Why are fund managers unable to outperform the Nifty?

The most important quality for an investor is temperament, not intellect.

Warren Buffet

In the past one year we have observed a very strange and perhaps unique phenomenon in the Indian stock markets. Out of the 289 equity mutual funds (regular) which invest in the Indian stock markets and for which performance data for the past one year is available (source: amfiindia.com, annual performance data from 16 Feb 2018 until 15 Feb 2019), only 63 funds managed to outperform their corresponding benchmarks. In other words only 21.8% of such funds could deliver alpha returns when compared to their benchmarks. This data is shown in summary format below:

Fund Category	Outperformers	Total Funds in category	Outperformer Percentage
Smallcap	14	17	82.4%
Midcap	17	25	68.0%
Contra	1	3	33.3%
Sectoral	17	76	22.4%
Multicap	6	35	17.1%
ELSS	4	42	9.5%
LargeMidcap	2	23	8.7%
Largecap	2	33	6.1%
Value	0	12	0.0%
Focused	0	18	0.0%
DivYield	0	5	0.0%
All	63	289	21.8%

Table 1 : Funds outperforming their benchmark, by category

We can see from the above table that except for Smallcap and Midcap funds, all other equity funds failed to beat their corresponding benchmarks in the past one year. Almost 4 of 5 funds underperformed their own benchmarks. How is it possible that so many experienced, skilled and highly paid fund managers failed to read the markets correctly in the past one year? Granted that the stock markets faced spells of high volatility in the past year, but the benchmarks would have been as volatile as the fund itself. Does this mean that most fund managers panicked during times of volatility and experienced a double whammy thereby getting hit on the way down as well as back on the way up?

Dismal as this picture is, it becomes even more depressing when we change the goalpost slightly and compare each fund’s performance against the Nifty, instead of against its own benchmark. Here is how that picture looks like:

Fund Category	Outperformers	Total Funds in category	Outperformer Percentage
Sectoral	9	76	11.8%
Multicap	2	35	5.7%
Midcap	1	25	4.0%
Largecap	1	33	3.0%
Value	0	12	0.0%
Smallcap	0	17	0.0%
LargeMidcap	0	23	0.0%
Focused	0	18	0.0%
ELSS	0	42	0.0%
DivYield	0	5	0.0%
Contra	0	3	0.0%
All	13	289	4.5%

Table 2 : Funds outperforming the Nifty, by category

This table shows that in the past one year only 13 of the total 289 equity funds outperformed the Nifty. And of those thirteeen, 9 were sectoral funds which were primarily oriented towards the Information Technology sector. The question arises at this point, what was the Nifty return in the past one year. It was a meager 3.14% mind you. And yet more than 95% of skilled, qualified, experienced and highly paid fund managers failed to make more than 3.14% from the stock markets in the past one year! What can we attribute such huge underperformance to? Is there some superior intelligence that is more insightful than the collective intellect of more than 95% of the fund managers in this country? On the face of it, that is what it looks like. The other explanation could be that fund managers in general have a herd mentality and panic collectively during times of high volatility. 

Let’s dig deeper and look at the performance of the Nifty components themselves. Here is a summary of their performance in the past one year:

Performance range	Total stocks
-15% and below	19
-15% to 3.14%	12
3.14% to 15%	5
15% to 30%	8
30% and more	6
Total	50

Table 3 : Performance of Nifty components in past one year

As shown in the above table, of the 50 stocks in the Nifty only 19 outperformed the Nifty during the year. In other words less than 2 in 5 of the Nifty stocks outperformed the Nifty during the year. What this implies is that all fund managers had to do was to have a few of these 19 stocks in their folios in order to compete with the Nifty. Yet a vast majority of them (more than 95%) failed to do exactly this. Was it so difficult to identify at least a few of these 19 stocks at the start of the year? Seemingly it was. It shows that nobody is infallible, regardless of what the mutual fund commercials will have you believe day in and day out with their ‘Sahi Hai’ campaign. 

