Secret to Long term investing – “See me not”

Equity returns – more common on paper than in real lives..

In the last 5 years, the Sensex has given decent returns of around 82% which works out to a compounded annual return of 13% every year.


In fact, most of the diversified equity mutual funds have better returns than the Sensex, especially the mid cap funds.

But somehow in real life, we rarely find people who have actually benefited from the equity rally of the last 5 years.

Unlike real estate, where each and every neighbor has a “I-bought-this -land-and-it-multiplied-so-much” story, the stories of huge returns in equities while is true on paper is very rare to see in actual portfolios.

What can be the reason?

As all of us know, equities are an extremely volatile asset class in the short run, with temporary losses historically going as high as negative 56% (2008 when the financial crisis happened).

While this temporary loss looks easy on paper, in reality it is emotionally very difficult to view losses in our hard earned money even if it is expected to be short term (the other issue being you never know how long is the short term).

This “emotionally difficult” part unfortunately is very difficult to quantify.

Thus majority of the times while investing in equities, we only see the past returns (easily available and vivid) and conveniently ignore the “emotional stress” part (cannot be seen, only felt).

So, how do we get a sense of this “emotional difficulty” part??

Dan Kahneman to the rescue..

Thankfully for us, the gurus of behavioral economics, Daniel Kahneman and Amos Tversky have done several experiments to understand how we humans psychologically react to losses vis-a-vis gains.

Their key finding was that:

  • Human beings feel the psychological and emotional impact of a loss more than that of a gain
  • The estimate is that we feel the impact of the pain twice as much as that of the gain
  • This is also called as loss aversion


Source: Franklin Templeton

Now, that’s pretty interesting stuff – Emotional pain from loss is twice that of a similar gain

Let us see if we can use this to evaluate the “emotional stress” of holding on to Sensex.

Emotional Returns of Sensex

The mistake that most of us make when we see the statistics that Sensex gave a return of 82% in the last 5 years is the assumption that we will buy, forget and one fine day we will wake up after 5 years and voila – 82% returns handed to us on a platter!!

Reality is that we keep monitoring our portfolios very frequently. Some do it every month, some every week and some even every day.

Now every time we monitor the Sensex value over these short time periods, we inevitably witness negative return periods and along with it the anxiety of what if this extends and becomes permanent.

And to make things worse, as per the loss aversion theory, these negative return periods are twice as painful as the actual returns. Eg a 5% loss is twice more stressful (i.e like a loss of 10%) while a 5% gain is only as emotionally uplifting as a 5% gain.

1m return.png

While not very scientific, however to get a crude sense of how the returns would feel from an emotional point of view, let us calculate what I call the “emotional return” index (don’t google it..I just made it up)

Here is how I calculate it..

Every monitoring period (eg 1Year ,6 months, 3 months etc) where there is a negative return we will assume twice of it (as per loss aversion theory) and every monitoring period when markets are up we will consider the same gain.

So for eg if we are looking at monthly monitoring, if in Jan-17 my returns are down by 10%, then I will assume it as 2*10%=20%. If it is up by 10% then I will assume it as the same 10%.

Based on this method, for different monitoring periods, the Sensex has been simulated over the last 5 years.

Now let us see how for the same 5 year returns, investors with different monitoring frequency would have emotionally experienced drastically different anxiety levels.


(for the purists out there, the numbers are just approximations to visualize and appreciate the emotional stress involved and by no means is of any serious mathematical validity)

While the Sensex in the last 5 years, actually went up by 82% from 17,430 to 31,730, for an investor who had monitored it every day, emotionally it would have actually felt like the Sensex went down -96% to 655!


As seen from the table, while the on-the-paper return of the Sensex remains 82% in the last 5 years, the emotional experience of investors in getting those returns would be vastly different based on how frequently they monitored their portfolios.

Takeaway: The lesser you monitor the portfolio, the better your experience

Parting thoughts

So it is easy to say invest in equities for the long term, but the real test is whether we will be able to withstand the emotional stress in the intermediary periods and hang on to equities.

In a world, where portfolio updates are instant and get tracked in your phones, each and every minute, it’s far easier said than done.

So for people entering into equities for the first time, while we know the perils of frequent monitoring, given your anxieties (which is natural given you are entering for the first time), its very difficult for you not to monitor your portfolios frequently in the initial days.

The only choice is to brace yourselves for the emotional roller coaster and while the actual returns might be good over the long run, emotionally it will always “feel” a lot more draining and less exciting.

As you get more experienced, one of the best ways to try attempting at being a long term investor is to stop monitoring your portfolios frequently. I have personally tried this and trust me it makes a huge difference in your ability to hang on.

Once you are past your panicky first time investor phase, you can gradually look at monitoring every quarter and gradually improve to once in 6 months, 1 year etc

And yeah, as always Happy Investing 🙂

P.S: All this long term thinking, is assuming you have done your work and have picked good fund managers or businesses:)

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Create your own financial plan while you are waiting at the traffic signal

Most of us switch off when someone says “Hey..Let’s create your financial plan”. Those dreadful excel calculations, long term projections, future goals, inflation assumptions blah blah…


No worries. I completely get it!

But what if we simplified this whole complicated financial planning business to something that you could just do it in your head while you are waiting at the next traffic signal.

Not a bad deal right. This is exactly what this post is all about. Be with me for the next 5 minutes and you can  create your entire life’s financial plan while you are returning back from office tomorrow.

Image result for waiting in traffic india

A financial plan is simply three things put together:

  1. How much are your future expenses? (adjusting for inflation)
    (for various goals such as kid’s education, retirement, buying a home etc)
  2. How much to save for these future expenses?
  3. Where to invest whatever we save ?

