Investment Performance- September 2017

 

Investment Performance-September 2017

September 2017 was a time when markets took a small pause. All indices took a small hit over the values of end-A

ugust 2017, and were even more down compared with end-July 2017. Midcaps and small caps till better than large caps.

Accordingly, my investment performance also suffered, though I still managed to eke out a postive return for the month. This is primarily due to the higher contribution of midcap and small cap stocks in my portfolio.

The SBI Small and Midcap Fund was the standout for the month, rising more than 5% in a month. So was the Centrum PMS. Both of these did better than my own investments. Centrum PMS came back to life after a nice break. The Motilal Oswal PMS continues to languish. September was also not a good month for the HDFC Top 200 fund.

Here is a graphical representation of the above. As time goes on, clearly, the men are getting separated from the boys.

Investment Performance
Graphical Representation of the investment performance compared to several benchmarks.

And for those who prefer numbers, here is the same data  in numerical format.

Investment and Trading Performance
Comparison of investment and trading performance of my portfolio and trading activity relative to various benchmarks

Investment Returns and Performance-July 2017

Investment Performance in terms of returns

Below is a graphical representation of my investing performance upto July 2017. Further below is a table of returns.

Investment Returns
My investing performance relative to other benchmarks

First, some housekeeping. You will notice that this graph is different from earlier ones, where I had also mentioned my trading performance. The reason for this change is simple.  The trading performance in July was simply crazy. So if this line is also added to the above graph, then the range on the axis changes in such a manner that there is no possibility of distinguishing between the various investment benchmarks. In addition, there is difficulty in understanding what the exact trading capital is. As a result, it is best to look at trading and investing performance separately, and maybe, once a year or so, revisit a comparison. In any case, below, I also present a table which details the returns on trading along with investing benchmarks.

As can be seen from the graph above, and the table below, the trend established earlier still continues. The mutual funds outperform my investment performance, which outperforms the PMS schemes from Motilal Oswal and Centrum. All of them outperform index benchmarks, except the Bank Nifty Index.

My investment performance continues to be marred by underperformance of my biggest holdings-IDFC, IDFC Bank and Oberoi Realty. On the other hand, Bajaj Finserv continues to outperform, as to other stocks like Indiabulls Housing Finance.

In July, I also converted about 4% of my portfolio to cash. I also made a concerted effort to pare down the number of stocks in my portfolio (from around 100 to around 75). I will continue this exercise of bringing down the portfolio size to around 30-40 stocks over the next one year. Among my larger holdings, I have completely exited Muthoot Capital Services (and have partially switched to Muthoot Finance), Munjal Auto (and partially added to Munjal Showa), Alkyl Amines and Bayer Cropsciences (and have partially switched to PI Industries and also added Tata Chemicals). I have further exited IL & FS Investment Managers. I have also exited Tata Steel (and switched to Vedanta and Tata Investment Corportation). I have exited Sobha Developers and added to NESCO. I have exited Vardhman Acrylics and added to Vardhman Textiles. I have also exited JP infratech and JP Power and added to Jain Irrigation. I have further added to IRB infra and Pokarna. I continue to slowly accumulate Pharma Stocks (Sun and Dr Reddy’s). I have completely exited my small positions in Hindalco, EIH, IL&FS Transportation Networks, Federal Bank, Laxmi Vilas Bank. Finally, I have finally exited MPS ( a large holding) and added to EClerx.

All of these switches have been done more to reduce the number of stocks I want to track, than any fundamental reasons. In some instances (like MPS), I did not like the business prospects.  In some cases (Bayer or Munjal Auto), I just felt that the price had run ahead of the business.

Here is a table of my investment returns compared with various other benchmarks.

Portfolio Returns
Table of Returns for different time periods

Performance of Trading and Investing-June 2017

Trading and Investing Returns-June 2017

It’s the 10th of the month again, and its time for another update on performance. Nothing really new to report, except that I started trading commodity futures in earnest in June, and had I not, trading performance would have been weak. This has only strengthened my conviction that diversification across uncorelated instruments is important while using trading systems.

