The returns are post fees[Uploading…
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Not entirely right.
See, there are few things that you should understand here (as a potential PMS/Advisor/Cat 3 AIF Funds investor) . No 1 is expected returns from equity investment is always inversely propotional to anount of money under management with a fund management house (the sum total of money under management by the house and not the scheme as all houses has a one man who finally takes most of the calls and he can’t at the end of the day have high conviction beyond a certain number of ideas). As the amounts under management increases, the expected returns should decrease as because of liquidity reasons your position sizing and concentration decreases which leads to lowering of weights for individual stocks resulting in returns more along the benchmarks reducing market deviation but also alpha potential (outperformance over market is called alpha).
So there has been a lot of flow towards PMS, but MFs have also raised much more money - infact MFs have so much money that it would be difficult for them to outperform the market - already I think more than 50% of the MFs are underpeforming the benchmark. Infact a recent report highlighted that the average alpha generated by non-small/midcap mutual funds has come down from 3-4% in 1990s to 1-2% in 2000s and that is when MFs were comparing total returns generated against benchmark which didnt had dividend in it. Now with SEBI coming up with a requirement to compared MF performance against total return benchmark - I think soon we will get to know that most of the MFs are a bit lower or similar to benchmarks in terms of performance. And this is not out of alignment with other geographies - globally 75% of active managers are unable to beat the benchmark and in India that figure will soon move from 50% to 75%. One more important point is that benchmarks over time are becoming stronger as better perfoming strong companies are gaining weightages - classic example is NIFTY BANK in which HDFC Bank now has upwards of 30% weightage and is a damn difficult index to beat for managers of BFSI focused funds (I have run one in the past, so I know :-)) So, even NIFTY which was earlier dominated by oil major PSUs etc. is becoming over years a more and more dififult to index as better companies are gaining weightages and more and more MF managers would find it very hard to beat in the coming years.
So, what does it all lead to and how do we take decisions.
For most of the small and retail investors who have small ticket size for equity investments - Ideally they should invest 60-70% of money in large cap ETFs in direct plan with minimal fees and rest of the money with some small/mid cap MF fund with direct plan.
For others with ticket size of 50 lakhs or more, they should park 50% of money in large cap ETFs and for rest of their money, try to find out some excellent managers in PMS/Advisory/AIF Cat 3 where there is alignment of interest and investments are primarily in small & mid cap and the amount of money under management is not very large (else expected performance would drop). The former will give them market returns with minimal fees (say at ~12% over the long term) and the latter will generated wealth over long term (say at ~20-22% gross returns and 16-18% net returns).
LTCG is not so high as of now that it materially tilts the equation in favour of anyone. PMS/Advisory firms which charge a hefty commission upfront and high fixed fees should have been avoided earlier also (unless one has a very strong conviction on the high fee manager )
So you think index fund will perform better? I also think india still has a lot to go with active investing rather than the passive one…
Stated returns for most PMS are model portfolio which distorts actual returns…Actual returns realized are usually much lower…
Could you elaborate in that please? For eg Motilal’s pms’s have given around 18-24% CAGR across all 3 products for last many many years. What do you mean by model portfolio and actual returns?
Please do elaborate on this. Ty.
Most PMS talk about return of Model client…how you define that client have significant impact on stated performance…usual idea is to show the best part…not sure how Motilal does it exactly…but there PPT also says model client…
Let me explain this to you as I used to be a ex-PMS fund manager. Say Motilal or somebody else starts its scheme on Day 0, they make a model portfolio and then say Bajaj Finance was trading at 300 rs and is a 5% allocation and similarly other cheap and good stocks are taken in on Day 0 with various weightages. Now two things happen, for the person entering 2 years later - Bajaj Finance has more than doubled and lets say its allocation is 10% now. So for this person there is a double whammy - a) he buys Bajaj Finance now and not earlier when the stock has already appreciated 2.5x for instance and the margin of safety etc. has reduced considerably and so is return potential and b) he buys 10% of Bajaj Finance instead of 5% for the investor who joined on Day 0. Just this example can help us understand that while the marketing document will show the performance for the guy who joined on Day 0 (highlighted as performance since inception), the actual returns of most investors would be significantly lesser than that due to anomalies created by following the same model portfolio - especially for funds who are value based on only buying and not selling.
Secondly, I am yet to see a fund which doesnt show its performance from down years and a trough - most of them are showing their performance from either from 2003 (when the bull cycle was just to start which ended in 2008) or from 2009 (when markets were at bottom just before the recovery) or from 2012-2013 (when again small caps were bottom) - this automatically improves the performance. So much of money actually comes at the peak of the market but I only see performance numbers strarting from the bottom of the cycle for most if not all schemes and funds.