We will explore the first two questions for today and address the 3rd question in our future posts.

1.How much are your future expenses?Image result for inflation expenses

We have already addressed this in detail in our earlier post here.

Here is the quick summary:

In India, historically  rise in costs (i.e inflation) has been around 7 to 7.5%.

Rule of thumb 1:

The rough math for a 7 to 7.5% inflation implies prices will approximately go up by

  • 1.4x or 40% up in the next 5 years
  • 2x in the next 10 years
  • 3x in the next 15 years
  • 4x in the next 20 years

From here you can build for all incremental 5 years using the logic that prices double in every 10 years. So for 25 years, we know that in 15 years prices are 3x and hence for 25 years it is 3×2= 6x. For 30 years it will be 4x (for 20 years)*2 (for the next ten years) = 8x

So if we remember 1.4x, 2x, 3x and 4x we can calculate an approximate value for all of our future expenses!”

2.How much to save for future expenses?

Image result for savings

Assumption 1:
A reasonably well designed equity portfolio
should provide me with ~15% returns for time frames above 10 years.

(This is based on history and your guess is as good as mine when it comes to predicting future returns. So just in case you think my assumption is optimistic then you can refer to the annexure of this post and adjust your calculations accordingly.)

Assumption 2:
I will be able to increase my savings by at least 5% every year

(Assuming a static monthly savings for the next 10 years and more is being a little too conservative as our salaries normally are expected to increase at least to keep up with inflation)

Rule of thumb 2:

We need to spend some 2 minutes and memorize the below numbers. The table tells us how an investment of Rs 1000 every month which is increased by 5% every year and provides a return of 15% will fare over different time periods.


(this table will be different based on your return assumptions. Refer annexure)

How do we use this?

If you have an expense of 40 lakhs after 15 years, how much will you have to save every month?

Simple. For every Rs 1000, you end up having Rs 8 lakhs after 15 years. So for accumulating Rs 40 lakhs in need to save 40/8 lakhs = 5 and hence 5*1000 = Rs 5000 every month.

Now this is all we require for our financial plan. Let us put the entire thing into action

A simple financial plan

Let us take the case of Rahul, aged 30. He is recently married, has a 2 year old daughter Sandya and earns around a lakh every month. How does he go about doing his financial plan while driving back from office ?

Traffic signal 1:

Image result for traffic signal

Rahul’s mind voice:
“Let me get done with my daughter’s education first

.Image result for education

A decent 4 year engineering degree roughly costs around 10 lakhs today. My 2 year old daughter will be in college at around 17. So I have another 15 years left.

Now based on the above table, the cost of education will become 3x in the next 15 years i.e Rs 30 lakhs.

So how much will I have to save every month?

Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 8 lakhs in 15 years. So I need to save around Rs 4,000 every month which will give me approx 32 lakhs in 15 years.

The traffic light turns green and Rahul is done with the plan for his daughter’s UG education!!

Takeaway: He needs to start saving around Rs 4000 every month for his daughter’s under graduation

Traffic signal 2:

Rahul: “Now let me also decide on her MBA expenses. Assuming she does her MBA at 22. That is around 20 years. An MBA today costs around 25 lakhs. So the cost of an MBA 20 years hence is 25*4 (the inflation multiplier) = roughly Rs1cr.

Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 18 lakhs in 20 years. So I need to save around Rs 5,500 every month which will give me approx 1cr in 20 years.

So, Rs 4000 for UG and Rs 5,500 for PG – in total let me round off and start saving Rs 10,000 every month for my daughter’s education.”

Traffic signal 3:

“Now I would also like to buy a home after 20 years. The current cost works out to be around Rs 80 lakhs. This implies the cost after 20 years accounting for inflation would work out around Rs 80 lakhs * 4 = Rs 3.2 cr!

Image result for home in anna nagar

Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 18 lakhs in 20 years. So I need to roughly save around Rs 18,000 every month which will give me approx 3.2 cr in 20 years for the house that I am planning to buy.

Traffic signal 4:

“I would also want to save some corpus for retirement. Approximately, the math says I need around 20 times current earnings to create a similar annual income stream which can grow along with inflation.

Image result for retirement

Since my current salary is Rs 1 lakh per month, or Rs 12 lakhs per year, I would need around Rs 12 lakhs * 20 = Rs 2.4 cr if I were to retire today. Thus this implies adjusting for inflation after 20 years I need Rs 2.4 cr * 4 = 9.6 cr for retiring with the current lifestyle.

Looking at the above table, every Rs 1000 invested per month (and increased by 5% every year) gives me Rs 80 lakhs in 30 years. So I need to roughly save around Rs 12,000 every month which will give me approx 9.6 cr in 30 years for my retirement corpus

Traffic signal 5:

Thus summing it up:

  1. Daughter’s education: ~10k per month
  2. Home: ~18K per month
  3. Retirement: ~12K per month

Thus overall, Rahul  will need to roughly save a total of Rs 40k per month for all his goals. And the waiting time in 5 traffic signals is all that it took 🙂

And there you have your simple financial plan !!

What if you have already saved up some amount. No worries, we have a solution for this too.

Thumb Rule 3:
At 15% your money doubles every 5 years

So if you have saved let’s say around Rs 10 lakhs, it will be Rs 20 lakhs in 5 years, Rs 40 lakhs in 10 years, Rs 80 lakhs in 15 years and so on..

Do let me know if you found this helpful and if you had any issues while implementing this.

