Tag - investing

11 Oct

All you need to know about Index Funds

When one talks of investing in the equity markets, one aspires to be as successful as Warren Buffett. While many consider him to be their investing ‘Guru,’ he calls investing a simple game that advisors have convinced the public is harder than it is. He has recommended investing in low-cost index funds. So what are these index funds?

An index fund is a type of mutual fund or exchange-traded fund (ETF) that purchases all (or a representative sample) of securities in a particular index. The goal is to match the fund performance as closely as the benchmark it tracks. Some of the most common indices are S&P 500, NASDAQ-100, and Russell 2000. Closer home, we have the Nifty 50 index, S&P BSE Sensex, and Nifty-Next 50.

How do index funds work? Consider an index fund that follows the Nifty Index. There will be 50 equities in this fund’s portfolio, all of which will be distributed similarly. Bonds and equity-related products may both be included in an index. The index fund makes sure to invest in each security that the index tracks.

A passively managed index fund attempts to replicate the returns provided by the underlying index, whereas an actively managed mutual fund strives to surpass its underlying benchmark. A passively managed index fund manager may have to reduce the tracking error as much as possible.

Portfolios of index funds only change significantly when their benchmark indices change. The management of a fund that tracks a weighted index may occasionally adjust the percentage of various securities to reflect the weight of those stocks’ participation in the benchmark. A technique called weighting equalizes the impact of each asset in an index or portfolio.

Why would you invest in an index fund?

The primary advantage of investing in an index fund is the lower management expense ratio compared to their actively managed counterparts. (A fund’s expense ratio includes all the operating expenses such as payment to advisors and managers, transaction fees, and accounting fees).

As index fund managers are focused on replicating the benchmark performance, they do not need to hire research analysts to assist in the stock selection process. As trading is also less frequent, the transaction fees and commission expenses are also lower.

Are there any risks to investing in an index fund?

Yes, like any investment, index funds are also subject to certain risks. First, the index fund will be subject to the same risks as the securities in the index it tracks. Second, there is less flexibility to react to price declines in the securities in the index vis-à-vis a non-index fund.

If the fund does not exactly follow the index, there can also be a tracking error. The performance of an index fund, for example, may not perform as well as the index if it only holds a portion of the securities in the market index.

So, who should consider investing in an index fund?

Now that we know what index funds are, and the pros and cons of investing in index funds, we wonder if index fund investing is right for us.

As index funds track a market index, the returns are approximately like those offered by the index. Hence, investors who prefer predictable returns and want to invest in the equity markets without taking a lot of risks prefer index funds.

The Taxation Aspect

Being equity funds, index funds are subject to dividend distribution tax and capital gains tax. Redemption of index fund units may lead to taxable capital gains. The capital gains earned in the case of a holding period of less than one year is short-term capital gain (STCG) which is taxed at 15%. In case of a holding period of more than one year, an investor would be liable to pay long-term capital gain tax (LTCG). LTCG up to Rs 1 lakh is not taxable, and the amount above that is taxed at the rate of 10% without indexation benefits.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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07 Jul

Is there any easy way to pick quality stocks?

After completing your education, you started working and realise a portion of your earnings needs to be invested in equity markets to earn returns. One glance at the media, and you realize equity investing is just too complicated. How to understand the financial jargon, the never-ending ratios?!

You don’t need to have a very high IQ to make money in equities. But you certainly need to understand the basics of accounting to understand the business.

You must first identify a business.  A look around your house will give you different investment ideas. Start with your daily cup of tea or coffee, and you will find several businesses which you will understand.

Once you have identified the business, you can have a look at the information published by the company – website, annual reports, and corporate presentations to understand the business.

Once you have a fairly good idea of the factors that influence the business, you come to the financials. The Holy Trinity of Profit and Loss Statement, Balance Sheet, and Cash flow statement. Each of these will tell you different information. The profit and loss statement will help you understand how the company makes money, its expenses, and its profitability. The balance sheet will explain how well the company is utilizing the funds invested by shareholders, and the cash flow will answer the most basic question – does the business generate free cash for shareholders?!

Analysts can derive any number of ratios from these statements which can be difficult to interpret. Understanding the basic ratios to compare two companies within a sector is critical. One search on Google can help understand some of the basic ratios.

In addition to the financials several qualitative factors aid decision-making.

