Monday 14 December 2015

Exchange Traded Funds(ETF’s) : why too much may be dangerous now?


“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”: Mark Twain

Zara espouses low cost investing as a way to gather assets and it is unlike us to speak out against a perceived low cost option like ETF’s. But let us clarify we are not the first, Warren Buffet has railed against them for some time now. Carl Icahn has added to the debate by calling some of them downright dangerous (only to be proved right by the high yield bond markets).

Firstly, we don’t think ETF’s are a cheap form of investing, when they enable and encourage you to trade every minute and second of the trading day, thus adding to cost of ownership. A simple index fund with a low expense ratio would otherwise be fine for an investor looking to keep his costs low.

Secondly, Investing blindly in indices or a bunch of stocks in the hope of coming out okay is probably the most dangerous activity in the investing world today. Just as any activity carried out to the extreme makes no sense, neither does index following carried out to an extreme. The Nifty Fifty craze (investing in the top 50 companies) of the 1970’s in the United States, is an example of how massive amount of wealth is destroyed, when investors blindly invest in a bunch of stock in pursuit of returns.

Today in a repeat of the 1970’s USA, there is a worldwide proliferation of indexed (including ETF’s) assets under management at the expense of active management. For example of global equity fund assets, approx. two thirds are US raised assets. The ETF market worldwide is also dominated by the US, who has 73% of the global ETF assets garnered. Just 10 years back ETF fund assets  were less than 4% of US fund assets versus ~20% now. In CY14 almost 90% of equity fund net inflows worldwide were through indexed funds. If like the Nifty Fifties of the 1970’s in USA , this fad of index tracking ( possibly causing overvaluation in some market segments) results in a sharp fall in global markets, in this correlated global village, we are sure to be part of the collateral damage (like it has been in the past).

 In India of the approx. USD 300 billion Foreign Institutional Investor (FII) holding in the Indian equity market , approx. 45 % is  through funds that track/ benchmark some index (ETF’s were a decent part of inflows in recent times but are a small part of current overall  FII equity assets in India). FII’s now own ~20% of the market major indices (Sensex/Nifty) and approx. 40% of the floating stock and hence are important participants to track. All this point to the possibility that, stocks that are part of the country indices tracked by these FII funds, may have been bid high or could lack qualities of a good bargain (due to crowding in of investments).

Thirdly, in a market stress situation participants that ensure liquidity find it difficult to value units accurately, hence increase their bid ask spreads or just do not provide bids, increasing the cost of trading ETF’s. In such a situation, even index fund providers may find that every redemption request the industry receives causes steeper price falls. It is also possible some components of the index may not be as liquid as thought earlier, causing issues in redeeming units in the first place, like in the high yield market worldwide today.

Fourthly, many of the ETF’s/ index funds track their indices through synthetic instruments (derived exposures), which expose you not just the market, but also to counter party credit risk and even leverage sometimes.
Finally, for such a complex aggregation of stocks as in various indices it is difficult to quantify risk undertaken in meaningful terms. An investor needs to split up the components of such a complex aggregation of stocks and examine the risks he is actually undertaking, or he may inadvertently end up exposing his portfolio to risks he was unwilling to take in the first place.

Anything taken to an extreme has the potential for disaster. Even healthy eating.
 Gregory L. Jantz, Ph.D.
 
ETF’s and Indexing as a phenomenon may have been taken to extremes in the rapid growth of the last ten years. Also, there is never a given trend in the investing world, any trend carried long enough, makes space for its demise. By now, you get the import; keep your eyes open, invest carefully.

At Zara as you already may know, we believe in long term commitments and see market fluctuations as an opportunity to either sell or buy, keeping value in mind. As such we are not driven by market benchmarks and their movements, but are cognizant of them. Zara believes in advising fund deployment based on fundamentals which include margin of safety, meeting estimated cost of capital, minimising risk to generate reasonable returns across a business cycle of 5 to 7 years.

In your service
Dinesh da Costa, CFA                                                                                                       
Zara Investment Advisory
  
Please note information given above is not a recommendation to invest, but an educational illustration.
Please leave your comments by emailing at dineshd@zarainvestmentadvisory.in  or if you have a Google account by clicking on the link below       


Sunday 6 December 2015

Judging Fund Performance: What is most relevant?


You will note we had stated in June 2015 in a friendly pre-launch note “We do not, like most NAV oriented institutions, focus on daily, weekly, monthly, quarterly beating of the markets on a consistent basis. We find on a risk adjusted basis almost none of these players manage to beat the general markets( if they do at all beat absolute benchmark numbers they do so by taking higher risk than the benchmark embodies). The near term markets in which these institutions participate embody the definition of efficiency by being instantaneously efficient; all new information is immediately incorporated in prices, it is impossible to outperform such a market unless one has access to insider information, which is illegal anyways”.

It is imperative to look at third party data for justification. We have attached a link to SPIVA or S&P index versus active management analysis here which you can click (SPIVA link ) to get a note on for example how in the large cap strategy, looking at a 5 year horizon, 60% of funds do not perform the benchmark. We believe if you take into account the higher risk taken, by a few of the benchmark beating funds ( by buying some of the portfolio outside the large cap universe or taking some other factor exposures other than size), you will find very few funds have actually beaten the index, after  adjusting for risks taken.

