Friday, August 31, 2012

Mutual Fund with a Twist

This week I had the privileged opportunity to meet Professor Narasimhan who teaches corporate finance at IIM Bangalore. No matter how much you know, one can expect something new in such interviews. Prof overwhelmed us with his very simple yet powerful insights into how to invest in equity and markets in general. He was addressing group of final year MBA students who sought it as a parting gift. He explained Relative strength analysis in detail and suggested that to people who would have a lot of time. And for those who were entering the busy corporate world he gave away another easy program that I guess makes a lot of sense to many of us who are working on urgent but less important issues.

The program was to invest in mutual fund investment with a twist. He suggests that one should not invest in stocks directly unless he is prepared to spend several hours in a week preparing for it. For the rest he suggests investing in a systematic investing plan in a debt fund initially. He explains that we then look up for the 100 day ‘daily moving average (DMA)’ of the index as a whole. This can be looked up under ‘technical analysis section’ after getting stock quote price of ‘S&P CNX NIFTY’ in finance site like yahoo. The DMA is an average price graph that removes the noise in the market; it’s a smooth line that cuts a second choppy price line. Here is the method he recommends. When the price curve cuts the 100 DMA curve from below (bottom to top), move the entire holding from the debt fund to the top diversified equity fund. In the reverse when the price line cuts the 100 DMA from the top, switch the holding from equity fund back to the debt fund. This, he reasons, as the safest strategy that ensures two things. One: Yor wealth will never get eroded due to a huge market fall and second: ensures you will never miss out a huge upward movement. This is like ensuring you exit before the market crashes and enter before the market goes up. This system allows you to sell at higher price and buy at lower rates in general. If you have a look at the 100 DMA for a period of 5 year, you would be able to relate.

Now let’s talk of the flip sides. You may do multiple transactions in a short time if market is volatile and incur trading cost. But if you see the last average of last 5 years, you would have done about 5 transactions a year, a small cost for the advantage it offers. You will never be caught napping if there is a sharp correction or again you would be invested before the market moves north. The second flip side is that you will not be able to enter at the lowest level or sell at the absolute peak. The third factor as you will make out from the graph is that you may buy at higher rate causing regret or you would have sold too soon loosing potential gains. Blame this on behavioral problem and to be successful he advises “never develop regret factor in investing”. The lighter way of saying that is leave some money on the table for others to take. He assures this method will allow you to make significantly higher returns than investing directly or through a mutual fund.

He reasons that you will be able to beat the market because you are constantly selling and as per him selling is how money is made as most us are very bad sellers either selling at lows or not selling at all. Selling at right times will help us out-do the market in performance. The other behavioral aspect he asks to overcome is the anxiety of the future not of the financial markets in particular but of the personal life in general. He exhorts students to be relaxed and not chase money rather have a balanced approach as nobody who ever had lot of money was always happy. In As Kartik Sharma said ‘There is a middle path, a happier path. Where we do not have to give away all those things that make us human, just to get an excess of one thing – money’.

David Geffen knew it when he said “Anybody who thinks money will make you happy, hasn't got money.”