Thursday, February 7, 2013

An investment for all seasons

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For an investment advisor, it is important to manage the asset allocation in equity vs bonds and others at the first level and to generate larger alpha


SO WE are amidst a Big Fat Indian wedding season. In these social gatherings usually conversations are either expressing awe or anguish over the money spent on the marriage or Indian cricket team's performance in the latest series or the Khans' performance in the latest blockbuster or finally over the capricious behavior of stock markets. If you want to seize attention in a social conversation you start talking about marriages, cricket or Bollywood.

 

You can equally well try it with Sensex or Nifty, but participation will depend on recent most behavior – ranging from "forget it, stock markets are a casino" to "oh, razzmatazz holdings is a multi- bagger, bought it for a dime, taking it to my grave". The least I would like to accomplish here is to provide fodder for social conversation! I was at Surat for Mr. Hirabhai Patel's son's wedding amidst one of those "can't understand the markets" discussions. Manibhai had just had a heated argument with his investment advisor. His advisor told him rates are going to go down so participate in auto and infrastructure stocks. And then you know what's happened! The Government has taken some serious steps and markets have turned buoyant indeed. But as a result, mid cap indices instead have gone up more than the popular index and PSU stocks in general with banks in particular have risen more than auto or infrastructure stocks. Having seen this many a time, I could understand Manibhai's frustration with his investment advisor and his advisor's frustration with the market!!! But it's important for us to understand what they could have done better. While it is always difficult to pick a stock or a sector which will most likely benefit in an event, it is relatively easier to pre- judge an upward movement in the market index in general. So what's your expectation on a pre- budget rally if any? What will be announced? Which sectors and which stocks will benefit if at all? I am sure you found the first question easier than the latter two.

This is where you can use Exchange Traded Funds ( ETFs). If you believe it's the Mid Cap index that will go up in a rally, instead of trying to identify any of the MidCap 100 in the CNX Mid Cap you could just call your friendly broker / advisor or log on to xyzdirect. com or abcsecurities.

In and buy a Mid Cap ETF. If the gyrations of a MidCap index are not your cup of tea and you prefer the more staid Nifty, you can place an order to buy a Nifty ETF. ETFs are exchange traded securities which consist of the same constituents as the index and move in line with the movements of the index.

Trade like a share, but act like a fund. So next time you read Nifty is up 5% you don't need to wonder where your portfolio is. If you have bought the Nifty ETF, it would be up 5% or thereabouts. And what's more, unlike a normal mutual fund, your ETF trades on prices updated live every minute on the exchange as a function of prices of underlying stocks so that you can buy and sell intraday and it comes at less than half the expense ratio of a normal mutual fund or its direct plan even.

What's good for the investor is good for the advisor but, for the advisor there are further benefits. In a normal mutual fund, the fund manager charges a fee because he generates the alpha - outperformance over the index. My experience tells me investors invest for alpha as in outperformance over their friendly neighborhood bank's deposit!!! So anything over 1012% should be good – not anything over the index for the index can land up anywhere! For an investment advisor it is important to manage the asset allocation in equity vs bonds and others at the first level and to generate larger alpha there – in 2008 whether you were in stocks are bonds made all the difference and in 2012 whether you were in large caps or mid caps made all the difference; which fund manager beat the index by how much came much later. In today's challenging world where it is important for advisors to be seen to be advising and adding value to earn a fee, alpha generation through pure asset allocation is a must rather than pre- packaged alpha under an actively managed mutual fund. ETFs which ride on global equity indices, local equity indices, commodities et al are the ideal building blocks with low cost for " Aiding Advisory Alpha". That's my take.

Oh so, to come back to our story, I did not get time to stay and explain all this because the food was too good and Mr. Patel told me over 50% of the cost was the food. I just penned my thoughts on Manibhai and his advisor after I got back home from that sumptuous meal.

 

Happy Investing!!

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