Maggi on the Wall – the bigger picture

In my last post titled “Throwing Spaghetti Against The Wall” I showed how after picking up 3 portfolios whose stocks were randomly picked, I could still beat the overall return of the market over a time frame of 10 years.

In continuation of the same, I decided to to a double blind test on picking random portfolios and comparing them to the returns Index gave. I randomly selected 1 date in a year and on that date randomly selected 25 stocks (all done through Excel so as to avoid any bias creeping in).

I did it for the years through 2005 to 2010. The results can be downloaded from here (Link). To summarize the same, Random portfolio created beat the Indices in 3 out of the 5 years, in 1 year it under-performed Nifty and Mid-cap while out-performing Small cap Index and in one year has under-performed all other indices.

But if one were to take the final tally, the net results beat the results of all three indices comfortably.

The question that comes thus is, is it a real waste to spend time, energy and money trying to analyze companies? Well, to me, it isn’t so if you believe that you are the 5% of the achievers when the rest of the 95% under-achieve. But if you aren’t sure and your bank balance (from trading / investing and not Salary / other Income) doesn’t seem to show that, its not too late to admit and get back to doing what we do best.

Do note that the only filter I have used was to select stocks that had closed the previous day above 50. It did not matter for me whether they were bullish / bearish based on technical parameters or whether they were fundamentally strong or not based on value analysis. Its pure random selection.

The reason why its tough to believe and even tough to implement this in real life is that we are all suckers for stories. We want a solid reasoning (that resonates with our mind) that comforts us that despite the fact that our investment is deep under water, its not we who are to blame but market forces and the desertion of lady luck.

The whole financial industry is build on this story that you can be better than the markets though not everyone can be above the average (statistically impossible, eh? ), the story has takers (as can be evinced from the number of Mutual funds to PMS to Hedge Funds who offer to take care of your money for a small fee). 

In US, it seems for the first time in decades (if not more), people are finally getting out of active strategies and investing into passive ones (ETF’s that provide market returns with minimum fuss and very low charges). Here in India we do lack the spread of ETF’s that are available in US, but I believe that over time, we should see more and more ETF’s hit the market and that would enable investors to invest without having to pay through the nose and yet end up with more or less the same return (or heck even lower).

The reason random portfolio works has nothing to do with selection (after all, we aren’t selecting) but with the concept of compounding. If you were to look at the excel sheet, you shall notice that its not the number of winners that count, but the returns outliers have been able to deliver. 

For example, in the portfolio of 2009, the biggest winner was Vakrangee Software. This one stock was able to return the whole capital in affect making the other 24 stocks free. 

Warren Buffet has made his money not because he was able to pick all the right stocks, but because some of the stocks he has picked has been multi-baggers to a extent that it wipes off the losses of the few stocks (or should I call business since he having grown so big rarely picks up small stakes and instead wants to get fully into the company) where he called it wrong (and he has several wrong calls).

Markets grow in fits and starts, but in the long term, growth is there for sure (unless you believe that the India story is done with and we shall see a phase such as one seen by Japan). Long term some business will grow at a pace more than others and if we are lucky to have them in our portfolio, our returns should at the very least equate to market returns and at best out-perform the other asset classes easily. And all this without having to burn mid-night oil on what stock to buy, when to buy, when to sell and a thousand other loaded questions.

And before I conclude, do read about how funds rated as Gold can under-perform and many rated neutral / negative outperform (Link). If companies that spent thousands of man hours analyzing in depth funds cannot distinguish the bad apple from the good, what are the chances we can?

 

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About Prashanth

Have been a full time participant in the stock markets since 1996. Run a Yahoo Group where focus is exclusively on discussions of the Indian Markets using Technical Analysis as the tool (groups.yahoo.com/group/technical-investor)
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10 Responses to Maggi on the Wall – the bigger picture

  1. Bhaskar says:

    Thanks, enjoyed the article.

    For a retail investor, a good bet could be junior nifty. Has around 100 stocks.
    http://www.moneycontrol.com/mutual-funds/nav/goldman-sachs-nifty-junior-traded-scheme/MBM002

    Your views?

  2. Jigs says:

    Prashanth,
    This is again very good conclusion backed by solid data. I do agree equity research/stock picking etc is waste of time and is just to console ourselves that we are above average :-).
    I focus only on sector as I personally very strongly believe every 4 years different sectors get in to bubble. 2012-2016 belongs to Midcap IT, Media & Pharma?

    • Prashanth says:

      I think the answer to that question lies in the correlation matrix I posted. Mid Cap has a very high correlation while Media hasn’t had such a great run during the last bull run. Will it perform differently this time around? Well,only time can answer that 🙂

      • Jigs says:

        Yes Just checked your last matrix. See that exact above 3 sectors are under-performing Index in last 6 months which is currently experiencing high beta rally. My belief is IT media and Pharma are just going through correction before they explode and get in to bubble zone aka Sep 1998- Feb 2000.

  3. anish says:

    Prashant, Dont agree with the point on ETF unless u are referring only to index etf only. US now has a multitude of ETFs. Inverse, leveraged, double leveraged etc. Also cheapest isnt necessarily the best. Check out this story. http://www.cnbc.com/id/101373670

    Also life is usually not so simple as excel with a load of hindsight bias and surivorship bias. “In theory there is no difference between theory and practice. In practice there is.” – Yogi Berra.

    • Prashanth says:

      Anish,

      Well, agree with regard to ETF’s being of all kinds in US . Launching one I am told is not a very complicated process either, Meb Faber had a article on that aspect recently.

      If you want to just get the Index returns, cheaper generally is better (Vanguard is one of the cheapest way to get exposure to S&P out there).

      As to survivorship / hindsight bias, I took the Bhavcopy of the date that the random generated spurted out. That takes care of both. As I said, I did a double random in terms of selection of date and selection of tickers.

  4. Yamini says:

    Prashant,

    Great write up. Resonates with our discussion of the last time. The part about lady luck is as good as it can get in writing. Cheers 🙂

  5. Ani says:

    Gr8…this really leaves the balance-sheet and cash flow readers dumbstruck…Can you in the same way generate 3 portfolios with data as on very recent date.

    • Prashanth says:

      Sure, Creating portfolio is easy, truth about its performance to be known though will take quite some time 🙂

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