Understanding “Atmanirbhar “ as a Layman

Understanding “Atmanirbhar “ as a Layman

Lots of economic stimulus package given to help all segment of society and economy in general. Different experts have different view on it. Some are praising and some finding shortcomings . There is political affiliation also in individual expert or economist view point so one can not say if it is devoid of any bias or prejudice . If a layman reads two  divergent view reports he will get confused on which to believe as both from highly learned economist and expert .  

I have tried to explain to the layman with a layman perspective .

Indian government has already deposited a huge chunk of money directly in the banks account of crores of poor still many find it quite less . Some Opposition leaders and even economists aligned with them advocating of more and more money to be given to poor .

Assuming we have 10 crore poor families in about 35-40 crore total families  Indian government  decides to put total of 100000 crore ( 1 lakh crore ) in the bank accounts of poor . How much to put in each account . lets say 10000 in each so that each of 10 crore poor will get 10000 each . how long this money will last ? 1 month , 2 month ? what after that ?. Will government again shell out another 100000 crore ( 1 lakh crore )? . Its getting into an unending cycle of transfer of money every month . With revenue growth already under stress  is it a viable solution ?. Yes its very bad time for poor and they need to be ensured of 3 time meal at least but it is bad time for revenue generators ( business ) in the economy as well . We need a balanced approach to fight present crisis .  

Lets see this with an example . A family requires 10 litre of water in a day for drinking . for that they store it in a bucket of say 100 litre . If they just keep consuming this reserve will  be over by 10^th day . what will they do then ?. So if there is continuous consumption, simultaneously there has to be regular filling of bucket also . From where water will come to fill the bucket on daily basis ? It simply means there is another (3^rd ) much bigger storage with much larger capacity not only to fill 1 bucket but many buckets daily and not keep providing consumption requirement of 10 litre to one family but to many families . That BIG STORAGE is what we call ECONOMY .

Now lets understand Atmanirbhar . In simple layman words it is allocation of capital to all sectors of economy to boost consumption ( cater to demand ) , to boost production (cater to supply ) . Supply and demand are two end of same thread . Job and People are vital ingredient in this thread . In my view it’s a very holistics view with a balanced approach to get out of economic slump where people , money , job , livelihood , companies , industries all integrated together .

We need to make labour as productive asset ( providing job/self employment  and making them to earn ) and not a liability asset ( make them idle and just keep feeding them 3 times of food ) .China has made its huge population as productive asset and is a economic giant today and India has followed making population as liability asset (feeding them and not making every individual Atmanirbhar )   . So this is Atmanirbhar all about . Slowly every citizen has to become a productive asset and self reliant and make India a self reliant economy which develops a capability to withstand all economic shocks like USA , Japan and other developed countries .

How Diversification helps in reducing the Portfolio Risk

How Diversification helps in reducing the Portfolio Risk

Many people feel that they can also construct a portfolio on their own or manage risk on their own. This thought comes when (1) market is having a bull run and one makes money in almost all equity stocks (2) when they see return going down and feel risk has not been managed so why to invest through a professional manager.

Diversification is not just buying securities from different industries but much more than it.

This article is to make them aware how risk is managed through diversification which a normal person howsoever learned he may be, can not do the way the professional fund manager does. This article will talk on those aspects.

·        Investment process – (1) security selection based on risk –return of available investment alternatives (2) best Portfolio selection from the set of feasible portfolios.

·        Having an Optimal portfolio in any given situation. Optimal Portfolio is one which gives maximum return at a given level of portfolio risk OR has minimum risk for a given level of return.

·        As per fund mandate, Portfolio is made based on type of security. Security is selected after security analysis based on fundamental and technical factors with due emphasis on economic and industry analysis.

·        Business Cycle is forecasted:  The current state of the business cycle gets incorporated into asset prices. Fund Manager makes decisions based on future economic conditions. It is important to evaluate and also forecast changes in economic variables.

·        A strong relationship exists between the economy and the stock market.

·        Security markets reflect what is expected to go on in the economy because the value of an investment is determined by (1) its expected cash flows (2) required rate of return (i.e., the discount rate). Both gets impacted by economic situation.

·        Stock prices consistently turn before the economy does. Stock prices are forward looking. Stock prices reflect expectations of earnings, dividends, and interest rates. Stock market reacts to various leading indicators. Very important to assess, understand and analyze the trend which only a professional can do well.

