Holding volatile assets can be frustrating

I was planning to sell some of my Google shares (GOOG) by the end of this month. Just a few more days to go for the end of the month, but all of a sudden, GOOG has fallen by about 7% in the last 5 days.

I already had to change my plans once because Google share prices fell badly right before I was going to sell them. Now this is the second time within a year where my plans are changing because of price movements.

Not everything is bad news, however. The way price moves up is also dramatic. See how rapidly the price has risen by the end of August only to fall again just as dramatically within a few weeks. (I also sold some shares at $138 when the going was good.)

The Motley Fool says this about growth stocks:

The price of a growth stock tends to be extremely sensitive to changes in future prospects for a company’s business. When things go better than expected, growth stocks can soar in price. When they disappoint, higher-priced growth stocks can fall back to Earth just as quickly.

GOOG being a growth stock means such high volatility is to be expected.

Not too long ago, I was afraid of losing the high growth that comes through Google shares. Now I am starting to appreciate the lower volatility that diversified stock portfolios (e.g. mutual funds) offer.

Takeaways for me

• Selling mutual fund units is far easier—emotionally speaking—than selling something as volatile as GOOG is.
• The more volatile an asset is, the harder it is to use it in financial plans.

Don’t sort debt funds by recent returns

I learnt about debt mutual funds before I learnt about equity mutual funds. I consider myself more knowledgeable in debt more than in equity. What follows is one of the first lessons I learnt about debt mutual funds.

When you come across a debt fund that has given incredibly high return than its peers, it’s usually a sign that this fund has had a troublesome past. In the screenshot below, we see that Bank of India AMC’s Short Duration debt fund is topping the charts with 14% and 12% returns while other funds have given merely 7.5% or 6% return.

It takes only a few seconds to see why the high returns.

This is ICICI’s short duration debt fund. Nothing stands out here: just some volatility over the past 5 years, and it’s given 8.2% annual return.

Now look at the Bank of India fund: it has seen about 3 credit events in the past 5 years! Thankfully, the fund has recovered from 2 of these credit events, it looks like. After all that drama, this fund has managed to earn at 4.1% per annum over the past 5 years.

That was interesting to see, but what’s the takeaway? If we cannot rely on recent return data, what data can we look at then? I am no expert, but the following is what I do.

• I like to look at past portfolios and fact sheets of the fund to see how much risk they take. I don’t like anything below AAA. So many funds invest in AA bonds since they are pretty safe on typical days, but I am too conservative for that.
• I especially like funds that choose PRC matrix positions of A-I, A-II, and A-III since they commit to not holding too much sub-AAA debt. Unfortunately, many funds that never/seldom hold sub-AAA debt choose the ‘B’ position just to have some extra wiggle room.

Can we “buy the dip”?

New investors cannot earn outsized return by investing in debt funds after they have seen credit events. If someone bought Bank of India Short Duration debt fund a year ago, what return they’ll be looking at? Definitely not 14% because they wouldn’t have gotten access to the troubled bonds. They will likely be getting around 7.5% which seems to be the typical return.

Once there is a credit event, the troubled debt assets are moved to an illiquid “segregated portfolio”. New subscriptions to the scheme only get access to the “core portfolio”, i.e. the debt assets that are not troubled. Existing investors who have a share in the segregated portfolio will have to live with the troubled bonds until either the bonds become good again or go completely to zero.

You seldom win by taking credit risk. It’s prudent to exhaust your risk appetite in “safer” assets like equity rather than betting on lower quality debt.

Uncharted territory

Every territory is an uncharted territory.

Maybe a thousand people have already done what you are about to do. But that doesn’t make a difference to you if this is the first time you are doing it. When you do it, you should do it your way. That means you learn, improvise, and improve as you go.

So what are the takeaways?

• Remember that you don’t have to copy others. Do it in your own way.
• You have learnt and done so many things in life. The challenge of this new thing is not going to define you. (You do not define yourself based on how you fare in this one challenge.)