  1. Management: The management will lead the company to achieve its goals and generate shareholder wealth over a long time. The information about the education and experience of management is available on the corporate websites. A LinkedIn search will help gather additional information about the previous experiences of the key managerial personnel.
  2. Promoter holding: Investors might prefer companies that have a promoter’s wealth tied to its success. There have been several cases where companies run by people who don’t have a financial interest in them have been mismanaged.
  3. Other factors such as a moat or competitive advantage of a company, demand for the products, or bargaining power with suppliers are some other factors that help understand a company better.

If you are someone who simply does not have the time to study accounting, it does not mean that you should not consider equity investing. You can hire SEBI registered Research Analysts who will do all the work and advise stocks that you can consider investing in.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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17 Jun

Short-Term Performance is Everything

Two years ago value investing was dead, now it is the obvious approach to adopt in the current environment. What has changed? Short-term performance. There are more captivating rationales but underlying it all is shifting performance patterns. These random and unpredictable movements in financial markets drive investors’ behavior and are the lifeblood of the asset management industry; but they are also a poison for investors, destroying long-term returns.

Narratives + extrapolation

Short-term performance in financial markets is chaotic and meaningless (insofar as investors can profitably trade based on it), but they don’t see this; instead, they construct stories of cause and effect.  Furthermore, because the stories are so compelling, investors are certain that they will go on forever. This is why when performance is strong absolutely anything goes. Extreme valuations, unsustainably high returns, and made-up currencies cannot be questioned – haven’t you seen the performance, surely that’s telling you something? Of course, what it is telling is not particularly useful. It is just that investors struggle to accept or acknowledge it. There must always be a justification.

Performance is not a process

Financial markets do not provide short-term rewards for efforts and hard work. Nor can any investment approach consistently outperform the market except by chance (unless someone can predict the near future). Many investors seem to accept this. If performance is good a fund manager can say almost anything and it will be accepted as credible. If performance is bad then everything said will be disregarded. The problem with lauding short-term performance as evidence of skill poses the question of what happens when conditions change. If the process leads to consistently good short-term outcomes, what does one say when short-term outcomes are consistently bad? When performance is strong it is because of ‘process’, when it’s weak it is because of ‘markets’.

Sustaining the industry

Not only do the uncertainties of markets give investors something to talk about, but they also give them something to sell. The sheer number of funds and indices available to investors is a direct result of the randomness of short-term performance. There will always be a new story or trend to exploit tomorrow. Judgments made based on short-term performance will make everyone look skillful some of the time.

Misaligned incentives

The obsession with short-term performance is a vicious circle. Everyone must care about it because everyone cares about it. This creates a harmful misalignment problem where professional investors aren’t incentivized to make prudent long-term decisions; they are incentivized to survive a succession of short-time periods. Irrespective of whether this leads to good long-term results.

Source: ‘Short-Term Performance is Everything’, by Joe Wiggins published on www.behaviouralinvestment.com

Asset Multiplier Comments:

  • If investors are concentrated on short-term success, long-term returns may be unsatisfactory.
  • Investors can avoid the chances of capital erosion and damaging outcomes by choosing to stay focused on their long-term investing approaches.
  • They should refrain from trying to make sense of short-term market fluctuations because doing so can be mentally taxing and lead to poor choices.
  • Long-term investing decisions can make one look foolish in the short term, but they are sustainable ways of achieving capital gains over the long run.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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17 Jun

Beginners’ guide to investing…

“Bro, suggest me some good stocks please.”

“Hey, I heard stock X is going to go up, should I buy it?”

“I want to start an SIP, how to do it?”

“So, like can you double my money?”

As a 20 somethings guy working in the financial advisory industry, I have had my fair share of interactions mentioned above. Somehow you become the de-facto person in your circle whom people confer for financial advice. In this series of articles, I’ll be sharing some of the very basics of Investing for any beginner who has very little information about how the system works. Be advised that this is a very generalised heavily simplified version and the actual actions may differ on a case-by-case basis. Let’s take a dive into the world of bulls and bears, shall we?

