Value Investing

Value Investing

Self Awareness

Drawing lessons from this piece by Samuel Lee of MorningStar, I put together this grim doodle to keep reminding me of the importance of awareness of our ignorance. The solution obviously lies in either reducing our self ignorance or seeking external help. In the context of investing and speculation, reduction of self ignorance usually means learning by reading more and learning by application. If one has little time for that, then turning over the game (fully/partly) to a qualified investment advisor is the best option.

Awareness of Investor

Progress Through ReGrESS

Middle men have always blocked new ideas and won reconciliatory middle ground in India. The inclusion of ETFs in the Rajiv Gandhi Equity Savings Scheme (RGESS) is one such example. While the matter of the difference of opinion between the Finance Ministry and the Securities and Exchange Board of India (SEBI) is interesting, the development is noteworthy since it could benefit us retail rats quite a lot.

 The thing is that equity remains shunned as an asset class by an overwhelming majority of small investors in 5% – 7% growing emerging India. Whatever little money does get invested goes into managed funds finds its way into the Mutual Fund coffers. ETFs offer a long term, cost efficient vehicle for parking money and are quite cheaper as compared to Mutual Funds. So if the retail rats don’t get it, why shouldn’t the Government play pied piper and lead them to the bourses. It certainly helps that the current Finance Minister (Chidambaram) is more taken to the merits of equity as compared to his predecessor. A part of him may even secretly look at the market levels as a barometer for his success.

 It’s also a great idea to pool in slivers of equity from profitable PSUs, bundle them into an ETF and offer it to investors. That way you don’t have to do an IPO/FPO for each constituent PSU and give some semblance of portfolio stability to the investment. How much this appeals to local financial institutions is the key question. It is institutional demand that really gave the initial impetus to ETFs in the US. The other factor is the capacity and standing of the sponsor has always been key during ETF issuances since a strong, well spread out sponsor will bring it the much need liquidity without which ETFs generally fail.

 I will be exhorting whoever I can and whoever is bothered to listen to max up their contributions in RGESS. While direct investing in equity is always better when we are taking about holding it through a full business cycle, ETFs could be better for people who do not have enough financial savvy as it takes the guesswork out of the process. Here are some useful links to additional material on the topic:

Seven Habits of Highly Ineffective Investors

Inverting the perspective sometimes yields interesting insights. Here’s my attempt at an inverted mashup of Stephen Covey’s widely popular work. Stephen Covey died on 16July 2012.

Lack of Independence or Self-Mastery

Habit 1

Being ReactiveEquity investing is never risky. The risk does not come from the trade but from the trader. Reactive traders are influenced by the noise around them – hot tips, consensus, crowd behaviour, market gloom etc. All losses that are experienced by investors fall into three categories – direct control, indirect control or no control. Almost all the losses of highly ineffective investors fall in the direct control area. The boring but effective investors usually have control on their losses or experience losses due to events totally out of their control (9/11, Lehman Collapse, etc.)

Habit 2

Begin With No End In MindThe ineffective investors’ Covey urges them to visualise their funeral. What would their obituary read? Here lies an ineffective investor: he was a wayward arrow and never knew where he was headed (until his last journey!). Ineffective investors do not have a personal trading mission statement. Neither do they have personal trading heuristics or models and typically tend to get along with the flow. They don’t write down what their closing position should be before entering the trade.

Habit 3

Don’t Put First Things FirstIneffective investors do not prioritize and plan their tasks based on importance. They have no independent will and are generally incapable of thinking for themselves. If they read a research report or a stock story, they rush into buying or selling without spending enough time on self discovery and understanding ‘why’ they trade.

No Inter-dependence

Habit 4

Don’t Think Win-WinIt is not at all important for an ineffective investor to have a plan B and a pre-determined response to what one needs to do if the investment thesis does not work according to plan. A win-win thinker hedges his bets, uses stop losses and balances his portfolio wisely. Why bother with all this if your aim is to be as ineffective as possible? “What dork expects to win on a heads and win on a tails as well? Is it really possible?”, is something which a highly ineffective investor would like to know.