What to Do

If you are a Mutual fund investor you have to realize that fund managers are not as smart as you wish them to be. The data clearly confirms this fact and it is indisputable. This logic can perhaps be extended to portfolio managers who run Portfolio Management (PMS) schemes as well, but I do not have the data to support that argument at the moment. If you are a PMS investor, your own experience in the past one year with the performance of your fund may confirm my point of view. Either way, in such difficult times it is handy and especially useful to have an open line of communication with your investment advisor. Ask incisive questions about the non-performance of specific stocks in your portfolio to your advisor, understand the reasons for the same and then convince yourself about the way forward. Nobody is infallible including your advisor, but at least a direct conversation between you and your advisor will make both of you aware of the situation and then make him/her work out ways to deal with it going forward. Hopefully both of you will emerge as better investors in the process.

The 4 Ps of personal financial planning

Someone's sitting in the shade today because someone planted a tree a long time ago.

Warren Buffet

Personal financial planning is a very important aspect of every individual’s personal life. Simply put, it is just the process of developing a roadmap for your financial well being – now, tomorrow and well into the future. When it is done well enough, it helps you in achieving your goals and your dreams, but more importantly it helps you navigate life’s ups and downs by overcoming the financial barriers that are an inevitable part of everyone’s life journey. This aspect of personal financial planning is rarely visible in public though. What is starkly visible however - mostly amongst your friends, neighbors and families - are the financial difficulties that arise in their lives due to lack of adequate financial planning and the discipline to stick to the plan in cases where a plan may even exist. These are the people who due to their own laziness or indiscipline or both land themselves in financial quicksand and then cover themselves with debt of all kinds - credit cards, personal loans, business loans, overdrafts and even loans from friends and families - to try and get out of it. If such people are lucky to have the benefit of good financial advice they do come out of their financial distress over a period of time. Else they continue sinking deeper into the financial hole which they have dug for themselves with each passing day.

The irony is that personal financial planning is not a difficult process at all. It is very easy and to make it even simpler to remember and etched into your memory I have codified it into a pyramid named the “The 4 Ps of personal financial planning” as shown below.

Provision: This is the first P of personal financial planning and is at the bottom of the pyramid. It is mostly applicable in your early years when you are young and preparing for a career although it can be applied all throughout your lifetime. It calls for making an investment in yourself i.e. educating yourself with the knowledge and the skills that will enable you to make your mark in society. It is equivalent to planting a seed that will grow into a tree someday. This is the stage in your life when you are in the red, when you have no personal wealth unless you are blessed with an inheritance. Hence the best thing to do at this stage is to build large provisions of knowledge and skills that will enable you get a job and earn an income. As you increase your knowledge and skills and grow in your career your income will grow and after providing for your expenses it will enable you to start building a nest egg, which will be the start of your wealth creation process.

Prevention: The second P of personal financial planning lays emphasis on preventing any illness that may come in the way of your ability to earn regular income. In this phase you invest in your health and hence you need to focus on best health practices – such as a healthy diet and regular exercise – but also supplement it with a good health insurance plan just in case some illness were to afflict you, god forbid. A good health plan not only pays for the cost of your hospital stay but also gives you cash for out of pocket expenses when you are ill. Most importantly it ensures that for a small fixed amount every year, your growing nest egg is prevented from being dented by a significantly large medical bill. 

Protection: The third P of personal financial planning is applicable when you have got married and started planning for a family. At this phase in your life you find that you have dependents, whose financial well being depends on you. This creates an additional financial obligation on you but most people do not realize it and those that do are inevitably late. Financial wizards have created a solution for this problem too and it is called life insurance. In this phase you invest in your peace of mind which ensures that for a small amount every year your life remains protected and that in the event of your untimely demise your dependents can continue to enjoy the financial well being that you had planned for them. Life Insurance products are often sold bundled together with investment plans in the name of endowment policies, ULIPs, etc. It is a best practice to always separate insurance from investments so that each product can work for you for the specific purpose for which it is designed. 

