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Judging your advisor this way can be dangerous!

Feb 14, 2015

In this issue:
» Staggering losses faced by oil marketing companies in the December quarter
» Would the comparison of gold with stocks be unfair?
» The billionaires that cashed in the maximum from the 2014 rally
» ....and more!

Investing is simple but it's not easy. This is arguably one of the shortest and the most succinct definitions of investing out there.

Indeed, investing is simple because you don't need unusually great insights to be successful at it. At the same time it's not easy because it needs one to have a great degree of focus and a sort of long term orientation which is very difficult to maintain day in and day out. Especially at a time when the world around us is all about short term results and headlines that don't look beyond a few days.

Popular asset management company GMO just came out with a white paper about how this uneasy part of investing can lead to disastrous long term consequences. As per the firm, 2014 is likely to go down as one of the worst years for equity managers in the US. Why? Simply because anywhere between 80%-90% of these managers will have underperformed their benchmarks! And mind you, this is not good reading any which way you look at it. If only about 1 out of 10 fund managers can outperform the index, there's no point paying hefty fees to them. Why not simply practice passive investing?

Well, there's certainly a case to be made here for passive investing. However, we believe that the basis for coming to such a conclusion is all wrong. For no other reason but for the fact that we can't simply extrapolate results based on such a short term study. As we've pointed out in the past, in the short term, investment performance can be attributed as much to luck as it can be to skill. On the contrary, it won't be wrong to say that in the short run, luck can often play a dominant role. As it has happened with the US fund managers we just discussed.

By digging deeper into this issue, GMO came to the conclusion that 2014 was a bit of an unusual year in that the US large cap index, the S&P 500 beat both the international and US small cap stocks by around 10% and also punished firms that had some of its funds parked in cash. Consequently, diversification, which is a good strategy in the long term, backfired in this case and majority of the funds ended up underperforming the benchmark index.

But does this mean that one should switch to passive investing and there's no long term benefit to be gained from actively managing one's portfolio? We don't think so. In any given year, a fund can certainly end up underperforming the index. However, if it focuses on an investment philosophy that works and then consistently follows the same process then the long term results can certainly be much better than what can be had from passive investing.

And this is where the hard part that we talked about earlier comes into the picture. It does not matter whether your fund manager has an IQ of 120 or 150. However, what matters is his ability to block out the noise in the form of short term results and headlines and focus only on the process. And if this is what your fund manager excels at, you've got a winner we believe irrespective of him underperforming in the short term.

What do you think? Do you think a fund manager should be chosen more based on his process instead of his near term performance? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
With equity markets having gained substantially in the last one year, the members of India's billionaire club have become even richer. Their wealth, tied to the stock market, has risen substantially on the hope that Modi led government will initiate a string of reforms.

However, surprisingly, this time around Mukesh Ambani is missing from the list of top gainers. While he continues to be the richest Indian, his set of companies did not gain much in the last year. As can be seen in today's chart, it is Dilip Shanghvi of Sun Pharma who is the top gainer having added Rs 362.1 bn to his wealth in the past one year. Gautam Adani of Adani Enterprises comes second with wealth addition of Rs 227.9 bn.

While this list changes year to year depending upon how stocks perform, it would be encouraging to see new entrants here. You see, there's no shortage of entrepreneurial people here. And if the government provides the right kind of support then India could well witness an entrepreneurial boom. It may not only create jobs but also the right kind of environment for the country to prosper.

Sun shining on Sun Pharma promoter

We recently came across an intriguing article on Moneynews where the author makes the case for gold. He puts forth his belief that comparing the long term returns of stocks as measured by the stock indices like the Dow Jones Industrial Average with that of gold is unfair.

Why? His rationale is that an ounce of gold remains an ounce of gold. On the other hand, the components of a stock index change multiple times over the years. And often, lower priced stocks are replaced with higher priced stocks.

Does his argument hold water with us? Not entirely. Because for any investor, investments are not an end in themselves, but rather a means to an end. And that end can be summed up in just one word - returns. And in that sense, every investment is comparable to every other in terms of the returns it can deliver to him. So if a stock index represents the returns that you could have made by investing in its replica, it very well can and should be compared to the returns from all other asset classes including gold. Having said that, there's no denying gold's role as an important hedge and therefore, no harm in having gold a small percent of one's portfolio.

Oil prices, higher or lower, do not seem to be offering any respite for oil marketing companies (OMCs). High prices in the past led to under recoveries in a regulated fuel price regime. Now with oil prices on a decline mode, inventory losses have taken a toll on the performance of these companies. One must note that these losses happen when the OMCs' cost of purchase for crude oil is high while they are forced to sell refined products at lower prices, due to their inability to pass on the high input costs in falling market.

As reported by the Economic Times, OMCs - IOC, HPCL and BPCL, - collectively have reported inventory losses of about Rs 170 bn in the quarter ended December 2014. While oil prices have been moving upwards in recent times, all that the managements can hope for is this trend to continue so that the losses can be minimized. As per the Finance Director of IOC, gains cannot be expected here. While the bottomlines have come under pressure, compensation for LPG and kerosene has offered some relief.

Meanwhile, the major global stock markets witnessed gains in the week gone by. Among the European markets, stock markets in Germany were up 1.1% while markets in France were up by 1.5% during the week. The gain in the European stock markets was mainly on the back of slight improvement in the Euro zone economy and positive outlook on Greek debt deal. Growing corporate earnings and the announcement of more stimuli from the European Central Bank to boost growth in the region have also led to the turnaround in investor sentiment.

The stock markets in US were up by 1.1% during the week, boosted by the oil rebound that pushed US energy stocks higher. Oil prices increased to over US$ 60 a barrel for the first time this year.

The positive mood spilled over to major Asian equity markets as well. Stock markets in China and Japan witnessed gains of around 4.2% and 1.5% respectively during the week. This was mainly on the back of reports of a new cease-fire agreement between Russia and Ukraine, Sweden interest rate cut and hopes regarding the Greek debt deal.

Back home, the Indian stock markets ended the week on a positive note on account of better than expected results reported by some of the blue chip stocks. Positive global market cues and stable inflation data also boosted the investors' sentiments. The BSE-Sensex closed the week with 1.3% gains, led by stocks in the pharma and power sector while realty stocks and oil and gas found themselves at the losing end. In the coming week, events like Budget announcement will determine the direction of the stock markets.

Performance during the week ended February 13, 2015
Source: Yahoo Finance

 Weekend investing mantra
"90% of what passes for brilliance or incompetence in investing is the ebb and flow of investment style." - Jeremy Grantham

This edition of The 5 Minute WrapUp is authored by Rahul Shah.

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