Habit 5

Seek First to be Understood, then UnderstandBragging rights are reserved for ineffective investors. There is a certain male bravado amongst this set. They unnecessarily keep staring at the screens and fantasise and want to talk about their exploits to anyone who would care to listen. The clinically precise and hermit-like reclusive effective investors tend to focus their energy in listening to what the market is telling them

Habit 6

No SynergyIneffective investors do not tap into the power of the network; they do not read extensively and they do not develop their lattice network of various mental models that are required for one to be effective in analysing investment options. Why waste time in reading books, investment blogs and other data reports when all one wants to be is ineffective at investing?

No Self-Renewal

Habit 7

Forget To Sharpen The SawSelf-rejuvenation and self-renewal are only meant for people who want to be effective. These losers seek a balance in their life, are not obsessed with the markets and are perfectly fine checking their portfolio values once a day (it at all). Ineffective investors are blunt instruments are would be the ones who’d typically lose sleep over their positions and want to keep tabs and follow the market even when they are on a vacation. Ineffective investors do not plan, practice and re-test their models.

How Many Eggs In Your Basket?

“Don’t put all your eggs in one basket”. That’s what Cervantes made the  rotund Sancho Panza say in his book Don Quixote. The view expressed across the Atlantic, however, was quite different. Mark Twain told us to put all eggs in one basket and to watch that basket very carefully. Wise wits and financial advisors take Cervantes’ cue and tell us to scatter our assets and attention. The saying undoubtedly originated from the simple observation that if you put all your eggs in one basket and if you were to drop that basket, then you’d lose all your precious eggs. If I were a CFA or a wealth advisor I’d have egg on my face if I said that I believed that Mark Twain was right, but since I am not, I am going to exactly do that in this post! It’s important to understand the context in which it’s good to diversify and where it is not. This is the context I am referring to: make a pie chart of your wealth and ensure that you always have 3 – 4 wel diversified slices in it. Within the particular slice of the pie that indicates your equity exposure, you shouldn’t have too many further sub divisions. Many people interpret the eggs in one basket to mean that they need to own multiple stocks and multiple mutual funds!

According to me, it’s obviously important to have a little diversification and redundancy but generally small investors take this to the extreme. They play with woefully small stakes. So even if they bag multi-baggers it hardly grows their personal wealth. Even if you get a 3x return what’s the point if all that you have running on it is a measly 10,000/-? If I have to talk co-variances and correlations, the multi-basket approach only works if the baskets are independent. Which means that it is obviously a great idea to spread your wealth across (mostly non-correlated) asset classes like gold (not too much please!), real estate (uncorrelated really?), stocks, equity mutual funds, fixed income (PPF, bonds, debt MFs) etc. Fixed income may be interesting over a 2 – 3 year horizon if the local interest rates move down. If you noticed, I did not mention insurance since I do not consider that asset class as an investment, sorry.

But it’s a horrible idea to spread your investments across > 15 stocks (just to pick a number, my Kelly Formula post notwithstanding). Why? Because its impossible for a small investor with a daily job to digest all those bits and bytes of information that get generated in the financial marketplace everyday. You can’t monitor multiple baskets beyond a point. By spreading your capital across multiple stocks you are certainly setting yourself up for cleaning the mess that’s soon to appear on your floor. Be careful with those egg shells when you walk, you may bleed (in more ways than one).

