By ArunaGiri NSecret of getting ahead is getting started, said Mark Twain in his famous quote. But he left something unsaid, which is far more important from an investing perspective. Once started, what is key is to ‘stay put’.
Like the proverbial Zen paradox, the best way to move ahead is to stand still. Switching strategies (from value to momentum or vice-versa or from smallcaps to largecaps etc.) to suit the flavor of the season is recipe for disaster in the investing world. Rolling stones hardly gather mass. In stillness, there is greater dynamism.
Value Is Dead. Long Live Value
In 2017, at the peak of the bull market for smallcaps, value investing was applauded as a glorified virtue. Through 2018 to 2020, in the bear market (in smallcaps and midcaps) that followed, it was vilified as a vice. Now, with the search for the next smallcap winners gathering steam, the tide is turning for value.
In every cycle, it is natural to get tempted to switch sides based on the tide. More so, because it sounds very logical and profound to tame the tide by switching loyalties. Such switching may look smart in the short run, but takes a heavy toll in overall long term returns. This is because, the tide is so swift and fast when it turns that one ends up always late (when switching) however smart one is. The second challenge is, only in hindsight one will know if a cycle has really turned. The easier thing to do is to stay the course to get the most out of the eventual turn (every cycle eventually turns, however deep or long it can be), though it is hard to execute emotionally.
Switching strategies would have worked in the market if the navigation is through a rear-view mirror. Unfortunately, investing is all about driving forward looking through an often hazy windshield.
Let us look at the live case of the smallcap cycle of 2018-20 to illustrate this point. The BSE Smallcap index made a bottom after two long years of a bear market in late March with the onset of pandemic lockdown. At that time, the already emerging consensus trade of ‘quit smallcaps and move into largecaps’ got further ammunition in the form of the Covid-19 disruption to gain further momentum.
It appealed to the logic of even seasoned investors, who had seen multiple cycles. Panic selling followed in smallcaps. Precisely when everyone quits, a cycle bottoms and turns.
Look at what happened to the consensus trade. Post March, on a year-to-date basis, Nifty is up 50- odd per cent, while smallcap index is up nearly 70 per cent from March lows. This return differential is likely to be much bigger in individual cases, as rarely anyone does instant switching.
Instead of clinical switching, one often ends up trying to outsmart / time the market. This adds heavily to the switching costs, and results in a much higher differential than indicated by the indices’ performance given above.
It doesn’t stop here. If the smallcaps continue this outperformance (which it does for a reasonable time after tide turns, as seen in the past cycles), this prescient, yet misguided switch would have created a big hole in investor returns over time.
When a strategy underperforms for a very long time, the biggest pressure point for fund managers and investors comes precisely at a point when the cycle is about to turn. For us, such a pivotal point came in March-April. In investor calls during that time, many questioned our prudence of sticking to a failing strategy. Now the same investors are happy that we stuck to it.
Questions will quickly turn now to why we couldn’t be more aggressive in allocations. Such time is not far away.
“To borrow a phrase from one of the seasoned stock pickers, value investors are like a group of beasts now that is being hunted to extinction. Why? It is not difficult to fathom the reasons. Value as a strategy has been underperforming for an extended period of time since early 2018, because of flight to safety and polarised market dynamics. Even the last man standing out is being tested for his tenacity. Should the last few standing be worried? No. If one sets the clock back and look at the past two decades, one would find that neither this narrative (that value investing is dead) is new nor the crowded trade in quality is new. There has been only one thing that has been constant across cycles: that is, every strategy has a day under the sun and only thing that has always worked all the time is ‘reversion to mean’.
It is a question of time before the market takes fancy to value, though it is difficult to predict the time of the turn. Seasoned investors understand that every strategy has its time of outperformance and that of under-performance. The key is to stick to a strategy and not to flirt around with the flavour of the season. Stay the course to smell the roses, however hard one is being hounded”.
Credit: Stocks-Markets-Economic Times