Being ‘Actively Passive’ vs. ‘Passively Active’

In few months from now, I will be completing a decade in Equity Investing- a journey that has not only given me steep learning curve (much more than any academic book could possibly impart), but also grown my wealth. During this period, I have actively indulged in whole gamut of Equity trading/investing: starting with earnings-based investing (straight out of MBA I believed that financial models, DCF, P/E are the only truth), than style-based investing (Quality, Momentum, Size, etc.), to trading based on technical charts. Further, the approach was sometimes complex and institutional-driven, when I indulged in derivatives (F&O) or say special situations (Buyback, Spins, M&A, Event-play), and sometimes as simple as going the mutual fund way.

Interestingly, if I were to write my blog consistently across the last 10 years, then you would have seen how convinced I was on each of these approach, which I was pursuing then. Yet, no specific strategy for wealth creation lasted for over 2-3 years for me, which some may classify as a sign of incompetency, but I would rather define it as a constant evolution of myself. Now which of these techniques is best suited to grow wealth is an open-ended debate, and there is no one size fit all recipe here- you could be a good trader, or a patient investor, or just brilliant with risk mgmt., or combination of everything. One has to evaluate it for himself, as to what works for him to grow his money.

But what astonishes me is how every individual in this field tends to overestimate his abilities to find a multi-bagger winning portfolio idea. Every new entrant, be it a professionally-qualified person (CAs, CFAs, Engineers), or say a guy with family-legacy in equities (generally belonging to say Gujrati, Marwadi communities), or say someone who has just learned some basic concepts through some hearsay, enters this equity world with a belief that he can easily outperform market returns consistently over a long period of time. When I advise my friends or colleagues to invest through mutual-fund (MF) route rather than doing the stock-picking themselves, I am looked down upon, with some even doubting my aptitude & skills. They counter me with a theory, which says MF investing is good if the objective is to grow wealth ‘steadily’ and broadly in-line with market returns, but MFs are lackluster if someone wants to grow their wealth at say 25-30% cagr.

My only question to them often is: “Is your portfolio return expectations rationale?       

Since we do not have dataset on number of retail/HNI individuals who pursue active stock investing, and further we do not know how many of them have actually outperformed the markets consistently, I therefore rely on institutional (MF) data to see the kind of returns that are generated by professionals.

The fact that Nifty has delivered just 8.8% CAGR return in the last 10 years (even when both starting & ending point are in favor) and that only 13 funds (out of 171 MF schemes) managed to deliver over 15% returns, with highest being 18% cagr, I really doubt if return expectations of 25-30% are rational. Especially because retail/HNI individual lacks access to real-time information, interaction with company management, and time to analyze annual reports, as much as these professionals do. And further note, 20% of fund managers have failed to even outperform Nifty, despite all the resources.

Obviously, there will be exceptions, few retail/HNI do make supernormal returns (Damanis, Jhunjhunwalas, Chokhanis, of the world), as they do not need to mimic benchmark, and that they can take disproportionate risks, but then they will be few and far between. And to assume that you are among that few, without any credible track-record is a far-fetched thought, in my view.  It is like believing you can be next Tendulkar or Kohli, just because you can play cricket (which millions other can do as well).

Do you really have a portfolio-approach?

The other characteristic of retail/HNI’s Active Investing is that they spend lot of time in researching a new winning idea, but pays little attention in tracking development of their existing investments i.e they are Active on new stock ideas but Passive on their broader portfolio monitoring. They feel immensely satisfied to see how their latest stock pick have done well, while in overall portfolio context, it might have little significance, and at many times the other broader portfolio could be losing ground everyday. Further, while there are lot of techniques available to find a ‘multi-bagger’ stock, there is very little academic literature on when to exit. Quite often it means, these active investors tend to exit, when there is a big negative event/ fall in price, rather than selling at highs. In other words, possibly great entry point, but terrible exit.

Therefore, increasingly I am getting convinced that individuals should not attempt to do Active Investing (stock-selection) and rather leave it to professionals. This is not to say that Professionals are more capable than any single retail/HNI, but given that Professionals have institutional approach, the risk element and portfolio sizing is better managed.

So how does one keep himself intellectually simulated on markets?

All said and done, then how does one satisfy the deep intellectual urge to build opinions regarding economy, company management/ strategies, earnings expectation, etc. How can these retail/HNI individual satisfy their ego and prove a point to their peer group which they often claim, ‘I had told you that xxx stock will rise /fall….” At many times, for most, it is less about making wealth, but more about getting due recognition from your peer group on your wisdom.

My solution to them is that use all the energies and analysis to take a view on market direction, and decide on your Asset allocation- no fund manager will be able to do that for you, as it will vary depending on your risk capacity, time horizon, liquidity needs, etc. Once you are decided on this allocation, give it to ETFs or professionals (MF, PMS, etc) and let them take care of stock-picking and portfolio risk.

Conclusion

As you would have seen, this post is not about Active vs Passive approach to fund management – a debate that has grown rapidly in the last couple of years. But this post is for every individual investor who starts with stock-picking, but at many times, cannot give adequate time and energy that is required to build a portfolio over a long-period, and in most cases they lacks the skills, too (albeit no one admits despite their losses). I would say it is best to be Actively Passive (i.e being Active on framing/deciding asset allocation every quarter, and Passive on stock-picking, risks framework, etc), rather than being Passively Active (i.e passively monitoring your active stock portfolio). Always remember, "Investing is a Marathon", and not one-time process of finding undervalued stocks. 

So what is my Equity allocation now?

Personally, I started going Underweight Equities at the start of 2018 (Nifty at 10,800 than) as valuations appeared to be dislocated considering it was late-cycle and tariff news started gaining momentum. My belief got strengthened after US recession fear gathered pace in Q4 2018 (trade war, yield curve inversion). But in reality it turned out to be a lost opportunity, as H1 2019 had a sharp rebound globally. Particularly from India perspective, things were just looking to come in my favor post July-2019 budget, with increasing investors starting to doubt the 'India Story'. But with the unexpected corporate tax cut in Sept (see my previous post on it for more details), the bulls are back in the market.

I have continuously increased my underweight stance (just ~30% of my savings are in Equities now vs. ideal 50% that I want to keep, which I had prior to 2018). This equity allocation is the lowest I have held since I have started following asset allocation principle 4 years back, and is being achieved not necessarily through selling equities, but doing lesser incremental investments each month of my savings. Today, I am slightly disappointed to not participate in this up-run for over 2 years now. But, I am not a fund manager who has to prove on 3m, 6m, 12m returns, and therefore can afford to still wait for the better opportunity, as time horizon is very long. The objective is to enter at levels that are comforting enough to see 12-15% index CAGR for the next 5-7 years, which I doubt will be achieved from current Nifty levels at 11,900.  That said, the market strength remains solid, with every minor correction getting bought heavily, adding to my frustration.