Do you think index investing is something which already has lived its life given that the orientation of the world is now changing very rapidly because of technology, because of Covid and what is happening in the disruptive world?
I will give you a very brief genesis on why I and Varun Daga decided to write on index investing. We are very big believers in the index, very big believers in what markets do. Technically, the index manages unlimited amounts of money. It is larger than all the large cap fund managers put together but something that drove us to write that article was that we had a lot of complaints from people saying that look our mutual funds have not really done that well in the last five years. Of course there are some active managers who have healthily beaten the index, but it is a startling figure. Not more than 8% or 10% have managed to beat the index in the last five years. That is the cause of disgruntlement amongst the investor class. Mutual funds have received a lot of money.
We decided to dig deeper to look for the cause of this underperformance? From our own experience at Girik Capital we actually believe that most fund managers and investors have cognitive biases; they have certain preconceived notions in their minds which sometimes force them to rebalance portfolios in not a structured and thought process driven manner.
Many times when a stock runs up too much, investors and fund managers tend to take profits too early. Similarly, when a stock falls, many will average down saying how can I be wrong? The stocks have fallen. The index does the exact opposite. It will keep up-weighting and increasing the weight of its winners naturally because of price increase and it down weights its losers naturally because of price disruption. In fact it even eliminates losers time to time.
So many of the stocks that were in the index 10 or 12 years ago, are not there today. The index churns several stocks a year. I will give you a shining example. HDFC Bank was something like 1.79% of the Nifty 12 years ago. It is 11% of the index today. The index has done a superb job of consistently making sure that the weight of its biggest winners is at the highest point and it is kept increasing over time right so the index does not time.
The index does not have biases, the index is universal. It follows a very system-driven automated process which according to us every manager needs to have. The first thing an investor needs to ask when they invest in an active manager is what is it that the active manager does differently, why is the active manager really charging the fees? Is their process sacrosanct and robust?
We believe that most managers over the long term will fail to beat the index, but some will beat the index. The process of manager selection is similar to stock selection. It is an art that requires a process and thus most investors who do not have that much knowledge must stick to an index one rather than go out finding managers who they think might beat the index.
For those who want superior returns, how will index investing give them benefits of superior returns because it is ultimately passive investing? You will never hit a multibagger in your portfolio if you are walking on the path of index investing?
The index actually has multibaggers. I am not saying that stop picking and trying to be an active manager. One must do that, one must build knowledge, process discipline. The index has a superb methodology right; it follows processes and systems and is so disciplined that it is able to weed out its losers and add to its winners. The index has over time got several multibaggers. If you look at some of the stocks in the index, they are hundred baggers. What was HDFC Bank in 2008 and what it is it today? What was TCS 20 years ago and what is it today?
On the flip side, the index also makes sure it eliminates its losers. As a fund constituent, the index provides is always saying something that an investor cannot ignore. This is not saying do not pick multibaggers. There are several smart investors in India who will beat the index; there are several fund managers who beat the index. All we are saying is this is not easy over the long term and investors must be realistic about their probabilities.
But these are human biases. We as investors and fund managers tend to overestimate ourselves, overestimate our forecasting capabilities, overestimate our ability to what we believe is to beat the index and have a superior system. This is the only point we are making.
What is the best way to invest in the index – time it or be disciplined like a SIP?
I think there is no exception to discipline. We do believe that SIP is a phenomenal way of investing. Human beings have very little ability of timing the market. Like for example, we have been hearing people calling tops all around us for the last five or six months and we say that is a great and healthy sign. Now if investors had done their SIPs consistently over the last one year, they would come up fairly ahead and I think it is a very sensible thing not to try to time markets. Very few people have the ability to do that. I do not know a single person who in March had called that within the same calendar year or financial year, something like this would happen. So this is a shining example of why one should not try to time. And I think ultimately they come through.
The right way to do it is systematic, disciplined and being consistent. That is exactly what the index does. It is systematic. It is disciplined and it is very consistent. Also the index fund charges no fees. These are points to be highlighted. Being systematic and SIP driven is being very, very wise.
The entry price is a very important denominator of what your future returns are. If you are starting now and if you have got five to seven years, should one expect double digit returns in index investing?
Five to seven years is a very good time horizon, I think the longer your time horizon, the chances of you getting into those double digits get higher. I can tell you that until March nobody was in double digits and now everybody is in double digits. The time in the market is your best friend. It is very important to have the right time horizon as an equity investor to understand that short-term blips will come. You could have a 30% fall tomorrow, nobody is saying that is not possible. Keep your discipline, keep your structure alive. I have seen too many people all my life trying to time markets but very few can do it consistently. Those that can do it, by the way, have phenomenal processes and discipline. It is not that they wake up one morning on a whim and say that oh, the market is going to crash.
This is like a kitty party and coffee conversation where people try to talk about markets being too high or too low and in March, everybody was a bear because the world was coming to an end. Today everybody is a bear because it is too high and this does not work. Being consistent and giving it five to seven years is a very base case. I think anything less than that you should not really be in equities. It is not a wise use of your time and money.
Are you still convinced about owning Bharti given that they have not managed to consider a price hike? The 5G capex is round the corner. Are you in double mind or are you convinced that we should ignore the short term noise which is there in the telecom sector?
The beauty about price is when prices fall, people tend to question that thesis. The way our system is setup is very similar. We do take notice of price depreciation in our portfolio. When something is not performing, we tend to try to dig in and understand as to why it has not done well, have we been wrong somewhere so price is a leading indicator and research is where we add value. We follow a process; we try to eliminate our biases.
So when we bought something and we have made a mistake we are very open, we sit on the table and we tell one another okay, we have paid for this, we have bought it, it has not worked out so far; let us really understand why and we take time to do this. We do tend to downgrade positions that are not performing over time. So Bharti we have downgraded a little bit and it is a smaller component of our portfolio than it was earlier.
We still believe that the earnings tailwind is very much there, what can happen in the short term is when too many people chase certain stocks in the near term, they run up quickly and can consolidate for long periods of time. Case in point could also be Reliance which after such a large runup, is one of our larger holdings. We are not recommending it, it is just a caveat but it is one of our larger holdings.
In the telecom space of course we are still convinced that the earnings tailwind is very much there which helps us stay in our position in our stocks. We are going to wait and watch and we think that the earnings super cycle is still to come. We will give it some more time.