Yes I agree with you on that point. But Motilal’s ntop fund was started in 07, that was at the peak of the market. Since then it has recovered to produce some 19% cagr.
I was also looking at vallum capital who seem to have done very well. They managed to do well in FY16 as well, a year that had alot of issues on macro global front as well as with India. for an investor who has a goal of compounding at 18% CAGR for the next 10 years what is the ideal bet?
One can of course bet on all nifty 50 scrips and then bet on a few high conviction outliers to drive up performance.
Only concern as you have stated is that valuations are expensive and essentially all the PMSs have given supernormal returns due to the fact that they were all started very early on.
What is the solution for a new investor looking to generate that type of a return from today?
Well explained Sarvesh. Can you reccomend a couple of funds. Even the ones you may have invested in
You guys looking for a PMS Manager could speak with Sarvesh @8sarveshg himself. He runs a value PMS. Have seen him in action. Pure value guy with a very strong background. Highly recommend. He will be too humble to mention what he does himself, so I can mention it. Best Regards.
Hope some of you had the time to read Berkshire Hathway 2017 Annual Report. It has a beautiful section in its printed page numbers 24-26 (PDF page numbers 26-28) on how Warren Buffett won a 10 year bet against one of the best fund of funds managers (glorified distributors/advisors) wherein Buffett had predicted that net of fees the average returns from best fund of fund managers wouldn’t be able to even beat the benchmark. Its outstanding to come to terms with the fact that globally 75% of the managers with the best of pedigree, education and connect with management as well all the resources be in human resource or money are not able to beat even the benchmarks over long term.
Buffett has expounded on these points beautifully and I am quoting and commenting on some of those I found very useful in terms of thinking about manager selection.
"I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”
To put this simply, most of the industry works on the principle - “Heads and I (the fund manager) wins a lot & you the investor win as well But Tails and I still win but you loose even more that you should have”. The existence of only a fixed fee or a high fixed fee plus performance fee results in still great money in bad years and unreal money in good years for managers. This lopsided structure results in as per Buffett’s estimate almost 60% of the investor’s gross return being eaten up by managers (as mentioned in this annual report). My own sense of a fair share for the manager is not more than around 25% and that too only when the performance is above a certain high water mark and compounding hurdle rate.
“Under this lopsided arrangement, a hedge fund operator’s ability to simply pile up assets under management has made many of these managers extraordinarily rich, even as their investments have performed poorly.”
Again a very pertinent point, when you have existence of high fixed fee - it leads to creation of a very strong incentive to indulge in activities which will result in one’s assets under management going up rather than focusing on research and portfolio management which is the core of activity for a investment management operations. This is the reason one of the better-known managers discussed earlier spent a full day at ET NOW office post budget and is also very regular on twitter. Imagine, once I was trying hard to see an interview by Radha Krishan damani on Youtube and I was not able to find even one. Best of managers even outside of investment management business avoid being too salesy or media friendly cause they create value through their actions and not words. Just compare the number of media interactions of Aditya Puri with some of the PSU Bank managers and you would understand what I am saying. So wrong incentives - > lead to wrong actions -> bad results (especially when it comes to managing money but true elsewhere as well)
"Bill Ruane – a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul – said it well: In investment management, the progression is from the innovators to the imitators to the swarming incompetents.”
Here, Warren Buffett is quoting Bill Ruane, another truly outstanding manager and some of you might know that he is the founder of the legendary Sequoia Funds. This is a point which Warren hasn’t explained well in his letter but let me explain my sense of what he meant here.
One of the pitfalls of setting wrong fee structure and hence wrong incentives is that as a manager, your focus changes from generating high returns over the long term to managing expectations over the short term (this is the single biggest reason why majority of the MFs in India are already underpeforming the markets as per recent research). It is said that no manager has ever got fired buying IBM. It is also said that it is better for fund managers to fail conventionally than to succeed unconventionally. So what happens is that managers are all too focused on safeguarding AUMs (for instance who wants to take a contrarian call in that beaten down telecom stock, lets just focus on buying Dmart/Bajaj Finance - everyone is buying it and if it falls no investor can blame me for that, all likelihood investor would have some Dmart/Bajaj Finance in his direct holdings as well). This is why Bill Ruane says that you move from becoming a innovator in your early days to just an immitator (to protect the already high fee as % of AUM that you are enjoying) and hence incompetent soon.
Lack of contrarianism which is very difficult to do when you are constantly chasing more and more funds (as your fees is in proportion to funds rather than returns made for investors) is a major reason why smart people are not able to beat the benchmarks over the long term. If your views are more or less like the market, you will get more or less market returns and investors would do even worse because they still have to pay your high fees.
A corollary of my understanding of industry is also that is tremendously important for managers to keep their costs low as in most cases, managers operating out of swanky offices and paying to distributors to get assets all the time is a lot of cost which puts further emphasis on chasing AUMs. One of the most successful adviser of HNI assets (more than $1.5 Bn in assets in India) told me recently at an event that they are still unprofitable and under pressure to breakeven soon to do a listing (unsurprisingly they have also raised PE money). And this firm advises to some of the most well known families in India - I wonder about the quality and incentives of advice emanating from someone who can’t manage their own affairs and chase fee growth at any cost.
“Finally, there are three connected realities that cause investing success to breed failure. First, a good record quickly attracts a torrent of money. Second, huge sums invariably act as an anchor on investment performance: What is easy with millions, struggles with billions (sob!). Third, most managers will nevertheless seek new money because of their personal equation – namely, the more funds they have under management, the more their fees.”
I have written extensively on my other posts on why the law of gravity in investment management is that size of funds is inversely propotional to expected returns. This is where Buffett has mentioned three excellent reasons why it happens so. Only few investors who have the ability to successfully a) not over market, not chase funds and b) say no when you have enough in the interests of your investors over your own interests will be able to create high returns for their investors over the long term.
Unfortunately there won’t be another investor like Buffett is and this year’s letter like some of the previous ones ended in a rather morbid note as Buffett detailed his succession planing and how things will change at Berkshire post his death. I just hope that all of us are able to remember these pearls of wisdom and act accordingly while investing directly or indirectly. These lessons are true for all asset classes.
All the best,
Mr Buffett writes this letter to shareholders of his company. In other words, it forms part of his own corporate governance program. I am bit amused to find he includes lambasting of hedge funds and managers year after year. Is the communication to shareholders supposed to include opinions (even backed by up facts)? Assume fund managers are not good, what are we advising to ordinary shareholders? Either buy his company share or a retail shareholder should become do it yourself.
Berkshire Hathaway has given 20.9% CAGR since inception. In last ten year it has given 11.36%. Are we saying no one has achieved has these returns? Or a particular fund?
Reliance Industries on other hand has doubled money for shareholders every two and half years. This is also 40-year track record. This translates 28.8% CAGR! Does this mean Mukesh Ambani punched out Buffett by miles (8% differential compounding in 4 decades is massive out performance), and every year Mr Ambani should brag about he has delivered more return than the most successful investor? Being a shareholder of RIL how one is supposed to gain by this information?
Second aspect become DIY type of investor, is that really easy for anyone to become successful on a long term? Can anyone come to market and make 20-30% CAGR by whistling and merry making? Who is stopping them of course? We have been discussing on and off, and you know very well how hard it is to survive in a non-linear place with multiple disciplines in method, psychology and money management.
globally 75% of the managers with the best of pedigree, education and connect with management as well all the resources be in human resource or money are not able to beat even the benchmarks over long term.
Agreed, but this does not lead to a conclusion that any Tom, Dick and Harry travelled through Ganges by a boat and next day he became advisor. Or was roaming in deep sea digging oil, saw a dolphin and next day re-incarnated himself as an advisor. Or got that magical spiritual kick on first day of job. This is pure BS, misleading the people.
A fund manager doesn’t get the eternal kick or holy water like these super heroes. He comes from strong educational background, gone through layers of process and performance being designated as fund manager.
Now choice for a retail investor (not DIY), whether to choose fly by night Super Man or a time-tested process?
Read these lines- from a super hero type, I can’t reproduce exact text. But a flavour tells you all.
- You need to be courageous and you should be able to take risks. Experience is all that matters.
- When I was internally fighting between a MBBS and MBA quest for knowledge drove me to investing.
- My acquaintance with fellow investor made me thinking every hour.
- I love to be an independent thinker.
Few more vocabularies, it does not talk about where he studied, where he worked, what is investment process, what is audited return? Nothing! By the way huge fan following in social networking, arrange seminars etc. There are hundreds of more examples!
Sarvesh, will we be really serious about these guys? Or I look for some one like you who has left a cushy job to fulfil his own dreams and, in the process, support few other people to achieve their own dreams too. In fact, this continuous online mongering has damaged the genuine start ups like you more than anywhere else.
On the fees
Entrepreneur creates the idea, create and an amend process, take the risk and capital at early stage. She is an innovator, bound to be rewarded higher than others. In capitalism this has never changed.
The CAGR of Sunil Mittal, Mukesh Ambani, Ray Dalio or even Warren Buffett’s wealth is far far more than the wealth created for shareholders. This is neither going to change or else there is no incentive for entrepreneurs.
Not sure of the hoopla around fees? Are we bothered about our own return or their fees? Not sure why so many of us fixated on high CEO salary, fund manager fees etc. Government, I can understand. They have a responsibility to maintain socio economic equilibrium. Even they do not interfere, because price of playing with entrepreneurial spirit is far more dangerous than salary and wealth of an innovator.
Few weeks back I told someone PE (Private Equity) business we can try for 20% return around, I know of some. The first question comes from the gentleman, I am told these guys makes 60-70% return, why only 20% to me. Oh really, 60-70% comes out of air? Should I be interested to maximising my money or should I blame why should someone else is making money? If someone can smart out market, build a process by himself and make more money than what others are giving who has stopped? In fact, many are able to do here and available on this forum.
I have highest regard for Mr Buffett like many, somehow his lambasting of hedge funds every year doesn’t make sense to me. Of course I continue to be stupid, but still can make an opinion.
Any body subscribed Old Bridge PMS? I would like to have feedback on services before I join it.
I recently wrote something on the concept of “Alternative history” - this concept has been ellucidated very well by Nassim Taleb in his books. When it comes to assessing past performance of your own portfolio and somebody else’s portfolio - it remains very vital - I think knowledge of this is absolutely necessary.
Recently I had read one more book in which the author has explained the same in lay man terms. I am taking the liberty of borrowing his example to explain the same:
Let’s say there is a CEO who decides to save millions of dollars by deciding to not take an insurance against hurricanes in the US. This also helps him in his paycheck for that year which depends on his company’s stock performance which is in turn dependent on profit levels for his company.
With Lady Luck’s help, there was no hurricane in the first year. Now the question is that should the CEO be given a huge bonus for saving millions of dollars on insurance premiums, or should he be fired?
If we just look at the company’s past performance and be data focused only it will tell us to reward the CEO as the company’s performance has been good by saving insurance dollars.
However this analysis completely ignores other very probable alternatives and risks which could have materialized. For instance, what if the probability of hurricane happening resulting into a extremely large loss because of uncovered risks was more than 10%. And what if there was two consecutive hurricanes costing damages to the tunes of billions in an effort to save millions.
Hence, even when we assess the past portfolio performance, it is important to understand the alternative paths that a portfolio could have taken had luck turned its way in some different manner. This is necessary for us to better predict the future performance of a portfolio or a manager. In the above example, there was a substansial hidden risk which just on the basis of the past numbers alone would have been difficult to judge.
Next time you hear someone bragging about the performance, do wait and think about the alternative historical paths his portfolio could have taken. Was this a result of leverage or betting too much on one sector which was unpredictable (for example commodity linked) or happened because valuation multiples just expanded beyond the wildest expectations (what happened in speciality chem and organized retail recently) or because one large risky bet turned out to be very well etc. Think about the cost of being wrong.
One way to address this problem is that the overall investment process of the manager should make sense to you and you should be comfortable with the same. The other important task is to focus not only on what has happened, but what could have happened. It is not so easy but then all things worthwhile do take some time and effort. As Sherlock Holmes would agree - “There is nothing more deceptive than the obvious facts”.
hello yogeshji …
can u please update ur excel ?
very Insightful indeed!
Excel sheet is suppose to update itself but SEBI has stopped publishing Portfolio Manager Monthly Report from May 2017. So only data until April 2017 can be downloaded from SEBi website.
One News story which highlights everything which is wrong with the equity asset management industry (Or why select few value investors will keep beating the market hands down over the long term)
Today there was an a news story in Mint about Avendus Asset Management plans to raise new CAT 3 AIF fund of 1500 cr. Assuming what the articles says is correct, I can’t help but write something on what all is wrong with this approach. Will highlight few lines from the news story and comment on the same.
"Mehta added that the differentiating feature of the fund is its aim to reduce risk by reducing volatility and drawdowns. It is supposed to give less pain to the investors when there are deeper corrections in the market. Besides creating a long-only portfolio, it actually risk-manages the exposure to equities by hedging on a dynamic basis and that’s what helps stop the fall. In fact, the way the fund is structured, it ends up giving a positive performance when there are corrections,” said Mehta.
This seems to be a plain stupid formula. While risk (as defined by permanent risk of capital) and expected returns in equities don’t always go hand in hand but risk (as defined by volatility) and expected returns do go hand in hand. So reducing volatility for the investors on a large amount of capital is necessarily going to reduce long term returns for the investors as well.