If I have lost you or you remain skeptical, then let me try some other way. Let’s try to visualise as to why you may want to keep all your eggs in one basket:

  • You have only one egg [well. you shouldnt be in the markets. Line up to buy Super Lotto.]
  • You have only one arm [I do. I am not ambidextrous – juggling work and finances and home and hobbies is challenging on me. Quality suffers. So I have only one arm to give for monitoring my trades]
  • You need all your eggs [which means dropping one basket with all eggs will cause you similar grief as dropping some baskets]
  • It’s a trash basket [all your eggs are already broken or rotten – i.e. hopeless loss making holdings. I’d strongly urge you sell off all your shares (if they are really broken or rotten) and A) start fresh and B) start reading this post from the top!]
  • You eggactly know what you have [i.e. you’ve focused on a few ideas but really thought very deeply & are honest to admit to yourself what you don’t know]
  • Last time you spread your eggs across baskets you dropped a few of them [This is true in my case and the following paragraph talks about that]

A past colleague and good friend drilled this message into me. Since then (this was nearly 3 years ago) I have consciously tried to reduce the number of positions I have at any given point in time in a bid to improve my performance. I have been resonably able to limit my holdings to a few, and I can now stand up in front of the mirror and talk about the basis for each of my speculation – when bought, how many shares bought, why bought, when will I fold, maximum loss threshold etc. It was impossible to do this when I had > 15 stocks in my portfolio.

The challenge here? As your portfolio size increases having just 5 – 6 stock positions at any given point in time means your stakes go really high. If you cannot make the mental shift to think in % terms and remain rooted to absolute rupee amounts, then this focus will be impossible to achieve. You will either end up being under-invested in equity (since it’s too much work) or have loads of positions to monitor.

Finally, inspired as I am by Mark Twain, let me invent a quote: “Never own more stocks than there are colours in a rainbow!” Am I an egghead or what? 🙂

Why Long Term Financial Planning Sucks

Long term planning lulls one to believe that the future is under control. Many of us meet fast talking financial salesmen (women?) and feel smug when we buy some investment cum insurance policy or unit linked insurance plans etc. Even a house or the index for that matter bought for the purposes of holding on to 10+ years makes us feel confident that we have secured our future. A book that I really like doesn’t think so. Its called The Zurich Axioms (by Max Gunther) and I like picking it up and reading a small chapter or two on and off, repeatedly. The fable of the ant and the grasshopper is turned on its head in the book:

The dour and practical ant works all summer long in anticipation of the winter ahead,while the planless grasshopper just sits around singing in the sun. In the end, of course, the poor grasshopper has to come around, hat in hand, to beg for food, while the ant has the satisfaction of saying, “Ha, ha, I told you so.”

In real life, however, it is more often the ant who gets himself fumigated or has his nest torn up by a bulldozer. That’s what comes of having roots, and roots come partly from long-range plans. The grasshopper, lighter on his feet, just hops out of the way.

You may have visibility for probably a week ahead (unless black swans fly over your head). If you are really gifted, maybe you can portend the events to come a month ahead. What about six months? Or a year? The visibility dims considerably, but you’d still beable to reasonably predict where you will be in your personal and professional life a year or two ahead. I can bet that you can’t predict where the markets will be a year or two ahead with the same level of confidence. Even on personal/professional matters, a period of five years  itself starts getting quite blurred to predict into, especially if you are a relatively young person who has just started his career and family. If you older, then yes, maybe you can see five years ahead. But then long term financial planning is done by young ‘uns, right? And wait, we just got to five years! What about ten years? Twenty years?

You just can’t see through the fog of time. Remember that – you just can’t see through the fog of time.

The advise: don’t try to make really long range plans or let others make them for you. Instead, be light on your feet, like the grasshopper. React to events as they unfold around you, all in the present. When you see opportunities, go for them. If you see some danger coming your way, just hop away and come back when the trouble has rolled over.

The only long term plan you need, as far as your wealth and finances is concerned, is to have a sincere intention to get rich. The ‘how’ will differ from person to person – do try to discover it, but do so in the now and operation in today’s moment with a less of a “buy and forget it” kind of an attitude. It may work for Peter Lynch or Warren Buffet – that strategy may really suck in your case.

REC Tax Free Bonds

 I just applied for 1L worth of tax free bonds from the Rural Electrification Corp (REC) whose IPO opened today. This appears to be the last opportunity this year to buy tax free bonds and the application window is open till 12Mar (very small really). Unless you have pigged up heavily on fixed income, this issue should warrant more than a cursory glance by you. Here are the salient points from the prospectus (click here):

  • Ratings: “CRISIL AAA/Stable”, “CARE AAA” , “FITCH AAA(ind)” and “[ICRA]AAA”. So from that perspective looks to carry a low credit risk
  • No one’s underwriting the issue. No one wanted to or did the AAA ratings make REC say no to middlemen?
  • Usual 3 categories but NRIs absent from the scope. Sad. This is apparently to ensure that the allotment etc gets done within this FY and some folks say that involving our foreign bhais will slow down things. In any case the previous issues by NHAI, HUDCO etc took more than a month to get listed.
  • Interest of 8.13% for 10 yr and 8.32% for 15 yr bond for Category III (retail rats). 750 crores (25%) of the issue is reserved for Category III which means if more than 75,000 individual applications come in at cut-off, then the allocation game of dice will play out. Allotment will be made on a first come first served basis. In case it gets oversubscribed (which I assume it should) then if your application reached the bankers one day prior to the date when oversubscription occurred, you’d get the FCFS treatment else you’d get proportionate to your application amount. So it pays to apply early. The recent NHAI tax free issue was oversubscribed by 2.5 times.
  • The NHAI tax free bond, while it took its sweet time to list, jumped up immediately when it listed on 7/8 of Feb’12. It went up some 2 – 3% during listing time – which means that tax-free bonds are best bought during their IPOs and not from the secondary markets.
  • The 09.15 G-Sec maturing on 2024 (12 years to go) is trading at yield spreads of 8.27% – 8.28%. (
  • Interest will be payable yearly on 1Jul. Would’ve been nice for Category III to get a cumulative interest option. Even then, 10 yr bank deposits offer less than 10% today and when you bake in the tax benefit (if you are in the highest tax bracket, these bonds give you a return of ~11.5% or so.
  • While you can apply in lots of 5 bonds (fv 1000/- each) you can sell one bond at a time, if you wish. Given heavy institutional interest for the 10 year paper, liquidity and therefore demand is likely to be high on that and therefore price of the bond on the secondary market (will list & trade on BSE) should be higher. If RBI does start dunking down interest rates towards the latter part of the year, then the price will canter up more. But capital gains tax will apply.  

It was good that IRFC’s (which is the financing arm of Indian Railways) budgeting went a bit awry (their plan size for FY11/12 was cut by 16%) and they could not use up their quota of tax-free bonds. That slack got transferred to REC instead of the Government allowing railways to roll over its unutilized portion to next FY. The Government had allowed INR 30,000 crores to be raised by infra sector PSUs during the current FY via the tax free bonds route. Assuming an interest payout of 8% this translates to a servicing cost of 2,400 crores. Assuming a low tax rate of 20%, this translates to INR 480 crores of income forgone by the Government which means a margin give up of 1.6%. But I guess that’s small change if you get INR 300 bn of capital in a year to fund infra building…

This is surely a good thing – I hope that the FM announces an even higher quota for the next FY.

2008/09 vs. 2010/11

The charting fun continues…

Here, I have highlighted the two massive cuts in recent times in the NIFTY chart since 1Jan’01. The US sub-prime/Lehman correction is in red while the current recessionary times are in dark aqua. Well, there is hardly much of a time span between the end of the red phase (6Mar’09) and the start of the second drop (5Nov’10) which obviously leads one to believe that the red and the aqua phases are part of the same pain that started once the sub-prime mess started. 20 months can hardly be called a recovery.

What I also did (ref chart below) was to phase shift the second bearish drop and superimpose it on the first drop to see how they compare. I know past patterns may or may not portend the future, but then all I said was that I wanted to have some charting fun! So, here is what is looks like. Please draw your own conclusions, for I know of none. Caveat Emptor, as always.

 But tell you what, reading all the stuff that is being talked about Europe, who knows what will happen. It’s like this:

HEADS: Merkel and Sarkozy do the impossible and let the European Commercial Bank’s (ECB’s) priniting presses run and run and run. I am happy since I do not have to update my chart. It happens just I thought it to.