·        So, what a professional manager does – (1) Analyses Economic situation and predicts probability of different economic scenario (2) Allocation of capital accordingly for best possible return (3) sector rotation (4) security selection (5) strategy and style for better performance of fund

Let’s take an example of a portfolio management in a span of time say 5 years and how diversification helps in reduction of risk.

·        Few things we need to understand in all these 5 years, economic condition might not remain the same. For some months it can be very good and some months normal and some months could be very bad (like present situation).

·        For simplicity sake and for quick understanding let’s take a portfolio with 2 securities.

·        Portfolio risk is measured by Portfolio variance of return and Portfolio Standard deviation of return.

·        Portfolio variance of return and Portfolio Standard deviation of return is less than that of individual securities ?

·        Its because of Covariance and Co-efficient of correlation.  

·        Portfolio return is weighted average of expected return of individual security but Portfolio risk is not the weighted average of expected risk of individual security but the interplay of two securities also play a role and that where diversification helps in reduction of securities.

·        Co movements or interplay between returns of securities are measured by the covariance (an absolute measure) and coefficient of correlation (a relative measure)

·        Covariance reflects the degree to which the returns of the two securities vary or change together

·        Positive covariance between 2 securities means the return of the 2 securities move in same direction (positive or negative) whereas negative covariance between 2 securities means the return of the 2 securities move in opposite direction (if positive in one then negative in another and vice versa)

·        Coefficient of correlation is simply covariance divided by product of Standard deviation of the two securities

·        Coefficient of correlation is from -1 (perfectly negatively correlated or perfect co movement in opposite direction) to +1 (perfectly positively correlated or perfect co-movement in same direction). 0 means no correlation or co movement. If Coefficient of correlation is -1 it means if return of security A is x then return of security B is -x and vice versa. Similarly, If Coefficient of correlation is +1 it means if return of security A is x then return of security B is also x and vice versa

·        For Portfolio risk we need information on weighted individual security risk and weighted co-movement between the returns of securities included in the portfolio

·        Portfolio Risk in case of 2 security is:

Variance = σ_p² = w₁²σ₁² + w₂²σ₂² + 2 w₁w₂σ₁σ₂ρ₁₂

Standard Deviation = σ_p = (w₁²σ₁² + w₂²σ₂² + 2 w₁w₂σ₁σ₂ρ₁₂)^1/2

(σ_p² is the Variance of the portfolio return, w₁ and w₂ are weights of security 1 and 2 in portfolio, σ₁² and σ₂² are the variance of return of the of individual security 1 and 2 and σ₁σ₂ρ₁₂ is the covariance of the returns on security 1 and 2)

·        Fund Manager will ensure that covariance between the two securities and Coefficient of correlation has been negative . That has helped the reduction of Portfolio Risk .

·        It’s a not possible for a normal investor to calculate these complex variables, select securities keeping them in mind and construct a portfolio to give least of Portfolio risk (Variance and Standard deviation in portfolio return)

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Lets see a portfolio with more than 2 securities

·        In a portfolio you have many securities, may be 10, 15 , 22, ….. If there are 10 securities portfolios then it will have 10 variance and 90 covariance (10*9). If say there are 30 securities then it will have 30 variances and 870 covariances (30*29). Is it possible for a normal investor to calculate so many covariances?.

·        One thing also important to note as the nos of securities increases the impact of individual security variance (individual security risks) becomes less and impact of covariance increases in overall portfolio risk

·        Hence the Portfolio Risk (Variance) of a well-diversified portfolio is largely dependent on Covariance. The lower it is, risk gets further reduced. If it is negative that is the best situation. This is where role of diversification helps in reduction of portfolio risk

·        With more securities added in portfolio the portfolio risk keeps reducing, reaches a minimum level (not zero). For each type of portfolio there could be maximum number of securities desired to make Portfolio risk to a minimum level. Beyond that if more securities added will not help in further reduction of portfolio risk. Its not easy for a common person to know what is that maximum number of securities.

·        Portfolio total risk cannot reduce beyond a certain level because there exists systematic risk also (from economic and market factors) also along with unsystematic risk (company specific risk).

·        In an Equity fund portfolio since asset is same, they will have positive covariance. But there also diversification can be done considering the nature of business and effort is to reduce the covariance as far as possible.

Conclusion:

·        In a scenario where there are so many economic variables which impacts industries, securities and security market in different way the best way to manage risk and get optimal return is by investing through a professional Fund Management like Mutual Fund.