Please remember that these numbers are rough approximations and hence don’t get too obsessed on precision. The idea is to get you started with a simple plan 🙂


If your return assumptions are different from my 15%, then refer to the table below for the appropriate values (and round the values off to make it easy)

SIP at various returns

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A simple trick to estimate your future costs in 2 minutes

Recently my mother received Rs 2 lakhs from a money-back-insurance-scheme on its maturity. She had been paying a small amount every year for the last 15 years.  Now, 15 years back when the insurance agent told her that she would be getting Rs 2 lakhs she was excited as  it looked like a large amount back then..

Unfortunately, today when she actually received her amount, the reality is a lot less rosy than she had imagined back then. She had grossly underestimated the eroding power of inflation on money.

Now most of us, similar to my mother may end up underestimating our future requirements, as inflation increases all our costs gradually and most of us tend to not appreciate its significant impact over the long run.

How do we ensure that this doesn’t happen to us?

She can obviously use an excel and calculate her future requirement by plugging in some inflation and current cost estimates. But knowing my mother’s aversion to excel and numbers, I wanted to give her an easy way to approximate her future costs.

So here is an easy shortcut..

Historically, India has witnessed an inflation of around 7-7.5% (refer here)

(While inflation has come down recently, I would still like to be conservative and go with  history 🙂 )

Short cut 1: Estimating future cost

As it is tough to calculate the compounding formula ( future cost = today’s cost*(1+inflation)^no of years) in our minds, let us develop some quick approximations.

The rough math for a 7-7.5% inflation implies prices will approximately go up by

  • 1.4x or 40% up in the next 5 years
  • 2x in the next 10 years
  • 3x in the next 15 years
  • 4x in the next 20 years

From here you can build for all incremental 5 years using the logic that prices double in every 10 years. So for 25 years, we know that in 15 years prices are 3x and hence for 25 years it is 3×2= 6x. For 30 years it will be 4x (for 20 years)*2 (for the next ten years) = 8x

So just remember 1.4x, 2x, 3x and 4x (these are approximations but works fine as anyway planning for the future in itself is an approximation exercise)

How do we use this?

Let us assume your kid is 2 years. You estimate the current cost of under grad to be around Rs 10 lakhs.

So now without using an excel, you can quickly approximate the education cost of your child after 15 years to be 3x of 10 lakhs i.e 30 lakhs.

If your monthly expenditure is Rs 50,000 today then it becomes

  • 40% up i.e Rs 70,000 after 5 years
  • 2x i.e Rs 1,00,000 after 10 years
  • 3x i.e Rs 1,50,000 after 15 years
  • 4x i.e Rs 2,00,000 after 20 years

If someone’s salary is Rs 30,000 today and in the next 5 years it becomes Rs 42,000. Should he be happy?

Of course not. Our short cut calculations, indicate his salary just to account for inflation should have grown by 40% i.e from Rs 30,000 to Rs 42,000. This means his actual salary hike across the years in reality has been zilch!!

You get the drift. So go ahead calculate all your future costs while you are waiting in the next signal on the road 🙂

Short cut 2: Putting future values in perspective

Remember: 70%:50%:35%:25%

i.e to equate future values to today’s costs at 7-7.5% inflation

  • Today’s value of the money you get after 5 years = 70% of the money (accounting for inflation)
  • Today’s value of the money you get after 10 years = 50% of the money (accounting for inflation)
  • Today’s value of the money you get after 15 years = 35% of the money (accounting for inflation)
  • Today’s value of the money you get after 20 years = 25% of the money (accounting for inflation)

So if your insurance agent promises lets say Rs 40 lakhs in 15 years, you should think of it as 35% of 40 lakhs i.e 14 lakhs in today’s terms.  So whatever 14 lakhs can buy you today, will be what this 40 lakhs can buy you in 15 years.

Use these 2 thumb rules to quickly calculate your future requirements post inflation and to put future values in proper perspective.

But what if we can do an entire financial planner within 5 minutes in our head. Wouldn’t that be super awesome. Hang on till the next week, I have got you covered!

And do subscribe so that you don’t miss out on the next post 🙂

The next time you see an awesome ad ask these 6 questions – Your “Aha” moment is guaranteed!

There are literally hundreds of ads which we are subject to, each and every day of our lives. While majority of them are crap, once in a while, there are some memorable gems which touch our hearts.

Here is one of them, which I came across recently..

In a world, where our attention time span is decreasing day by day..

How in the world, does this ad manage to get us engaged for 4 long minutes?

Are there some underlying patterns across these memorable ads which we can make use of while communicating our ideas?

While I don’t expect most of us having to shoot ads for a livelihood, but irrespective of whatever profession we are in, inevitably majority of us have to communicate our ideas in some form or the other. Wouldn’t it be great if we could find the secrets of these ad makers and use it for our own communication..

Hang on and soon we will find them out..

The Dan brothers to the rescue..

As always, thankfully instead of us having to do all the hard work, we have two super cool brothers to our rescue.

  • Chip Heath, a professor at Stanford Graduate School of Business
  • Dan Heath, a Senior Fellow at Duke University’s CASE center and previously a  researcher and case writer for Harvard Business School

Image result for chip and dan heath

They have written a mind blowing book on what makes certain “ideas” sticky (i.e remembered easily and for a long time)

Let us find out what the Heath brothers have to tell us..

6 Traits Of Ideas That Stick

Most of the ideas which are communicated well have 6 traits in common:

  1. Simple
  2. Unexpected
  3. Concrete
  4. Credible
  5. Emotional
  6. Stories

This can be remembered by the acronym – SUCCESs

Image result for made to stick


Image result for simple can be harder than complex

Strip down your message to the single most important idea that you want the audience to remember!