It is important when you meet these fund managers you ask them, how they define risk in their portfolio and what kind of lead or lag of performance with respect to indices does the risk expose you to. Do not be satisfied till you get a precise answer, from anyone who you hand your money to. We expect a large majority will give you vague answers (which shows up in their long term performance).These people manage for daily returns and still tell you to invest for the long term, when they themselves don’t follow their own advice. Portfolio turnover is an indicator of what the risk measurement horizon of the fund manager is; anything less than 3 years i.e covering less than half of a business cycle is laughable, 5 to 7 years is the best targeted horizon, so that fund managers advice , market cycles etc all coincide.

Do not judge a fund manager unless you have seen at least one business cycle of money management from him. In the meanwhile focus on his risk management process; if this is poor, your portfolio/investment is as good as fried/ disaster hit, unless of course divine providence is with you.

In your service

Dinesh da Costa, CFA                                                                                                       
Zara Investment Advisory
  

Please note information given above is not a recommendation to invest, but an educational illustration.

Please leave your comments by emailing at dineshd@zarainvestmentadvisory.in  or if you have a Google account by clicking on the link below       

Friday 27 November 2015

Pharmaceutical sector- achieving an edge by managing risk

The last couple of years the market has been gung-ho about all the sales growth coming from pharma company exports to USA. In fact any company that had low share of sales to the US market had a dramatically different (lower) valuation band compared to the companies with greater presence there (USA). In spite of the greater earnings stability of the former (low US market share companies) from a regulatory perspective. In addition:
·         Retail pharmacy chains are far more consolidated (with a few large players making up majority of the market) in USA, than anywhere else in the world, hence you are playing a lowest cost game with group of large and knowledgeable buyers.
·         The consolidated nature of retail pharmacy chains, in a way also reduces barriers to entry.
·         Unless of course a company has  a first to file which gives it six months of selling exclusivity and some head start in the market as a brand. Even then there are always USFDA data or manufacturing audits that can upset the apple cart, when the company is rushing to be the first and could make some mistakes(i.e  inadvertently take short cuts) .
In face of such clear risks, buying the most popular pharma growth story, comes with its risk ,as the stock of one of largest market cap company’s clearly showed with a correction of  almost 30% ) from the top of March 2014 to now (due various concerns like a possible growth slowdown and a rare special audit ordered by the USFDA). Another large cap company in the sector similarly had its stock fall 21% in one month on adverse USFDA observations.  Factoring these business risks appropriately, depending on the company under consideration, therefore buying only when there is a margin of safety tends to protect downsides, and puts you and your portfolio in a favourable situation with respect to returns in a business cycle  of 5-7 years.
Dinesh da Costa, CFA

Please note information given above is not a recommendation to invest, but an educational illustration.
Please leave your comments by emailing at dineshd@zarainvestmentadvisory.in  or if you have a Google account by clicking on the link below                 


Monday 23 November 2015

Risk management is paramount

Approximately a year and a half back a few of us fund manager friends were sitting around discussing our portfolios over tea, of which I wanted to highlight a particular interaction. We happened to talk about the software sector and one of us remarked upon my portfolio namely the extra-large holding of a stock we can call “I”. One top performing fund manager immediately compared it to other large capitalisation stocks in the sector, saying it was a non-performer for many years and that the management had no clue what it was doing. He further added it was preferable to buy a stock; we shall call “T” as its management was more aggressive and seemed to know what it was doing. After trying to explain, on his insisting of the rightness of his point, I kept my silence.

Forward to today the stock “I” has become the new darling of the market having returned almost 50% in the time period, while the stock “T” returned approximately 12%. The point I am making is, at a price, risk is minimal in a stock. A particular stock may also do better than another in the short term purely because it has a higher risk model which is currently delivering growth, but such growth may be at high risk, as we have seen with the US FDA notices to many popular Indian pharmaceutical companies. What makes you money is not whether the company is good, bad or ugly, but whether the price you buy it at, gives you a margin of safety, considering the present business model and its risk. Therefore exposing your portfolio to unnecessary risks in pursuit of returns, will most likely not deliver reasonable returns in a 5 to 7 year horizon.

Dinesh da Costa, CFA
Please note the information given above is not a recommendation to invest, but an educational illustration.
www.zarainvestmentadvisory.in

Please leave your comments by emailing at dineshd@zarainvestmentadvisory.in  or if you have a Google account by clicking on the link below             

Wednesday 18 November 2015

How it will be?

I write this first short blog to temper your expectations of what to expect from the posts. Zara will post on high finance (Global & India), general views on markets, whatever adds to quality of life and enriches it i.e book summaries, links to intelligent thought( as we define it). It’s going to be about education and wealth creation (money, mind and body).That’s what Zara Investment Advisory stands for.

Here's wishing you a great year

Dinesh da Costa, CFA  
Zara Investment Advisory
www.zarainvestmentadvisory.in