·        Why Mutual Fund – (1) Research is the key in Fund management (2) Top Down approach (Economy – Industry -Company) is followed methodically (3) Security selection more on fundamental factors (4) tactical allocation done more to take short term market advantage

Evaluating Mutual Fund Performance ( JENSON ALPHA )

Nurture India Consultant Risk Management Series for Financial Literacy

Evaluating Mutual Fund Performance ( JENSON ALPHA )

I have always been an advocate of managing risk and not about chasing return. Its just like one is more concerned about speed and reaching destination quickly whereas a sensible driver will manage the accelerator and brake in best possible manner looking at road and traffic situation. Second driver concern is not reaching fast and quickly with risk of accident but reaching safely even taking few minutes more. Managing risk in mutual fund should be like 2^nd driver and not 1^st one.

We have been seeing most investors, analysts, experts evaluating fund on return given or risk managed but vis a vis what???? Market or Peer group. Ideally it should be vis a vis the risk taken by that fund manager itself.

Alpha: For most people it means Fund Return minus Benchmark return. So within same category say Multicap Fund if 3 funds (A, B, C) have given return of say 12%, 13% and 15% and benchmark (same indices) has given say 10% return then the alpha as understood by many investors is

Fund A = 12-10=2%

Fund B = 13-10 = 3%

Fund C = 15-10 = 5%

Its looks C is best, B 2^nd best and A is the last performer in the three.

Do we know how smartly the fund manager has been able to judge economic and market trends and factors , what industry sector weightage in the respective portfolio  , similarly weightage in different companies . Looking at the economic and market condition fund manager will increase or decrease industry wise and company wise allocation. How frequent and how much he is buying and selling (Portfolio Turnover Ratio) to manage the risk and return etc etc .  

Its not easy for a normal investor to track on too frequent basis and so the easiest way to judge between good and bad performer for most is above stated Alpha and trend of the alpha in different time duration.

We always say “higher the risk higher the return “. But does this apply only for investors? In my view this applies for Fund Manager also.  if a fund manager has taken higher risk then he should generate higher return also.

Now when I evaluate the fund performance it will not be alpha over benchmark but alpha over the risk which the fund manager has taken which is called Jenson Alpha.

Any investor who invest expects (1) at least a minimum return which the economy can give ((risk-free return i.e. T Bill or G sec yield ), (2) market risk premium over risk free return otherwise what was the sense of investing in risky market related investment i.e. (return of benchmark/indices - risk-free return). But the larger issue is how the economic and market risk has been managed (sector weight, company weight, portfolio turnover etc). As an investor I need to be compensated for that i.e. if the risk has been taken more I need more return (Higher the risk taken by Fund Manager higher should be the return) . That risk is measured by fund beta .

Now Jenson Alpha is = Fund Actual Return – Fund expected Return (based on risk taken)

Fund Expected return (based on risk taken) = Risk free return + Beta (Benchmark return - Risk free return)

Now let’s assume Risk free return is say 6%, benchmark return is 10% and Beta for A, B, and C is 1.1, 1.2 and 1.8.

Now Expected return will be as follow (in percentage)

A = 6 + 1.1 (10- 6) = 10.4

B = 6 + 1.2 (10-6) = 10.8

C = 6 + 1.8 (10-6) = 13.2

Now Jenson Alpha for the 3 funds are

A = 12-10.4 = 1.6

B = 13-10.8 = 2.1

C = 15-13.2 = 1.8

Now just see Is the performance same as earlier as done by most investors . Now B looks as best performer of the three and not C .

(Pl note – The above example is just a hypothetical one just to explain the concept of correctly evaluating the fund)

Understanding Risk and Return if investing in Equity Today

Understanding Risk and Return if investing in Equity Today

Many investment experts are telling to invest in equity as many stock and indices are 30 % to 40 % down from its peak ( Nov – Dec 2019 ) level . Can we superimpose past mathematical facts and calculate forward return ? . This time Risk is different from all risk what we have seen in the past. Last such similar type of health related risk (Spanish flu) was 100 years back . Sensex , the oldest indices came into existence in 1980. All previous recession was not having risk of today so just on the basis of past market indices data and movement we can not tell exactly by what time “x” return will come  . Yes but one thing is for sure that there will be upside but from when , how much can not be told.