In other words as the famous saying goes – Keep It Simple, Stupid

Does the ad do this?

Yup. It communicates the single core idea –
Samsung will take care of you, wherever you are!


When things become routine for us and have become familiar through repetition, our conscious mind stops paying attention to them.

Further our minds are always guessing “What next” and if the communication is in line with our guessing pattern then we easily get bored!

The key to capture our attention is to – Break that familiar pattern! 

There should be an unexpected, surprise element!

Image result for break the patterndan heath

Does the ad do this?

Yes again.

On reaching the home of the customer, the engineer is taken aback to see that the customer (a young girl) is visually impaired. We are surprised too and left wondering as to why a visually impaired girl would want her TV repaired. This moment breaks our guessing pattern. The curiosity is further triggered as she calls all her other visually impaired friends to watch the repaired TV.


People need to be able to clearly see in their mind what you’re describing!

Instead of an abstract explanation the idea must be explained in terms of clear human action, sensory information and concrete things.

Does the ad do this?

“We service all places in India” would have obviously been abstract.

But instead the ad spends time, detailing the journey to establish a beautiful remote place with flowing landscape of roads, hills and rivers. The road blocks in the form of sheeps, rickety-looking suspension bridge, fallen trees etc  paint a concrete picture of the “remoteness” factor of the location.


The idea should be inherently believable – otherwise we dismiss them immediately.

Does the ad do this?

Samsung Cares - Samsung With You Forever

The ad has some great actors who make the whole story relatable and believable.

The best thing that adds to the credibility factor is the fact that the ad avoids the usual models and has used real life special kids across India from across India. The lead Drishti is extremely adorable and the voice of the kid who sings is simply out of the world.


Appeal to the heart, not the mind.

Image result for heart over brain

An appeal to the emotions is a great recipe for successful communication. It should evoke emotions, make us feel something – and in doing so it should make us care.

We all think with our head but always act from our heart.

Does the ad do this?

Of course. Its a heart warming story which pulls all the right emotional strings.

Be it the soul stirring background song, the poetic lyrics, the innocence of the lead girl, the heart tugging blind hostel situation, the warmth of the special children, the captivating voice of the singer in the reality show – the campaign for sure makes an emotional connect with us and touches us in a really special way.


We remember stories more than statistics!

Image result for stories

We all love a good story which has a simple plot, contains unexpected twists, expressed in a language that helps us feel, see and touch it, is relatable and credible an appeals to our emotions.

Does the ad do this?

Do you remember the television brands which usually talk about some impressive features – such as high-definition picture quality, surround sound system, movie theatre like attributes in its ad film?


But the reason you do remember this one is because the heart and soul of the entire ad is its storytelling.

A Samsung service engineer, who undaunted by rough terrain, reaches a house in a remote hilly area to repair a television. But what he thought was a normal phone call turns out to be a special one…

The joy of bringing a little smile to the bunch of visually impaired special kids who could finally listen to their friend sing on the TV.. Priceless.

He leaves the customer’s home with a smile on his face..and then it goes..

“At times one must venture a little further than usual for the sake of relationships”

And it just couldn’t get more beautiful than that..


Conclusion – Go read the book!

And yup..see the ad again 🙂

Wow.. Now you know why the ad is so interesting and memorable 🙂

I have just given you the gist of the SUCCESs framework (and have obviously done grave injustice to the actual contents of the book) and hence would highly recommend you to check the actual book out.

The next time you find an awesome presentation, speech or ad. Just check on how many of six traits of the SUCCESs framework does it tick. Also do it for ads that don’t make the cut.

I am sure your “Aha” moment is guaranteed:)

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Evaluating equity mutual fund returns – from theory to practice

In our last post here, we found the reasons as to why short term fund performance is not a great way to evaluate a fund manager’s skill.

The cyclical nature of market returns argues for evaluating manager performance over a full market cycle. When evaluating investment managers it is important to understand that managers can perform differently during various parts of the market cycle. Since a full market cycle incorporates a diverse range of environments, it provides a better context for performance evaluation.

While track records over entire market cycles may not be available for some managers, choosing a time frame which covers a wide range of market conditions provides the best context for fund manager performance evaluation.

Your mind voice: “Err..All this is fine. You make it sound elegant and intelligent (yawn). But if I were to be honest with you. Can you you please cut all this mumbo jumbo, and tell me how does this help me in real life? “

Oops..Apologies! I guess I got a little carried away. Anyways let us learn on how to put all this into action.

Putting “context” into investment returns

If you are someone who is planning to invest in equity mutual funds today, what will be your first starting point.

If you are like the rest of us, then the answer is simple – Past Returns!!

So you go to Value Research and find out the top 5 funds of the last 5 years.
(Since you have read my earlier posts here and here you have decided to ignore the shorter time frames (1 and 3 year returns) and go slightly longer.)

Fund Selector Returns Value Research Online

Returns as on 30-Jun-2017

Wow!! More than 30% compound annualised returns in the last 5 years ..Let me invest immediately!

Or if you are someone being advised, there is a good chance that you have been recommended one or all of these funds.

Obviously the 5 year returns are mind blowing and hence when we are recommended one of these, our natural tendency is to go and invest.

So how do we evaluate recommendations such as these?

This is where we need a checklist to ensure we put these returns in the correct context.

Checklist Question 1: Does the return period, cover an entire cycle – i.e is it sufficiently capturing both bull phase and bear phase?