Profusion: The final P of personal financial planning is the one that focuses on multiplying your nest egg. In this stage you invest for your future. The future is not only uncertain but it is paved with ups and downs. The future also holds the key to your goals, your aspirations and your dreams. Realizing this fact early on in life will compel you to plan for the future by investing your nest egg in such a way such that your goals may be achieved without undue stress on your finances. There are multiple investment products available for multiplying your nest egg, ranging from fixed income products such as fixed deposits and bonds to equity products such as stocks, futures and options. Mutual funds are a convenient way of investing in these products since they not only reduce the ticket size abut also provide useful combinations of these products bundled together in a single fund. 

What to Do

If you have incorporated one or more of the above elements into your personal financial plan, you are already ahead of your peers. If not, it is better late than never that you start as soon as possible. Assess where you stand today and then if you need help, engage the services of a Registered Investment Adviser (RIA) to help you navigate the complex world of investments and select the ones that are best suited for realizing your financial goals. Your Investment Adviser will understand your financial goals, assess your risk profile, calculate the optimal asset allocation mix for your needs and then create a financial plan for you that is aligned with your needs. A regular review of this plan with your adviser will ensure that you stay on top of the financial markets and in control of your own financial dreams!

Happy Investing.

The interim budget’s impact on the stock markets

I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.

Warren Buffet

The interim finance minister – Hon. Shri Piyush Goyal – presented the interim budget last Friday. Technically, the interim budget is supposed to be a stop gap budget, meant only for the express purpose of financing government expenses until the next elected government takes over. However, since it is the last budget before the general elections, historically governments have resorted to announcing populist schemes in the interim budget in order to woo the masses. And indeed, this has become the norm over the years. Hence holding true to this tradition, the finance minister doled out tons of largesse to the masses in the interim budget. Farmers with less than 5 acres of land will now get a cash benefit transfer of Rs 6000 per year directly into their bank accounts. This will benefit 12 cr farmers and cost the exchequer Rs 75,000 cr/per annum.  Allocation for MGNREGA which benefits landless farmers and laborers has been increased to 60,000cr. A mega pension scheme has been announced for the worker class who earn less than 15000 per month. The government will provide a matching contribution up to Rs 100 per month to provide them assured monthly pension of Rs 3000 per month when they retire. This will benefit 10 cr workers in the unorganized sector. Standard deduction has been raised 25% from 40,000 to 50,000. The tax-free income limit has been doubled from 2.5 lakhs to 5 lakhs. This will provide benefit of Rs 18,500 crore to about 3 crore middle class taxpayers.

So the question naturally arises – what does this interim budget do to the economy? Simply put it will put more money in the hands of the masses, increasing their spending power. It will stimulate rural growth, stoke inflationary expectations and put upward pressure on interest rates and downward pressure on GDP growth. The finance minster has already admitted that financing these schemes will increase the fiscal deficit from 3.1% to 3.4% of GDP. But analysts believe the deficit could be much higher. Financing this deficit will force the government to borrow from the bond markets which in turn will result in hike in interest rates. A small trailer of this was already witnessed when the 10 year bond yields jumped up about 1.7% immediately after the announcement of the budget!

What to hope for

As investors, the best thing to hope for is that the next incoming government comes in with an absolute majority. A hung parliament will be the worst case scenario at this time in India’s history, because then coalition compulsions will creep into decision making. In the worst case this will lead to proliferation of corrupt practices and in the best case the nation will be saddled with policy paralysis. Either way, it will be a setback for India from assuming its rightful stage at the world table. A stable majority government on the other hand will have the political support and the will to continue the path of fiscal consolidation for stimulating economic growth and the overall well being and prosperity of the nation and its citizens.

What to Do

As investors, it is futile to speculate which sectors of the economy and specifically which businesses within those sectors will do well due to the stimulus provided by the interim budget. Such top down approaches to stock picking are susceptible to errors of judgment that can go horribly wrong. A recent case in point was the big bet on the infrastructure sector five years ago by many fund managers and research analysts due to heavy spends earmarked for roadways, railways and waterways by the present government. However infrastructure stocks hardly benefitted from these spends and many of them continue to languish even till date. As investors, it is best to leave the market forces of demand and supply determine the winners and losers.
The best approach for investors is to always invest in businesses which fulfill the following three criteria:

1. Has a track record of making more money than its cost of capital 
2. Has a sustainable competitive advantage in the market place. 
3. Is available at reasonable valuations. 

The icTracker database is the only publicly available database that constantly scans stocks for these three criteria and the icAdvisor service is designed to guide investors to benefit from the findings of this constantly changing database.

The recent spate of stock buybacks

When stock can be bought below a business's value it is probably the best use of cash.

Warren Buffet

The Indian capital markets have seen a spate of stock buyback announcements in recent months, and that too from businesses of all sizes and industries. Here is a summary of some of the recent buyback announcements:

Company	Announcement date	Buyback price	CMP	Premium%	Buyback size (Rs cr)
Infosys	11-Jan-19	800	727.9	9.9	8260
IOC	13-Dec-18	149	137.35	8.5	4435
ONGC	21-Dec-18	159	141.05	12.7	4022
NHPC	14-Nov-18	28	24.45	14.5	2615.6
Bosch	10-Dec-18	21000	18171.95	15.6	2159
Oil India	19-Nov-18	215	170.3	26.2	1085.7
Mphasis	27-Nov-18	1350	972.8	38.8	988.3
HEG	26-Nov-18	5500	1980.3	177.7	750
Tata Investment Corp	16-Nov-18	1000	822.1	21.6	450
SKF India	4-Dec-18	2100	1920.05	9.4	399
Natco Pharma	5-Nov-18	1000	665.95	50.2	250
Persistent Systems	28-Jan-19	750	583.4	28.6	225
Triveni Turbine	1-Nov-18	150	106.35	41.0	150
Indian Energy Exchange	20-Dec-18	185	158.35	16.8	69

In a buyback, a firm purchases its shares from existing shareholders, usually at a price higher than the prevailing market price. Buybacks are a more efficient way of returning money to shareholders compared to issuing dividends, since the firm avoids the burden of dividend distribution tax (DDT). A buyback announcement is a strong statement of belief by the firm’s management that the market is undervaluing the shares of the company. The management backs up this belief by using the firm’s money to buy back shares from the existing shareholders at a predetermined price (which it considers as the fair value), thus reducing the number of outstanding shares available. This boosts the earnings per share and consequently the price of the share as well.

Of late we are witnessing a phenomenon where an increasing number of companies are choosing to announce buybacks. This indicates general fatigue in the market for correctly valuing shares of the firm. Moreover, the above table shows that the price of the share continues to lag behind the buyback price by a significant amount despite the buyback announcement. Although the data presented here is from the last quarter of 2018, this trend has been witnessed throughout 2018 and is nothing sort of an anomaly. The management of the firm has the best view of the business and competitive landscape and if they think that buying back their own shares is the best use of cash then that belief deserves nothing but support.

What to Do

A buyback announcement presents investors with an opportunity to exit their investments at the buyback price in a depressed market, of the kind that we are witnessing now. Hence in such times investors should always subscribe to the buyback to the fullest extent possible. The buyback ratio is calculated differently for different categories of investors and it determines the percentage of shares in an investors holding that qualify for the buyback. After subscribing to the buyback to the maximum extent possible, investors should hold on to the balance shares until the market price reaches the buyback price, which is an event destined to happen sooner than later.

How to find businesses with wide moats

I was a chartist. I loved all that stuff. I had charts coming out my ears. Then, all of a sudden a fellow explains to me that you don't need all that, just buy something for less than it's worth.