 

  • The Difference Between Saving and Investing: A common misconception amongst first-time investors is that both are the same. However, there’s a critical difference between the two. Savings, in essence, are any money that you don’t spend from your earnings. For eg. On a salary of Rs. 50,000/- per month, a person is left with around Rs. 20,000/- every month, those are their savings. Investing is when you allocate these savings with the expectation of generating income and wealth. An example, of the Rs. 20,000/- saved the person buys Mutual Funds of Rs 10,000/- and Rs. 10,000 in a bank FD, only then can it be considered investments.
  • Set Goals: It might feel like a boring and tedious task, but a lot of investment decisions are based on the person’s financial goals, their risk appetite. The first step before investing is asking questions, why am I doing this? when/how will I be using this money? To appropriately assess investment options.
  • Safety Cover: A critical aspect before starting the investment journey is deciding on an adequate safety cover. It is generally advised to have at least 6 months of your expenses stored away in a rainy-day fund; any unexpected setbacks should not deter an investor from their investing goals. Unexpected illnesses/ accidents or death are the biggest threats to an investor’s long-term investing goals as they can cause wealth erosion pretty quickly. Investors should adequately Insure themselves before investing.
  • Discipline: Investing has very little to do with markets and everything to do with behavioural impulses. It’s easy to start investing, it’s difficult to keep investing and it’s hardest to stay invested. Many first-time investors lack the discipline to consistently keep investing, but persistence is the only thing that generates wealth in the long term. Another trap most first-time investors fall for is consistently checking their portfolio for gains and losses, which is as unpredictable as the wind blowing and are tempted to cash in on their investments for short-term gains or stop investing altogether because of losses. Discipline wins in the end.
  • Uncertainty: Like all things in life, Investing too is unpredictable and difficult to understand at times. Not every investment will give an investor their desired returns, nor does an average investor have the time and skills to analyse their investments periodically to take corrective actions. In order to mitigate the risks, it is recommended that investors confer with SEBI registered Investment Advisors to guide them through their investing journey.

This is the 1st Part of the Introduction to Investing Series, which will discuss critical aspects of investing aimed at first time investors. Stay tuned for more.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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02 Jun

What We Should Remember About Bear Markets: Part I

The following article is taken from ‘What We Should Remember About Bear Markets’ by Joe Wiggins.

Bear markets are an inescapable feature of equity investing. They are also the greatest challenge that investors will face. This is not because of the (hopefully temporary) losses that will be suffered, but the poor choices investors are liable to make during them. Bear markets change the decision-making dynamic entirely. In a bear market, smart long-term decisions often look foolish in the short-term; whereas in a bull market foolish long-term decisions often look smart in the short term.

If investors are to enjoy long-run investment success, they need to be able to navigate such exacting periods. There are certain features of bear markets that it pays to remember:

They are inevitable: Bear markets are an ingrained aspect of equity investing. Investors know that they will happen; they just cannot know when or why. Their occurrence should not be a surprise. The long-run return from owning equities would be significantly lower if it were not for bear markets.

It will feel predictable: As share prices fall, hindsight bias will go haywire. It will seem obvious that this environment was coming – the warning signs were everywhere. Investors will heedlessly ignore all the other periods where red flags were abundant and no such market decline occurred.

Nobody can call the bottom: Market timing is impossible, and this fact does not change during a bear market. The only difference is the attraction of attempting it when falling portfolio values can become overwhelming, and the damage it inflicts will likely be greater than usual.

Economic and market news will be conflated: The temptation to interlace economic developments with the prospects for stock market returns can become irresistible during a bear market. Weak economic news will make investors increasingly fearful about markets, despite this relationship being (at best) incredibly hazy.

Time horizons will contract: Bear markets induce panic, which shortens time horizons dramatically. Investors stop worrying about the value of their portfolio in thirty years and start thinking about the next thirty minutes. Being a long-term investor gets even more difficult during a bear market.

Investors don’t consider what a bear market really means: In the near-term, bear markets are about painful and worry-inducing portfolio losses, but what they really are is a repricing of the long-run cash flows generated by a business / the market. The core worth of those companies does not fluctuate nearly as much as short-term market pricing does.

Lower prices are good for long-term savers: For younger investors saving for the long-term, lower market prices are attractive and beneficial to long-run outcomes (it just won’t feel like it).

Source: ‘What We Should Remember About Bear Markets’ by Joe Wiggins published on behaviouralinvestment.com

Asset Multiplier Comments:

  • Losing investment plans during bear markets is inevitable. Although difficult, long-term investors should sit through such exacting periods patiently and stick to their investment approaches.
  • Investors can use bear markets to their advantage by accumulating quality stocks at cheaper valuations and profiting from long-term gains.
  • Investors should avoid getting consumed by noise and immediacy and focus on building wealth over the long term.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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31 Mar

Discipline and Investing!


Discipline and Investing!

An investment philosophy contains the core beliefs that guide an investor’s actions and decisions.  How many times have people heard people say “Meditation has changed my life” or “Running has changed my life”.