In this case the recommendation to us is that the last 5 year returns have been great in these funds. So let us check on how the broader equity market fared in the last 5 years.

sensex Google Search

As seen above, the sensex has moved up from 17,500 levels to ~31,000 levels. Broadly the trend has been a bullish one, with some intermittent correction and consolidation in 2015-16 period.

This implies the current period of evaluation does not sufficiently capture an entire market cycle.

Further if you notice all the 5 funds are small and mid cap funds.

As we understood in our earlier post, mid & small cap segment also go through cycles and hence let us check which part of the mid cap cycle is the last 5 year period covering i.e from Jun 2012.


MidCap Cycle

As suspected, the last 5 year period predominantly covers only the up cycle in mid caps. Hence a significant part of the returns is also because mid and small caps were o

Thus the first step is to ask your advisor, to extend the time frame to cover an entire cycle. i.e from 05-Nov-2010 till date

(A full market cycle can be defined as a peak-to-peak period that contains a price decline of at least 25% over at least a six month period from the previous market peak, followed by a rebound that establishes a new, higher peak. I have ignored the peak to peak from Mar 2015  till date period as the cycle is yet to get over and hence have clubbed it along with the earlier cycle )

Now let us see how the returns pan out over an entire cycle:

Nov 10 till date.jpg

In 2011 there was a huge crash in mid cap funds. The same funds were down between 24 to 27% (except Mirae Asset Emerging Bluechip fund which was down by 15%) in the year 2011.

Yet, the full cycle returns for the 5 funds are extremely decent (due to fact that last 3 to 4 years mid cap segment had a significant rally) and are in the top 10 diversified equity fund returns across the entire cycle.

Fund returns in last cycle.jpg

So all the funds look good as of now..Great!

Now the next step is to check returns across the earlier cycle which is between 10-Jan-2008 till 05-Nov-2010

2008 till 2010

Three funds have not experienced the previous cycle

  1. Reliance Small Cap – Inception date – Sep 16, 2010
  2. Mirae Asset Emerging Bluechip Fund – Inception date – Sep 09, 2009
  3. SBI Small & Midcap Fund – Inception date – Jul 09, 2010

The fact that the above 3 funds have not experienced the 2008 recession period is a negative for us as we only have a limited track record over one cycle 😦

So let us check out the full cycle returns of the other two funds
Franklin India Smaller Companies Fund and DSPBR Microcap fund have track records covering the earlier cycle (from 10-Jan-2008 till 05-Nov-2010)

Equity Div Funds 2008-10

As seen above, Franklin India Smaller companies fund was a bottom quartile performer (97 out of 129 funds) with negative returns over the entire cycle.

DSPBR Microcap fund was a tad better but nowhere near its current performance. It was ranked 37 amongst 129 funds.

Even when compared with its peer group average Franklin India Smaller companies fund was in the bottom quartile.

Mid cap returns in 2008-10

Thus the moment we extend our horizon to include 2 cycles it allows us to sober down, and provides a much more balanced view on these funds.

Now if you really think about it, the real time to have bought these funds is in 2013 period. But given the past returns at that juncture there is no way we would have invested in these funds.

Anyway the takeaway is that the top performers of today, weren’t the top performers of yesterday and hence we must keep our expectations in check (as we are only interested in reasonable performers of tomorrow).

Checklist Question 2: How long has the current fund manager been managing this fund?  Has the fund manager changed in between?

Now to make sure the past performance evaluation is relevant, we need to check if the fund manager has remained the same

  • Reliance Small Cap: Sunil Singhania since Aug 2010
  • Mirae Asset Emerging Bluechip Fund: Neelesh Surana since May 2010
    • There has been a CIO change in the fund house recently (link). My subjective opinion is that most often than not the CIO plays an important role in portfolio decisions in most of the AMCs especially in smaller ones. Hence this is a red flag for me and would want to evaluate the fund manager for some more time.
  • SBI Small & Midcap Fund: R Srinivasan since Nov 13 – After SBI took over Daiwa AMC, Daiwa Industrial Leaders Fund, a large cap scheme was converted to SBI Small & Mid Cap Fund. So the track record before this is not too relevant. Red Flag!
  • Franklin India Smaller Companies Fund: R Janakiraman since Feb 2008
    • Longevity of fund manager is a positive and makes our evaluation across 2 cycles relevant
  • DSPBR Microcap Fund: Vinit Sambre since Jun 2010
    • This reduces the weightage we must place on our evaluation of the fund’s performance in previous cycle

Thus in effect except for Franklin India Smaller Companies Fund all the other 4 funds have relevant track records only for one cycle (SBI Small & Midcap Fund has it only from Nov-13)

Checklist Question 3: Is the fund manager managing other funds with similar strategy? If yes, how is the track record in other funds? And check if he has a longer track record in any other fund?

Reliance Small Cap is managed by Sunil Singhania who is also the CIO of Reliance mutual fund.

He manages Reliance Mid & Small Cap fund. But unfortunately the fund was earlier called Reliance Long Term equity fund (closed ended for sometime) and was changed to a mid cap fund only with effect from January 22, 2015 and hence the past performance may not be too relevant.

He manages another mid cap oriented fund (50% mid cap exposure) called Reliance Growth fund from 2004. However this fund has returned only 9.8% versus Reliance Small cap returns of around 20.9% in the 2010 till date cycle. This implies the higher returns in Reliance Small Cap may have been due to the focus on small caps.

