An investment advice for retail investors... - The 5 Minute WrapUp by Equitymaster
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An investment advice for retail investors...

Nov 1, 2014

In this issue:
» The widening crisis of shadow banking
» Japan goes the US way
» Amazon - staking too much on an extra rosy future?
» and more...

Stock picking is a tricky affair, especially for retail investors. With limited financial knowledge and financial tools, researching stocks is a tough task for them. No wonder a lot of them take cues from fund managers, hoping to beat index returns by mimicking an apparently careful selection of stocks by a set of individuals who are perceived to be smarter.

But can retail investors just rely on fund managers' expertise and sit back hoping to earn similar returns on their portfolio? An article in Economic Times does not suggest so. And we could not agree more on this. But before we start convincing you with why it may not be a good strategy, allow us to break some myths in the world of investing.

The first is regarding fund managers' better access to investing related resources and its contribution to higher returns. Numerous studies have shown that most actively managed funds have underperformed the markets. In his classic finance book 'A Random Walk Down Wall Street', Burton Malkiel contested that even a blind folded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts. Some researchers disagree with this. They believe that the famous economist underestimated the dart equipped monkeys, as the latter not just equal but may actually outperform! We are not glorifying random stock picking here, but trying to clear some illusions.

Now let us remind you of your real edge over the fund managers. Unlike for the latter, your investment choices do not affect your career. Far from bringing out the best, such pressure on fund managers makes them act against their convictions. And not in the best interests of investors. This is especially true with regards to time horizon. While a successful investment will be one that multiplies returns over long term, it would not be wrong to say that most fund managers are more likely to focus on short term performance. This is because their incentives and career progression depend on the same. Similarly, most of them are more apprehensive of taking contrarian bets. While they can easily get away from a widely followed stock that fails to perform, a contrarian bet that goes wrong is difficult to justify and may jeopardize their career.

These are some fundamentals reasons why you should not follow fund managers. Coming to practical aspects, the process is hardly as simple as it seems. The way to act on the strategy will be to mimic the best performing fund manager or best performing fund. The problem with former is that they have their own periods of losses. Afterall, even geniuses fail. Similarly, copying the best performing fund too is not a good idea as you may end up following multiple fund managers. The problem with that is you will be blindly following investment strategies that may be totally out of tune with your risk and returns profile. Further, it is not possible to get real time information of what fund managers are doing. Even the best of stocks may not offer good returns if entered and exited at wrong times. Last but not the least, unlike fund managers, retail investors do not enjoy economies of scale (hence end up paying higher brokerage charges), and tax advantages that fund managers do. To conclude, retail investors have a considerable edge over fund managers. With a focus on fundamentals, valuations and disciplined investing, there is no reason why they can't beat markets over the long term.

Do you think that retail investors have a certain edge over fund managers, and mimicking them may not be the best strategy to follow? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Shadow banking is a term that is frequently used to depict financial activity that lies outside the regulated banking system. Shadow banking entities were used to by banks to spread junk debt around the world before the whole system blew up in 2008. These entities have been under intense scrutiny by regulators since then. However, this does not seem to have stopped their growth. As traditional banks have had to face an increasing amount of regulation; shadow banking has kept growing globally and now has grown to a US$ 75 trillion industry. Since 2008, most of the growth seems to have come from China.

As today's chart shows, China's unregulated shadow banking sector is now the third largest in the world, with assets almost of US$ 3 trillion! In 2013, this sector grew by an astounding 37.6% YoY and that too on the back of a 42% YoY growth in 2012. Clearly, the growth of this financial activity in China should be of concern to the world. China is a global economic power. If this sector were to witness a meltdown on the scale seen in the US in 2008, then the world will not remain unscathed.

Shadow banking looms large over global economy
* as at end of 2013, and excludes traditional FIs such as banks, pension funds and insurers

It was only a few days ago that we wrote about ex-Fed head Alan Greenspan dismissing the entire QE episode in the US. As per him, all that the money printing program has done is boost asset prices, while not really achieving the key objective it was set up for - stimulating growth. Nevertheless, at a time when the US plans to shut down its bond buying program, it seems that Japan is doing quite the opposite. It has upped its money printing activity. And how!

As per reports, the country's central bank - the Bank of Japan is looking to increase its annual purchases of government bonds and other assets to as much as US$ 725 bn from US$ 91 bn. This is being done in hopes of boosting lending, investment and inflation by increasing the amount of money in circulation. Well... going by experience of the US, it seems that in the short run, it could lead to a boost in asset prices (Japan stocks ended higher by about 5% yesterday). However, given the different dynamics of the Japanese economy to that of the US, whether such a program will have a desirable outcome remains to be seen. As per us, the probability seems less.

