Linkfest – 87

Monday, August 20th, 2018

Interesting commentary from across the web in the last few weeks:


Anoop Vijaykumar – How many investments will survive? – Capital Mind

Annotated reading list of Indian Bankruptcy reform – The Leap Blog 

The role of housing and equity prices on inequality – Urbanomics

Five niches that could still survive active management – Barry Ritholtz

Challenges to deepening Indian corporate bond markets – Tamal Badyopadhyay


John Oliver on the Trade War –YouTube

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Hot tips to Financial Success

Friday, August 17th, 2018

If you switch on any business news channel, or look at websites like MoneyControl, you will normally be flooded by the latest hot tip or suggestions for the next “multi bagger” stock. Viewers of these channels are looking for shortcuts to make wealth and these channels readily serve up exactly what investors want to hear. You will get many tips, using derivatives, futures and options, on how to leverage your money to make that quick buck. Even the forums are full of users who give “advice” on making money in intra day trades. Is it any wonder then that derivatives and futures form the bulk of the trading activity in Indian markets?

Christine Benz at Morningstar captures this mentality beautifully in her note:

What gets annoying to me is when people start treating food like it’s part of their own personal science project. Aided and abetted by pseudo-food scientists peddling cookbooks and packaged meals, they surmise that if they could only find precisely the right things to eat–or avoid–they’d be able to start losing weight and running marathons. So they jump from fad to the next; one week they’re avoiding gluten, a month later it’s dairy, then they’re drinking cider vinegar. If you dare raise the possibility that eating and feeling well is more about boring old balance–focusing mainly on whole, plant-based foods while also allowing the occasional indulgence–than it is any sort of nutritional alchemy, they don’t want to hear it. They’d rather keep searching for the magic bullet.

What I find interesting–and at least a little crazy-making–is that a nearly identical phenomenon exists in the realm of finances. Just as many people seek a magic nutritional formula to help them get in shape and feel better without a lot of sacrifice, so do many people gravitate toward investment alchemy to help solve their financial problems. If they can just find the right mix of investments for their portfolios, they think, or hit on a hot stock or two, the rest of their financial plans will fall into place without a lot of heavy lifting on their part.


Unfortunately, creating wealth is actually quite boring and takes patience, time and a bit of luck.

Of course, investment selection matters. has an unparalleled array of tools for picking stocks, mutual funds, and ETFs that align with your goals. Luck invariably plays a crucial role in financial success, too, even though a lot of the lucky ones among us don’t like to admit it. But don’t underrate the mundane financial jobs–the no-fun, super-unsexy financial equivalents of eating lots of fruits and vegetables and logging 10,000 steps a day. Do a passingly decent job with them over many years and it’s a near-certainty the rest of your financial life will fall into place.


So what are some of the keys to financial success? The article goes through some of them and I would encourage you to read the whole piece, but to summarise:

  1. Maintain an appropriate savings/investment rate
  2. Build your human capital so that you can increase your earnings potential
  3. Stick to an appropriate asset allocation
  4. Get adequate insurance
  5. Reduce the impact of costs such as fees, taxes and emotional decisions on your investments

I think thats as good a starting point as any on the road to financial success.

Death of Brands and Traditional Advertising

Thursday, August 16th, 2018

The rise of the internet and the smartphone has led to some disruptive changes to consumers and society. Slowly, but surely these innovations are changing the old ways of doing things and having a major impact on businesses and the economy.

One of the major trends that I would like to explore is the role technological innovation has on traditional brands. For decades, FMCG companies have built up strong moats and have been very profitable and stable companies because of the strength of their distribution and marketing.

Ensemble Capital had a good note last year that captures this:

These brands created value by lowering “SEARCH COSTS” for consumers. Search costs are the costs incurred by a prospective buyer in trying to determine what to buy. In the case of a consumer packaged good like canned food, toothpaste, or laundry detergent, the search cost for consumers is the cost of trying to determine the quality of the product and weighing this against price differentials prior to purchase. By eliminating this cost for the consumer, companies with a successful brand were able to charge more for their products, even while providing an improved cost/benefit offering to the consumer. The consumer could pay more for their products, because doing so reduced the search costs they were otherwise incurring

Companies with a trusted brand could earn excess economic returns so long as the cost of building the brand costs less than the premium consumers were willing to pay for a product due to the brand. Because brands have historically be very durable (notice the global brands that were built in the 1950 are still dominate today), they created an economic moat that caused these companies to generate outstanding returns for shareholders.

Many of the most well known brands in the world are based around reducing search costs. For example the Coke, Gillette, and Yellow Cab brands are assurances of quality and value that reduces the search costs of consumers looking to purchase beverages, razors and transportation.