SBI Small & Midcap Fund is managed by R Srinivasan who is also the CIO of SBI mutual Fund. He also manages SBI Emerging Business Fund. But however the fund after being the top performer in 2010,2011 and 2012 has significantly under performed in the last 3 years after its size increased. Its best return period came when the fund was sub 1000cr and was a relatively unknown fund

SBI Emerging Businesses Fund   Growth   Mutual Fund Performance Analysis.jpg

Similarly SBI Small & Mid was also sub 1000 cr and a relatively unknown fund before this scorching performance. Hence this raises concerns on whether the strategy is replicable at larger fund size. (but the good part this time is that the fund size has been capped)

Franklin India Smaller Companies Fund: R Janakiraman manages another mid cap fund Franklin India Prima Fund which gain has similar performance characteristics as Franklin India Smaller companies fund – under performed in the 2008-10 cycle and outperformed in the 2010-17 cycle.

DSPBR Microcap Fund: Vinit Sambre manages another mid cap strategy via DSPBR Mid & Small Cap Fund which has provided 14.5% over the 2010-17 cycle which is slightly below the peer group average. (again implying the relevance of small cap exposure in boosting returns for DSPBR Microcap fund)

Checklist 4: How consistent has the performance been? How has it performed during bad years?

For this we need to check the calendar year returns of every fund from morningstar.

SBI Small & Mid Cap Fund:

SBI Small   Midcap Fund   Regular Plan   Growth   Mutual Fund Performance Analysis.jpg

After 2 years of strong performance, the fund has under performed its peers in 2016.

Franklin India Smaller Companies Fund:

Franklin India Smaller Companies Fund Growth Mutual Fund Performance Analysis

The fund has remained reasonable consistent across the last 5 years. However the declines during 2008 and 2011 were more than the category average

Reliance Small Cap

Reliance Small Cap Fund Growth Mutual Fund Performance Analysis (1)

The fund has remained reasonably consistent across the last 6 years and has outperformed its peers.

DSPBR Microcap Fund

DSP BlackRock Micro Cap Fund Growth   Mutual Fund Performance Analysis.jpg

Good consistency in performance across the last few years

Mirae Asset Emerging Equities Fund

Mirae Asset Emerging Bluechip Growth   Mutual Fund Performance Analysis.jpg

While the fund has been extremely consistent across the years with lower declines, but since there is a fund management change I am not considering this for analysis.

Checklist Question 5: Is the fund facing any size constraints (as strong past performance generally leads to investors chasing these funds and hence sudden increase in fund size)

Most of these funds seem to have either capped or stopped inflows citing possible size constraints if the fund were to grow further. While this is good for existing investors, for someone who wants to invest now, it provides a subtle message on the possible size constraints the category might be facing.

  • Mirae Asset Emerging Bluechip Fund: INR 3898 cr (as on 31-May-2017)
    •  Temporarily suspended fresh lumpsum subscription (including switches) in this fund w.e.f. 25th October, 2016
    • “Considering the significant flows which we are getting in the fund recently, we believe any large incremental inflow at this stage could be detrimental to the interest of the existing investors,” said Swarup Mohanty, chief executive officer, Mirae Asset Mutual Fund.
  • SBI Small & Midcap Fund: INR 691 cr (as on 31-May-2017)

    • No fresh subscriptions either as a lump-sum or through SIPs since 30-Oct-20115
  • Franklin India Smaller Companies Fund: INR 5696 cr (as on 31-May-2017)

    • No restrictions till date despite being a relatively large fund (5,696 cr) amongst the rest.
  • DSPBR Microcap Fund: INR 5,818cr (as on 31-May-2017)
    •  In September 2014 it implemented a restriction of Rs 2 lakh for daily lump sum subscription. It was reduced further to Rs 1 lakh in August 2016.
    • On 20 February, 2017, all subscriptions to the fund has been temporarily stopped
    • Vinit Sambre, Senior Vice President and Fund Manager, DSP BlackRock said, “While we continue to find interesting investment opportunities for the fund to invest in, its current size poses the bigger challenge of liquidity. It is challenging to incrementally build positions, i.e. to increase stock weightage of companies to a meaningful size in the portfolio.”
  • Reliance Small Cap: INR 3,767 cr (as on 31-May-2017)
    • Removed restrictions from Jan-14. Earlier lumpsum investments were restricted to 5 lakhs

Trend of funds restricting flows implies possible liquidity constraints for the segment. Increasing valuations amongst stocks of this segment might also be another reason.

“When we speak about midcaps, some of the companies have become really expensive as compared to their historical norms. This is, in a way, linked to the kind of money flow coming into the market. As the markets are touching new highs, there is this typical bull market phase, where the retail investors also want to participate. Everyone is trying to seize the opportunity and put money in the market. So, I think there is some sort of frenzy in the midcap space. Valuations are high. I would be happier if there is some correction here” – Vinit Sambre, Fund Manager, DSPBR Microcap Fund
Source: ET

Checklist Question 6: What are the drivers for the recent performance? Is it only the fund or the category which has performed? If its the category, then what is the outlook of the category for the next 3-5 years?

The fact that all the top funds belong to the small & mid cap category gives us a mild suspicion that its the category that is the biggest driver of recent performance.

CAP Past 5 yr returns

As suspected, that’s the case and hence we must first take a view on the mid and small cap category for the next 3-5 years before we decide on the funds. For this we need to evaluate the current valuations vis-a-vis possible earnings growth going forward and get an approximate sense of where we are in the mid cap cycle.

Summing it up:

Thus as seen above, from a simple “Wow, the 5 years performance is awesome – so let me invest!!” scenario, just by asking a few more questions we have managed to get a far better picture on the above funds.

Remember its your hard earned money. So whether you are investing on your own or with an advisor, do make sure to look beyond the short term performance and most importantly to understand the “context” of the current returns before you take the plunge.

