Sunday, December 6, 2015

The real truth behind long term investments

“Our favorite holding period is forever” – Warren Buffet

Financial advisors, fund managers, research analysts and other elites of the investing community always claim that ‘equities provide the highest return among all asset classes in the long run’. The pink press regularly dishes out data comparing long term returns from various assets classes, such as equities, gold, real estate, bank deposits and so on. Usually, stock market indices such as the BSE Sensex or NSE Nifty are used as proxies for returns from equities. Stories of successful “long term” investors such as Warren Buffet, serve as useful mascot to support these claims. The consensus currently, in the personal finance community, is that to create serious wealth, you need to invest in equities, and stay invested for the long term.

Rakesh Jhunjhunwala
Rakesh Jhunjhunwala is among India’s best known investors and needs no introduction to the investor community. Recently, I came across a study published by financial newspaper 'Mint'. The study analyzes 91 stock market investments of Mr. Jhunjhunwala in 84 companies (some companies were bought & sold more than once, hence the difference) over the last 10 years where he has held more than 1% stake at any point of time. Under extant regulations, investments above 1% of a company’s share capital are required to be disclosed to the stock exchanges, hence this is publicly available data.  Before we proceed, I urge you to read the full Mint article here.

The study finds that Mr. Jhunjhunwala’s “…average returns have been highest from stocks he held the longest”. The message for the lay investor, is that the longer you remain invested in a stock, higher your return. This argument is supported by a quote in the article, attributed to a professor from IIM, Kozhikode, “In the long run, stock markets in general have been seen to move in an upward direction. Therefore, the longer you hold on, the probability of superior returns is quite high” (emphasis mine).

However, this conclusion is not even half the story.

Behind every successful 'long term' investment are nine other not so long term investments

In fact, the Mint study finds that average holding period of Mr. Jhunjhunwala for these investments is just 3.44 years. In 26 out of the 91 investments (i.e. 29% of the time), Mr. Jhunjhunwala has exited the investment in less than one year. The article itself quotes a study of Warren Buffet’s investments, which found that “he held most of his stocks for approximately a year. He held his stake in only a fifth of his companies for at least two years.” Clearly, Buffet’s favorite holding period may be forever, but only 20% of his investments enter even the third year. This is quite at variance with the conventional image of these “long term” investors, who are thought to hold their investments for decades, not just years.

Even the market indices such as Sensex or Nifty that are used as proxy for the equity asset class are not static. Their composition changes frequently as some stocks are removed and others added. An article in The Hindu points out (click here) that between the period 2002 to 2012, the Sensex delivered a compounded annual return of 17%. Very attractive by all means, but during this period the index was reshuffled 18 times, with 26 of the 30 stocks replaced! I am sure if returns were calculated using the same stocks which existed at the start of the period, they would certainly not turn out to be as attractive.

The Mint article makes a reference to some of Mr. Jhunjhunwala’s best known investments (such as Titan, Lupin etc.) which he has held for decades. However, to state that these investments have provided best returns because they have been held the longest is to put the cart before the horse. The truth in fact, is the other way round.

These investments have been held the longest because they have provided the best returns.

The strategy of ruthlessly exiting mediocre investments quickly seems as much an integral part of Mr. Jhunjhunwala’s (or Warren Buffet’s) success as holding on to best for 10 years or longer. And the ability to differentiate between what to exit and what to hold on is what makes these investors stand apart from the rest. Not an easy act to follow. 

Wednesday, November 25, 2015

The Intolerance debate

Intolerance (n.) – unwillingness to accept views, beliefs or behavior that differ from one’s own

Over the past few weeks, a debate about rising “intolerance” has been raging in India. Several writers have returned awards citing “rising intolerance in India”. Talking to India Today TV, film actor Shah Rukh Khan has reportedly said, “There is intolerance, there is extreme intolerance… there is, I think…, there is growing intolerance”. More recently, actor Aamir Khan said that alarmed by recent events, his wife Kiran Rao has suggested that they should leave India

I find this whole issue utterly ridiculous.