Lets remember Risk is not dependent on  return but return is a function of risk . So we need to understand risk. 

Valuation at any point of time reflects all the risk incorporated by the market . But more than Valuation important is the trend of valuation ( falling/ rising  ) as that reflects the mindset ( fear/greed ) of market participants .

Valuation at any point is a static variable whereas trend of valuation is dynamic in nature i.e. changing regularly. Apart from Valuation level one should also give importance to trend in valuation.

The risk in Nov-Dec 2019 was not the same as what the risk is today and risk will not be same 6 month or 1 year or x year from now . Risk changes every second , every minute , every day . Change in Risk leads to trend ( fall/rise ) and the valuation .

In Dec 2019 – there was hardly any risk from Covid 19 .

Today – Covid 19 impact . heavy sell off from FIIs . The mindset of FIIs is aligned more with the Covid 19 impact in their economies . Stock market falling there . In india -- Domestic investors still holding by and large . Have we seen the worst of Covid 19 in India ????? . Has Indian Stock Market factored Covid risk in India . Please remember up till now its Indian Stock market impact is more from external risk and not from internal risk .

Tomorrow ( Short term ) – Much depends on Covid 19 impact ( external and internal ) . God forbid nos in India remain less and under control . But if that not happens then our stock market will factor this risk also .

Its not a question of 30 % discount sales but what’s ahead in short term and post Corona .

Post Corona Situation – (1) Since all countries are affected their economic policies will have domestic orientation. Will then FIIs and FDIs will invest in India and how much they will invest ?  (2) Banks were already under asset stress pre Corona . With businesses getting beaten , earnings will dip and chances of more NPAs in bank Balance sheet (3) Government will have lesser Corporate tax so will impact Government spending (4) Retail Individuals spending priority will change . Luxury and discretionary expenses will see reduction and impact on such industries . (5) Govt might resort to borrowing through G Sec and surplus money will move there (6) Even Corporate expenditure will see overall reduction and prioritisation w.r.t various head of expenditure and that will impact sales, revenue and profit .

A lot depends what will be government economic and industry policies and that will decide how quick India recovers back to normal level .

Best Strategy – hold cash as no one other than God knows if we have reached bottom .  Also your next 3 to 5 year defined planned major expenditure should be ensured by debt investment . If not done first do that .

After that If  have excessive surplus of cash and want to invest then invest in large cap with clear limit order . Go for stop loss or profit booking strategy . Put limit order with spread on bid/ask price . The spread should be realistic and realisable.

MF is the best Option – As managing the risk is key to investment there can not be better option than Equity Mutual Fund . Most of the risk and strategy which has been mentioned above will be taken care better here than direct investing . Whether evaluating Govt policies, industry wise exposure , Company wise allocation, Cash position , Tactical calls etc a research driven professional fund manager will do better than any other individual.  

SIP helps you to get invested in staggered way at different valuation level  . If you have lumpsum that one can invest in staggered way . say 10 % now . If fall of say 5% then next 10% and so on . But in either case the investment horizon must be minimum 5 year or more.

Rather than trading in direct Equity better will through MF ETFs with same stop loss, profit booking strategy with limit order with spread on bid/ask price .  

Stay Invested Don’t Panic

Stay Invested Don’t Panic

There is panic in market . Heavy selling leading to sensex , nifty and major indices tumbling down . One should evaluate this with a little bit of common sense .

·         Is this due to permanent or temporary reason . Its because of temporary reason – Corono virus .

·          How long the world can see the impact ( health wise ) of corono virus – difficult to say but definitely not beyond few months . No virus has stayed for very long time .

·          Why this impact in terms of business and market – Business Travels , business meetings , business conferences almost at a standstill pace . Impact on Order Book of any company . There is a gap when order booked and business realised and accounted in profit . So going forward there will be a big dip in revenue ( 1 quarter for sure , may be next 2 quarter there could be cautious wait and watch approach ) . Now with reduced future earning clearly visible and that on the back of already slowing economy short term problems have compounding negative effect psychologically .

What will happen once after few months Corono virus does not exist  --- Reverse of above . Business travel meet , order books everything will grow . The moment increased sales realisation happens market will revise the earnings upward and beaten valuation will again scale up .

Only one suggestion I can give – Don’t redeem your equity investment in panic . Have patience and stay invested . Valuations will move up because it went down because of temporary reason and once that temporary reason is gone it will move up.

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