The problem is most asset managers in their hunger for fees pander to the current needs of the investors which ultimately goes against the long term interests of the investors. Unfortunately, most investors, both large and small are themselves clueless about what is good for them in the long run. Currently, most investors have been stung badly by the volatility in the equity markets and many of them have seen drawdowns especially with the funds focused on small and mid cap. So obviously, their short-sightedness is leading them to want to have a investment style which can hopefully have lower draw downs (defined as fall from the peak) and volatility. And in my opinion, many reputed big names are actually shamelessly pandering to the same. This is similar to trying to sell an umbrella to a homeless person while the necessity is to increase his income so that he can stay inside a roof. This short term umbrella might protect him from the rains a little bit but will ultimately waste his savings and lead to non-fulfillment of ultimate goal of staying beneath a comfortable roof.
Charlie Munger has said that if you can’t digest 50% drawdowns then you should not be investing in equity in the first place and deserve the lower returns that fixed income investments provide. Volatility is an essential feature of equity as pricing of equities is governed by the madness of the crowd and not the real worth of companies. High quality investors world over want to take advantage of volatility rather than being bothered by it and their paper losses. Its sad that regular TV commentators and so called experts are infact working against the interests of their invetors - only to fulfill their desire to earn more.
“Given the current volatility in stock markets, the fund should be able to attract strong investor interest, Mehta said. This is attractive for people who have large equity exposures. The way equity markets are, in terms of Indian macros, global macros and the volatility in terms of elections coming in 2019, weaker currency, higher interest rates, people are unsure whether they should be putting money into equity or take some money off,” he said.”
This sounded so ridiculous. Totally focused on short term macro events like 2019 elections rather than investing based on real fundamental strength and intrinsic value of the companies. Exactly opposite to long term patient approach. Infact, in my opinion, given the current fall in some high volatility names - this may be one of the best times to invest in the same rather than seek highly valued stocks which have hardly displayed any volatility which may fall and underperform from this point onwards.
"Apart from the Systematic Equity Fund, Ocean Dial will also introduce its other investment strategies in India over the next 12-18 months, Mehta added. These include an open-ended multicap fund and a small and midcap fund. Ocean Dial is also looking to expand its fundraising and distribution to other new markets too. “From an Ocean Dial offshore fund perspective, we are looking to expand the reach, in terms of distribution and raising capital, to the US, Asia and Japan,” said Mehta. The new fund from Ocean Dial is part of Avendus’ growth plans for its asset management business, which in the last 12-18 months has seen strong fundraising traction. In April, Avendus said the Avendus Enhanced Return Fund, its second hedge fund, crossed Rs1,000 crore in assets under management in the four months since launch. The fund is managed by the Holland-Sanghavi team. Last week, Mint reported that Avendus Capital is in talks with potential investors to raise a $300-million consumer sector-focused fund. Other business verticals of Avendus Capital—wealth management and non-banking financial services company (NBFC)—too, are raising funds."
I actually lost count of the number of strategies they are offering investors - one is a systematic equity fund (or whatever it means :P), one is open ended multi cap and then there is small and mid cap, then there is some random name called enhanced return fund which is the second fund, so there is some first fund as well. And then there is a consumer sector focused fund. If you read the lines above - it sounds like the only way to scale for this firm is to raise funds rather than to create a genuine long term track record of returns which will attract lot of investors in the long run. Why should one start multiple random strategies - left, right and center (if they know one strategy is better than the other, then why launch so many strategies, this seems to be just random carpet bombing) if one is sure of atleast one which will do very well.
The bigger problem is multi business line formula in financial services. Many houses resort to multiple lines of business to grow rapidly as there is a limit to how fast one can grow in just one line of business. So someone with NBFC and investment banking would also like to do asset management and so on. The problem is that assets in equity asset management should only be built at a very comfortable pace as the more one is desperate to quickly built up the asset base, the lower its long term returns will be as lot of money in a short time can only flow by displaying high short term performance which generally is a result of a short term mentality. Also, once you start rely heavily on distribution agencies - who provide nothing but hot money in most cases, you are always chasing short term returns and end up doing a lot of things which are harmful rather than helpful for the investor cause.
Overall, this story actually reinforced my belief that select few value investors will always keep making tons of money in the long term as the entire investment management world is mostly clouded with so many of so called expert investors and institutions who are so much focused on the short term and in raising money at all costs to earn more fees rather than create genuine long term returns. Unfortunately, the joint misery of so many investors who fall for all these gimmicks will lead to outsized returns for the few who won’t.