This time, instead of me giving my final opinion on these funds, I have presented you with some interesting data on the above funds and will let you folks connect the dots and take a view on the funds. Also, do share your views via the comment section.

That’s a pretty long post. Phew.

As always happy investing folks 🙂

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The framework or checklist as with all things in investing is an evolving process. And I tend to use a few more parameters while evaluating funds at my workplace as I have access to both the fund managers and other fund related data. Nevertheless, look at this as good starting point to evaluate returns 🙂

Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments








The mystery of short term past performance versus future equity fund returns

10 minute read

In our earlier posts, here and here, we found to our dismay that, our natural inclination to choose the top mutual fund performers of the past 1 & 3 years hasn’t worked too well.

That leaves us with the obvious question..

What actually goes wrong when we pick the top funds of the past few years?

 The rotating sector winners..

Below is a representation of the best performing sectors year over year. What do you notice?

Sector wise calendar year performance.png

The sector performance over each and every year varies significantly and the top and bottom sectors keep changing dramatically almost every year.

Sample this:

  • 2007 – Metals was the top performer with a whopping 121% annual return
  • 2008 – Metals was the bottom performer with a negative 74% returns & FMCG was the top perfomer (-21%)
  • 2009 – The tables turned! FMCG was the bottom performer (47%) while Metals was the top performer (234%)
  • 2010 – Oops! Metals reversed to become the bottom performer (1%)
  • 2012 – IT was the bottom performer (1%)
  • 2013 – Reversal of fortunes – IT was the top performer with a huge 55% return

Now if you want to seek some pattern/connection out of this I am afraid it might be a futile attempt. It’s just our pattern seeking brains at work!

Image result for pattern seeking

The simple takeaway is this: Sectoral winners and losers keep rotating randomly and drastically across short time frames

Thus, when we start picking funds based on their last 1 year return, for the fund manager to get into the top yet again, he/she has to exactly know which will be the new sectors which will be on top for the next year and has to rotate back into them.

This in my opinion, unless the fund manager has some supernatural ability to predict the future, is impossible to pull off consistently year after year.

Going by this, it is natural to expect fund rankings to be extremely random in the short run and hence we must not give too much importance to short term performance.

This brings us to our next question:

If the sector performance of the short run is anyone’s guess. And logically since the long run is nothing but the accumulation of the short run, is selecting funds a huge gamble. How in the world do we evaluate fund managers then?

Understanding Market Cycles

Let us turn to one of the most experienced Indian fund managers for some possible answers.

Now for those, who are running short of time, the gist of what Prashant Jain has to say is:

  • Indian stock markets historically has moved in 6-8 year cycles
  • Sectoral leadership in the market changed with every cycle
  • In every cycle, one or more sectors that were often correlated with each other assumed leadership and vastly outperformed the broad market
  • The next cycle then brought with it new leadership 
  • Between 1995-2016, markets have witnessed 3 broad cycles
    1. 1995-2000:
      IT sector was the leader (stocks up by 96-97x); S&P BSE SENSEX (Sensex) moved from 3,000 to 4,000
    2. 2001-2007:
      Capex/Banking/Commodities/Auto led the market (stocks up by 8 to 30x) (; Sensex moved from 4,000 to 20,000
    3. 2008-2015:
      Pharma/FMCG/Auto were the new leaders (stocks up by 3 to 15x); Sensex moved from 20,000 to 26,000

Sector Performance across cyclesSource: HDFC Equity Fund presentation

You can also read his interview on the same topic here

A similar view is also echoed by another experienced fund manager Sankaran Naren of ICICI Prudential Mutual Fund

“Whenever we raise a toast to outperformers, we tend to forget the role of market cycles. Companies become outperformers because of the sector becoming an outperformer. That part is forgotten by people very often.

In the 1990s, we were in an export cycle. After that, there was a very strong boom in technology. Between 2001 and 2003, there was a lull phase and then from 2003 to 2006, there was a mid-cap cycle, followed by an infrastructure cycle that went on till 2008. Post that we had a consumption rally.”

“When the cycle is on an upswing, it doesn’t really matter if a company is great or not — companies in the sector outperform because of the upturn in the business cycle.”

Now before all this goes over our head, let us try and make some sense out of this..

While it is impossible for the fund manager to get the sector calls right year after year, reasonable long term outperformance can still be provided by fund managers who can broadly position their portfolios for sectors which lead the cycle but at the same time not get carried away by the euphoria and can reasonably transition portfolios  across cycles.

Now what does that mean for us?

Short time frames end up capturing only a small part of the cycle and hence it is difficult to evaluate if the fund performance is sustainable as an when the cycle turns.

For past performance to make sense, we need to increase our evaluation periods to cover an entire cycle (i.e not just the bullish phase or bearish phase in isolation). The more the cycles over which we can evaluate the fund manager’s performance the better.

Great..but is it just the sectors that tend to move in cycles??

Even investment styles tend to exhibit cycles..

Investment Styles & Cycles

As seen above, historically in India (and also in other global markets), different investment styles tend to perform at different periods and go through similar cycles as seen in sectors.

You can learn more about this from this video

The other way to look at this is in terms of moat, growth without moat etc.

In the period between 2004-07 moat investing (popularized by Warren Buffet and Charlie Munger) did not work, but instead growth-without-moat worked brilliantly. So naturally funds which did not have growth without moat style, would have suffered.

However, in the period between 2008-13, moats were back in fashion and funds which followed moat based strategies outperformed everything else.

So in addition to evaluating returns over a complete cycle, we also need to place in context the investment style of the fund manager and ensure that our evaluation period covers an entire cycle from an investment style perspective too.