The rest was more of the same. The mutual funds outperformed my own investment performance, which in turn outperformed the PMS benchmarks. Something for the PMS folks to think about.

Investment returns against various benchmarks
Trading and Investment Performance-June 2017

Trading and Investment Performance-May 2017

Trading Performance May 2017
Investment Performance May 2017

 

Again, after a haitus, I present my trading perfonmance and investment performance.

Here is a graph of my performance, both for trading and investment, in comparison with various benchmarks. The benchmarks I have included are the performance of the HDFC Top 200 and SBI Small and Midcap Funds, and two PMS’s I have invested in, the MOSL Value Strategy, and the Centrum Deep Value Strategy, in addition with 3 indexes.

Performance of trading systems and investment gains
Trading Returns and Investment Returns

As can be seen, the trading has had a great last few months. However, there is a caveat here. In my base calculation for capital employed (i.e., the 1000 figure in November), for trading, I have only included the actual capital employed in my brokerage accounts, and not the shares pledged as margin, or the reserve cash I hold. Still, all in all, a creditable performance.

My investment performance in the last seven months is also not bad, second only to the HDFC Top 200 Fund. I otherwise beat both the PMS’s and the indexes handily.

What risk did I take to get these stellar trading returns? Quite a bit. Please see below:

Trading Equity Line
Absolute trading equity line.

As can be seen, there is a deep drawdown in the months of October and November 2016. This corresponded to three external events, Brexit, Trump Election and Demonetization. Such deep drawdowns are what keeps one afraid of trading in futures. I have since changed strategies (more in another post), and hopefully, I can avoid such sharp drawdowns in the future.

Trading Equity Drawdown
Drawdown of Equity from Maximum Equity

Portfolio Composition as on March 31, 2017

Portfolio Holdings, March 31, 2017

The following stocks constitute at least 1% of my portfolio as on March 31, 2017. These 39 stocks amount to 81% of my total investment portfolio.

 

Porfolio Composition, March 2017
Holdings which constitute at least 1% of Investment Portfolio

Some discussion is warranted. The average age of my holdings is around 2 years, and as can be seen, there are very few stocks in the red. These include United Spirits (McDowell), ILFS Investment Managers (Which has given great dividends though), IDFC and IDFC Bank Combo (Which on the other hand is a looong term bet). NMDC has barely broken even. Even with NMDC, the dividends have been great.

Where have the best gains come from: Clearly Can Fin Homes, KRBL and Oriental Carbon have given the best percentage gains. I bought all of these when the markets were at a trough in September 2013. The largest absolute gain has come from Bajaj Finserv, which was again bought in the same period.

I am reasonably happy with the overall portfolio mix. It consists of realty (Oberoi and NESCO), MNC (Cummins, United Spirits, Akzo, Grindwell Norton), Pharma (Shilpa and Ajanta), NBFC (Bajaj Finserv, Canfin Homes, IndiaBulls Housing Finance), Banking (IDFC and IDFC Bank), Great Indian Mid to Small Cap Companies with an export focus (Balkrishna Tyres, Bharat Forge, PI, Aarti Industries, Polymedicure, Mayur, OCCL), and IT (Eclerx, MPS). There is considerable diversification. However, I am comfortable with the diversification.

Trading and Investing Performance on 31/3/2017

Portfolio performance in the last 4 months
Trading and Investing Performance
Chart showing my investment and trading performance against the indices and good mutual funds

 

I don’t want to comment too much on this chart, since it is only a 4 month performance.

It is obvious though, that good mutual funds like HDFC Top 200 have outperformed both my equity portfolio as well as my trading.

As is obvious with a system based on leverage, my trading performance fluctuates wildly, while the others are more or less with similar trajectories.

There is usually mean reversion in markets, and so over a period, my investment portfolio’s performance should improve.

The methodology of calculating the NAV’s have been mentioned in an earlier post on measuring investment performance.

Investment performance has been slightly understated, because I have not taken dividends into account.

 

How much trading capital does one need?

Trading Capital

How much trading capital does one need?

