What is possibly causing the turbulence in Financial Markets in Sept 2018?
There are some external and some internal events leading to this situation.
- Continued increase in crude oil prices (above 80 USD/barrel for Brent crude) and Indian rupee depreciation against the rupee (INR has depreciated 12% in the last six months)
- Regulatory action by RBI against banks (capping CEO tenure), Bandhan bank (freeze in branch expansion)
- A large financial institution (IL&FS) with total borrowings of Rs.100,000 crores has defaulted on commercial paper
- Federal Reserve interest rate increase by 0.25% and the expected upward trajectory
- Worsening fiscal deficit
What’s the silver lining at this juncture?
As we all know, ultimately in the long run, earnings growth of the Indian companies will drive market returns. The broader economic growth continues to be robust. The consumption demand has remained upbeat, investment in building capacities have started although in a smaller scale.
A Mint analysisof 1462 companies showed that aggregate net profits rose 22% in Q1 of 2018-19. Bloomberg consensus estimates for the Nifty 50 earnings growth this year is also positive. This is a silver lining in the horizon.
In fact, the rupee depreciation will give a boost to Nifty earnings (earnings could go up by 3% this year as per Credit Suisse).
While the current quarter earnings will provide additional insights, the micro indicators for various manufacturing industries continue to be positive (e.g. acquisitions by Tata Steel, Amazon in September). Also as and when NPA recognition by banks peak, the pressure on the P&L will ease for these institutions.
Keep Investing and do not stop!
Equity investments are always made keeping long term goals in mind. In the long term, we want our purchasing power to be protected.
We would like to reiterate the key messages we shared in this blog in Julythis year as well in our earlier newsletters. We would encounter this market volatility during our long-term wealth creation journey and continue to focus on basics (correct asset allocation, risk management and ignoring noise). We cannot stress enough on the importance of not only staying invested but also adding to your investments when the prices fall. Equity investing will continue to remain volatile, while producing long term returns which beats inflation.
Too often in the past, individuals have put in money when the market was at a high and stop their investments at exactly the time the markets fall. This trend is visible already this time also. AMFI data shows that net inflows into equity oriented mutual funds have dropped 60% from 20,000 crores in August 17 to 8,300 crores in August 18.
The ability to ignore the noise and remaining invested for the long term will give us the behavioral edge which helps us achieve superior portfolio returns in the long run!! Easier said, than done 😦
Continue with your SIPs and STPs, add more, if you can. There is definitely light at the end of the tunnel.
India’s largest equity oriented fund (more than 65% equity) in 2018 was HDFC Prudence with assets of Rs 36,000 crores in early 2018. It has now been renamed as HDFC Balanced Advantage Fund (BAF). Today let us take a deeper look into this fund to see how the reclassification has impacted the fund.
In 2018 the market regulator SEBI has asked mutual funds to reclassify their funds so that investors can be clear about where they are investing. SEBI has created 36 categories of funds and several fund houses have had to merge and align funds so that they fit into a category.
India’s largest equity oriented fund – HDFC Prudence was impacted as HDFC Mutual fund had two funds in the erstwhile balanced category – HDFC Balanced and HDFC Prudence. Both these funds used to have between 65 to 75% equity allocation and they had an excellent track record.
HDFC Prudence was merged into HDFC Growth and it was classified as a balanced advantage fund. Hence, the fund was renamed as HDFC Balanced Advantage fund. As per the mutual fund website page for HDFC BAF (click here), the Investment objective is as follows “To provide long term capital appreciation / income from a dynamic mix of equity and debt investments.”
No additional information is available. The SID (scheme information document) link given in the Documents tab in the website is for the SID of HDFC Growth from April 2017. There are no leaflets or product presentations for HDFC BAF. In the overall SID section a SID for BAF is there (click here).
In their product positioning document in April 2018 (click here), HDFC BAF is at the extreme right end of the expected risk return spectrum for hybrid funds. This is above HDFC Hybrid Equity which is a Hybrid aggressive fund with an explicit mandate to invest in equity
Current Fund Portfolio and Category Comparison
With a change in mandate from HDFC Prudence to BAF let us take a look at the portfolio between April 18 (Prudence) and Aug 18 (BAF).
