The magic of targeting fixed return per annum - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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The magic of targeting fixed return per annum 

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In this issue:
» What Modi means to interest rates?
» Forget RIL; ONGC demands US$13 for deep sea gas
» How have Indian markets fared in the UPA regime?
» India fares abysmally low in social development index
» ...and more!


00:00
 
Investing performance is always compared to a benchmark. Hence, the goal of every fund manager is to outperform the benchmark. This, in simple words, is called relative performance orientation. The return of the fund manager is compared to a benchmark to decide whether he generated excess return or not. However, Seth Klarman, noted value investor, has stated that relative performance evaluation leads to sub-optimal results in the long run. Hence, every value investor should have an absolute return goal. He should not be worried about outperforming any benchmark. Rather, he should just focus on meeting his absolute return goal.

The reason relative performance evaluation is not meaningful is because it impacts time horizon and asset allocation of a value investor. As an example, if your performance is relatively assessed, you cannot afford to bear long periods of underperformance. A two year of underperformance and a fund manager could lose his job. So, in order to manage the near term performance, one would invest in what is currently popular.

On the other hand, if you have an absolute return goal, there is no peer pressure to invest in popular stocks to stay ahead of the race in the near term. Such an investor can bear near term underperformance and buy out of favour stocks that can generate huge returns in the long run. Thus, absolute return investors can afford to have long time horizon as compared to relative return investors. Longer time horizon allows the portfolio to recover from any near term shocks and multiply the return.

Relative performance evaluation also impacts the asset allocation decision of any investor. For instance, relative investors will more often than not be fully invested. If they sit on idle cash and the market rises, their returns would lag. Hence, by being fully invested in markets, their asset allocation decisions are sub-optimal. They cannot afford to be in cash when they want to be.

On the other hand, absolute return investors are not afraid to hold cash if they do not find a lucrative bargain. They are not under pressure of being criticized for sitting on cash and missing out on a market up move. In fact, sitting on idle cash provides them an opportunity to enter into lucrative stocks if markets fall. On the other hand, a relative investor would have suffered a loss in such a situation by the virtue of being fully invested. Thus, sitting on idle cash provides flexibility in investing, which only absolute return investors could afford.

The bottomline is that relative performance evaluation results in peer pressure and sub-optimal decisions. There is a constant need to beat the markets and other investors. It leads to herding behaviour. By being with the street, your performance vis-a-vis other investors would not vary much. But by doing this, a manager loses his independence of thought. He may also passively follow index investing just to match his performance with the benchmark. Imagine paying fees for such an investing approach!

Thus, it is seems clear that absolute return approach is free from peer pressure, helps you adopt a long time horizon and results in ideal asset allocation from a long term perspective.

Do you think targeting returns like 15% per annum can improve stock selection and return over the long term? Let us know in the Equitymaster Club or share your comments below.

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01:50  Chart of the day
 
The UPA government has been in power over the last decade in India. During its term, we have had a series of scams and corruption scandals. In short, we had a decade of mis-rule and poor governance. Reforms took a backseat and growth suffered. And this is reflected in the stock market returns as well. As can be seen in today's chart, the annual MSCI index return of Indian stock markets was 11% amongst the BRICS nations during the last decade where UPA was in power. Only Russia fared poorly with return of 7.5%. All the other BRICS counterparts had returns better than that of India.

Considering that India was one of the fastest growing emerging markets, one would have expected it outperform other markets. However, as highlighted earlier policy deadlock and delays in decision making hurt the business prospects. This affected the earnings profile of major corporations, especially in the infrastructure and engineering space. As a result, the market returns were capped.

For Indian markets to outperform over the next decade, we need a stable government with clear policy stance which improves the ease of doing business. This shall revive the capex cycle and put India back on growth track. Ultimately, the stock market returns would follow.

How have Indian markets fared amongst BRICS in UPA regime?
^SA = South Africa


02:25
 
With a Modi led Government turning into a high probability scenario, experts have now started speculating about the economic policy decisions the new Government will take. And perhaps top on this list is the future of the RBI Governor Raghuram Rajan. Experts are of the view that the dapper Rajan could be some sort of a misfit in the Modi regime. Simply because his approach seems at odds with the economic think tank at BJP. Rajan has given enough indications of his hawkish stance towards tackling inflation. BJP on the other hand appears keener to see rates softening in order for their development agenda to get fulfilled. Well, we don't know what the outcome of this likely confrontation is going to be.

