These days, the debate is between active management and passive management. Without doubt, a worthy debate. But there are other interesting findings that demand our attention. I had observed on many occasions that there is a huge gap between returns delivered by an equity mutual fund scheme and the returns realised by unit holders. If you had been a unit holder of a mutual fund scheme, I trust you would have experienced this with a few schemes if not all. If you had been distributing mutual fund schemes, I trust you would have noticed this with a few portfolios if not all.
An article in livemint, pointed to a study by Axis MF. The study spanning a period of 16 years from 2003 to 2019 showed investor returns were far lower than corresponding fund returns. It was also observed that this is not unique to one Asset Management Company (AMC) but across the Industry.
The study did not end without commenting. It highlighted three key reasons for this gap in the returns. In my opinion, all three reasons were very valid but they were not suggested solutions to bridge the gap.
After going through the reasons, one would be left with the following questions.
How to ignore the latest performer ?
How to live with short term performance of a scheme ?
How early is early enough ?
Before attempting to find answers to above questions, let me bring to your notice another interesting data point.
Excluding categories like Fund of Funds, Retirement Funds, Index Funds, Global Funds, Hybrid Funds, Balanced Advantage and Dynamic Asset Allocation Funds, there are a total of 322 schemes classified under various categories like Large, Mid, ELSS, Focused, Value etc., Should I say that these are pure equity schemes with different objectives of investing ?
Out of these only 3 schemes have lost money (meaning NAV is lower than 10 as on date). In addition to the three, one scheme that was launched in 2010 managed to deliver just 0.35% return since launch.
What this means to you is less than a percentage of schemes have lost investors’ money. To be exact, 0.932% of 322 schemes lost money. I also excluded schemes that were launched recently. I intentionally avoided names of the 4 schemes, mentioned above.
Let us for the time being ignore inflation, opportunity cost and other thoughts running in your minds. While everyone, including your 6 year old kid, understood that “Mutual Fund investments are subject to market risks…”, we were never told that money managers have not lost money. What got registered in everyone’s mind was the market risk but not facts.
Mr Benis Kumar of Final Mile, a behavioural architect, highlighted in a recent talk that instead of tracking NAV of schemes, unit holders should track the units they were accumulating. This, in my opinion, is a tremendous shift that can aid in bridging the gap between investor returns and scheme returns.
An investor in Real Estate, always shares the number of acres / square feet he owns, proudly !
An investor in Gold, always shares the total number of grams he owns, proudly !
A unit holder in MF, always forgets the total number of units he holds, sadly !
Prices are volatile not just with MF but with other assets too. Unless you and I move away from NAV to units, the gap between investor returns and scheme returns will continue to remain or widen.
It was 14th of July 2019. Novak Djokovic was fighting Roger Federer in the final of Wimbledon 2019. There were many predictions by former champions and commentators, earlier in the day. Few of them favoured Roger and few predicted Novak would triumph. But most of the predictions were for a five setter. Novak was the top seed but Roger, an eight time champion was the darling of the crowd. Fans of Roger would very well agree with me that there is no better sight in the world of tennis than watching Roger play, irrespective of the outcome. He does a ballet on court ! He is the Tennis equivalent of Indian Classical dancer Padma Subramanyam. It had to be really tough for Novak as he had two opponents on that day, one the elegant tennis artist & the other centre court crowd.
The first set was closely fought and ended in a tie-breaker. Novak gained an early advantage in the tie-break but Roger fought back to lead 5-3. After that, the mercurial Swiss, Roger made four forehand errors that resulted in Novak winning the first set when Roger hit a backhand wide.
The second set saw Roger play some wonderful tennis whereas Novak struggled with his intensity dropping like a parachute. The Swiss master sealed it with a score of 6-1. The third set again was decided with a tie-breaker during which Roger committed unforced errors while Novak raised his game to perfection. Novak won the set 7-6 and it was getting jittery for the Federer camp as he had lost 2 sets.
Roger attacked more in the fourth set and went a break up to reach 5-2. Novak got one break back but ultimately it was the Swiss who grabbed the set 6-4.
The fifth set was fought with more intensity by both and Roger edged up by breaking to reach a scoreline of 8-7. Then he went up 40/15 with two aces, against the best returner in the game today. He had two championship points and the entire centre court was behind the Swiss with chants of Roger. It was then that Roger mistimed a forehand and Novak broke with a winner and sealed the match with a tie-breaker that was dominated by Novak. It was his fifth Wimbledon crown and 16th Grand slam.
