The Chase for Alpha

Much has been written and publicized by the investment managers about their ability to generate Alpha – above market returns. Most of the Mutual Funds offer documents and advertisements talk about how the fund has consistently beaten the market over the past years. And surprisingly, using very carefully chosen time frame as well as parameters, most of them have data also to substantiate their claims.

So, does it mean that these managers actually beat the market? Well, very unlikely – and if one adds the entry load (1-2% for most schemes), management fees (~2% annually), and exit loads (0-1%), there is very very miniscule chance that an investor would be better off by investing in a fund as against directly in the market index. Assuming an average all-expenses of 3% for a fund, you need the manager to beat the market by more than 3% to be actually able to generate alpha to his end clients. Add to it the fact that alpha is strictly a zero-sum game, and for every manager who beats the market, there would be another one who has been beaten by the market.

I’m strictly against use of Mutual Funds, atleast by people who can understand the basic nuances of stock market, and have the resources/skills to invest directly in the market. Most of the time we are afraid of losing money in the market – a fact compounded by frauds like Satyam, and we always run the fear that we may be caught on the wrong foot. However, the reality is that the same is true for a professional fund manager as well, and in fact I would like to think that they would have a larger tendency to take risks. And most of the fund managers in reality were caught napping during the Satyam fiasco.
So where does this leave an average retail investor? There are two choices for generating the market returns - (a) Using Index Futures, and (b) Using ETFs. I tend to prefer the latter over the former as futures are by their very nature a short term betting instrument, and if one plans to have an investment horizon of atleast an year, then futures would entail rolling the contract at every expiry – a costly as well as cumbersome exercise. ETFs are nothing but essentially a basket of all the stocks in an index, and have a small ticket size (currently INR 500 for Nifty BeES). Much goes behind the scenes with regard to how they are structured, and how they are able to track the Index. However, for a small investor, it would be sufficient to understand that they would tend to trade very close to the actual index value, and the management fees are much lower (0.50% or so) for these funds. So, if one just wants to have a plain exposure to the market, ETFs present a much better option compared with the mutual funds.

Why there is no word called ‘Bear-sh*t

To start with, let me put the disclaimer first:

I have a very strong belief that most of the asset classes in the world always trade at a premium over their fundamental value – defining fundamental value as what people would earn if they indeed keep the asset till perpetuity. I have a term for it as well – the ADR phenomenon. It goes like this – any ADR can anytime be converted into the underlying stock, and hence the value of an ADR will seldom fall below whatever an investor can earn by buying the ADR and then immediately converting that into stock. So, ADRs most of the time trade at a premium to the intrinsic price of the underlying share. The price of the stock here is the ‘Opportunity Value’ of the ADR – which could be derived any time the investor wants to. The same rational goes for the stocks or any other asset class – they always trade at a premium over what people can earn by holding them to perpetuity (their “Opportunity Value’). Only in times of deep recessions and market crashes do they trade below their values. So, more than 80%-90% of the times there is a bubble in the market.

Now building on my belief about the perpetual asset bubble in the world, any rational person would most of the time expect the market to correct (looking deeper into the terminology here – market falls are called ‘correction’, while the rise in markets are given terms like ‘bubbles’, ‘frenzy’, and ‘euphoria’). So, there is an inherent bias in the market where more people always believe that markets should fall. Whether they expect the fall to happen immediately or later is where the opinion differs, but they are all united in their belief that they are over-valued. There seems to be slight sophistication in thinking ‘Bearish’ – anyone who thinks markets would keep on rising is termed a naive retail speculator, whereas anyone who can substantiate a market fall is an ‘Economist’ or a ‘Trader’. So much are the professionals in the field biased against the bulls that they have named the ultimate description of crap as ‘Bull-sh*t’.

So, little wonder that all the ‘E’s and ‘T’s of the world are united in terming the latest rally as overdone, and are predicting another crash to happen ‘any moment’. No one likes a rising market – anyone can make money there. The dumbest of people end up making the most mullah in a bull market – as they don’t have the slightest of fear about a market fall. If one was born in US in the last 1970s, and discovered their senses in mid-1980s, then he/she saw was an ever rising market. How on earth would someone explain him/her that markets could fall as well. They were living in a ‘fool’s paradise’. NNT also warned against the bull markets, and bought deep OTM options – in the full knowledge that markets one day would fall big, and he would make a killing. He did make it, but that came after years of painfully watching the market move up, and seeing all his options expiring worthless (he did get all his money back, but that was from the sale of his books, rather than from the markets). No one ever loses everything in the market – either you make money, or you learn.