TAILS: Politicians are for the polity, by the polity, of the polity. Crazy things happen and I have to redo the comparative chart all over again! 😦

This week the dice is expected to roll. Let’s see. While I don’t mind the extra effort involved in updating my wayward chart predictions, the way I sway depends very much on the way the dice rolls. I have a lot of hard earned money whose trail somewhere leads up to the presently idle printing presses of the ECB. But not all’s gloomy: there is one positive lesson to take from the above chart. Just look at the comparative chart and reflect on the 2008/’09 time period. You lived through it. Correct? Some of your positions would have been abandoned at a loss but if at all you initiated any fresh positions towards the end of the red phase, you’d have made up a good part of the drop, correct? The most important part is that you are alive (if you are reading this) and are still sane (if you are reading this!).

And here is the best and most audacious part. Chartbusting stuff really! How many years did the Pension Commissioner say I have till retirement? (By retirement I mean growing old and easing out of the active labour force). 20 more years? Ok. So I took the first chart, which shows the NIFTY’s march since 1Jan’01 and increased the scale by a 20 more years. Values of the index are blanks since who knows what tomorrow may bring…but do look at the resulting chart (shown on the right) and stare at it for a loooooong time. Do you see what I see? Ok, you know that I have played around with the axes of the chart but then that’s what I said at the start I would do right? i.e. having some charting fun.


Registration of Investment Advisors

SEBI has uploaded a concept paper on regulation of investment advisors to its website on 26Sep’11 and has been inviting comments from the public till 5:30pm, 31Oct’11. The contents of SEBI’s discussion paper look so very similar to the provisions of the Regulation of Investment Advisors in the US. In the US, investment advisors are regulated by the Investment Advisors Act of 1940. At the state level (or depending on the net worth/size of operation of such advisors) they could alternatively be governed by the Series 66 regulation or the Uniform Securities Act (click to download).

The following caught my eye from SEBI’s discussion paper:

  • This thing has been going on since Mar 2007. A committee and a sub-committee
  • The regulation is proposed to be implemented through a Self Regulating Organisation (SRO). Hopefully that will be without sin.
  • Duality of market participants as sometimes they act as agents of the producers of the financial products they sell and sometimes they act as advisors to the end consumers.
  • The role of the SRO will be to cleave this duality and make advisors (somewhat) accountable
  • The paper trashes enhanced level of disclosures as an effective tool since it cites India’s lack of (financial) literacy and generally high levels of information asymmetry as being two facts that would blunt the effectiveness.
  • Any entity of individual providing investment advise – whether it be a bank, wealth manager, private banker etc will have to announce him/her/themself as an investment advisor. Period.
  • Advocates, chartered accountants, media publishers, etc will be exempt. I guess the exemption naturally extends to blog authors as well – if at all someone felt that the category was subject matter of the discussion paper.
  • Folks wishing to get registered under the aegis of the SRO need to be chartered accountants from ICAI, MBAs in Finance or have a relevant work experience of at least 10 years.  

Obviously, it’s a good practice to copy regulations from advanced markets but it’s also important to recognise that such regulation did not prevent the gross mis-selling of financial products in the US – the latest example being home mortgages. Investment advisors, whether registered or not – packaged homes as ATM machines and sold them to the American public.

I have two comments/suggestions to make:

1. With relation to advertising and general disclosure: It should be made mandatory for registered investment advisors in India (whenever such a breed be whelped) to declare their historical track record of investment advise rendered. Accepted that information flows may be asymmetric in India and that most of the consumers of financial products may be financially illiterate, but I don’t think they are so illiterate as to not appreciate quantitative measures of historical track record of the advisors they are dealing with.

2. Buying a house is definitely THE most important and largest financial transaction that Indian investors commit themselves to. Do the objects of this discussion paper touch the property buying process? Or are young property buyers always to depend on the mortgage provider (i.e. producer) to act as financial advisor? Maybe some scheme or arrangement that notifies some independent advisors as being registered property purchase investment advisors. Maybe property buyers get an incentive for buying property via such advisors….i dont know what may work, but i thought this is an important area that may need independent and unbiased investment advise. A natural extension of this point is the question that asks if “real estate brokers” be considered as investment advisors or not?

