11 Nov 2024

Drawdown of the Nifty 500 Value 50 index

The theory is that value stocks have a margin of safety, and hence, they tend to fall less. Intuitively, if you already buy stocks that are priced lower than their worth, how much more can they fall? They should fall less than stocks that are priced more than they are worth.

Investopedia also says the same:

Value stocks are at least theoretically considered to have a lower level of risk and volatility associated with them because they are usually found among larger, more established companies. And even if they don’t return to the target price that analysts or investors predict, they may still offer some capital growth.

However, the Nifty 500 Value 50 index has historically fallen more than the broad market Nifty 500 index. 

Image source: ETMoney’s Instagram post

I have thoughts on why this could be, but they are mostly just opinions rather than facts with data to back them. I’ll just say one thing: don’t invest in this Value index if you prefer to avoid large drawdowns.

PS: Also, don’t think that this index usually does better than Nifty 500. The rolling return data on the 5th image of the same ETMoney post makes it clear that the Nifty 500 index is a lot more reliable.

7 Nov 2024

How can banks retain customers?

I used to be an HDFC Bank customer. Some 5 years ago, the staff at my HDFC Bank branch were so lousy that I severed all my ties with HDFC Bank and went to Kotak Mahindra Bank. Back in 2019, Kotak was a much better experience than HDFC, especially with their much improved net and mobile banking interfaces.

I was a happy Kotak Mahindra Bank customer. But other than a bank account, there was little else that Kotak Mahindra Bank had for me. I didn’t know this back then, but now I see that this is a vulnerable position for the bank.

Each customer wants a different set of functionalities from their banks. My banking needs today include:

  1. Basic banking operations, such as receiving and sending money, supported by good net and mobile banking apps.
  2. A good set of credit cards that pay meaningful rewards.
  3. A way to optimally manage my safety buffer cash (aka emergency fund).
  4. Ability to hold small savings accounts, such as PPF and SSY accounts.
  5. Not strictly necessary, but nice to have: automatic bill payments.

Of these, Kotak Mahindra offers #1 and #3. I was a happy Kotak Mahindra customer until I learnt that HDFC Bank offered an unbeatable forex conversion rate to Google employees. I have to regularly convert USD into INR. To reduce my forex conversion cost, I decided to open an HDFC Bank account. I didn’t intend to make HDFC my primary bank, though. I thought I’d transfer all the cash to my Kotak Mahindra account and transact from there.

But within a few months, I got pulled deep into the HDFC Bank ecosystem. I got their top-of-the-line credit card that pays incredible rewards. HDFC’s SmartBuy became my primary shopping destination. HDFC SmartPay started tracking all my bills and paying them automatically.

I opened an HDFC Bank account with the intention of not using it for any transaction. Within a few months, I am in a situation where most of my transactions happen through that account!

Partner discounts and automatic bill payments are not unique to HDFC Bank—almost every bank offers it. But HDFC Bank does them so much better that I actually want to use those features. Credit cards are not unique to HDFC Bank. I am a Kotak Privy League customer, and they have given me their Zen credit card for free. But I barely ever use the Zen card because the rewards aren’t attractive. HDFC Bank’s offerings are simply more practical.

Within a year since opening the HDFC Bank account, I am considering closing off my Kotak Mahindra Bank account. This is shocking even to myself since I like Kotak Mahindra and this had been my primary bank account since 2019!

How can a bank like Kotak Mahindra not lose customers to a bank like HDFC? I think they should think more holistically and build products that work together to deliver value. HDFC’s bank accounts, credit cards, SmartBuy, SmartPay, etc work so well together that customers would often want to use those products. Competing banks need to have a vision, a viable strategy for building a good ecosystem of products, and execute well towards that vision. Such a task is so difficult that most banks would never accomplish it.

PS: I sound like an HDFC Bank fanboy, don’t I? 😅 But I am not affiliated with any bank. I am just writing down my observations and thoughts.

30 Oct 2024

Small cogs in a big engine

Balaji is a taxi driver. He drives a taxi at night. Most of his customers after 11pm go to the airport. He stays awake till well into the morning taking people to wherever they need to go.

Does Balaji contribute to making the world a better place?

On the surface, no. He is not inventing medicines to cure diseases. He is not inventing technology to ease people’s lives. He is not counselling families to stop their quarrels. All Balaji does is taking people to where they want to go.

If we use the same lens, most people’s work doesn’t contribute to making the world a better or an easier place to live in. Yet, the world has constantly been becoming a better and easier place.

What was the world like in 2014? Are our lives easier now? Of course! What was the world like in 2004? Are our lives easier now? Definitely!