- There is no major change in the portfolio either on the debt or equity side
- The Equity allocation has actually gone up from 75%in April to 78% in August (for comparison, the average BAF fund has 40% in Equity)
- The Cash holdings of the fund is 1% (The average BAF fund has 28% holdings in cash)
- The standard deviation and beta of the fund is twice that of ICICI BAF (the pioneer in this category)
- The debt portion of the fund has an average maturity of 5.25 years, against the peer group average of 1 year
- The top 10 holdings on the equity side and the top 5 holdings on the debt side has remained constant during the last 6 months or so
- The portfolio turnover is around 14.5% compared to ICICI BAF Portfolio turnover of 500%
Based on current information, it is clear that HDFC has retained the HDFC Prudence portfolio in BAF without making major changes to the portfolio. This has helped the fund house retain nearly 39,000 crores of assets in a fund with a great track record.
What should Investors do now
Investors looking for a high-risk hybrid equity fund similar to erstwhile HDFC Prudence can continue to hold on to the fund. This is an excellent high-risk hybrid fund run by a superb fund manager.
Investors looking for lower risk balanced advantage funds may look at other funds in the category. The biggest mismatch is for those investors who are investing in HDFC BAF treating it as a balanced advantage fund as per it’s stated objectives.
Investing in equities for the long run requires a variety of skills, both technical (understanding of the business, future prospects, industry scenario, relative valuations) and emotional (managing volatility and emotions of fear and greed). This is particularly true in the case of small cap stocks.
We have received multiple queries from clients about Research services from various firms, reputed and otherwise. How good are these research services and are investors better off investing based on this research?
What is a small cap?
As per SEBI classification, any stock which is ranked 251 and above from a market capitalization viewpoint is considered a small cap. You can access the list here. The largest company in this segment has a market cap of 9800 crores and there are more than 1000 stocks with a market cap greater than 300 crores.
This is also a segment where various market related news, rumors, insider information is all peddled as “expert views” and claim to provide an edge to the investors.
Let’s look at the long term returns of the small cap index over the last 10 years. The NIFTY Small Cap 250 Total Return Index has an annualized return of 11.75%. This is an interesting number! But, we believe that the index returns hides more than it actually reveals.
– The volatility of small cap stocks are much higher than their large cap peers.
– The small cap valuation is very cyclical in nature. Small caps have had a great run over the last five years. But today, there are more than 1700 stocks which has corrected above 25% from their January 2018 peak levels.
We believe that individual passive investors are better off by investing in well managed “Small cap funds” as compared to investing in small cap stocks. Why do we say that? Because, after analyzing the stock recommendations from a well-known research outfit in small cap space and comparing the performance of small cap funds, we have come to this decision.
What has been the performance over the years?
Equity Advisory Firm Recommendations:
One of the leading stock advisory research firms to which we subscribe has a separate section for small caps. We were looking at their recommendations from Jan 2017 to June 2018. Over an 18-month period 17 recommendations were made!
– Out of 17 stocks, positions in 2 of them were closed with an average gain of 45% within six months of the recommendation.
– The remaining 15 continue to be open and they are all down with the average notional loss at 25%.
– Even going back over the past ten years, they have recommended exits in 56 stocks. There is only one stock for which they have a buy record which is still open after five years.
One thing which becomes clear is that it requires too much of action, nimble footedness, constant monitoring of the portfolio and quick entry and exits in identified stocks. Is it all possible for a passive investor?
Small Cap Mutual Funds:
On the other hand, Small cap mutual funds offer exposure to a diversified set of small cap stocks across industries. Many of the bigger funds have strong track records over the long term.
|Fund Names@||3 year||5 year||10 year|
|Franklin India Smaller Companies||15.01%||31.46%||19.61%|
|DSP Small Cap Fund||13.76%||34.76%||20.73%|
|HSBC Small Cap Fund||12.15%||31.67%||12.07%|
@These funds are not recommendations but just to show the performance over 10 years
While liquidity and valuations continue to be a challenge for the small cap fund managers also, they have access to management, ongoing tracking and the ability to re-balance.
What should we be doing?
There is no doubt that small cap investing adds an amount of “spice” to our portfolios. But it is not mandatory for all investors. Even if someone fancies small caps, rather than making individual stock selections or looking at paid research services, investing through quality small cap funds seems to be the “safer if less adventurous” way.
Buying a house – particularly for the first time is always a significant event for a family. There are various factors related to the property (location, cost, size etc.) as well as the family (savings, asset allocation, liquidity, income potential, age etc.) which play a key role in the decision.
Today let us look at one variable – the size of the unit and how it impacts us. This also manifests itself in the need to move from 2 to 3 bedroom apartments.