In the end, everyone is right about it – but seems that if you do not think about it too much, you are right on more occasions than the rational thinkers. You might lose everything you made in just one bad year, but then, its the same with the other side as well. So next time an expert warns you against a crash, just tell him that you would rather lose money in a couple of crashes, than being worried about it for all your life. And for all the ‘bears’ in the world, there is one simple answer - ‘Ignorance is Bliss’.

Market View - August 13

This is getting really interesting with the whole world now divided almost equally between the Bull and the Bear camps. Past two years we have seen people all over having similar views. 2007 was the year of the bulls, whereas 2008 was the peak of bearishness. This year has been a mixed bag for both the camps, and people have often changed their places.

The fight quarter truly belonged to the bears, and they kept sitting tight over the market. It was a classic range bound market between January and March, and Index almost finished flat at the close of the quarter. The second quarter belonged to the bulls with market seeing returns of 15% and 28% in April and May respectively. The bears were left too stunned and circuited to do anything about it.

As we moved into the 3rd quarter, the bulls have done well with momentum with them. However, lately they seems to be running out of the 'good news' fuel at their end. The markets are more than 75% up from their low, and still 33% away from their peak. However, the peak of 2007 was a result of exeberance where the word 'RISK' completely disappeared from the world. Whatever progress we have made over the past years, whereas it may be debated that we are out of depression zone, but certainly we are far far away from the exuberance period as well.

So, I'm turning a little cautious on the markets, and think that over the medium term, 4800 could well turn out to be the pivotal point for the markets. If they are able to cross it by the end of September, I would believe that we would end the year on a high. Else, we may be pulled into the deeper holes of recession once again. This rally is no doubt driven by liquidity, and one needs this ponzy scheme to keep feeding itself till the time the global economy recovers. However, if this thing falls flat, and the train is stopped too soon, we may be back to square one. The markets would need to keep going up to sustain the bull run - much like the space rockets. The printing press all over the world have injected fuel into the markets to move out of the recession zone, however, if the markets are stuck into a zone for even a month, and public confidence gets lower, we could all be into a big mess once again. 

Are IPOs Underpriced?

In my B-School, I wanted to do a term paper on the Under-pricing of the IPOs. Sadly, the concerned professor had already been approached by many other students, and he rejected my application. And when I joined my job, the markets crashed within a short span, and IPOs almost dried up.

Now 2009 promises to be a good year for the IPOs, and I would expect at least 5 big offering to hit the market over the next few months. And I would really like to test the theory of under-pricing by actually subscribing to them. 

The first issue to hit the market is NHPC, and it has already opened. The price band is INR 30-36, and I would expect it to be over-subscribed by as much as 10 times at the least. Lets see how it performs!

Have we entered the Bull Market?

It initially started with disbelief, and people were laughing at any levels above 3000 for Nifty. Everyone though there was free money to be made by writing Calls, and people wrote OTM and even ATM calls in size. People blindly sold 3000C and 3100C, in the belief that we wouldn’t be seeing these levels in the whole of 2009. Once that was crossed, 3500-3600 become the TOP for the market, and people continued to write calls to cover for the losses they made on 3000-3100 Calls. Had it not been for the Knock-Out punch delivered by the election results, people might have foolishly continued to write calls even up to 4500 levels.

Now markets are flirting with 4500-4600 upper limits, and have been trading into a range between 4100 and 4500 for some time. I’m slowly turning quite bullish on the markets. While I will agree that valuations have turned quite costly, and rationally one should be selling the stocks at these levels. However, markets tend to move with a ‘herd mentality’, and there are legs to every rally/correction. This is due to the fact there are different classes of investors who invest at different points of a move. And where we are standing today, we still haven’t seen too much participation from ‘Long Only’ and ‘Private Equity’ guys. These guys are sitting with huge chunk of cash, and even though some of it has been deployed, the majority is still ‘all cash’. And the longer the market sustains at these levels, the more probable is this money flowing into the equities.

My overall sense of the market is that we won’t be seeing any more ‘crash’ in the market going forward. There would be issues on the loan books of the commercial banks, as well as concerns over the credit card defaults. However, I think these won’t escalate into very big problems, and would result into a couple of billions of charges and write-downs. Other potential triggers could be some Sovereign defaults, but again I think we won’t be seeing any major nations defaulting. Overall, I think we don’t have too many downside triggers for now (I repeat FOR NOW).

On the upside, the buying pressure from local Mutual Funds could pick up in the coming days. I think they would soon be launching new schemes, and public would come back to the markets after staying away for some time. Equity allocation has been close to a low in recent times, and I expect more and more people moving their debt funds into equities. Another upside shock could be the results – the results would surprise on the upside for most of the corporates.

On the volatility front, I have now changed my view. I now believe that we will have a low volatility period from July to September. Markets would trade in the range, and might slowly move up from here. Volatility might continue to drift down, and we may enter the sub-30 phase soon. That would also mean VIX entering a sub-20 phase, and when that happens, the funds would start flowing back into the markets.

On currencies, I think INR would appreciate from these levels, and we may touch 45 levels by the end of this year. I would be a seller of USD at any level close to 49 (currently).

Recession Over?

I am completely clueless about the markets right now. However, am not sure which is better – being completely clueless about the market, or being totally wrong about it. I guess in most scenarios, the former follows the latter.

All over the world, the markets are rallying, and the bears can no longer the dismiss it as just another bear-market rally. Somewhere down the line, the bears became too bearish about their predictions, and people lost it in their gloomier and gloomier forecasts. I’m not saying that the current rally is indeed THE RALLY, and we are out of recession. Personally, I have a feeling that the worst is yet to come, though am too scared to put the view into positions.

In my personal opinion, what caused this rally is the fact that globally the central banks infused massive dollops of cash into the system. The printing press all over the world went into the over-time mode, and printed millions of green and blue backs. The cash was supposed to be used to plug the holes into the balance sheets of the banks (and other corporations essential for free money supply into the economy). However, all the cash went into investment assets, and led to the massive short squeeze. People jumped to buy everything available - junkier-the-bond, longer to queue of potential buyers. Risk became history, and all the high beta names sky-rocketed. This is where we find ourselves as of now.

There are two possible paths which the markets could take from here. If the central banks indeed didn’t screw-up big-time, then we may well have seen the bottom, and are unlikely to go there again. The markets would then become a buy-on-dips market, and we would see the mother of all rallies in the emerging nations. Considering the massive amounts of cash sitting with the domestic as well as global asset managers, the BRIC and other developing nations could well go past their past highs. And the buzzword succeeding ‘recession’ would be ‘de-coupling’ for the next few years.

The second scenario, which I think has slightly a lower probability at the moment (but higher payoff if it materializes), is that the central banks erred in their bailouts and packages. And instead of reaching the ones who needed it the most, it ended up just creating a mild bubble in the asset classes. When the tides goes down again, the quarterly results would come back to haunt everyone, and the governments world-wide would by then have run out of ammunitions. Given the high deficits being run by all the governments, we are close to using the full quota of bailout funds. And for some reason, this bubble dies, then we would be in a free-fall again.

Lets see how things pan-out in the coming weeks. I think the picture would become clearer by the end of July as most of the corporates would announce their Q1 results. I’m expecting another quarter of record profits by the US banks, and if it happens, we could see the markets going into the stage 2 of this rally.

Market View: June 20

Markets have been trading in the range for the past few weeks. And surprisingly, have hold very well after the recent up move. One would have expected the correction to have come thick and fast, but the markets have refused to comply with the bear wishes. There are many people waiting for the market to fall, and as the reports claim, there is plenty of fund lying on the sidelines which has to be deployed.

I’ve become slightly bearish now on the markets, and think everything has moved up all too fast and too much. As for the markets holding up, I think its more of funds trying to play catch up, and investing late into the rally. We have seen good buying by the domestic funds in the past couple of weeks.

There are plenty of things that could decide the market moves in the coming weeks. And given that the list is quite long, I would expect the volatility to move higher from the current levels.

1. Quarterly results of domestic companies: With the result season starting, we may have a few surprises. Already we have seen some patterns with the advance tax numbers (with banks posting good results, while manufacturing sector lagging), and we may see high dispersion between sectors in their results.

2. US Bank results: No longer the size they used to be a year or two back, the US bank results still are eagerly awaited. They had all posted very good numbers in the last quarter, and another good showing could really seal off the recession here. However, a set of bad numbers could really hurt badly as well.

3. Indian Budget: With budget coming in the first week of July, expectations are quite high with the dream team. However, as with the T20 World Cup, expectations may well have exceeded the upcoming reality.

4. Swine Flu: Markets have completely stopped reacting to any news on this front. With fresh cases being reported almost everyday now, it might surprise the markets on the downside.

5. Budget Deficits: With all the governments around the world facing huge and still mounting budget deficit, we may see rates rising through the roof. Already we have had a failed auction, and a couple more could be the trigger for this.

6. Oil: Oil has slowly moved from 40-something to 70s now, and its not far away from where it would start hurting India. A level above 80 in the next couple of weeks, and then we would start having pressure on the currency again.

