Today in the morning I downloaded historic NAV of one of the most popular and successful mutual fund in town(DSP BlackRock Microcap fund) to RUN some back-tests. What I wanted to check was the difference between buy and hold Vs the dreaded timing.
The usual feedback one receives about Timing/momentum ranges from negative to neutral. Negative feedback goes something on the lines of ,
‘It is futile to time the markets”. “Time in the markets is more important than timing it”.
The neutral bit says, may be it works, but it is for the professionals, it is a full time endeavor and retail is better off without it.
I am of the opinion that the above statements are just copy paste regurgitation of Mr Planck’s chauffeur rather than empirical evidence and fact based synopsis. Either that or sheer incentive caused bias where brain dead buy and hold passive guinea pigs are good for business.
Anyways, instead of talking about my biased opinions, let us get down to work and let the data speak for itself.
We started the study from 14th June, 2007
WHY HAVE U SELECTED THIS AUSPICIOUS DATE and THIS FUND.
That is the date when the fund started. This entire exercise is done to draw a comparison between buy and hold Vs Timing and not concerned about individual brilliance, therefore don’t pay too much attention on date of back test ( it just has to cover a full blown bear market and a decent euphoric rally) and the mutual fund selected (this can be done on any mutual fund, Index fund, I just wanted to select something with spectacular returns for the contrast to look better (survivorship bias, you can say).
The 10 year period ended with funds current NAV of 61.003 which is a CAGR return of 19.29%
To achieve this respectable figure, our buy and hold client had to go through a Peak (16.5) to trough (4.90) journey of around 70% in the sub-prime lending crises of 2008.
How many people actually rode this roller coaster is anybody’s guess, but it is fair to assume NOT MANY.
Mark my words: NO AMOUNT OF INVESTOR EDUCATION CAN TEACH ANYONE TO STOMACH 70% DRAWDOWNS.
All this talk and gyaan of rational investing does not factor in the beautiful concept of ‘STOMACH CHURN’. There is a choice word for it in hindi.
And therefore you can do either of the 02 things.
Do such an Asset Allocation that you deploy only that part of your net-worth in EQUITY that you are willing to see 70% of it under water.
That ladies and gentlemen, would ensure that only your kids get RICH coz u will be either dead or almost there by then.
MIND YOU, which is still a better option than FD of course where both you and your kids remain poor.
The second option is what interests me. It is to have my cake and eat it too. You see just like Warren, i don’t believe too much in leaving inheritance ;)
Let us set up a simple rule of absolute momentum as a benchmark before we go long an asset. Let us say, We only buy DSP blackrock microcap fund if its last quarter/monthly/yearly return was more than our benchmark of 8% P.A.
We check this criteria 1st of every month (or any lucky date that you decide) . If the answer is yes, we stay invested, if the answer is NO, we get the hell out and move to DEBT fund.
For the uninitiated, let me break it down, we are back testing 03 portfolios. in first we check every month if the previous 12 month return > 8%. In second we check every month if the previous 3 month return > 8%(PA) and in third we check every month if previous months return > 8%(PA)
Do you think it will make any difference? Let us see all the 03 scenarios. (monthly, quarterly and yearly benchmarking)
Yearly Absolute momentum.
Yearly Absolute momentum returned 19.30% cagr with a drawdown of very acceptable 22%.
***Our system was not long the fund for first 12 months due to lack of data (remember it looked for the condition last 1 year return >8%)***
So it is not an apple to apple comparison.
A total of 9 decisions were taken in last 10 years. Which is to say 9 trades either moving to cash or the fund. That is 01 decision per year.
Quarterly Absolute momentum
Quarterly Absolute momentum returns a stellar CAGR of 30.5% with a drawdown of 25%
All of a sudden, the same mutual fund actually becomes a tool for you (not your kids) to get RICH . I do not really have to spell out the power of compounding to my intelligent audience here, difference of cagr between 19 and 30 over a long period of time tantamount to a FORTUNE.
A total of 22 trades were taken in Quarterly Absolute momentum which amounts to around 2 trades an year.
Monthly Absolute Momentum
Monthly Absolute Momentum returns with a CAGR of 27.60% and a maximum drawdown of 27%.
2008 subprime was the worse drawdown (27%) and other troughs were meager 12% or less.
A total of 50 trades were taken in 10 years which come to 5 trades/year. (even that doesn't really make you a dreaded trader, you shop for your veggies every week, you can surely check your portfolio once a month and adjust it 5 times in an year)
** One genuine rebuttal to this is the point of TAX. I leave the decision to the audience to earn 19% tax free with 70% ditch compared with a 30% CAGR taxed with a ditch of under 30%.
NOW, here is an important piece of the puzzle. In the above example, every time a SELL signal came, we parked our money in debt fund giving us an average 0.6% return/month. What if we put that money in an inversely correlated asset class (USDINR comes to my mind).
From a simple Absolute momentum strategy, this would become Dual momentum strategy as propounded by Gary Anntonacci). Will write another blog once I get currency data.
Conclusion is simple, loud and clear. Buy and hold is a hope trade. When the push will come to shove, and due to x, y and z reason (in hindsight) 2008 like crises manifest again and your corpus is decimated to pieces, your advisor and your mutual fund will give you a 1000 genuine reasons of why it happened and how, and how NO BODY COULD HAVE PREDICTED IT.
Take ownership of your money, it is yours. You are responsible for it. I am not saying shit will happen, All I am ASKING is that are u living on hope that it won’t happen?
- **The data from DSP was not compatible with my Amibroker and therefore the entire analysis was done on Excel with the help of my friend and trader par excellence Mr Ankush Raghuvanshi. Twitter handle @ankush_iitb
He can be reached at firstname.lastname@example.org for details of the backtest and other relevant information like No. Of winning months/years/quarters etc.
Like always, comments are welcome.