For students of equity investing, there is fascinating live case study playing out there. That is of a company whose name probably all of us have heard, and one that trades at upwards of 13 times its equity. Yet - and this is the intriguing part - over its 20 or so year history, it has hardly made any money! The company we're talking about is none other than Amazon.

Amazon was founded in July 1994 by Jeff Bezos in his garage. It focused on book retailing initially, but has now become the seventh largest retailer in the world. One of the reasons for its stupendous growth in such a short span of time may be that for years it has been selling products and services below cost. That too with a lot of publicity, all with the hope of making itself such an integral part of people's lives and their spending habits, that they will just not be able to do without it in future. And this is when it will strike gold, or so Mr. Bezos may envision.

But this is a very slippery slope indeed. We are inclined to believe that a company that cannot turn in a decent profit at even US$85 bn of sales, is a company that is staking a little too much on an extra rosy future. With the company entering the Indian markets recently, its growth story has today inspired countless mini Indian Amazons. While hope springs eternal, a wise investor will surely know better.

As we've mentioned above, the Bank of Japan has accelerated the purchase of Japanese government bonds while tripling its purchase of exchange-traded funds and real estate investment trusts. This step comes as fresh move to invigorate markets particularly after the Federal Reserve has announced an end to its massive quantitative easing program. Through three rounds of bond-buying since 2008, the Federal Reserve had pumped trillions of dollars to stimulate the American economy. Therefore concerns of fall in liquidity post withdrawal of the bond-purchase by US, spread of Ebola and slump in oil prices were more than quelled by higher stimulus measures by Japan. Resultantly the global stock markets rejoiced and climbed higher for the week gone by.

The Japanese index was the biggest gainer posting a gain of 7.3%. Indices of other developed economies such as US, UK and Germany were up by more than 2.5%. In the Asian markets, both China and India were up by more than 3%.

The Indian markets witnessed a rally across the board. Among the sectoral indices this week, IT, capital goods and metal stocks were clearly the top performers while FMCG and consumer durable stocks registered modest gains during the week.

Performance during the week ended Oct 31st, 2014

 Weekend investing mantra
"Although it's easy to forget sometimes, a share is not a lottery ticket... it's part-ownership of a business." - Peter Lynch

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5 Responses to "An investment advice for retail investors..."


Nov 4, 2014

I disagree.Not easy for individual investor to study fundamentals, keep track of technicals, to know macro factors that can affect a given sector, to decide upon entry and exit strategies,---etc.

Consider converting your advisory service in to a Mutual Fund and try to achieve the performance which you claim for your advisory service. Try it first as a notional scheme.Run on paper simulating MF like operation & you will realise what I am trying to say.

Like (1)

Sandeep Sahajpal

Nov 2, 2014

Someone wise wrote, a little while back, that if it was so easy to become rich by printing money, our forefathers would have figured it out centuries ago. The wisdom of QE1-2-3, Japanese bond buying and shadow banking by China do try to make the world more sustainable or other way round will be analysed in the hindsight, but all these measures are leaving a gap between the super rich and the poor of the world wider by the day.

Growing costs of assets and weakening commodity costs is a very scary sign. To my mind, no other measures, but an inclusive growth prospects can save the world economies. I am sure the top notch economists of the world can figure out ways to address the root problem, rather than doing quick fix measures of suppressing symptoms temporarily. However, if their mandate is to "save the riches", then we are heading towards disastrous end!?

Like (2)

Mohammad Zubair Khan

Nov 1, 2014

Fund managers are there to maximize the profit of fund houses,and for their own salaries and bonus.Investors are prey for them.Earnings are often less than FD's

Like (1)


Nov 1, 2014

Fund Managers recommendations are mostly based on capitalisation ie 1000 crores and above..There are lot of stocks which give agood return when held for couple of years. They are dividend paying and have expansion progerams. For example Chemical industries which are the one which provides chemicals for all industries. caustic chloine plants fertiliser and insecticide plants etc whose capitalisation is less than 1000 crores.

Like (1)


Nov 1, 2014

(1)Controlled and intelligent mimicking will be a good idea by following the below path
(3) You will get 15 scrips
(4) Out of the 15 select 3 to 5 that is repeated max.
(5) Always review the portfolio periodically

Like (1)
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