 

When one invests in stocks in the cash market (i.e., when taking delivery of the stocks, and holding them for a long time), the notion of how much capital is involved is straightforward. The total amount invested at any point is your capital, and returns must be calculated accordingly.

Trading Capital

When it comes to trading, this is not so clear. This is because of:

  1. Trading involves leverage. Typically, the amount of leverage available is anywhere from 5X to 10X. So, if the money invested for margin is Rs. 1 Crore, the positions created will be anywhere from Rs. 5 Crore to Rs. 10 Crore.
  2. Because of the leverage involved, the amount of drawdown is also magnified. And unlike in investing, the drawdowns (in other words, the mark to market losses) must be made up in cash daily. So, in addition to the margin in a) above, another sum must be kept aside for drawdowns.

 

 

How much money should be kept aside for drawdowns?

 

The answer is not so clear. In practice, I follow the following calculation:

 

  1. For each strategy I use(Note: I am a purely system trader, I do not use discretion to time my trades, so I can use backtest results. Discretionary traders will not find this post useful), I note the maximum exposure of the strategy (in terms of margin) in the last 10 years. I also note the maximum drawdown on the strategy in the last 10 years. So, if a long mean reversion strategy involves 40 open positions (at a time of a massive fall in the market), and each position involves Rs. 1 lakh as margin, then Rs. 40 lakhs is needed as margin. In addition, if the maximum drawdown in the last 10 years is Rs 40 lakhs, then the total capital to be kept aside is Rs. 80 lakhs. This way I would be able to fund my account in the face of any market condition.
  2. I repeat the above calculation for every strategy I use, and then I total all the strategies up to arrive at the figure of the total capital to be kept aside. So for instance, I would trade two strategies like the one mentioned above, I would have to keep aside 1.6 crores.

 

This is a somewhat conservative way to go about it. In practice, I would rarely require as much capital, because long and short strategies are rarely likely to both experience a combined drawdown. Also, as long mean reversion strategies kick in, long trend following strategies start getting wound up. So, in real life, I am unlikely to need as much capital. However, it is better to be safe than sorry. I like to have a margin of safety. I therefore keep aside the capital based on the above calculation.

Notice that I am using the phrase “keep aside the capital”, rather than use “invest the capital”. That is because capital can be generated for trading in many ways.

How can trading capital be generated?

  1. Cash  in the form of liquid ETFs (i.e., liquid bees) and broker float. One third of the capital required to be kept aside is invested in this manner. Brokers will give 90% margin against liquid bees. Around 80% of the amount is in liquid bees, and the balance in my broking account. (keeping 100% in liquid instruments would involve transaction fees which may exceed any return expected). This cash of course represents investment in the trading business.
  2. Shares as margin. Typically, brokers will give margin between 60% to 80% on widely traded stocks. Again, I keep one third of the capital required to be kept aside in the form of stocks in my demat account.
  3. The last third is probably likely to be used extremely rarely, in the face of a massive market meltdown. I keep this in the form of overdraft accounts against securities (where all I pay is the annual renewal fees) or in the form of inter corporate deposits (ICD’s which I can call at short notice) and in government securities which can be instantly liquidated.

Why this 1/3:1/3:1/3 pattern? In a way, it is completely empirical.

However,  in a general sense, the margin against stocks represents the “core” margin required on  a daily basis. For instance, if the normal maximum position size is Rs. 10 crores, I require Rs. 2 crore as “core” margin. This can be provided cost-free by taking margin against stocks.

The balance in the brokerage account is usually around 25% of the total cash, and represents normal mark-to market losses for a couple of days. So, if the position size is Rs. 10 Crores, then it is reasonable to assume that two back to back falls of 2% are possible. So to keep Rs. 40 lakhs in the brokerage account is reasonable. The balance in the liquid ETFs is to accomodate large drawdowns, or the occassional spike in position size (I use long mean reversion strategies and long trend following strategies, so in the case of a sharp market downturn, I suffer a sharp drawdown on the trend following strategies, and a sharp increase in the position size of the mean reversion strategies simultaneously).