Average unit size aspiration has gone up
Recently Housing.com and Makaan did some research which showed us that the average unit size aspirations of Indians in cities continues to grow and it was around 1300 square feet.
Hyderabad leads the way with an average aspiration of 1757square feet followed by Gurgaon (1600) and Bangalore (1409). The only exception is in Mumbai where the aspiration has gone down to 875 square feet (down 8%), possibly because of the high prices.
This is in line with global trends. In the US, the average home size has increased by a 1000 sq. feet over the last forty years and is now 2687 sq. ft.However, financial planners in the US have started pointing out the challenges with such large apartments.
So does larger apartment size help?
We all love having more space for ourselves. From the days of having a joint family in a 1 or 2-bedroom house, having a larger 3-bedroom house for nuclear families (typically couple and 1-2 kids) has increased the space available per individual. In addition, the larger apartments tend to be inside gated communities which offer more facilities and space for our children.
This UCLA study in the US highlights the downside of such large apartments
“costly but virtually unused “master suites”; children who rarely go outside; stacks and stacks of clutter; entire walls devoted to displays of Barbie dolls, Beanie Babies and other toys; garages so packed with household overflow that cars have to be parked on the street”
While the context in India needs to be studied, one also has to keep in mind that education is very important to us and time and again we come across families sending their children abroad for education.
From a sustainability viewpoint also, larger houses inhabited by fewer people does impact the environment adversely.
What are the financial implications
Typical financial implications are the following
- Apartment value – Increase in size is another form of leverage! If the real estate prices go up then there is significant capital appreciation from larger flats. However, if it remains flat or starts to fall (what we are seeing over the past 4-5 years) then this can be a burden
- With more size comes more EMI!! – As the size increases the overall cost of the apartment goes up. Of course, if the property is brought with own funds then it locks up capital
- Increase in community maintenance cost – In most communities, maintenance is computed based on the apartment size. This expense will increase in the coming years
- Cost of maintaining the apartment – there is an increase in this cost as well
What we can do?
Ultimately the size of the ideal house would be different for each individual considering their circumstances. Also, the emotional satisfaction from living in a dream house (of the right size) with our family cannot be measured.
Purely, from a financial and maintenance viewpoint, we need not blindly follow the trend. Be it an increase in the size of the apartment or moving to three bedroom apartments, understanding our current situation, future income and needs will help us choose the right size. In the long run, compact houses are easier to maintain and are easier on the pocket as well!
One of our oft-repeated themes is that it pays to just remain invested in good funds or direct stocks with a long term perspective.
Recently Association of Mutual Funds India (AMFI) has released voluminous data on the holding periods of the different kinds of investors.
- Looking at the total investor community (across Retail, HNI, Institutional investors) the % of Folios which are more than 2 years old has come down from 58% in March 2010 to 30% in March 2018 – such investors have dropped by half!! Most probably they are chasing performance, by churning from one fund to another.
- In March 2018 more than 30% of the folios is less than 6 months old and half of the equity folios were less than one year old!
- Only 22% of the HNI folios are more than 2 years old.
While there are some reasons which can be given for the above data (lots of money has come into equity over the past two years, easy of investing online, new fund classes etc.), the overall trend is consistent over the past decade – holding durations for investors are getting shorter. This doesn’t augur well. Majority of the investors will lose out in the long run by these constant churning. Longer your hold, better your returns are!
Did this continuous churning help?
In the same time period of 2009 to 2018 instead of churning folios what would have happened if the investor had stayed in the same fund? We have more than 120 funds from large fund houses with ten-year track records.
The Average ten-year return for these funds is 13.5% with the worst fund delivering 8% and the best fund giving 20% returns.
Staying invested in a good quality fund for the long term generates tremendous returns. Even investing in an average fund would have given 13% over ten years.
This 13% return over 10 years translates in to your 3.39X in 10 years. Your Rs1 lakh investment would have grown in to Rs3.39 lakhs.
What does this mean for us
Equity as an asset class tests our patience and conviction at various levels. While there will be overall cycles in equity as an asset class itself with highs (e.g. 2009, 2017) and lows (e.g. 2008,2011) in addition we will see short term fluctuations in the actual fund/stock itself where we have invested.
Ignoring all this noise and staying invested in good equity funds through the ups and downs will give us superior returns.
Pick right and sit tight!! If we have held on to the same fund for more than ten years itself we would be in a small minority in the market. This positions us very well for long term returns. Of course, now you can also save some taxes by avoiding constant churning of funds.
“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!” – Jesse Livermore