Intolerance is a subjective term; it means different things to different people. Also, opinions always differ from person to person, and there is nothing wrong in different people having divergent opinions. Beyond a point therefore, the current debate on whether there is growing intolerance in the country or not is futile, it is never ending. Nobody claims that each and every one of 121 crore Indians are tolerant. Nor are all of them intolerant.

The slant in the current debate is that intolerance has increased after the new government came to power in May 2014. For example, Aamir Khan has reportedly said that “…the sense of insecurity and fear has been growing in the past six or eight months”. Coming from Aamir Khan, the statement is all the more surprising, since his film “PK” was considered to be hurtful to the religious sentiment of Hindus and was demanded to be banned by certain right wing organizations. However, the film was not only allowed to be released, but became one of the highest grossing Indian films of all times. 

The so-called “intolerance”, was nowhere on display, neither on the part of the government, nor on the part of majority of the viewers.

No intolerance on display - PK was a big hit

How we decide

On any such issue, a rational person should base his opinions & judgments on two primary sources:
  1. Official data
  2. Personal experience.
Sources such as newspapers, television are secondary sources and should never be made the primary basis of our opinion and judgment. They can best be used for confirmatory signals when they support what data and personal experience indicates. Secondary sources should be taken with a pinch of salt when they contradict data and personal experience. Further, even while using these secondary sources, care should be taken to differentiate facts from opinions.

Let us say, the TV anchor reports something like this:

A person was killed because he was selling beef. There is growing intolerance in the country.”

In this,
  1. A person was killed is a fact.
  2. Because he was selling beef is the suspected motive. It may be proved or disproved after a full investigation is over.
  3. There is growing intolerance in the country is a generalization which will need supporting data with a much larger sample size.
When we listen to such news, and form our opinions and judgments based on them, we must be conscious of what we are relying on. When I listen to the above news, I would give 100% weightage to point no. 1 above, 50% weightage to point no. 2 and zero weightage to point no. 3.

Where is the data?

The Home Ministry website has lot of statistics on the country’s crime. None of those who allege intolerance have provided any data to support their thesis. Note that even when data is present, it needs to be analyzed carefully, as raw numbers may prove existence of fact, but not causation. I have often seen that from the same set of numbers, different people draw different inferences. For example, economists differ on whether the economy is doing well, or poorly, though both sides refer to the same sets of data.

In the present debate, there is no data or survey which indicate how many attacks have been caused by this alleged “intolerance” and whether there is any substantial increase in them after the change of government at the Centre. Besides, let us also not forget that under the constitution, law and order is a state subject. We cannot blame Modi for riots in Gujarat while using a different yardstick for law and order problems in Assam, U.P. or West Bengal or elsewhere. The intolerance argument fails miserably against the “data” test.

Personal experience

My personal experience and observation does not corroborate the intolerance allegation. To the extent I see around myself at home, in office or in my neighborhood, behavior of the people, inter-personal and social relationships and attitudes towards others including towards people belonging to other religions are the same today as they were before May 2014. If your experience is any different, you are entitled to hold a different opinion.  But to me, the intolerance argument makes no sense. 

The only intolerance I see is an intolerance towards Modi.

Monday, November 16, 2015

Reforming the education system

The only thing that interferes with my learning is my education – Albert Einstein

Make no mistake. India is heading into an education and employment crisis.

At more than 127 crore people, India is home to world’s 2nd largest population. Nearly 1/3rd of this is in the age group of 0-14 years, who are / will be entering primary & secondary schooling in the coming years. An estimated 40 thousand colleges in the country enroll more than 2 crore students under various courses every year, a majority of them in the 3 year B.A. / B.Com. / B.Sc. courses. There is no way any government scheme or programme can create gainful employment for these aspirants in such large numbers. The task before the country’s education system is to prepare this generation for the humongous challenges that lie ahead.

India’s current education system traces its origins to Thomas Macaulay’s English Education Act of 1835. The Act introduced English as the principal medium of instruction, and sought to create a neo-intellectual class who held English in high esteem and contempt towards the traditional. “We must at present do our best to form a class who may be interpreters between us and the millions whom we govern; a class of persons, Indian in blood and colour, but English in taste, in opinions, in morals, and in intellect”, Macaulay wrote. The Act created a system which produced a useful workforce of English speaking clerks and officers, loyal and ready to serve the Raj.

To this day, the basic character of the system Macaulay framed remains the same. Our education holds conservatism and obedience as big virtues, discourages daring & risk taking, and challenge to established conventions are held in contempt. Deference to authority becomes a ‘good habit’, discipline is demanded and rewarded. Creating such a mindset among the people suited the Imperial administration subjugate a large population, who could otherwise rebel and throw the outsiders out.

But is that what we need to teach our children today? We need a system which abolishes this slave mentality, and creates employers, not employees.

At a fundamental level, the purpose of education is to cause mental, physical and spiritual development of an individual. These qualities form in the early years of a child’s life. To start with therefore, we need a much larger focus on soft skills in primary education than is given at present. Risk taking needs to be encouraged. Failure should be taught as a stepping stone to success, rather than something to be ashamed of. Qualities such as hard work, perseverance, team spirit, motivation and determination need to be tested and assessed for each child. We need to teach our children that long term gain often involves short term pain. A mindset which embraces change needs to be consciously cultivated.

I don’t even ask whether we are doing it today, I first want to know whether there is a way to do this today, formally and methodically. Most probably – the answer is ‘no’. So this is where we need to start. We need to find ways how these qualities can be inculcated in our children. What are the teaching methodologies we should use, and how it can be done effectively & consistently. I have no straightforward answers for these questions.

On a more practical level, our education needs to prepare our children to make a gainful living. They need to create ‘value’, in the economic sense of the term. Where are we on this paradigm?
Rajabhai Tower, University of Mumbai

Like in many other fields, the internet has completely changed the playground for education. Information on nearly everything is available at our fingertips. Accessing knowledge has become easy. But using this knowledge in ways that benefits humanity, creates value, is what will differentiate tomorrow’s winners from the rest. The graduates our universities churn out year after year are little capable of doing this. Industry complains that they are unemployable. The lucky few who find jobs get trained by their employers after joining. They find little use in their day to day work for what they learnt in college. After spending 15 years of life and lacs of rupees, for a majority of our graduates the return on investment in education is zero.

To address this problem, the present government has focused heavily on “skill development". The initiatives under various skill development programmes recognize deficiencies of the current system to impart job oriented skills to students and make them ‘employment ready’ with the industry. While these initiatives are welcome, it is still too little when confronted with the enormity of the task of making our children ‘life ready’.

In the last 15 – 20 years, new technologies and business models have completely altered the global business landscape.  At the risk of using a much clich├ęd term, change has become the only constant, and at a pace that is simply mind boggling. We have no clue how the business world & industry will look ten years from now. The ‘skills’ we train our children today may become redundant in a few years from now, while those which dominate tomorrow have not even been developed today. This is what the focus on skill development leaves out. It is not to say that skill development is not useful, but it is just not sufficient. Skills come much later in life; it is training the mind where we are failing miserably.

A paradigm shift is needed in the way we look at education itself. Periodic revision of curricula does little to address these concerns. TV Mohandas Pai points out that education has now moved to a technology platform. A student in India can get a U.S. degree sitting at home, while our Universities are not allowed to offer courses outside the state. He foresees “many students will soon move away from the formal system of education and would get a degree through MOOCs (massive open online courses) and online courses, and these degrees will be recognized by the world”.

There is little recognition of this disruption in government circles. The system seems to be unable to move beyond minor tinkering of the mandated curricula, exam patterns and Nehruvian regulation. For example, a recent committee appointed by the HRD Ministry was tasked ‘to review’ the JEE system for admission to IITs. The committee viewed the private ‘coaching industry’ as a menace rather than a partner in imparting education to willing students. But before we reform the 'entrance tests', the important question to ask is - do we even need entrance tests and selection processes at all, when we can digitize our books and lectures, opening them up to every single aspirant? Professors can concentrate on solving queries and answering questions online, while holding webinars which can be attended by thousands of students from their homes. My guess is that even if 80% of a course can be ‘delivered’ in this way, it can bring manifold economic benefits, because access has been given to every single aspirant at no extra cost & effort, and not just to select few who pass the entrance tests. In fact, a scenario where the universities concentrate only on conducting certifications while giving students the freedom to learn from wherever they want, will dramatically improve the effectiveness of education. Unfortunately, such changes are not even on the agenda.

If we don’t fix our education urgently, we are heading for a job crisis of mammoth proportions.

Sunday, April 26, 2015

Four ways of bringing back Black Money

The subject of black money stashed abroad has attracted considerable attention in recent times. It was an important issue in last year’s general elections, and UPA government’s inaction was seen as one of the reasons behind its electoral defeat. Recently, the NDA government has introduced the Undisclosed Foreign Income and Assets (Imposition of Tax) Bill 2015, popularly known as the Black Money Bill, in the Parliament. In a discussion organized by the Moneylife Foundation, Dr. Subramanian Swamy (sorry, he doesn’t need an introduction!) shared his views on the bill, and black money in general. Here is a quick recap of the event. (I have given a more detailed perspective on the black money issue in a previous post, click here)

By some estimates, an amount of approximately Rs.120 lac crores is lying outside the country. Dr. Swamy started by saying the bill falls short of the objectives of bringing back this amout. The bill depends on the assumption that the money is detected or declared by the assessee, but does not have steps to actually bring it back. It is essentially a "tax bill", clarifying how to tax what is already known. It can also be misused, as it gives draconian powers to tax officials.

Dr. Swamy said there are two aspects to this whole issue – first, bringing back the money stashed abroad and second, stopping creation of new black money. On the first, he said there are four ways of dealing with the problem.

The Black Money Bill will not bring back the money, said Dr. Swamy at a Moneylife event

One, exchange of information under Double Tax Avoidance Treaties (DTAA). India has DTAA with several countries. An Indian assessee having income in a foreign country (say, Germany) and intent on avoiding tax tells India he is paying tax in Germany, and tells the Germans he is paying tax in India. Actually, he pays at neither place. Such cases can be detected with exchange of information between the two countries. Most media discussion on the black money subject is centered on this aspect. The UPA pursued only this angle during their rule. However, this is a very small aspect of the overall quantum of black money.  

A second alternative is to obtain details of account holders who are holding accounts abroad secretly and illegally, secretly and illegally! In one instance, Germany reportedly bribed bank officials and obtained information about its nationals holding accounts in Liechtenstein, a tax haven in the heart of Europe. France did the same with HSBC.

A third alternative is to extract information by force, used by the U.S. (who else?) against banks such as Credit Suisse and UBS. The U.S. government charged local branches of these banks with crime, arrested its officials and forced the banks to share information.

Finally, Fali Nariman, a noted Indian constitutional expert and lawyer has suggested that an ordinance can be passed nationalizing all foreign assets lying abroad, and asking all other countries to repatriate the money to India. There is a 2005 United Nations Resolution backing this, and the foreign governments will be forced to comply, irrespective of their bank secrecy laws. This has been done very effectively by Egypt to recover illegal assets of its former President Hosni Mubarak, by Libya against Qaddafi and by Philippines against Ferdinand Marcos.

Dr. Swamy said this last method is the best and the cleanest method to recover the money lying abroad. Incidentally, this is the same one I have mentioned in my previous blog post on this subject (link given above) as “the one I have found the most actionable” quoting an article by India’s National Security Advisor Ajit Doval. 

Besides the issue of bringing back money stashed abroad, a second aspect is how to stop its generation in the first place. In this, he touched upon a number of topics such as the need to abolish P-notes due to its role in facilitating money laundering, abolishing income tax, streamlining excise, bringing in e-governance and quickly & efficiently delivering justice to a few ‘big fish’ caught in the act. He recalled how Bernie Madoff was quickly sentenced to 150 years in prison within just six months of his fraud coming to light. On the other hand, Ramalinga Raju's case, which came to light at around the same time, is still dragging in court. Dr. Swamy also stressed the need for deregulation and simplification. For example, he pointed out that more than 2000 products have excise on them, but 90% of excise revenue comes from just 22 products. He emphasized that honesty needs to be encouraged in society. 

There was a very interesting question & answer session at the end, where he took questions from audience and touched upon several other aspects of corruption and black money. On the whole, a very engaging session!