Spiced it Up!

Turmeric is on a roll. Prices of the yellow spice are up a whopping 64% this year. That’s about thrice the rise of the Sensex. India is the largest producer, consumer and exporter of turmeric, so I am sure a few people in India must be very happy these days. But the bulk of the masses are not since the party is not just limited to turmeric (aka haldi). Prices of most spices are spiralling upwards. Cardamom, pepper, cloves, mace, nutmeg and all sorts of things are becoming dearer by the day. This article here talks about the awesome climb of turmeric and other things. And that left me thinking about what type of people invest in commodities and how do they do it and is there some opportunity here for people like me to dabble in condiments.

Most online brokerages offer commodity trading and one can take positions in the spot or the futures markets. That’s all I know and I guess I have no desire to know more. These are highly cycical things and difficult to understand. I guess the only commodity that I have direct exposure to is Gold in the form of units of an exchange traded fund. All rest are beyond my comprehension. The ban on commodity trading in India was lifted in 2003 and volumes have certainly risen along with the advent of institutions like MCX, NCDEX etc. Speculators, industry houses must be trading a lot for both hedging as well as speculation. Thankfully there is not much retail money being put there. Since commodities are much more volatile than stocks. That characteristic should be an ideal breeding ground for the day trading gangs hoping to make some alpha given the high beta. However, given the predominantly agrarian nature of the country’s economy, I would guess that commodity trading should be quite popular here. It was a pretty short-sighted decision on the part of the Government to have banned commodity trading in the wake of the serial droughts that had hit the country during the 50s and 60s limiting the farmers’ ability to honour the various forward contracts that they had taken positions in. So whats happening now that while commodity prices are zooming up due to inadequate supply lines, the action is restricted in the hands of few. And that must be fostering mindless speculation with the action centered around a very small clique. Reportedly, the average daily turnover by value of spices futures on the National Commodity Exchange has doubled from a year earlier. Since the market lacks depth, only a handful of players hold sway. Definitely not a situation for retail rats like us to be found dead in.

My father and his ancestors used to grow cotton on their fields. I stay away from the black alluvial ancestoral soil of mine, but trading in cotton and making a few bales of money in the bargain might just emotionally connect me to my roots. So what do I do? Where do I go? Some quarters advise the advent of commodity based mutual funds as a good avenue for retail investors to build exposure to commodities. That advise certainly does not work for me. These mutual funds do not take positions directly in the underlying commodities. They buy stocks of companies that are long commodities by the virtue of their area of operations. That’ s proxy investing and a bit of misrepresentation by the asset management companies if one goes by the names of such mutual funds. At least the Mirae Asset Management company’s fund in this regard is more modest by including the word ‘stock’ in its name:  “Mirae Asset Global Commodity Stock Fund – Regular Plan (G)”. And then there is constant drone from the commodity perma bull and India basher, hitchhiker and biker Jim Rogers who keeps telling us how commodities as an asset class has a looooong way to go – up, is what presume he means.

I guess we need to wait for some time for Indian banks & mutual funds to be given the green signal to start trading in commodity futures. The Forwards Contracts (Regulation) Amendment Bill is pending approval in the Parliament and once that happens, not just commodity futures but even exotics like weather indices and derivatives off them will start trading. The logic for people long agriculture to trade in weather deivatives is compelling enough. But it still comes back to the point regarding competency. Even if a (fairly liquid) avenue gets created and is readily available in the hands of retail investors like me (no hassles, slightly higher commission online brokerages), I guess I’d still stay away since I don’t think I will be able to understand what moves such markets in this lifetime of mine.

During an exit interview of a past colleague of mine, it was revealed that he had put down his papers to pursue his dream of trading in the commodity markets. I know not of what has happened to him. Hope he is fine and is profiting from his love for cloves.

%d bloggers like this: