From High to Low

As readers of this blog may be aware, I am a sucker for statistics.  I frequently go digging into historical data.  But it isn’t something that I do for entertainment.  Every now and then, looking into data, I find something that sharpens or enhances my understanding of the nature of risk.  It is with the intention of sharing some of that, that I present below the results of my latest effort, which looks at the returns of some equity schemes over a 16 year period.  In such studies, it is often the case that some schemes end up with far more impressive returns than others- that is but to be expected.  While there may be a case to raise eyebrows and ask questions, I wouldn’t suggest passing judgment on any scheme without further investigation.  As I have maintained in the past, there is more to performance than what returns may convey. As I have also previously mentioned, one should be careful about drawing any inferences from such observations other than on the merits of diversification. 

Almost a month ago, on Feb 11, the BSE Sensex hit a new low, relative to its last high.  It may well fall further but at the time of writing, that has not (yet) happened.  Its closing value on Feb 11, was over 22% below the last closing high on 29 Jan 2015.  As far as I can make out, this was the 11th time since its inception that the Sensex has fallen 20% or more from a previous high.  The first time this happened, it fell just over 20% before rebounding.  On the subsequent nine occasions, the fall to the bottom has ranged from 27% to 61%.  On five of these occasions, the fall was in excess of 40%.

Feb 11 also happened to be the anniversary of an earlier high.  In 2000, the Sensex peaked on this date.  The identical date brought back the memory of something that I had heard many years ago, from a certain advisor.  He had said something to the effect that the acid test of the long-term performance of an equity scheme was the return that it generated from a market peak to a market bottom.  In that light, I thought it might be interesting (even if premature) to check out the returns of equity schemes over these 16 years.  I am aware of the vagueness of the term, “long-term” and the mixed feelings that people have about its use.  But I doubt if anyone would question the validity of a period of 16 years being “long-term.”  Using data from Value Research, ICRA Online and Moneycontrol, I give below some of my observations.  Do note that the scheme returns do not consider loads.

• Currently, there appear to be 49 actively managed, diversified, domestic equity schemes that were in existence in Feb 2000. 
• The return on these schemes over these 16 years ranged from 18.7% pa to 5.2% pa.
• The CAGR of the BSE Sensex Total Return Index (TRI) over this period was 10.6% pa.
• The return on 14 of these schemes was less than the CAGR of the BSE Sensex TRI. At least 4 of these were once positioned as flagship schemes, so to say, of their respective fund houses. 
• Amongst schemes that are currently rated with 5-stars by Value Research, the lowest return was 9.7% pa.
• Amongst schemes that are currently rated with 1-star by Value Research, the highest return was 18.5% pa.
• The preceding 13 months (i.e. preceding Feb 11 2000) was a period of extraordinary returns for equity schemes.  One scheme, it appears, had delivered a higher absolute return over the preceding 13 months than it did over this entire 16 year period. Its absolute return over the preceding 13 months was 326% while over the entire 16 year period, it was 297%.
• At least 4 other schemes delivered an absolute return over the preceding 13 months that was over 50% of what they did over this entire 16 year period.
• At the time, there was only one index scheme, which continues to be in existence.  This scheme tracks the NSE-50.  As against a CAGR of 10.6% pa for the NSE-50 TRI, the return on this scheme was 8.3% pa.

Remembering the Tech Boom

This month, fifteen years ago, signalled the end of the bull run that has come to be referred to as the dot-com boom or the tech boom by some, and the dot-com bubble or the tech bubble by others.  As the monikers suggest, it was a period that was marked by the steep and questionable rise in the share prices of technology companies.  As I see it, what happened during that phase, and what followed afterwards, has a lot to offer current investors in equity schemes to think about.  In this post, I propose to take a walk down memory lane, and share some observations.

A number of people trace the start of this boom to December 1996.  But it was two years later that the boom truly gained momentum.  And though the biggest gains were seen by investors in the shares of ICE companies (information technology, communications, and entertainment), investors in equity schemes also saw significant gains, on account of the investments made by their schemes in these companies.  Consider this: over the fifteen month period from 1 Dec 1998 till 1 March 2000, 25 equity schemes and 2 balanced schemes saw their NAVs at least triple, while another 9 equity schemes and 4 balanced schemes saw their NAVs double.  There were 8 equity schemes whose NAVs went up 5 times or more, during this period.  Leading the pack was Kothari Pioneer Infotech Fund (now, Franklin Infotech Fund), whose NAV (adjusted for bonus units) astoundingly went up over 10 times during the same period.

An industry observer with whom I was speaking recently, had this to say about the gains during that period:  “Never before, or since then, has there been such an opportunity for the masses to legitimately make so much money, in so short a time.”

While the opportunity may have been there, the fact is that when the boom took off, very few people actually had investments in any of these schemes. Most investments in these schemes happened much after their NAVs had surged.  While this may be somewhat true of any bull market, in the case of the tech boom, this was partly because the sharpness and suddenness of the rise caught most investors by surprise, and partly because of a general lack of trust in mutual funds.

To go back a bit in time, the bear market from 1994 to 1998, on account of its prolonged tenure, had tested the patience of most investors,  particularly those in mutual fund schemes.  Funds such as UTI’s Mastergain 1992 (now, UTI Equity Fund) and Morgan Stanley Growth Fund (now, HDFC Large Cap Fund) had attracted large numbers of investors, but their investment performances had left a lot to be desired. Then there was the news of CRB Mutual Fund being wound up under charges of fraud.  Lastly, and probably, most significantly, UTI’s reputation took a major dent when it announced that the reserves on its flagship scheme, US 64, were wiped out and there loomed the possibility that it might not be able to meet commitments to unitholders in the scheme. 

It was not surprising, therefore, that most investors were naysayers or skeptics when it came to mutual fund schemes.  There were very few investors for whom the conceptual merit of investing in mutual funds remained intact in spite of all of these episodes.  When the tech boom took off (quite out of the blue, within months of UTI’s announcement), it was these few investors who gained the most.  In contrast, the naysayers and skeptics were left out for most of the rally.  By the time they shed their reservations to enter these schemes, the markets were into the last few months of the boom.  Given how late they entered the boom, the vigor with which these investors pumped in money, was truly astonishing .  To give some perspective, the gross investments into equity schemes in the quarter Jan-March 2000 were more than the total gross investments made into these schemes across the previous 11 quarters.  The net investments into equity schemes in that quarter were over 13 times the total net investments across the previous 4 quarters.  Obviously, these investors had no inkling of the brutal downslide that was to follow.

Over the nineteen months that followed the bursting of the tech bubble, most equity schemes saw their NAVs fall by over 60%, with some seeing a fall of over 80%.  As would be expected, investors who put most of their money around the peak were the worst affected.  Those who preferred tech funds (or funds with an overdose of tech stocks) were much more affected than those who preferred diversified equity schemes.  The differences were all the more starker for those investors who chose to hold to their investments for longer.  For instance, if an investment in a diversified equity scheme made at the peak of the tech boom were to have been held till today, the return on such an investment (without adjusting for loads) could range from 22% p.a. to 7% p.a. (most diversified equity schemes have given a return in excess of 15% p.a. over this period, which is the equivalent of growing one’s money by over 8 times). On the other hand, if an investment in a tech fund made at the peak of the tech boom were to have been held till today, the return on such an investment (without adjusting for loads) could range from 5% p.a. to 6% p.a. That would be equivalent to just over doubling one’s money.

But what about those people who were already invested by the time the boom gained momentum?  Returns in equity schemes over the 34 months from 1 December 1998 to 1 October 2001 ranged from 51% p.a. to –24% p.a. (without adjusting for loads).  Most equity schemes had gained enough on the upside to weather the downside and generate positive returns, with 10 schemes clocking returns in excess of 20% p.a.(without adjusting for loads).  Returns in Franklin Infotech Fund (the lone tech fund over this period) were close to 18% p.a.(without adjusting for loads).  If investments in any of the diversified equity schemes were to have been held till today, the returns would vary from 32% p.a. to 11% p.a. (without adjusting for loads) with as many as 28 schemes showing returns in excess of 20% p.a. (this would be equivalent to growing one’s money by over 19 times).  If an investment made in Franklin Infotech Fund were to have been held till today, the returns would be close to 22% p.a.(without adjusting for loads).  That would be equivalent to growing one’s money by over 24 times.

Would investing through a SIP have helped?  Obviously, those investors who invested large sums at the peak of the boom would have been better off staggering those investments. It would have particularly helped in the case of schemes which fell the most.  Consider this: A one-time investment on March 1, 2000, in the worst-performing, diversified equity scheme (based on returns over the entire cycle), would have taken nearly 8 years to double in value.  A monthly SIP in that scheme for 1 year from that date would have taken less than 6 years to double in value. 

Should investors have timed their investments?  As I see it, good timing involves getting two things right: the time of exit and the time of re-entry.  Getting even one of these wrong can have a significant negative impact on one’s returns.  Given the odds against getting both right, I do not advocate such an approach.  I do, however, recommend that one rebalance one’s portfolio in line with one’s asset allocation.  Looking back, I remember that some of my clients, against my advice, did indeed try to time their exit, and re-entry.  As far as I recollect, all of them would have been better off not doing so.

I’d like to share one last observation before I close this post.  It’s about two diversified equity schemes and highlights the fickle nature of equity performance and fund manager success.  The first was a scheme that did exceedingly well during the tech boom.  It was an iconic fund, managed by a ‘star fund manager,’ as people like to say. In the last fifteen months of the boom, its NAV went up over 5 times, and by some accounts, its performance in calendar year 1999 was a world record of sorts.  In the downturn, it fell sharply, losing over 70% of its value from the peak.  In the years since the boom, its performance has been patchy.  The scheme still exists but is all but forgotten, its past glory relegated to a footnote in the annals of history.  The other scheme was one whose returns during the tech boom placed it in the bottom quartile of equity schemes.  In the downturn, its performance continued to be unexceptional.  Yet, in the years since, it has delivered spectacular returns that have caused investors to regard it as an iconic fund, and its fund manager as a legend.  For those of us who like to predict future winners among funds, the tale of these two schemes should serve as food for thought.

Seven Years On

Call it the Seven Year Itch, if you like.  I was curious to see how equity schemes and hybrid schemes had performed since the peak of the 2007-08 bull run, seven years ago.  In this post, I present some observations that I found interesting.  Just to be clear: I’m not intending to pass judgment on any fund.  My intention is to offer food for thought around investing in equity schemes and hybrid schemes.  As I have stressed in earlier posts, there are compelling reasons to invest into some of these schemes but at the same time, it’s important to be aware of the risks.

Here, then, are my observations.  The scheme data has been taken from Value Research and does not consider loads.

• A hypothetical investment in the NSE-50 Total Return Index on 8 Jan 2008 would have grown over these 7 years by 4.87% p.a.  In contrast, a cumulative, 7 year deposit with State Bank of India would have given a return of 8.77% p.a., before taxes.
• There are, in all, 224 actively managed equity schemes today, that were in existence at that point as well. 
• The returns across these 224 schemes have ranged from 23% p.a. to –10% p.a. 
• 162 of these (i.e. 72%) have shown a lesser return than that of the bank deposit (before considering taxes). 
• 80 of these (i.e. 36%) have shown a lesser return than that of the NSE-50. 
• 8 of the top 10 schemes, and 9 of the bottom 10 schemes are sectoral/ thematic schemes. 
• Amongst domestic, diversified equity funds, the returns have ranged from 16% p.a. to –4% p.a.
• Despite the upsurge in the markets in the last 1 year, 22 schemes have shown negative returns over the 7 year period.  In fact, 19 of these 22 schemes gave returns in excess of 40% in the last 1 year.
• 17 of these 224 schemes are currently rated as 5 star funds by Value Research.  The returns across these schemes have ranged from 15% p.a. to 3% p.a. 
• There are 25 ‘balanced’ schemes today (Value Research category: hybrid-equity), that were in existence seven years ago. 
  • The returns across these schemes have ranged from 14% to –7% p.a.
  • 14 of these schemes (i.e. 56%) have given a lesser return than that of the bank deposit (before considering taxes).  
• There are 54 ‘MIP’ schemes today (Value Research categories: hybrid debt-oriented aggressive, and hybrid debt-oriented conservative), that were in existence seven years ago. 
  • The returns in these categories ranged from 12% to 2% p.a. 
  • 38 of these schemes (i.e. 70%) have given a lesser return than that of the bank deposit (before considering taxes). 
  • The scheme with the lowest returns happens to be currently rated as a 5 star fund in its category.

In part, these observations highlight the risks associated with investing in equity funds at the peak of the markets, something I talked about at length in an earlier post.  In part, these make the case for diversification, something I spotlighted in another post.  Some observations even highlight the limitations of Star Ratings, something I touched upon elsewhere.  But there is no denying that the performance of a number of funds is questionable and if the answers are not convincing, there is no reason for investors in these schemes to continue holding those investments. 

By my calculations, there seems to be in excess of Rs.32,000 crore invested in equity schemes that have given lesser returns than the NSE-50 over these 7 years.  While it would unfair for me to draw any sweeping inferences, I hope those investments are there for the right reasons.

Can you really make money by investing at a peak?

Statistics suggest that most Indian investors in equity funds make most of their investments in bull markets.  As someone put it, “Rather than buy low and sell high, most investors attempt to buy high and sell higher.”  So, what are the chances of making money by doing so? 

Obviously, it depends on how much money one is looking at making, and over what time frame.  While I don’t have a crystal ball or any other means to know what the future may hold, in this post, I propose to examine some historical evidence.

In a way, I had skimmed the fringes of this in an earlier post, where I attempted to make the case for equity funds serving a certain purpose.  To do so, I had looked at the NSE-50 Total Return Index and had examined the outcomes from hypothetical investments made in this index each day between 11 Feb, 2000 and 5 Nov, 2010 (both dates representing market peaks).  This period covered 2682 trading days.  The trailing P/E ratio ranged between 10.68 and 28.47, with a median of 18.10.

In this post, I propose to use the same data and examine the instances of making varying levels of returns by investing on 211 peak days i.e. days on which the index was at, or near, a peak in terms of price as well as valuations (these days were amongst the top 20% in terms of the trailing P/E ratio and also represented either a new price high or were not more than 10% below the last price high).

The performance has been analyzed up to 19 Sep, 2014.  It would be pertinent to point out that of the total 2682 days, there were 281 days on which, if an investment were to be made, would not have completed 5 years on or before 19 Sep, 2014.  Of the shortlisted 211 days, there were 48 such days.

Here, then, are some of the observations:

Across the 2682 days, investments made on 1283 days could have, on completion of 3 years, resulted in an appreciation of 15% p.a. or more.  Of the 211 peak days, there were only 21 days when an investment could have seen similar results.

Overall, there were 1366 days on which an investment, if made, could have, on completion of 5 years, seen an appreciation of 15% p.a. or more.  There wasn’t a single peak day, investing on which this would have been possible.

What if, instead of a buy-and-hold strategy, one were to have actively monitored one’s portfolio and cashed in the gains?

An annualized return of 15% p.a. over 3 years equals a total return of 52.1%.  An annualized return of 15% p.a. over 5 years equals a total return of 101.1%.  Of the 211 days, there were 41 days, investing on which, one could have seen a cumulative appreciation of 52.1% in 3 years or less.  These included 21 days, investing on which, one could have seen a cumulative appreciation of 101.1% in 5 years or less.  

The tables below give a more detailed set of observations pertaining to investments made on the 211 peak days.

Targeted  Return	Instances of achieving targeted return by holding for exactly
	1 year	3 years	5 years
30% p.a.	19	1	0
20% p.a.	20	21	0
15% p.a.	26	21	0
10% p.a.	32	33	9

 

Targeted Cumulative Return	Instances of achieving targeted return in a period of
	5 years or less	3 years or less	1 year or less
10%	184	115	92
20%	144	68	48
30%	133	55	34
40%	101	45	24
50%	49	41	20
60%	40	24	0
70%	24	24	0
80%	22	21	0
90%	21	21	0
100%	21	21	0
120%	21	14	0
150%	21	0	0
200%	21	0	0
250%	12	0	0

In case you have difficulty relating to cumulative returns, here are some quick indicators:

A cumulative return of 100% is approximately equal to a compounded return of 15% p.a. over 5 years, or 26% p.a. over 3 years.

A cumulative return of 150% is approximately equal to a compounded return of 20% p.a. over 5 years, or 36% p.a. over 3 years.

A cumulative return of 200% is approximately equal to a compounded return of 25% p.a. over 5 years, or 44% p.a. over 3 years.

A cumulative return of 250% is approximately equal to a compounded return of 28% p.a. over 5 years, or 52% p.a. over 3 years.

One final observation: there were dates on which, investments made and held,  would not have achieved a modest targeted return even over periods beyond 5 years.  For instance, investments made on certain dates in Oct, 2007 and Nov, 2007 would not have seen an appreciation of 8% p.a. at any point over the last six-odd years.  As of 19 Sep, 2014, these investments, if made and held, would have registered an annualized return between 6% p.a.-7% p.a.

Based on these observations, I am inclined to conclude that investing at, or close to, market peaks is fraught with considerable uncertainty.  While it may have been possible to generate returns as high as 50% in a period of a year or less, or in excess of 25% p.a. over a period of 5 years, such opportunities would have been very, very few.  The evidence suggests that there were far greater instances of, at best, generating single digit returns over the short term, and annualized single digit returns over the long term.

If at all one still chooses to make investments at similar peaks, I would recommend investing in a staggered manner, such as through a Systematic Investment Plan.  Further, I would suggest one set modest return expectations, actively monitor the returns and cash in and/or average out, as and when opportunities present themselves.