# Man vs System to Beat the Market

Feb 8, 2017

In this issue:
» Banks cannot ignore risks in Affordable Housing
» Status Quo in Monetary Policy
» Market roundup
» ...and more!

## 00:00 Chart of the Day

Yesterday evening I managed to get my hands on a book I'd been wanting to read for quite some time. A foreword by Nassim Nicholas Taleb further piqued my interest.

So far, the preface and foreword promise it will read like a fictional thriller.

The book is A Man for All Markets by Edward O Thorp.

It portrays the incredible journey of a card-counting mathematics professor who taught the world how to beat the dealer and who developed a quantitative system that handsomely beat the stock markets.

Thorp showed that a simple investment approach beats most investors in the long run, including experts.

In 1974, Thorp started a hedge fund called Princeton/Newport Partners using quantitative techniques.

The fund earned 15.8% annualised over its lifetime, with a mere 4.3% standard deviation. What is incredible is the fund saw only three down months out of 230 in operation.

Now, Thorp loved to think about anything in terms of models. A model is a simplified version of reality, like a street map that shows you how to travel from one part of a city to another.

## Cracking the Blackjack Code

For the uninitiated, here is a simple introduction to the game of Blackjack. The cards 2 through 10 are worth their face value. Kings, queens, and jacks are worth 10 each, while aces may be used as either 1 or 11. The player(s) compete against the dealer, all of whom draw cards trying to total 21 without going over. The best hand of all is a two-card 21, or a natural blackjack.

Thorp came up with a simple heuristic to profitably play the game. Here is Taleb on Thorp's simple play:

• The genius of Ed is demonstrated in the way he came up with very simple rules in Blackjack. Instead of engaging in complicated combinatorics and memory-challenging card counting, he crystallizes all his sophisticated research into simple rules.

Go to a Blackjack table. Keep a tally. Start with zero. Add one for some strong cards, minus ones for weak ones, and nothing for others. It is easy to just increment up and down mentally, bet larger when the number is high, smaller when it is low, and such a strategy is immediately applicable by anyone with the ability to tie his shoes or find a casino on a map.

The strategy was so profitable that the casino owners banned Thorp from entering their casinos and even tried to drug him!

The point here is to have a simple strategy and stick to it at all times.

Could a simple rule beat the Indian stock markets too?

We took the past twenty years of BSE Sensex data. Below you will find median Sensex returns from buying at different price to earnings levels.

##### Buy Low PE - A Simple yet Rewarding Index Strategy

If you kept your emotions at bay and purchased the index at price to earnings of 15x or lower and sold after a year or three years, you would have been richly rewarded.

Even if you bought the index slightly overpriced but at a PE less than 18x, you still would have made good three-year returns.

Why?

Because biases cloud human judgment at precisely the wrong time. Intelligent systems help one to exploit and profit from human behaviour.

Rahul Shah is an ace at handling both exuberance and despair on the street.

He has built a process-driven strategy for Microcap Millionaires where he forces himself to follow the rules outlined by his formulas and process.

He understands that emotions are a human reaction, and these extreme reactions sometimes hinder taking action on an opportunity.

The Microcap Millionaires track record says it all. The service has performed well and beaten the indices.

However, Rahul is not resting on his laurels. A couple of years back, Rahul stumbled upon a superior cousin of Value Investing going by the name momentum investing. So in the last 18 months, he has been working hard at back testing a market strategy to benefit from it.

Yes! Profit Velocity is Rahul Shah's new service that aims to exploit Mr Market using a momentum-based strategy. And the first report goes live on 10th February 2017.

So join before February 10th to get the first report and also grab the Founder Member Offer which gives you a whopping 60% discount on the normal price.

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03:45

After an interest subvention scheme on low cost housing loans announced at the start of 2017, affordable housing received a further leg-up in the Union Budget 2017-18. The 'infrastructure status' accorded to affordable housing has opened the doors of cheap funds for builders, a privilege enjoyed by only large public sector or private sector infrastructure projects. This means that affordable housing projects will now qualify for longer tenure loans at lower rate of interest. Other concessions offered are relaxed norms for classifying affordable housing by allowing carpet area instead of built-up area and increasing the completion time for qualifying projects. Enthused by these incentives, realty majors such as Oberoi Realty and Lodha are eyeing the affordable housing segment.

Easing financing norms is likely to boost investments in affordable housing. But at the same time, it also raises risk of defaults and bad loans if prudent risk management systems are not in place for banks. The unholy nexus between real estate and politicians has in the past kept realty prices beyond the reach of the common man. Hopefully, post notebandi, with greater vigilance on large value cash deals and also the implementation of Real Estate Regulation & Development Act 2016, the transparency and corporate governance are likely to improve in the real estate sector. But public sector banks, reeling under the bad loan burden, need to have stringent due diligence and better monitoring practices to avoid a sub-prime crisis that hit the US markets in 2008.

04:20

Contrary to strong expectations, the Reserve Bank of India had kept interest rates unchanged in the last monetary policy in December 2016. However, banks undertook sharp cuts in marginal cost of lending rates (MCLR) at the start of 2017 after loan subsidies announced by the government. This has led to significant fall in lending rates. The markets had still pinned hopes on repo rate cuts to kick start the economic growth engine amidst a benign inflationary environment. But RBI has maintained status quo in interest rates once again.

According to RBI, growth is expected to recover sharply in 2017-18 with notebandi induced pressures waning off, improved transmission of policy rates and the Union Budget's strong focus on public expenditure. However, letting the notebandi impact pan out fully and taking into account hardening crude price and volatile exchange rates, the RBI has chosen to keep the rate cuts on hold. A rate cut alone would not have stoked demand. But instead of getting carried away by short term fluctuations, it pays well to have a time-tested strategy in place.

04:45

After opening the day on a flat note, the Indian stock markets remained choppy and slipped in the red after no interest cut by RBI. At the time of writing the BSE-Sensex was trading lower by 117 points, while the NSE Nifty was trading down by 22 points. Sectoral indices are trading on a mixed note with stocks in the banking sector witnessing maximum selling pressure.

## 04:55 Today's Investing Mantra

"What we learn from history is that people don't learn from history." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rohan Pinto (Research Analyst) and Madhu Gupta (Research Analyst).

## Today's Premium Edition.

#### Why the Budget's Increased Infra Spending May Not Be Enough

The capital goods sector may have to look elsewhere for hopes of a turnaround.

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