Pain of Discipline OR Pain of Disappointment : Analysis of Investment Strategies

In the past few weeks I have come across several investment strategies, hence I feel this would be the best time to put it on paper (blog) so that this information can be accessed later as well. It is amazing to realize that, as in life there is no one way to salvation, investing also follows a similar pattern. There are so many investors following diverse strategies and making tonnes of money; the most pertinent reason for this is the discipline with which they stick to their strategies. Ofcourse they did not strike gold in their first attempt but have refined their strategies over and over, by incorporating experiences from their failures. I feel that they hold valid even in this volatile and continuously evolving environment, the only caveat being that one needs to identify which strategy best suits their temperament and stick to it through thick and thin. Have listed below the ones which have appealed to me….

1.  Index Investing: Index investing is a fairly simple and straight forward strategy, especially for people who do not have the bandwidth to invest time and energy into researching stocks. It involves either buying an Index Mutual Fund or buying shares that form part of a particular index, for example buying all the 50 stocks in the same proportion as in India’s NIFTY Index, and whenever the National Stock Exchange (NSE) changes the weight of a stock or replaces a stock, then the investor needs to do the same. In short it means replicating the NIFTY.

2.  Value Investing: Value investor is one who does detailed analysis of historical financial data and buys a stock only if it offers value i.e. it is available at cheap rates as compared to peers or historical averages or book value. Ben Graham was the proponent of value investing; he has captured the essence of Value Investing in his book Security Analysis (written in 1930s).

3.  Growth Investing: Growth investing is completely opposite of value investing, as per this strategy one analyses the industry in detail to ascertain the growth potential of a company, growth stocks are usually in sunrise industries like IT, internet, robotics etc. However, they are available at expensive valuations and also are susceptible to failures, hence it is very important to study the industry in detail. Warren Buffet follows a mix of Value and Growth investment philosophy.

4.  Contrarian Investing: Contrarian investor is one who basically invests in stocks which have gone out of favor, primarily due to short term head-winds or downward pressure on earnings. So contrarian investor is one who would invest in Infra or PSU Banking stocks in the current economic environment (November 2013). This strategy is primarily used for long term investing.

5.  Momentum Investing: As the name suggests, momentum investing basically involves taking long/short positions purely based on the daily/weekly/monthly price trends. So it’s a trading strategy for short term investors.

6.  High Frequency Trading: This trading strategy basically involves developing and applying complex quant based strategies. These strategies would involve taking simultaneous positions in various asset classes across International Markets.

7.  Alternate Assets: Alternate assets would include investments in Commodities, Real Estate, Hedge Funds and Private Equity. Each of them has its own nuances, which affect their prices.

8.  Fixed Income: Fixed income basically involves investing in Debt markets i.e. government bonds & Tbills, corporate bonds and asset backed securities. The duration of investments could range from few days to 30 years.

To make money one needs to be disciplined and hence Pain of Discipline will help one avoid Pain of Disappointment.

QE Tapering and India

The most pertinent question lying in front of the financial world is life post the unprecedented Quantitative Easing (QE). Just the thought about tapering has brought about a 100 bps rise and an upheaval in the currency markets. So we would like to present our thoughts on how the economic scenario shall pan out following the complete wind down of the US QE program.

Background: The US Fed since Alan Greenspan has constantly tackled economic problems by perpetrating another one. This began with the crash of LTCM and Internet bubble when the Fed went for loose monetary policies which in turn lead to a housing boom, mainly because the benchmark interest rates fell from 6% to below 2% from 2000 to 2002.  As the housing boom attained bubble proportions along with heightened economic growth, interest rates went back to 5.5% by January 2007, following this came a crash in mid-2007 due to excessive and complex derivative built-up in the system, the Fed tried to overcome this scenario once again by reducing interest rates to near zero levels and QE. Now we are faced with another bubble being formed in the Fixed Income securities market. So by the time the QE is wound up, the US Fed might have to propagate another bubble in another asset class.

Rise in Interest rates: Interest rates will surely get firm once we see the end of the QE program, we have already seen a glimpse of this in the recent past. Another factor would be the raising of the US debt ceiling; this could also perk up the rates further. Currently US is considering increasing the debt ceiling, any increase in the debt ceiling will go towards meeting the welfare obligations like Obamacare and unemployment benefits. This will is surely contrary to Keynesian economic thinking of increasing spending to perk up employment in the economy. However, if the commercial banks in the US start begin purchasing treasury bills instead of holding cash or reserves, then interest rates could be capped.

India will be placed in a precarious situation in case of withdrawal of QE as one of the foremost beneficiaries of QE, with Foreign Institutional Investors (FII) pumping in a lot of money in the Equity and Debt market. India has in the recent past relaxed FII investment norms for Indian debt, and due to capitalize on the high interest rates as compared to the US, we have seen good inflows. However, with the rising interest rates in the US, risk premiums for holding Indian debt would also rise and hence we saw a concomitant rise in the interest rates and the dollar. India will have to change its strategy of attracting FIIs from interest rate arbitrage to better growth potential opportunities.

With flawed economic policies being followed in the US and India; greater risks lie ahead for the Indian economy as the US will manage to float as its status not only as the reserve currency of the world but also a huge consumer of products. But India will have to put its house in order to raise the living standards and the per capita income; with elections looming ahead and chances of another weak coalition government prospects look extremely dim.