7. FII Selling: FIIs have been sellers in the market over the last 1 month or so, and if the selling continues, we may well see both INR and Equity Markets falling back to the earlier lows.

The Inflection Point?

The economists and traders around the world are engaged in the debate whether its a bear market rally, or the markets have actually turned around. The doom sayers are leaving no-stone to make everyone believe that their time under the sun hasn't finished. Whereas, the investors and money managers around are world are jumping to buy at every opportunity.

Its very difficult to say as of now which way the markets are headed. The short term momentum is certainly on the long side, but the valuations are getting costlier by the day. And unless the economy and earnings show a quick turnaround, we may see an over-heated stock market.

S&P has stayed close to 900 range for a few weeks now, and it has failed to break on the either side. There is good consolidation happening around this range, we may see a decisive move in either side very soon. If one is long vol, it may be a better idea to hedge less frequently as markets may be trending in one direction from here. I would expect S&P to be either below 800 levels or over 1000 levels by the end of June.

VIX also has been staying close to its 30 support levels, and even though it the breached it for a couple of days, it has failed to remain below the range for a longer period. We may see a gradual move up in volatility in the coming days, and I would rather be long vols at these levels.

Nifty has been playing around in the 4200-4500 range now, and contrary to all the initial expectations, markets haven't yet broken below the levels reached after the 'Super Monday'. Shorts have been cleared in the system, and the futures premium has jumped to high levels. Might seem silly to say, but I don't think markets are going to cross 4600-4700 range in the near term. With budget around the corner, long term investors would shy away from committing large funds.

EUR and GBP have been gaining against the USD, and last I saw, EUR was trading at 1.41 levels. Somehow, I am not very bullish on the Eurozone, and think the currency would depreciate. US economy in the shambles, and with General Motors filing for bankruptcy, another chapter in the US economic history comes to an end. However, I don't think EUR or GBP are the alternatives for the future.

Gold has been climbing for over a month now, and is trading close to 950 levels (mostly on the back of USD weakness). Oil has also been moving up, and is currently at 65. If the Oil keeps climbing, and moves into the 80+ zone, we may all be back to square one.

Market View: Gone in 60 secs

Election results came out on the weekend, and all the remaining bears in the market were brutally squeezed by the rising euphoria. We saw the first ever up-circuit in the market, and in less than 60 seconds, BSE sensex had risen by more than 2100 points.

Everything has changed in the markets, and FII continues to pump in billions into the markets. As things stand, we may be in for a long up move. There is a big gap in the market, and a lot of people have completely missed this rally.

Like someone said, one shouldn't worry too much about a single day's move. The trick is just to survive to see another day.

Market View: May 2009

Markets world-wide have seen the mother of all rallys in the past 7-8 weeks, and all across stocks have risen by anywhere between 30-100%. Nifty has moved from its 2700-2800 levels to 3600+ levels!!!

The big turnaround has been led by good financial results (in a system oozing with liquidity, that should have been expected), and some aggressive moves by the fed and treasury officials in US. Everyone could see the 'green shoots' in the economy in the form of falling unemploment numbers, rising output levels, rising retail sales, etc. And the result was an almost angry rally, wiping out all the 'nay-sayers'.

As we stand at the present, everything is up, and lot of people have shifted from the bear-camp to the bull-camp. March was scary as everyone (including me) was giving lower and lower target levels for the Nifty (with people quoting figures as low as 1200!!!). Now there is greater sanity in the market, and there is a suitable opposition to all the gloom-and-doom predicators.

S&P has been flirting with the 900 levels for whole of this week, and after breaking it, has come down again. If it breaks above 900 once more, a move towards 1000 is highly possible. However, if it fails to break it in in another week or so, then we may see the return of blood on the street.

Gold surprisingly has been going up even during this rally, and is currently at 925 levels. With all this bullishness, I would have expected gold to trade at sub-800 levels. So, there is a correction due in atleast one of the markets.

Credit markets have been improving, and JPM Emerging Market index is now at 500 levels. Still much above the pre-Lehman times, but this has improved considerably from its 800-levels seen in October'08.

My view on the Indian Market is that we may see this rally continue till 4000 levels. Unless something goes really wrong worldwide, we may see everything moving up. Elections, which have been the talk of the tinsel town over the past couple of months, may turn out to be a non-event. Either the NDA, or UPA could be making the parliament, and who amongst the two noone gives a damn.

EUR has surprisingly out-performed against USD, and has climbed to 1.35+ levels. However, I still believe its a ticking time-bomb, and might turn out to be very difficult to diffuse (unless the central banks round the world keep pumping liquidity into the system).