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Curious Case Of Returns

Jul 30, 2014 | Dr C K Narayan | Fundamental Twist, Interesting Read | 12 Comments

Curious Case Of Returns
Or, why volatility of returns is here to stay.

In my fund management vertical, I am often confronted by the variances in the returns. No doubt, my approach is a lot more hands on, a lot more proactive when compared to say, a Debt fund return. But then, when one seeks superior returns, will volatility of returns not be a part of the deal?  In this matter, I find that investors have quite a double standard – in their approach as well as their thinking. And this double standard creates a great deal of problems for the non-MF fund management or advisory business. It will also soon- or perhaps already has- create problems for the mutual fund managers.

The returns in the standard areas of investment are pretty standard too- with most of them moving around the 7-12% range (multiyear average). When an investor wishes to chance his arm for a higher return, he should, at the same time, be also willing to accept a greater volatility in the returns. Typically, this fluctuates from high positives to deep negatives and then back again to positives, finally ending (mostly) at a higher percentage return. But the minute the returns starts to experience volatility, the investors start to palpitate. They question the manager on the methods and offer unsolicited suggestions and opinions on how things are to be done and finally, withdraw much ahead of the promised tenure. Thus, they do not give the approach a chance to succeed. The ‘lesson’ they think they learnt is that such approaches don’t work! This is just dandy for the standard bearers of money management. They don’t do anything more to secure the returns, they can always blame the markets for the lack of performance and they can point to several other of their peers doing worse!

Turning to another aspect, I am beginning to think there is inherent shift in the way the market is functioning that is impacting returns. MF equity schemes for example have been showing considerably higher volatility in their returns in the last few years but no one really questions these. Back in Nov 2013, most large cap schemes were minor to deep negative in returns but the market rally this year has now taken the returns to a good positive. So, essentially, the market improvement produced the changes rather than any specific actions by the fund manager.
I then checked out the returns given by a famous deep value investor’s PMS and I find that their returns peaked back in 2003-4 (80%) and post 2009, the returns have been dropping steadily down into single digits (right into Mar 2014).   There were several half-year rests within that had negative returns. It can be presumed that since this was a more actively managed portfolio, the fund manager would have done something to improve returns. But results are far from impressive.

In my own area of expertise, I checked the performance of trend following vs the trend forecasting approaches and find that the returns there too are changing quite visibly. Trend following approaches used to be quite successful but of late they are not. Most people avoid forecasting, stating that it is very subjective, but across global CTAs as well as within my own organisation, I find that the forecasting approach is delivering better and more consistent returns.

So no matter whether the approach is top down or bottom up, whether it is growth oriented or deep value seeking, whether it is trend following or subjective forecasting, it seems that volatility of returns is here to stay in every form of investing. Could it be because of the increase in the role of machine-led trading? Are algos changing some fundamental characteristics of markets? Is the focus shifting away towards shorter term?
Whatever the answer may be, one thing is for sure. Investors need to now begin accepting that volatility of returns is here to stay. If they aspire for anything higher than the standard sub 10% bracket of returns, they should be prepared for seeing a bit of a yo-yo ride in their portfolios no matter which approach they choose. This acceptance can make the job of the fund manager a lot easier as he does not have to be defensive about the volatility at every client meet. And can concentrate on extracting a higher return from fast changing markets. The double standard of wanting but not accepting what comes with the want has to end.

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