The large cap vs mid cap cycles..

Mid vs Large Cycles

Mid caps (11x) trounced large caps (7x) during the bull run of 2003-07. But the interesting part came post that. For the same investor, in another 1.5 years, the returns of large caps and mid caps stood similar for the period 2003-09..Call it the power of cycles!!

As seen above, large and mid caps tend to converge over cycles, with mid caps outperforming in bullish phases and large caps outperforming in bearish phases.

This again is extremely important when we look at past returns of a fund manager as we have to make sure that our evaluation period covers an entire cycle and not just the bullish or bearish phase.

This becomes extremely relevant in today’s context as most of us tend to prefer mid cap funds based on their last 3-5 year performance. A casual look at the above graph will indicate the trap that we might be getting into. (this deserves a separate post on its own. so will reserve it for another day)

Summing it up..

  1. The cycles across sector, investment style and market cap segment more or less seem to coincide with the bull and bear phases for most of the periods, as seen from historical evidence

  2. Returns over short time frames are not a great indicator of future returns as most of the times they only represent performance over a small part of the cycle and the true color of the fund manager is known only when the cycle turns.

  3. To derive meaningful evidence from a fund/fund manager’s past performance we need to increase our evaluation periods to cover at least an entire cycle (obviously the higher the no of cycles the better)

  4. Thus while it is impossible for any fund manager to consistently perform over the short term, we can look out for fund managers who are consistent in performing across cycles

  5. When putting up a portfolio of funds together, we also need to diversify across investment styles (value &  growth) and market caps (large & mid caps) as different styles and market cap segments tend to perform over different periods of time.

All this is fine. But how do we exactly define a cycle and how have funds performed across various cycles?

Hang on. We will save that for the next week 🙂

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Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

The curious case of the “Top 5” fund investor – Part 2

A few weeks back we had explored the curious case of the “Top 5” fund investor here.

For those who haven’t read the earlier piece, the short summary goes like this –

Typically most of us intuitively tend to select funds based on the previous year returns. However when we tested how an investor who picked funds for his portfolio every year based on the previous year’s top 5 had fared in the last ten years, we found something very shocking. 

The returns of the investor who picked funds based on the past year’s top performers  actually was lower than the one who picked the past year’s bottom performers!!

But before you jump into any conclusion and go after the bottom 5 – the takeaway was that the performances across the investors who picked 5 funds from various ranks (1-5,6-10,11-15 and so on) were actually simply random. So neither the bottom 5 or top 5 is a fool proof strategy (or for that matter any “position of ranking” strategy).

Great. But that leaves us with another question.

Maybe 1 year is too short and is irrelevant. Agreed.

But what if we picked funds based on 3 years instead of 1 year. Will the results be the same??

Image result for investigator

Let us put our investigative hats on and find out..

So here is the new plan:

Image result for new year party

On every new year after our parties are over and we become sober, as usual we shall select the top 5 diversified equity funds (no sector, thematic, etf, index, international, balanced blah blah) but with a small change. This time it will be based on their performance for the last 3 years (instead of 1 year) and we will let it run for a year till the next new year party. And then repeat the same process again. Eg On 1-Jan-16 we would have selected the top 5 funds of the last 3 years (i.e covering 2013, 2014 & 2015). On 1-Jan-17 we would replace it with the top 5 funds of last 3  years (covering 2014, 2015 & 2016). And so on..

How do you think this strategy would have performed in the last 10 years? (i.e between 01-Jan-2007 till 01-Jan-2017)

Take a guess. Will it be better than our 1 year strategy?

The strategy of picking top 5 fund based on last 3 years gave 13.6% compound annualized returns vs 10.8% for the earlier strategy based on last 1 year returns.

Phew. Some good news at last..

Putting that in perspective,

The Nifty gave only 8.1% compound annualised returns in the same period

Further, the 10Y returns of the 95 diversified funds that existed for last 10 years was also lower at 10.8%

And here comes the best part..

Amongst the 95 funds, this new strategy was ranked 15th !!

So at the outset, selecting funds based on a 3 year time frame definitely seems to be much better option than on a 1 year period.

But wait…

Just before we go about jumping “Eureka”, here comes the dampener

The bottom 5 funds strategy (in this case the funds ranked between 41-45) gave a mind blowing return of 15.2%!!

And this bottom 5 strategy was ranked the 4th across all funds in the last 10 years!!

(Now the detective in you must be wondering how can 41-45 represent the bottom as there were 95 funds and hence shouldn’t it be the fund ranked 90-95. Am I upto some data jugglery. Relax. Since I had to use a 3 year past return – it implied we needed to have funds with 13 years track record which came to around 48 funds. So, I took 41-45 for convenience)

But as always,

Image result for the devil lies in the details

So let us check the returns of the other strategies which picked funds across other ranks i.e 6-10, 11-15 and so on..

3year based - All Strategies Performance.png

Oops. Yet again there seems to be no pattern. The top 11-15 fund picking strategy has given 10.0% while the top 16-20 strategy has given 14.3%.

Now based on this data, one thing is for sure. You and I should definitely not be betting our hard earned money on some random top 5 or bottom 5 strategy!

Thus yet again, it leaves us with the same conclusion and the nagging question –

Why the heck does this happen? How in the world do we select funds if we can’t trust the past performance?

Some interesting answers coming soon. Hang on till the next week.

And just in case you like the contents,

Consider subscribing to the blog along with the 1300+ awesome people, so that you don’t miss out on the free weekly investment articles & other interesting updates delivered straight to your inbox.

Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments