This is how you can beat most fund managers

Sep 2, 2010

In this issue:
» Indian auto has another bumper month
» IMF warns developed nations of excess debt
» US is not producing enough IT engineers
» There will not be any double dip in US, feels Biggs
» ...and more!!

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CRISIL, India's largest ratings agency has observed that over a five year period majority of equity funds underperformed the benchmark index. Similar studies and infact, more extensive ones have been done in the US as well. And they have come to the same conclusion. Surprised, isn't it? After all, aren't fund managers supposed to be the most brilliant and extremely skilful people around? What then, could be the reason for this massive underperformance?

Blame it on human evolution. You see, human beings are made to be whimsical and inconsistent. Giving attention to detail does not come easily to them. They hate monotony and instead, constantly seek excitement and novelty. Little wonder, it is hugely difficult for most people to lead a disciplined life. You would be mistaken to assume that the above trait does not extend itself to the field of investing. Whenever most great investors talk of their biggest mistakes, they do admit that majority of them have to do with failing to keep up with a disciplined approach and instead, getting caught in the irrationality.

Fortunately for us there is a way out of this problem. And it answers to the name of index funds. Index funds completely mimic the composition of a benchmark index and thus, help keep the discipline part out of the equation. Furthermore, most index funds charge lower fees than actively managed funds, thus giving the former another long term advantage. More and more investors in US have already started shifting to index funds. It has taken a crisis of epic proportions for them to conclude that most actively managed funds are after all not run in a disciplined manner. Hope it does not take a crisis for Indian investors to realise the same. Index funds may not beat all actively managed funds out there over the long term. But they will certainly beat most of them.

Do you also think index funds perform better than actively managed funds over the long term? Let us know your views or post your comments on our Facebook page.

 Chart of the day
The lines between trading and investing are quite blurred to say the least. However, one point that would still qualify for a difference between the two has to do with the magnitude of gains or losses. Traders usually have a predefined percentage gain or loss target whereas investors may not have either of these. Thus, it would not be wrong to say that traders thrive in an environment of one way price movements. For if price volatility is high, traders may not be able to make too much of a profit as they will keep switching in and out of positions very frequently.

Take the case of currencies. Major currencies of the world have seen too much volatility post the financial crisis. And this has made trading in them rather difficult. As today's chart of the day shows, although currency trading has topped US$ 4 trillion in 2010, the pace of growth between 2007 and 2010 lags the one witnessed between 2004 and 2007. Furthermore, the US dollar, one of the most volatile currencies in recent times, has seen its share of foreign exchange trades shrink while that of Asia-Pacific countries has risen.

Source: LiveMint

The US administration has made a big cry against American companies outsourcing their work to Indian IT companies. One of the key reasons it has cited is the rising unemployment in the US itself. However, what we learn now is that while unemployment in the US is high, IT unemployment is still very low. This comes from Francisco d'Souza, the chief of Cognizant Technology Solutions, a US-listed Indian IT services player.

D'Souza also laments about the lack of quality IT talent in the US. "If you look at the core of what we do, the technology work, the US simply doesn't have the talent base today," he says. Here's a statistic from Gartner - around 70% of US PhD students are foreign born and are often hired in the US, making their way into Silicon Valley or government agencies such as NASA. In such a scenario, the US politicians' opposition to outsourcing sounds nothing more than a 'political gimmick'.

That rising debt burdens are crippling the developed countries of the US and Europe is a long gone conclusion. In this regard, the IMF has also warned that high government debt burdens may constrain growth for years. Especially as countries cut spending and raise taxes to reduce deficits. But it also opines that markets at present could have probably overreacted to the debt problem. It believes that although repairing the balance sheets is a highly challenging task, countries have successfully adjusted before. And so, they could do it again.

Of course, the magnitude of the debt burdens this time is huge. But the IMF still feels that although difficult, it is still possible. That said, the IMF examined which countries were running out of fiscal room. These are the ones who would have to quickly shift their focus to curbing deficits. The list of countries with little or no fiscal space included Greece, Portugal, Italy and Japan. Among the countries the IMF deemed 'constrained' were the US, Britain, Ireland, Spain and Iceland. Australia, Denmark, Korea, New Zealand and Norway on the other hand enjoyed more fiscal room. Indeed, most of the developed world have years of cleaning up to do ahead of them.

There will be a double dip recession. There won't be a double dip recession. When there is news on the former, stocks start a happy rally upwards. When news and economic data suggests that the latter is more probable, the stocks get hammered. It's a perpetual roller coaster ride. The question on everyone's mind remains - 'is it a good time to be invested in equities or not?' As per hedge fund manager Barton Biggs, it is a perfect time to buy stocks as odds for a double dip recession are remote.

Yesterday, he stated that driven by the fears of US going into another recession, he had cut his exposure to stocks to 35% of his total assets in July. However, as odds of a double dip recession seemed remote, he subsequently increased his exposure. He has advised investors to learn from his mistake and remain invested in stock markets as the valuations at this point of time are very attractive. We for one, remain sceptical. After all, most of the growth in US GDP in recent times has been stimulus driven. If the same if taken off, there are strong chances that the US could double dip.

The contrast in growth rates in emerging economies like India and the developed world grows starker by the day. And nowhere is the growth story more upbeat than the auto sector. Take the auto sales for the month of August for example. Maruti's sales were up 24% YoY, while it was 29% YoY for M&M and 32% YoY for Tata Motors. Hyundai Motors India's experience with Indian markets was similar. It clocked a growth rate of 17% YoY. However, its exports out of India grew by a mere 2.3% YoY during the month, reinforcing the wide gap in demand between India versus the developed world.

Interestingly, the industry body - Society of Indian Automobile Manufacturers - remains cautious. It expects the sector to grow by only 12 to 13% in FY11. The important thing is, even that would far outstrip the growth rate in much of the world's other auto markets!

Meanwhile, after gaining more than 150 points in morning trade, Sensex, the BSE benchmark pared most of its gains in subsequent hours and was trading around 60 points higher at the time of writing. Banking heavyweights were seen driving most of the gains. Most Asian indices closed higher today whereas Europe has opened with a contrasting look as most indices are in the red.

 Today's investing mantra
"High prices inside of a year will typically be 100% of the low price. Businesses don't change in value that much. That is simply crazy. There are extreme degrees of fluctuation, and Mr. Market will call out the prices. Wait until he is nutty in one direction or the other." - Warren Buffett

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11 Responses to "This is how you can beat most fund managers"

Anil Bahl

Sep 11, 2010

I agree that Index Funds can do much better than all others.



Sep 3, 2010

"Instead of writing stories, kindly recommend few stocks which I can invest. Even after two months I did not get a useful hind from you.
Some people are even sending details to mobile also.
Kindly advise.

Mr Koshi!
You have to pay to get hints. Equity mastes is not doing social service,



Mukund Korde

Sep 3, 2010

The performance of the Mutual Funds managers is currently being evaluated on short term results. Therefore, in a bull market, the manager is forced to continue investing just to keep ahead of the herd, whereas, the wisdom lies in holding back from the market during its bull run and keeping one's reserve power ready to invest in the bear market. This is possible only when the manager follows a disciplined approach of maintaining a pre-ordained cash to equity ratio.Such an approach ensures that one books pfofits in a bull market and goes on picking quality stocks in a bear market.Sure, this approach is not going to give the best results ihe industry but at least it has a reasonable chance of beating the indices.



Sep 3, 2010

sir, i sincierly thanks to you for sending message throug mail. i like your words and i learn more matter matter from you. so,once again i than uyou and your acadamy



Sep 2, 2010

While investing, the fund managers do not act impartially to the interest of the fund. Many a times they invest in securities which are in their own interest and other considerations. Index fund debars them from investing in such undesirable securities.


Akash Sethia

Sep 2, 2010

Whether index funds are a better bet or not - i don't know. But it is foolhardy to expect a majority of people/organisation in a industry to outperform. This expectation belies the basic tenets of competition.

In a free market if one sees a possibility of making money then hordes of people want to be in that business. This does not mean that all of them are experts at that business. Only a handful of them will outperform and others will underperform. This will be true even if we assume that all of them were experts in the field. By definition winners will be lesser in number then those who fail.

Were the reasearchers expecting a majority of fund managers to outperform? I wish people waste less money on such research where the answer is so obvious.

And you have drawn a conclusion in favour index funds on this analysis. That, to say the least, makes the conclusion doubtful.


Tinu Jose Joy

Sep 2, 2010

Now the shareholders can buy the share. Because now is boom period. If there is recession period then it is not suitable to buy the shares. But there is boom period it is good to buy the shares. I think now is boom period. So the people who interested to buy shares can buy now. Because our nation have experiencing boom period.
Their is a inverse relationship between Bond price and Rate of interest. At high rate of interest Bond price will be very low and people buy the bond with all the money. On the other hand at very low rate of interest the Rate of interest will be very high and people not interest to buy the shares. It must be recession period.
So in my opinion you must be buy the shares, because now a days the Rate of interest is high and bond price will low. So it must more suitable to buy the shares.



m p choudhary

Sep 2, 2010

Dear sir

if Hindi version is available then it is easy to read




Sep 2, 2010

I donít buy this point, even an average equity scheme has done better than index fund. Schemes may have failed to outperform benchmark but consider investing into index fund on peek of market (i.e between 04-08Jan08) vis-ŗ-vis investing in average equity fund.
Index fund are still at loss whereas equity funds are nearing its peek NAV.
Not only this, some of good funds crossed their PEEK NAV (to name a few BSL FRONTLINE EQUITY FUND, HDFC TOP 200 etc)


koshy mammen

Sep 2, 2010

Instead of writing stories, kindly recommend few stocks which I can invest. Even after two months I did not get a useful hind from you.
Some people are even sending details to mobile also.
Kindly advise.

Equitymaster requests your view! Post a comment on "This is how you can beat most fund managers". Click here!