However, it will be sad for the country if Rajan falls out of favour. For the simple reason that if we need to see a sustainable development, then inflation has to be brought under control first. And one of the most effective tools with which this can be achieved is interest rates. Rajan's policies cannot be the cause for our poor economic state. It is the bad policy decisions that got us where we are. We therefore need to go back to a sustainable inflation level of 5%-6%. Until then at least, rates need to be kept at elevated levels. And it's important that Rajan is there at the steering wheel when this happens.

03:05
 
Hike or no hike, the Indian gas market seems to have little hope, in the near term at least. While gas producers must have frowned at the decision to defer the gas price hike due to upcoming elections, we doubt if celebrations would have followed even if prices were doubled. Amid all the controversies regarding gas price, ONGC has recently expressed that even the proposed hike will not be enough to make gas production viable from some of its deep sea fields. The threshold price suggested by ONGC is US$ 13 per unit. This is much higher than US$ 8.4 per unit, the price that Reliance Industries Ltd would have charged in case gas price hike was implemented.

In short, even if the gas prices were doubled, it would not have motivated ONGC to develop the discoveries in deep gas fields. Meanwhile, the gas scenario in India looks dismal. While there is not much discovery happening at the current prices, there is no guarantee that gas price hike will increase supplies. And the bigger question is who will foot the ultimate bill once gas prices are raised?

03:35
 
Elections are around the corner. And political parties have been shouting on rooftops about their accomplishments. The ruling Congress government has been at the helm of affairs for a decade. It proudly boasts rural employment scheme and Right to Information among its social achievements. But have these initiatives really succeeded? Not quite so as pointed out by a survey 'Social Progress Index 2014' by a US-based non-profit group. Based on this survey of 132 countries, India ranks miserably low at the 102nd rank on the social progress index.

Worse, India is the only country among the BRICS nations (Brazil, Russia, China, India and South Africa) to have a score lower than the 100th position. A deeper analysis is an eye-opener. The country needs to work hard in areas such as provision of basic human shelter, access to information for general wellbeing and tolerance & inclusion in growth opportunities to improve its social status.

A nation is built by its people. And a nation can truly progress only if its people are part of the development. Therefore, India with its rich resources and huge youth power cannot afford to ignore social progress. This is one issue that will act as a litmus test in these elections.

04:30
 
During the week gone by, global markets continued their upward momentum led by markets in Brazil, Japan and Hong Kong. US stocks had yet another good week, after non-farm payroll data for the month of March showed a continued pick up. The number came in at 192,000 after recording 197,000 in February. The US unemployment number also came in at 6.7% which was unchanged from the last month. The bad weather that had affected the US economy in the last few months seems to have passed.

European indices were buoyant this week amid increasing speculation that the poor economic situation in the continent would prompt the European Central Bank (ECB) to launch further stimulus measures. Factory orders from Germany also came in above expectations which added to the positive sentiment. The French CAC, the British FTSE and the German DAX indices registered gains of 1.7%, 1.2% and 1.1% respectively.

Back home, Indian markets closed the week on a flat note. There were no major triggers this week after the Reserve Bank of India (RBI) kept all key interest rates unchanged in its bi-monthly monetary policy. The benchmark BSE 30 index gained 19.5 points while the NSE-Nifty index fell 1.5 points. Investors clearly booked profits after the indices hit record highs.

Performance during the week ended April 04th, 2014
Data source: Yahoo Finance

04:50  Weekend investing mantra
"Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down" - Warren Buffett
Today being a Saturday, there is no Premium edition being published. But you can always read our most recent issue here...
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2 Responses to "The magic of targeting fixed return per annum"

ganesh rathod

Apr 7, 2014

i am investing per annul amount is 10 to 15 thousands rupees only. thanking you

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parimal shah

Apr 6, 2014

The statement, 'Rajan has given enough indications of his hawkish stance towards tackling inflation. BJP on the other hand appears keener to see rates softening in order for their development agenda to get fulfilled. Well, we don't know what the outcome of this likely confrontation is going to be.' presumes that there will be confrontation without any evidence - take example of Ms. Yellen in the US - she supported QE but actually began its taper.
Hawkinsh stance is currently warranted because of the policies of the government of the day. With new government and new policies, things will hopefully, change; and then so will be the hawkish stance of the RBI governor - irrespective of who s/he is.

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