Is it true that meditation, running, cycling, or going to a gym can change a person’s life? Well, it is the whole process that helps – not just the act itself. Let us say someone starts meditating 3 times a day for 10 minutes each. Once at 7 am, once at 1 pm, and once at 7 pm. Breakfast, lunch, and dinner? In the first week, they do 4 days and miss 3 days. Next week they do 5, then 6 and in 3 months they are meditating for 15 minutes at each session. Now, this ensures that they go to bed at say 11 pm at least – so that they can get up at 6 am and do their meditation at 7. This means no late-night parties – no drinking binges, etc.

So the activity of meditation has brought a lot of discipline to their life. That helps as much as the meditation itself! Ditto for running, cycling – the process helps. After 6 months or 1 year, they go around saying “meditation helps”. True, but partially.

When it comes to investing, again the first step is discipline – to start saving money. That is the toughest part. Once a person learns to save, doing a SIP is not so tough. The discipline of saving says 20% of a person’s salary is a good target to start with. Doing a SIP in an index fund is ideally recommended till one starts learning about investing.

So doing a SIP is about the discipline of taking money away from an investor as soon as it comes. It is one of the best ways of investing for a young person just starting to invest. It works just as well for a seasoned investor who does not want the need to think every day about where and what to invest.

Like meditating, once someone decides to think of saving and tell themselves that Rs. 10,000 per month should be the SIP amount – it can happen. Investors need not fret over missing one or two installments as it takes time to build in the discipline.

Creating wealth is a long-term, multi-year, multi-decade, multi-generational process. Somebody needs to make a start. The ideal age of course is 22, but it is even better if an investor’s father or grandfather had started the process. If they have not, anyone could. We hear such stories very often. Of SIPs started in 1999, 2008, …and continuing. The amount of wealth created is amazing.

On the other hand, we regularly read about celebrities who earned Millions of Dollars going bankrupt. Being driven to suicide. Yes, discipline is boring – especially when investors are young. However, at a later date, the same discipline gives you Financial freedom. Ironic is it not? Discipline leads to freedom!

Source: subramoney by P V Subramanyam

Asset Multiplier Comments:

  • Investing has very little to do with finance and a lot to do with human behaviour. Sticking to an investment strategy in a disciplined manner ignoring other temptations is the easiest way to build wealth over time.
  • Disciplined investing also gives the added benefit of staying invested over the long term ignoring the short-term fluctuations and volatility in the market. Acting during volatility is one of the most prominent reasons for wealth erosion for investors.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

 

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16 Feb

Performance Chasing and Outcome Bias

“Money flows into most funds after a good performance and goes out when bad performance follows.” (John Bogle)

We have all seen the wording discretely appended to mutual fund marketing stating that ‘past performance is no guide to future results’. Despite the ubiquity of this message, we struggle to heed its warning. This leads to the damaging behaviour of performance chasing, where we sell our holdings in laggard fund managers and reinvest in recent winners.

The tendency of mutual fund returns to experience mean reversion shows that our propensity to sell strugglers and buy recent winners is not just pointless; it is often the exact opposite of what we should be doing.

This damaging behaviour is driven by outcome bias.  Attempting to mitigate outcome bias and prevent performance chasing behaviour means overriding our instincts and also having a willingness to fail unconventionally.  Neither of these is simple, but that does not mean there is nothing we can do.

How Can We Prevent Performance Chasing?

Outcome bias cannot be switched off.  Whilst awareness is a starting point, it is evident from our continued performance chasing behaviour that it alone is insufficient.  We need to make clear and focused interventions to change our behaviour:

Stop Using Performance Screens: Mutual fund performance screens are ubiquitous across the investment industry. Everyone uses some form of historic performance screen to rank funds. Outcome bias and the performance chasing behaviour that follows are difficult enough to avoid even if you are not actively employing tools that encourage it. So, it is best avoided.

Create decision rules: A simple step to avoid performance chasing behaviour is to create fixed decision rules that strictly prohibit it. On average, it should be an effective means of avoiding the cost of purchasing active managers with a high potential for severe mean reversion.

Go Passive: The best behavioural interventions are the simple ones. Anything that requires behavioural discipline or continued effort raises the prospect of failure. Given this, what is the best way to avoid performance chasing in active mutual funds?  We can restrict ourselves to buying only passive market trackers.

Specify the activity in which you believe skill exists: When investing with an active manager, we are taking the view that the underlying manager has some form of skill. We tend, however, to be very vague about what we mean by this.