Warren Buffet

In the investing world, “moat” is a term that has been popularized by the legendary investor Warren Buffet to mean the amount of competitive advantage that a business enjoys in the marketplace over the competition. Moats create entry barriers for the competition and enable the business to harvest uninterrupted profit from its products and services. Therefore moats are a very desirable attribute for investors, when screening for investment opportunities. If they exist at all, moats can be either wide moats or narrow moats. Obviously wide moats are preferred over narrow moats, not only because of the extent of competitive advantage that they provide to the business but also because such an advantage may even be sustainable in the long run. Businesses with wide moats are therefore the ones that long term investors want to ‘Buy and forget’. In the Indian context, such investments fall in the category known as ‘Buy right, sit tight”.

Wide moats in a business may exist for a number of reasons. Some of these include strong brand, widespread distribution network, loyal customer base, low cost of operations, etc. Whatever be the reason for the wide moat, the search for the source for it always ends in an intangible asset – i.e. an asset that is not present or reported on the balance sheet of the business. Isn’t this strange – the one asset that gives the business a wide moat and hence a lasting competitive advantage does not even make it to the company balance sheet and hence never ever reported to investors. This is the single biggest reason why screening for businesses with wide moats is a task fraught with danger, because the person doing the screening may have to rely on hearsay and assumptions rather than hard facts. Unless of course there was a way to measure the intangible assets of the business and value it in monetary terms, in the first place!

This is where the icTracker comes in. We developed this software explicitly to address this very problem i.e. to measure the intangible assets of the business from the company’s reported financials and value it in monetary terms. Next we developed a ratio called the Knowledge Basis – which is just the ratio of the Intangible Assets over the Total assets of the business. Note that Total assets equal the Intangible Assets as calculated plus the physical and financial assets which are reported on the Balance sheet of the Business. The Knowledge Basis then becomes a simple measure for checking if the business has a wide moat. As a thumb rule we consider that a Knowledge Basis greater than 50% means that the business has a wide moat, else it has a narrow moat. The icTracker software has therefore quantified the calculation of wide moat and made it objective, thus making screening of stocks easier and more importantly, reliable. Our icAdvisor service in fact uses the icTracker database when designing and rebalancing client portfolios.

What to Do

When making investment decisions for your stock portfolio, always ensure that the underlying business has a wide moat. But that is the easy part – the difficult part is staying on top. Moats can disappear very quickly if a new competitor takes over the market for instance using a superior moat. Hence it is very important to check the moat of the business every quarter to ensure that the competitive advantage it enjoyed earlier is still in place. It is well and good if you have the time and passion for doing this yourself. If not, you should approach a SEBI Registered Investment Adviser to help you with this process.

2018 - Letter to Clients

After the stellar run of the stock markets in 2017, 2018 turned out to be somewhat of a damp squib for Indian investors. Here is how the year panned out for various asset classes during the year.

The Nifty started the year at 10,533 and ended it at 10,863 – giving a meager return of 3.14% in the process.  But at least it gave positive returns. The Nifty Midcap 100 and Nifty Smallcap 100 on the other hand did much worse, giving deep negative returns during the year. In comparison, the average annual return of client portfolios under our advice clocked in at 2.29% this year. Considering that our client folios are made up of a mix of Largecap, Midcap and smallcap stocks depending on the client’s risk profile, this performance was very satisfactory. Inflation was at 4.7% during the year which meant that only the relatively safe asset classes beat inflation during 2018 – none of the equity classes did so, as shown by the table above. 2018 was therefore the year of safety - but more importantly it was also the year of volatility. There were three major trends in the stock markets during the year – two on the downside and one on the upside. The quantum and duration of these trends were as follows:

This can be seen visually in the daily chart of the Nifty during 2018 below.