The match statistics read like this…
Break points won
Total points won
This epic had few interesting & vital lessons for an investor in equities
Novak Djokovic won fewer points in the match, fewer games in the match but he had fewer unforced errors
Novak Djokovic was well prepared for the environment in the centre court and completely shut off his mind to focus on returning the ball to the opponent. He said in his post match interview that when the crowd shouted Roger, he heard it as Novak ! When he had to save two championship points (one bad shot away from losing) he focused on the present and emerged victorious
When it mattered (tie-breakers) Novak was well in control of his game whereas Roger made errors. Knowing when to take right action made Novak to raise his game at the right time. Tie break points won : Novak 21 Roger 12
All the above influenced the match in a big way and the winner was obvious
Reduce Errors, Protect the downside
As an investor, rather than looking to buy multi baggers (winners), you need to ensure that the portfolio is protected from blunders (unforced errors). As a mutual fund advisor, I had always insisted to my clients that downside protection is paramount to ensure returns in the long run. This had been proved time and again in the past by a fund house that completed 25 years in India recently. A portfolio with over weightage to DHFL would have lost the gains made through other holdings in the last one year during which DHFL fell and is now trading at 1/10th of its high.
While this may seem debatable, I personally feel that this strategy ensures good returns (meaning better than fixed income by a 5% to 7% margin).
Here is an article by Ryan Rodenberg in The Atlantic dated 13th of Jan 2014 that talked of Simpson’s Paradox in the world of tennis. Does that apply to investing as well ? I am not a statistician but the parallel could not be ignored !
Simpson’s Paradox is a statistical quirk where seemingly correlated variables are reversed when combined. The application to tennis is nuanced: In tennis, a derivative of Simpson’s Paradox is seen in the small percentage of matches where players win more individual points than their opponent, but lose the overall match. This anomaly is an artifact of tennis’s decidedly unique scoring system. Its “best of N” format (best of three sets, usually, or best of five sets in some men’s professional matches) follows a point-game-set-match hierarchy with neither a running score nor a clock. The results can sometimes be peculiar. The only point the winning player must win is the last one.
Simpson’s Paradox can happen at the both the game level and point level in tennis. The former would be where the score is, for example, 0-6, 7-5, 7-5; the match’s loser wins more total games than the winner of the match. Such matches are exceedingly rare in tennis. The latter, those when the winner of the match wins less than 50 percent of the total points played, occur with some regularity and can be analysed on a per-player basis.
The last few lines quoted above convey a lot. It does not matter what kind of returns your individual stocks/schemes deliver but the overall return of the portfolio should be the one to watch out for. Only by reducing errors, reducing losers you can win as an investor and that is lesson number one from Wimbledon 2019
Focus, Preparing for the worst and ignore external noise…
Josh Levin, National Editor, ‘Slate’ wrote a wonderful piece titled “Novak Djokovic will win everything but our hearts” where he highlighted a few of Novak’s words that is reproduced below. It was amazing how Novak had clearly shut his mind to the external noise and kept his focus on the game.
“It was one shot away from losing the match,” Djokovic said afterwards. “In these kind of moments, I just try to never lose self-belief, just stay calm, just focus on trying to get the ball back.” Federer, for his part, called his loss “such an incredible opportunity missed.” It was the first time since 1948 that a man had held a match point in a Wimbledon final and lost.”
His best was more than good enough, whether or not the fans appreciated what he’d done. “When the crowd is chanting ‘Roger,’ I hear ‘Novak,’ ” he said after the match. While that line drew laughs in the press room, he wasn’t joking. “It sounds silly, but it is like that,” Djokovic said. “I try to convince myself that it’s like that.”
Ignoring the noise and staying focused in the process is an ingredient for successful investing. I would like to recall the words of a fellow advisor in 2017 when mid cap stocks were going through the roof. When the whole mutual fund industry was promoting mid caps & investors were chasing returns, this advisor ignored the noise and gradually moved to large caps. NIFTY Mid Cap 100 Index delivered a return of -16.4% since Jan 2018 as on 30th of Jun 2019. May be he heard “Large Cap” when the whole industry cried “Mid Cap”, like Novak !
Knowing when to Act…
Novak raised his game when it mattered the most (in tie-breakers). He knew what action was needed then and he exercised control by raising his intensity. Knowing when to take action on investments is crucial to long term success, be it booking profits or balancing asset allocation or staying in cash. Prudent investors always keep an eye on lead indicators of the economy to take appropriate action. They also know that most of the times inaction is the best action. Success in investing would not be easy but for the balance between right action and inaction
Conclusion : A Wimbledon final is not won on a day. Lots of preparation would be behind. So is the case with investing in equities. Luck is just one factor which determines the final outcome. By consciously choosing to reduce errors, by focusing on the process and ignoring the noise surrounding and by taking right actions at appropriate times, a peaceful sleep could be guaranteed.