One way to explain this would be to give the entire credits to specific inventions that have made our lives better. We’ll maybe find hundreds or thousands of people to cite as the reason for the improvements. Did those thousands of people accomplish all this all by themselves? No, they did not.

Taxi drivers like Balaji help scientists (and businesspersons and social workers and …) go where they need to go. Progress is faster because we have easy transportation thanks to taxi drivers. Let me repeat this in different words. In a society where there are no taxi drivers and everyone needs to manage transportation on their own, progress would be slower.

This is not just about taxi drivers, though. Everyone out there today, doing all kinds of work, is helping the society move forward. Maybe they are small cogs in a big engine, but everyone is a small cog in the humongous machine that is our society. All these small cogs come together to make the engine do wonderful things.

When you take a taxi ride next time, or when you have a plumber repair your water lines, or when you have a delivery person bring you things, or when you have a restaurant cook a meal for you—remember that they are also a reason you’re able to excel in your day job.

27 Oct 2024

Does diversification reduce risk?

Some people have the misconception that diversification reduces risk. Strictly speaking, it doesn’t.

Diversification is systemically exposing our portfolio to more kinds of risk while simultaneously capping the negative impact from any one kind of risk. The latter is the goal; the former is an unavoidable side effect.

  • Undiversified portfolio: Safe and well most of the time, but one occasional “bad event” can possibly take down the entire portfolio.
  • Diversified portfolio: Frequently impacted by “bad events”, but survives most (if not all) of them.

Diversification does not reduce risk, but rather, it manages risk by intentionally spreading the bets. Diversification sacrifices extreme highs to avoid extreme lows. (See also: Diversification shields you from extremes.)

Image designed by Freepik

This applies to diversifying across asset classes, e.g. holding equity, bonds, real estate, etc within a portfolio. This also applies to diversifying within an asset class, e.g. investing in equity from multiple countries instead of just one country, or investing in a diversified mutual fund instead of holding a few securities directly.

But don’t bring this up while advising beginners!

This “Diversification does not reduce risk” narrative is technically correct, but it’s annoyingly pedantic. Similar to claiming that mutual funds have no compounding. These narratives may be technically correct, but they both miss the point.

Practically speaking, many investors are better off investing early rather than investing late. Many investors are better off with a diversified portfolio than a concentrated portfolio. Citing these narratives—that compounding doesn’t really apply or diversification exposes you to more risk—to refute investment advice is more nuisance than it is helpful.

24 Oct 2024

What does ‘Investing for the Long Term’ mean?

The lifetime of a typical investment corpus is many decades long. Our investment corpuses often outlast our own lives. Decisions that optimise short term gains while ignoring the long term effects can end up causing a net loss.

1. Don’t invest in active strategies (such as active mutual funds, PMS funds, Smallcase, etc) if you don’t absolutely trust the firm running the fund/strategy. The fund manager will be gone in a few years, or at best a few decades. The market dynamics will change in a few decades. Will this strategy still be a winning strategy? Do you have a plan for managing the situation when the tables turn?

1a — Corollary: If you have an active strategy that you can execute on your own, and you can execute it without much hassle for decades, you can definitely follow it. But barely anyone knows such a strategy and have the conviction to bet large sums of money on that strategy.

2. Don’t get into half-baked strategies like Coffee Can Investing. Don’t enter the equity market like an Abhimanyu. You need to know when to exit and how to exit. It is not wise to assume that great companies of today will remain great investments forever.

3. Don’t invest in sectoral or thematic funds that are expected to do well in the next few years. They will see a slump after those few years. What will you do then?

3a. Don’t buy overnight sensations (such as the Nvidias/Teslas or Quant AMC funds or crypto assets) in the hope of making quick money. Yes, you may make quick money in the next few years. Can you hold onto those investments for the next 40 or 50 years? (Remember that a typical retirement corpus has a lifetime of 70 years or so.)

Both sectoral/thematic bets and overnight sensations require you to know when to exit. Unless you time the exit precisely, you may lose quite a bit of money. The vast majority of retail investors cannot exit on time. Hence, it’s better to simply swallow the FOMO (fear of missing out) and stay away from these temptations.

4. Don’t add portfolio clutter that is hard to manage. Either you will be dead and your family will have to declutter your messy portfolio. Or you will get old and won’t have the vigour to manage a cluttered portfolio. (See also: A cluttered portfolio is not a problem—it’s a symptom)

5. Don’t be afraid to correct your mistakes even if it is costly in the short term. It’s better to pay capital gain taxes today and exit a bad fund/strategy than to put your portfolio under unnecessary risk for many more years.