Note
This resumes from where I ended in a earlier review so to get the context you could start from the first part:
https://mouthshut.com/readreview/41019-1.html
As a reminder/disclaimer, I'm not an MBA or investment professional - just an informed investor/consumer who did a lot of background reading!
I also invested in two index funds from HDFC last year (SENSEX and Nifty) and was quite surprised at the lack of disclosure that is required by SEBI for individual investors.
When I spoke to their reps during a 'road show' here is what they had to say:
The 'excuse' was that they were new funds and as such had no performance history.
So what? They are index funds and they could have easily given the performance of their respective indices as a 'guide' as they do in the US when new funds are launched with adequate disclaimers.
The last 5 and 10 years CAGR (compound annual growth rate) minus the annual fees (usually a % of assets under management - AUM!) would give us some idea of what we could have expected had they been around for that long.
As a benchmark, I had invested in Vanguard index funds (the largest index fund company in the world) and they had razor thin expense ratios (annual maintenance fees) of around 0.25% on AVERAGE. HDFC was charging (and this was very hard to find in the fine print) about 2.5% annually just to have a PC manage the index since minimal human intervention is required. So they are 10 times more expensive than the best in the world!
AUM shaanti AUM ...
A more fair comparison would be the industry average in the US of about 0.50-0.75% for index funds which is still much lower.
Another excuse is that they are just starting off so the % would be higher initially due to heavy fixed costs and would eventually decline as AUM (per fund) increased from Rs. 1 crore to over 10 crore.
Even their optimistic projections still left the fees at about 2% after that.
This is just the RETURNS side of the investing equation but what about the RISKS?
Usually this is defined as volatility or a statistical measure called beta which is relative to the broader market.
A value of over 1 indicates more volatile on average and less then 1 is 'better' or less volatile.
Combine the two parameters and you get the concept of Risk Adjusted Returns (RAR).
This relative measure indicates how much additional risk a fund manager has taken on to get the higher returns.
So if a fund has outperformed its benchmark/underlying index by say 10% but the manager took 20% more risk, then it would have a LOWER RAR than its index and you the investor would have been better off blindly investing in the index.
To justify their existence managers must get a better RAR than the appropriate benchmark otherwise they add no economic value (for investors - the fund companies get paid not matter how the market goes).
Even US fund managers avoid giving such results since about 75% of funds have UNDER-PERFORMED indices like the S&P 500 for the last decade or more!
And this is on a pure return basis, if we factor in the big risks taken during the tech bubble they'll only be worse off.
Yet another excuse given is that most funds do not stick to one particular benchmark/index and adopt a variety of styles (this excuse is still used even in the US!).
By now you should be able to predict my reply:
SO WHAT?!
If the fund has a target allocation, say 10% cash/money market, 20% corporate bonds, 30% government securities and the rest (40%) in equities; they just have to take a blended/weighted average of all the 4 indices.
This is not rocket science (with all due respect to President Kalam)!
Makes you wonder what they teach the hot shot MBAs these days ...
You can always come up with a close approximation of a benchmark to measure the performance of virtually any retail fund.
The reluctance to compare their performances objectively shows that they may have something to hide ;-)
To PEG or not to PEG
So that was about mutual funds but what about poor direct stock investors?
Don't worry, there is hope for you too!
Before I dive into another quantitative metric please understand that no metric is ever 100% perfect/correct.
If that were the case, everybody with a calculator or excel sheet would be a billionaire!
The point is that just because we can never hope to get perfection, does not mean we should not strive towards that ideal.
These are some of the most widely used/reasonably accurate ones that I know of.
So lets start with the basics:
Gimme a 'P'!
Most of us are familiar with the price of a share (P).
Gimme an 'E'!
We should have also heard of its earnings per share (E).
The ratio of this two is the P/E of the stock.
A stock by itself CANNOT have a 'high' or 'low' PE!
Its always relative to something else (e.g., the industry average).
When you see the 'talking heads' on CNBC speaking of high or low PEs, they are actually making incomplete statements unless they specify relative to WHAT.
But even this is not enough as the industry as a whole could be in a slump or growth phase.
To know if a scrip is 'fairly valued' or not, we have to add another component.
Gimme a 'G'!
This is the earnings growth (G) expressed as CAGR over the number of years you want to go forward (usually related to the time frame of your position).
This is always a projection/estimate.
What does that spell?
Now the good part, this PEG ratio as it is called can give a much better idea than pure PE about the valuation of any stock.
If the ratio is around 1 (say 0.9 - 1.1), the future earnings growth 'matches' the current PE and the share is fairly valued (HOLD).
If the PEG more than 1, the PE is higher than the project earnings growth rate so the scrip is OVER valued (SELL).
If its less than 1, its UNDER valued (BUY).
Caution:
This ratio is more applicable for GROWTH (above market PE) as opposed to VALUE (below market PE) stocks.
You're so Sharpe!
A Stanford (aka The Cornell of the West! GO BIG RED!!) professor called Dr. Sharpe came up with an elegant way to measure RAR for mutual funds.
I looked it up on Yahoo and came across his paper:
https://stanford.edu/~wfsharpe/art/sr/sr.htm
I could not understand it beyond the first few paras but for the curious - dig in!
In plain english, the Sharpe Ratio represents the relationship between the following 3 factors:
AR = The average annual rate of return of an investment
RF = The best available rate of return of a ''risk-free'' security (i.e., cash)
SD = The standard deviation or volatility of the investment
The ratio is simply = (AR - RF) / SD
If AR is less than RF then don't go any further and avoid this useless investment like the plague!
Since it can't take LESS risk than a 'risk-free' investment (usually short term govt bonds), AND it has lower returns, its totally worthless.
Of course there is a lot more to the concept with the Modified Sharpe Ratio which is supposedly more accurate and his daughter's contributions to the Sharpe-Sharpe (or Sharpe^2!) ratios.
But I can't make head or tail of that - its just outta my depth...
That's all folks!
'Predictions are extremely difficult - especially when they are about the future!'