The balance 1/3 in OD’s, ICD’s and Short term gilts is essentially just margin of safety, in the case of a black swan event, or in the case of a 2008 like market meltdown.

Given the pattern above, how do you calculate the amount of capital invested in trading activity, so as to calculate the return on capital employed?

Calculating the return on trading capital

  1. The cash invested is clearly part of the capital. Liquid ETFs (currently) yield around 6% (pre-tax). Float in a brokerage account does not earn you anything. Hence, the dividend amount received on ETFs should be added to the total trading profit or loss.
  2. When shares are kept aside as margin, then it is not so clear that we should use them as part of the capital involved in trading. The stocks earn capital gains and they also earn dividends. And it is not as if I bought the stocks to invest as margin. I bought the stocks because they are good stocks to invest in. This is just an added utility.
  3. Similarly, when an overdraft account is created using securities as collateral, those securities should not be viewed as capital invested in the trading business. Similarly, ICD’s earn between 11 and 13%, and I might have invested in the ICDs anyway. So, I don’t think those should also be treated as trading capital. However, Government Securities (which earn around 6-7%) should be calculated as part of the capital invested, and the dividends or capitals gains thereon should be added to the total trading profit or loss.

Thus, when you see return on trading capital figures elsewhere in this blog, you should interpret the trading capital in the above manner.

Monthly Updates on Portfolio Performance

In an earlier post, I had mentioned several reasons why I would not publish monthly updates on portfolio performance anymore.

However, it is now time to revisit those reasons. The first reason I gave was a practical one. I was spending too much time on monitoring day to day performace, and that was taking a toll on me. Well, I have now used Access and VBA to create a database infrastructure, and so the difficulty in monitoring has been minimized greatly. I still have to spend half an hour or so everyday to enter everything, but I need it do monitor my trading activities anyway.

The second reason I gave was that I was spending too much time on minute by minute monitoring of my stock portfolio, leading to increased trading activity. Well, over time, I have acquired the discipline required not to obsess over minute by minute changes, even if I do monitor them. So I am less worried about it than earlier.

The third reason I gave was that as a long term investor, I did not see the need to compare myself with benchmarks on a monthly basis. I still believe this to be true. But I am now also a trader, and in trading, I am trying to trade for income. So that certainly involves monitoring myself in the long term and short term against benchmarks. Also, I realize that as an investor or as a trader, I do need to have “Alpha”, an outperformance against benchmarks.

Conclusion

Because my thinking has evolved, or because my situation has changed, I am now resuming the posting of monthly updates on performance.

2 Month Investment and Trading Returns (As on Feb 08, 2017)



 

Here is a comparision of my last 2 month performace of both Trading and Investing, relative to various indices and mutual fund performance.

Investing performance is slightly understated, since it does not include dividends. In the next installment, I shall take care of this.

I have explained the methodology involved in creation of these performance curves elsewhere.

I don’t want to comment on this performance too much, since it is only a 2 month performance, during which the market yo-yoed like crazy. But still, it is interesting to note that my investing performance was better than my trading performance.

Investment Performance October 2014



The last 2 months were not happy, from a relative performance point of view. The reasons for this are not difficult to see. I went on purchasing IDFC, Oberoi Realty and IL&FS Investment Managers, despite poor market performance. This general underperformance of some of my largest holdings was a prime reason for the underperformance. Other stocks which significantly underperformed also included Selan Exploration and Sesa Sterlite, partly driven by the Oil price fall. NMDC was another underperforming, based on low global iron ore prices, though NMDC’s own financial performance should continue to be robust.

Here is my graph of relative performance:

Here is a table of rolling returns:

Column1 Nifty Midcap Nifty SBI Midcap Fund Kotak Classic Fund My Porfolio
Last Month 3.3 4.3 3.6 4.4 3.8
Last 3 Months 5.6 7.6 13.0 7.5 8.3
Last 6 Months 22.0 32.7 41.0 24.0 47.3
Last Year 32.3 53.4 76.1 38.5 89.4
Since Inception 32.3 53.4 76.1 38.5 89.4