Beware of investment advice which reads...

Markets are in a celebratory mood. Election results not only met but surpassed expectations with the BJP-led NDA gaining a thumping majority. With markets surging northwards, it comes as no surprise that the performance of mutual funds has started looking up too. Pick up any business daily, and you are likely to find articles extolling virtues of mutual funds, discussing their performance and favoured investment areas. And then, there are experts dishing out advice on what investors must do. While some of the advice is sage, there is also a lot of rather disconcerting advice doing the rounds. I have chosen three pieces of investment advice which are at best half-truths, and at worst completely incorrect.

1. Dynamic bond funds work like a silver bullet

Will the RBI governor cut rates in the forthcoming monetary policy review or won't he? That seems to be the million dollar question at the moment. And this in turn, has led to a lot of discussion regarding dynamic bond funds. Simply put, the latter have a fluid investment style wherein the manager takes active duration bets, based on his assessment of where interest rates are headed. The manager's flexibility to position the portfolio across the yield curve is seen as a silver bullet. Sadly, there is a difference between plying a flexible approach and being successful at it. There are enough instances of even skilled bond fund managers woefully misreading the direction of interest rates. 

A case in point was mid-2013 when RBI's steps to bolster the weakening rupee spooked debt markets; at a time when consensus suggested that rates would soften, they rose sharply. As a result, several managers who had positioned their bond fund portfolios for a softer interest rate regime were caught on the wrong foot. Don't get me wrong--I'm not suggesting that dynamic bond funds are without merit. All I'm saying is: don't think of them as a magic potion for all woes. Even conventional short-term bond funds (which admittedly operate in a narrower band of say one-three years) are capable of adding value to the portfolio. Don't dismiss seemingly plain-vanilla products (read short-term bond funds) in favour of dynamic bond based on a misconception.

2. If the manager follows a consistent approach, the fund will perform

To be fair, a consistently plied approach is a positive as it infuses predictability. But to suggest that the same in isolation is a surefire recipe for success is naive. It takes a lot more for the fund to succeed. To begin with, it helps to have a skilled portfolio manager who is playing to his strengths. As for the process, it needs to be a robust one which is executed with skill. 

To better understand this, consider a process that relies heavily on making the most of mispricing opportunities between the cash and derivatives markets, or one that results in a substantial structural bias for certain stocks/sectors, or one that relies solely on momentum to deliver. These are examples of processes that aren't inherently robust, and ones that will succeed only in specific market conditions. Their consistent application won't automatically make the fund better equipped to deliver. Execution is no less important: consider a process which is rooted in valuation-consciousness and a long-term orientation. The robustness of the process notwithstanding, should the manager keep getting snared in value traps due to poor execution, the consistent approach is likely to be of little help.

3. Evaluate funds based on their holding pattern in top 10 gaining stocks

This one's rather bizarre. If it wasn't bad enough that investors were being misled to evaluate the performance of equity funds over shorter time periods like 1-year and 3-years (with scant regard for the risk-adjusted return showing), now apparently whether or not the manager was invested in the top 10 gaining stocks is a parameter to consider. To my mind, this demonstrates a poor understanding of both--the working of a mutual fund and what one must expect from it.

Funds are run based on their investment mandate and the manager's investment philosophy. A number of parameters such as market capitalisation, nature and quality of business, and valuations, among several others come into play. An investment universe is drawn out and stocks chosen from therein. Though it would certainly help if the best performing stocks were to feature in the manager's picks, it is certainly not obligatory. Let's not forget that in a sharp market upturn, it is often speculative, high-beta fare that fares the best. And the latter need not be the kind of stocks that every manager wishes to invest in. 

Broadly speaking, the test of a manager and his strategy should be the ability to score over the fund's benchmark index and comparable peers over longer time frames (read at least five years) across the return and risk-adjusted return parameters. Whether or not the manager is invested in the top 10 stocks is of no consequence.

In conclusion, there’s a lot of investment advice available in public domain. Investors on their part would do well to be discerning and act on advice that is apt for them.

Why election investing isn’t for all

To say that general elections 2014 have captured the public’s imagination would be stating the obvious. It’s not every day in a cricket-crazy country like ours that the IPL is relegated from the front page to the sports page. The magnitude of the election frenzy can be gauged from the fact that it has now spread to the domain of investments. Business dailies and channels have a plethora of ‘election investing’ tips to offer. Investors are being advised as to how they must position their portfolios to benefit from the impending election results.

What’s driving election investing?

It is widely believed that the NDA will form the next government and that markets will respond positively to the same. In fact, some have even termed the recent run-up in markets as a ‘hope’ rally. Others are invoking history, and banking on it being repeated: in 2009 when the UPA gained a majority (defying the odds) markets rose sharply.

But isn’t that speculation...

To be fair, investing in markets is a forward-looking activity i.e. assumptions are made and a hypothesis is built around it. Expectations of what may happen (going forward) are factored in while making investment decisions (at present). 

However, when investors pin their hopes solely on an event such as election results, they are speculating. Effectively, they are emulating soothsayers and trying to forecast not only what the outcome of the election will be, but even how markets will react to the same. 

And for those who believe that market behaviour after election results is a sign of things to come, here’s something to mull over. In 2004, when the incumbent NDA was voted out of power, equity markets tanked; however, that was followed by a strong bull run which lasted until early 2008. Conversely, when the incumbent UPA returned for a second term in 2009, markets skyrocketed; that was followed by one of the most testing periods for equity markets. Simply put, investors who would have based their investments solely on how markets reacted to election results would have been in for an unpleasant surprise.

What investors must do

It comes down to whether one is a long-term investor or a short-term investor. For a short-term investor who bases his investment decisions on momentum, sentiment and news flow, and is willing to trade aggressively, the election period (i.e. days leading up to the result, the result day, and the ensuing period) is undeniably important. There will likely be several opportunities to ply one’s skills and make money.

Conversely for the long-term investor, the election result isn’t particularly important, and he can afford to be passive. To begin with, he doesn’t have to re-align his portfolio in expectations of what may happen; neither does he have to buy-sell at a furious pace to benefit from the volatile markets.

If anything, it might be an opportunity to clean-up the portfolio. For instance, if the markets do indeed rise sharply, it will be a good opportunity to sell investments that aren’t right for the investor, or are overpriced at a neat profit. Conversely, falling markets might offer opportunities to make some bargain buys. But any further focus on election results will be a futile exercise. 

In the long-run, while several factors can have a fundamental impact on the attractiveness of an investment avenue, the election result is certainly not one of them.