Insight: India Worst 20' Index

Last Updated: Wed, Apr 03, 2013 07:00 hrs

When it comes to investing, there is no doubt that India is more active than passive.

Of course the new money, the news channels and internet has taken trading home to my aunt and other South Delhi modern influential decision-making housewives. This is all good; the problem is about giving up before you even started.

Just because there is no formal induction to stock markets, Reliance does not go up or futures turned out sharper than the kitchen knife should not be the reasons to give up. What if you were using the wrong investing style?

Anything which could be reviewed quarterly and more could be considered passive. This could be academically debated, but we are talking about an investing style evolution and taking investors and investing in India to the next stage.

Regarding, what is better "passive" or "active"? Actually it's more about your risk profile (you are either active or passive, not both). However, historically short term traders are known to underperform intermediate and longer term investors.

In any case with nearly a million Indices globally and more than 30,000 ETF's worldwide, India's passive scene is dismally underplayed. We need more passive instruments, if we have to increase market sophistication, liquidity, choices and investor awareness.

The new 25 NSE Sector indices was a much awaited initiative. Thinking sectorally is a first step towards passive style investing. More benchmarks could mean more ETFs, which would then become a virtuous cycle. We won't trade ETFs like we trade Nifty futures, hence a key passive step.

Why did we not think of passive earlier? There is a clear disincentive for passive as speculation is more newsy while passive investing become more print (relatively more reading and research than television).

According to a 1989 paper, Monitoring and Rebalancing the Portfolio written by Lowell and Arnott, the investment managers should focus on optimising client utility rather than maximising return. As even the most profitable strategy or investment process is useless if the client abandons it.

Churning portfolios is clouded thinking and comfort causes costly errors. Satta' (speculation) to sophistication definitely hurts the churning culture, but then is it not for the broader good? After all don't we want to retain the investing initiatives rather than scare it away? I am really speaking about a societal skill diversification here, more like cricketers managing their own passive portfolios. Can it happen? Would life become more interesting and easy?

Globally, the passive domain is also going through an overhaul. Ideas like Fundamental Index have already caused more than a few kinks in the market capitalisation armour.

Market capitalisation (popular passive style methodology, also used at NSE) is about being overweight on winners and abandoning the losers. But then underperformers surprise the star performers.

Bloomberg stories like, Arnott Index Derided by Bogle as Witchcraft Beats Vanguard Fund reminds me of Eugene Fama referring to behavioural finance as the anomalies literature' and technical analysis derided as falconry in early 1980s.

The Fundamental Index outperformed their US market capitalisation peers by 2% per annum.

Are we in the new age of passive indexing?

If we are, we are talking about market patterns, reversion (losers doing better than winners), divergence between asset performance (difference between intra sector components performance more than 100%), relative performance and rebalancing portfolios every quarter (or every January).

Orpheus recently created the India Worst 20' Index. This is a basket of 20 worst performers among the top 100 India components.

The aim was to showcase that just investing in worst 20 of top 100 could outperform the underlying index. The quarterly rebalanced Orpheus India Worst 20 outperformed the benchmark Nifty by 1.8% annually. DLF, Hindalco, BHEL, SAIL, Mphasis, SESA Goa, HCL Infosystems and Adani Enterprises were some which are in the running Worst 20 list (potential outperformers).

Why should such a Worst' basket held passively succeed?

First, losers over 12 to 36 months have known to outperform winners.

Second, it's counter-intuitive and hence avoids mass psychology traps.

Third, because you let it passively run rather than actively run behind it.

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