Extend your time horizons: Our susceptibility to outcome bias is greatly influenced by the time horizons involved. If we assess investment performance over one day it can be considered to be pure luck, but as we extend the period skill can exert more of an influence.

Performance chasing behaviour is, of course, not isolated to our selection of active fund managers.  It is also not entirely driven by outcome bias. This is not to say that outcomes do not matter.  Of course, all investors are seeking better long-term results for their clients. If we want to invest in active managers, we need to think far more about decision quality and process, and far less about yesterday’s performance.

Source: Why Do We Chase Past Performance and What Can We Do About It? By Joe Wiggins

Asset Multiplier Comments:

  • Selecting funds based on past performance is like driving a car by looking in the rear-view mirror. There’s very little correlation between past performance and future returns.
  • The best way to overcome outcome bias is to focus on passive index-linked funds, which remove the variability of performance chasing.
  • If investing in actively managed funds focus on investment thesis and stock selection process rather than past performance.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

 

 

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12 Jan

#Truths about investing 103- Think differently

This is taken from a presentation by Howard Marks Co-Founder of Oaktree Capital. This is the third article in a series. Mr. Marks makes concise and incisive comments about the art of investing that can help amateur and professional investors alike.

You have to think in a way that departs from the consensus; you have to think differently and better. The price of a security at a given point in time reflects the consensus of investors regarding its value. The big gains arise when the consensus turns out to have underestimated reality. To be able to take advantage of such divergences, you have to think in a way that departs from the consensus; you have to think differently and better. Any time you think you know something others don’t, you should examine the basis for that belief. Ask Questions like- “Does everyone know that?” or “Why should I be privy to exceptional information or insight?”

It isn’t the inability to see the future that cripples most efforts at investment. More often it’s emotion. Investors swing like a pendulum – between greed and fear, euphoria and depression, credulousness and skepticism, and risk tolerance and risk aversion. Usually, they swing in the wrong direction, warming to things after they rise and shunning them after they fall. Technology now enables them to become distracted by returns daily. Thus, one way to gain an advantage is by ignoring the noise created by the manic swings of others and focusing on the things that matter in the long term.

To be a successful investor, you have to have a philosophy and process you believe in and can stick to, even under pressure.

Since no approach will allow you to profit from all types of opportunities or in all environments, you have to be willing to not participate in everything that goes up, only the things that fit your approach. To be a disciplined investor, you have to be able to stand by and watch as other people make money in things you passed on. Every investment approach – even if skillfully applied – will run into environments for which it is ill-suited. That means even the best of investors will have periods of poor performance. Even if you’re correct in identifying a divergence of popular opinion from eventual reality, it can take a long time for the price to converge with value, and it can require something that serves as a catalyst. To be able to stick with an approach or decision until it proves out, investors have to be able to weather periods when the results are embarrassing.

Source- Truth’s about investing by Howard Marks

Asset Multiplier Comments:

  • Investors with a longer time horizon are less likely to make emotional judgments. A properly allocated portfolio has the appropriate mix of equity and fixed-income asset classes to provide an investor with the highest chance of success. This means retiring comfortably without running out of money.
  • A sound investment philosophy is founded on a thorough knowledge of markets. Determine the return you require, the income you will need for your retirement expenses, and the degree of portfolio appreciation you need to achieve that. Selecting a plan and adhering to it is also part of your investment philosophy. Passive investing might just be your investment philosophy.
  • Adhering to your philosophy entails avoiding emotion-driven buy-and-sell choices and sticking to your intended allocation regardless of market movements. The whole objective of allocating according to a strategy is to prevent hopping in and out of assets on the spur of the moment.

 

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

 

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21 Nov

This Week in a Nutshell (15th – 18th November)

Technical talks

NIFTY opened the week on 15th November at 18,141 and ended the truncated week on 18th November at 17,765. The index made a weekly loss of 2.1%. On the upside, 17,993 could act as resistance while 100DMA of 17,020 could act as a support. RSI (14) of 44 indicates the index is nearing the oversold zone.

Among the indices, AUTO was the only sector that ended the week with gains of 0.4%. METAL (-5.3%), PSU BANK (-3.4%), and REALTY (-3.3%) led the laggards.