Although volatility is a basic attribute of the stock markets, high volatility of this kind spooks retail investors and scars them for life. As for our part, we saw the first downtrend coming in early Jan and advised our clients to sell major portions of their portfolio and sit on cash at that time. We got them back in the market after April when the results of the quarter started coming in. This action benefitted all our Clients. However, we missed catching the next downtrend which started in early September, primarily because it was not a systemic downtrend – rather it was based on fears about risk in the NBFC space triggered by default of IL&FS – a leading lender to the infrastructure sector. The extent and impact of such sector specific risks are always difficult to assess but the markets always take a safe route by first pushing prices down and then analyzing the impact. Since none of our Client folios had investments in the NBFC space we considered it prudent not to react to this kind of downtrend but rather ride it out. In hindsight we can say now that this approach did not do too badly for our Clients.

On the economic front, the year was characterized by high crude oil prices (which moderated towards the year end), inflation fears, fiscal slippages and systemic liquidity concerns. State elections in five major states during the year also made the market nervous. SIP inflows into equity mutual funds continued at an increasing pace reaching a run rate of billion dollars a month by the end of the year, despite high selling by foreign investors. These flows found their way mostly into largecap stocks leading to their stability at the expense of midcap and smallcap stocks.

What can be look forward to in 2019? For one, the Indian economy continues to be the fastest growing economy in the world growing at a rate of 7.2%. It is poised to become the fifth largest economy in the world this year overtaking the UK in the process. The central elections are due in May 2019 and this will be a time when we can expect some nervousness and volatility in the markets. If the elections throw up a majority Government, then the markets will settle down and could even start a rally. If on the other hand the elections throw up a fragmented mandate then we could be in for a long phase of consolidation. At this point the best thing to do therefore is to stay invested. Investing is a long term game and those who stock to their convictions during difficult times get rewarded by the stock markets ultimately.

At the end of such a difficult year, it is well worth the time to take a moment and review the fundamentals of long term investing. We enumerate them here for quick reference:

1. Asset allocation – Diversify your financial assets across Debt, Equity, Real Estate, gold, etc. depending on your risk profile and age. In the current scenario, real estate and gold are no longer sources of capital appreciation. Hence these assets should be used to satisfy consumption needs only. It means that your assets should be spread only across Debt and Equity. One simple rule of thumb to do this quickly is to subtract your age from 100. The number you get should be the percentage of your assets that you should allocate to equity - the rest should be allocated to Debt.
2. Financial planning - Identify your financial goals and classify them by time horizon – short term, medium term and long term. Use Debt assets to achieve short term goals, mix of Debt and Equity assets to achieve medium term goals and Equity assets for achieving long term goals. This will be the basis of your financial plan.
3. Reviewing your plan - Review your financial plan yourself or with your advisor at least once a year and make adjustments depending on the prevailing situation.
4. Invest right - When it comes to equity, invest in the right businesses and then give markets time to give you returns. This calls for patience in the face of volatility. Speak to your financial advisor whenever you are in doubt and need a second opinion.

Finally, I want to inform all my Clients that during the year we made optimization improvements to our stock picking algorithm based on observations and our own backtesting. These improvements will ensure that we pick long term winners that have a high probability of returning generating alpha for our Clients. Having said that I have to add that there is always scope for further improvements in our stock picking and monitoring process and with the help of the active support of our Clients we will keep working diligently on such improvements. I also want to thank all my Clients whose active support and trust in us got recognized by Silicon India magazine in their 2018 ‘Consultant of the Year’ award to us.

In passing, I want to take this opportunity to thank you for putting your faith in our investment thesis and in our icAdvisor service with your hard earned money. Your continued trust makes us stay committed to the vision encapsulated in our tagline – ‘Growth through Knowledge’. I believe that we can grow only when you see value in our service and growth in your own portfolios. I am available to address client queries at all times and am approachable via email or whatsapp. I am also open to feedback and suggestions and welcome you to provide the same. I also hope that if you have benefitted from our service, you will spread the word to your own friends, family and colleagues and have them share the benefit as well. 

Finally, let me wish you and your family a very happy and prosperous Happy New Year and hope that our relationship will continue to grow for many years to come!

Abhijit Talukdar

Founder, Attainix Consulting

SEBI Registered Investment Adviser