No Pain No Gain: The Lake Ratio

I liked Prashanth's recent article on drawdowns. Leaving aside definitions we ponder over few things related to drawdowns in this post. The sun setting at Lake Washington. Photo taken by Deepak from Houghton Beach Park in 2022 There is some form of direct correlation between drawdowns in equity curves and pain suffered by investors/traders. The questions presented below are situations where you have to chose one of the two options which you feel is less painful. Assume this is the equity curve of your portfolio which begins it fall from value N at time t to some lower value at a future time. In one situation recovery is also shown. Simply note down which is a preferred Experience A or B (less painful for you). First try to answer each of these three questions impulsively. Then give each of these questions a few minutes of thought. Also try to recall real drawdowns you have witnessed in your equity curve before. Are you confident about the options you have chosen?  Sensex as the e

Price Earnings Multiple: An exception to Occam's razor?

I entered my MBA specializing in Finance at S P Jain Mumbai in 2008 just a quarter before Lehman came crashing down. One of the first classes in Finance was related to Financial Statement Analysis and in one of the sessions our Professor said something which set indelibly in my mind - Every company gets the PE it deserves. A low PE always doesn't mean undervalued and a high PE doesn't always mean overvalued. Sunset from the living room The usual definitions and explanations are not required for this note. I would recommend to flip over the CFA chapter on multiples for that or perhaps refer to any standard text such as by Professor Damodaran. In this post we will try to look at a general landscape of PEs in India and peek into two hypothesis -  Buying a stock at low PE yields a better stock price CAGR A high PE stock cannot give excess market returns Since investing is more of an art and not science the answers will 'tend' to one of these states and not be absolute in na

Can we time SIPs?

Time is an illusion - Einstein in Theoretical Physics Time  Timing is an illusion - Einstein in Stock Markets* We will straight away jump into what this article will try to answer. Question: Can a retail investor, one who receives salary every month, time the markets to achieve better returns while doing his Systematic Investment Plan? Conditions: The retail salaried person only does Index investing in Sensex. Assume that on Christmas in 1979 he decided to start an SIP in BSE Sensex with an ETF or an Index fund with no expense and no tracking error. Hypothetically assume these instruments existed since then (even if there is an expense we can reduce the returns appropriately). His strategy was Buy and Hold forever. Short Answer: No we cannot time our SIPs. Long Answer: With a lot of effort (which we will not discuss in this post) we can just scrape ahead of the index but the gains are not substantial enough in this long period of 40 years. At least in my opinion. Let us look at some

Measuring Risk: Utility Functions by Daniel Bernoulli

Background on these posts  Apart from reading books I think we must read Journal Papers. Now there is a problem in doing so - it's complicated, right? Yes they are and I feel they are made to be so deliberately as the end audience is not the common man but rather a specialist. I have read quite a few over the years, some I understood pretty well and some very minimally given my limited mathematical abilities. But in going through these papers I always could derive the essential takeaway - the crux. Also one problem I saw was application. I don't see how all these papers could be applied be it in actual trading or in developing some heuristic for our investing endeavour. Therefore I thought over time I will start doing the following 3 things: Crux : Summarise key points in some 'good' papers in plain english Simplify : Remove math formulas from the papers as much as possible Actionable : Share my ideas on application of the concepts in that paper Sometimes will throw in

Returns Expectations from Equity Investing

As amateur retail investors one question we usually do not know the answer to is - What is the return we can expect on a very long term time frame from investing? When we meet experts or see claims on twitter of a 30% annualised return how should we benchmark that in our minds. The returns mentioned in this article is based on the CAGR  formula. Next time when someone throws at you that his CAGR is 30% then you should quickly be able to know how good that number really is. More importantly this is an article which encourages you to tone down your expectations from Equity Investing. We try to see what returns we can expect from Index investing which is looked at boring and yielding very low returns. Let's see. Data Details For this analysis we have taken daily data all the way from 3rd April 1979 of the BSE marquee index the SENSEX. We have data till 4th November 2020. That is 40+ years worth of daily trading data. The argument which usually people give is that 'oh that is too s

Pied Pipers of Dalal Street

In 1284, while the town of Hamelin was suffering from a rat infestation, a piper dressed in multicoloured clothing appeared, claiming to be a rat-catcher. He promised the mayor a solution to their problem with the rats. The mayor, in turn, promised to pay him for the removal of the rats. The piper accepted and played his pipe to lure the rats into the Weser River, where they all drowned. Despite the piper's success, the mayor reneged on his promise and refused to pay him the full sum even going so far as to blame the piper for bringing the rats himself in an extortion attempt. Enraged, the piper stormed out of the town, vowing to return later to take revenge. On Saint John and Paul's day, while the adults were in church, the piper returned playing his pipe. In so doing, he attracted the town's children. One hundred and thirty children followed him out of town and into a cave and were never seen again. Three children remained behind: one was lame and could not follow quickly

Navigating the cacophony

The greatest edge a retail investor has is the ability to ignore the noise the professionals and the business media make. If an amateur can develop his investing sieve which gives him the ability to let only correct facts flow into his mind and keep opinions out that itself is a source of alpha. Equanimity is a trait which the professionals lack. If a business has a dip in performance epitaphs get written overnight and a mental pressure gets created for retail investors to sell at the opening bell. This is not how investing is done. Beating the Street This is the title of a book by Peter Lynch. And in the first 50 odd pages of the book Mr Lynch makes a case for investing in Equities. Long story short his point basis facts is that it is always better to be invested in equities on the long term scale. Going in and out of equities is detrimental, something I have personally made a mistake at times. Compounding the portfolio at a steady rate for multiple decades can lead to tremendous wea