Weekly highlights

  • Raring agency Fitch Ratings affirmed India’s long-term foreign currency Issuer Default Rating (IDR) at ‘BBB’- with a negative outlook. The negative outlook reflects lingering uncertainty around the debt trajectory. The Agency has suggested wider fiscal deficits and government plans for only a gradual narrowing of the deficit, putting a greater onus on India’s ability to return to high levels of economic growth over the medium term to stabilize and bring down the debt ratio.
  • S&P Global Ratings has predicted that the Indian economy will likely grow at 11 percent in FY22 but flagged the ‘substantial’ impact of broader lockdowns on the economy. S&P said the control of Covid-19 remains a key risk for the economy.
  • The Nasdaq Composite Index closed above 16,000 points for the first time, while the Dow Jones Industrial Average had a second successive weekly loss (-1.4%). The S&P 500 ended higher following strong retail earnings and positive signs for holiday shopping.
  • Over 4.4mn Americans left their jobs in September-21, according to the Labor Department’s Job Openings and Labor Turnover Survey. Incentivized by wage gains and other attractive terms offered by employers desperate for talent, several Americans are leaving their jobs. This has made it challenging for employers to fill positions while driving up compensation and inflation.
  • Crude oil prices fell to a six-week low following news of Australia’s lockdowns and surging Covid-19 cases in Europe threatened to slow down the economic recovery. Investors weighed a potential release of crude oil reserves by major economies for a fall in prices. Crude Oil futures settled at USD 75.7 a barrel while Brent Oil futures closed at USD 78.5 a barrel.
  • India’s wholesale price inflation (WPI) jumped to a five-month high at 12.5% in October. This month’s WPI broke the 5-month downward trend as prices of manufactured items and fuel have increased. High petrol, diesel, and cooking prices drove fuel inflation to 37.2%. high prices of basic metals, textiles, plastics, and edible oil drove inflation for manufactured items to 12%.
  • Prime Minister Narendra Modi announced that the three farm acts would be repealed in the upcoming session of the Parliament. The Prime Minister said a committee would be set up to make the minimum support price mechanism more transparent and effective.
  • Foreign Institutional Investors (FII) continued to be net sellers this week, selling shares worth Rs 44,109 mn. Domestic Institutional Investors (DII) continued to be buyers and invested Rs 39,265mn in Indian equities this week.

Things to watch out for next week

  • US markets are waiting for President Biden to nominate who will head the central bank after Jerome Powell’s term finishes in February-2022. The US markets have a truncated week next week as markets will remain shut on Thursday and Friday on account of Thanksgiving.
  • The Indian equity market is likely to see more selling pressure next week amid the rising US dollar, and the beginning of the Fed Reserve’s bond-buying program. Results for September-21 have been announced by most companies. Action is likely to be stock-specific till the end of December.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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24 Oct

Luck Vs. Skill in Investing

Jeremy Chia reminds us that investing is a game of probabilities. In any game where probability is a factor, luck undoubtedly plays a role. This leads to the age-old question of how much of our investment performance is impacted by luck?

Is an investor who has outperformed the market a good investor? Similarly, is an investor who has underperformed the market a lousy investor? The answer is surprisingly complex.

Long term stock prices tend to gravitate toward the present value of the company’s expected future cash flow. However, that future cash flow is influenced by so many factors that result in a range of different possible cash flow possibilities. Not to mention that on rare occasions, the market may grossly misprice certain securities. As such, luck invariably plays a role.

Skill is one aspect of investing that is hard to quantify. However, there are a few things Chia looks at. First, we need to analyse a sufficiently long track record. If an investor can outperform his peers for decades rather than just a few years, then the odds of skill playing a factor become significantly higher. Although Warren Buffett may have been lucky in certain investments, no one can deny that his long-term track record is due to being a skilful investor.

Next, focus on the process. Analysing an investment manager’s process is a better way to judge the strategy. One way to see if the manager’s investing insights were correct is to compare his original investment thesis with the eventual outcome of the company. If they matched up, then, the manager may be highly skilled in predicting possibilities and outcomes.

Third, find a larger data set. If your investment strategy is based largely on investing in just a few names, it is difficult to distinguish luck and skill simply because you have only invested in such a few stocks. The sample is too small. But if you build a diversified portfolio and were right on a wide range of different investments, then skill was more likely involved.

Mauboussin wrote: “One of the main reasons we are poor at untangling skill and luck is that we have a natural tendency to assume that success and failure are caused by skill on the one hand and a lack of skill on the other. But in activities where luck plays a role, such thinking is deeply misguided and leads to faulty conclusions.”

Chia concludes that it is important that we understand some of these psychological biases and gravitate toward concrete processes that help us differentiate between luck and skill. That’s the key to understanding our own skills and limitations and forming the right conclusions about our investing ability.

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