But this is changing rapidly. Companies like Google, Amazon, Uber and TripAdvisor are causing search costs to fall dramatically. Consumers now can, via reviews or from social media see peer reviews of products they want to purchase. This massively reduces the premium traditional brands can  charge their customers. And when you combine this with the rise of outsourcing and contract manufacturing, you can see that there is a lot of room for new brands to come in and capture market share from existing players. Amazon for example does this with its AmazonBasics brand. It is not uncommon for batteries of AmazonBasics to be half the price of Duracell or Energizer because the company doesn’t need to spend on advertising, marketing or on traditional distribution. And, given the reviews online, you can see that consumers also love the product!

Scott Galloway has a great video that describes the effect of the fall in search costs not just on FMCG companies, but also on the auto industry and on traditional TV and print media:


So what’s the way forward for brands? Ensemble capital has a follow up to its original post, where they say:

The Death of Brands does not imply the death of great products. It implies the death of top brands that do not in fact represent an outstanding product at a fair price. The very worst thing the concierge brands could do is recommend products that serve the concierge’s financial interests, but are not in fact in the best interest of the customer.

Ultimately you need to be able to show your end customer that you are giving them good value for what they pay.

Narrative or Earnings

Wednesday, August 15th, 2018

Josh Brown had a comment on a WSJ article which talked about how, since 2011, you could have focused either on corporate earnings growth or the negative commentary around FED tapering. If you had focused on the FED narrative, you would have missed out on the massive 161 per cent rally in the S&P 500 which was led by strong corporate earnings growth and good fundamentals.

Unfortunately, the Indian markets have worked the other way. While the markets have rallied over the years, it has primarily been based on hopes of a pickup in growth and turnaround of our domestic economy. Every year we see analysts start the year with projections of EPS growth in the range of 20 to 25 per cent, only to inevitably be disappointed and revise them down to single digits. Today valuations are at an all time high and everyone is betting on an “inevitable” acceleration of earnings growth, with most analysts projecting EPS out two or three years to justify prices.

No doubt that there have been a number of structural changes in the economy which will lead to strong medium term growth, but the question is whether this is all priced in the markets already. Any disappointments could lead to further corrections.

Phillip Capital has a research report out with a number of charts on current valuation. I found this one in the Appendix to be quite interesting:


The earnings yield is at the lowest it has been in more than a decade. And the spread between earnings yield and the bond yield has widened almost to levels last seen in 2008. With greater concerns on the macro front due to rising global rates and currency tensions, it is unlikely that this spread will come down due to falling bond yields. If this spread is to come back to more normal levels, either stock prices have to come down or earnings have to accelerate more than the already elevated markets expectation. On a risk adjusted basis then, clearly bonds seem like a far more attractive prospect.

Private vs. Public

Tuesday, August 14th, 2018

Professor Damodaran has a note on Elon Musk’s announcement of privatising Tesla. Even though the saga continues, I thought it was more interesting to focus on the Professor’s comparison of private businesses with publicly traded firms.


To summarise, we can look at the following table from his post:



Do check out this link to read the whole piece, which is full of some great insights.

Currency Wars: Turkish edition

Monday, August 13th, 2018

The Turkish Lira has been in the spotlight over the last few days as escalating tensions with the US have led to large depreciation of its currency.

According to The Economist, the US Treasury imposed an asset freeze on two senior Turkish officials over the detention of an American pastor. Turkey responded in kind by putting sanctions on two members of Donald Trump’s cabinet. Then on August 10th, Donald Trump tweeted he would double tariffs on Turkish steel and aluminium, resulting in the lira falling to the lowest levels it has seen in a decade.

Investors have been spooked not just by the tensions US but also by the deteriorating economic outlook of the Turkish economy. From Bloomberg Quint:

For much of Erdogan’s almost 16 years in office, Turkey enjoyed China-like levels of growth. But unlike China, an exporting powerhouse with a current-account surplus, Turkey runs one of the world’s largest deficits because its expansion was fueled by foreign debt. That all seemed fine when the world’s central banks were pumping cash into markets to help pull economies out of a crisis. But not anymore, as global interest rates rise and investors, less enamored with emerging markets, pull funds back to developed economies. Turkey buried much of the tens of billions it received from abroad in construction projects and shopping malls, which pushed up short-term growth. But that did little to improve productivity, or output per worker, the main source of long-term economic growth and higher living standards.

Inflation is above 15 percent, more than triple the central bank’s target. Yields on some government-issued debt are at record highs, and the Turkish lira is melting down. All that not only hurts consumer sentiment and wallets, it pushes corporate balance sheets closer to the abyss. Companies that borrowed heavily in foreign currencies now face a growing burden due to the tanking lira and rising borrowing costs. Instead of reducing government debt and deferring to the central bank to cool the economy with higher interest rates, Erdogan wants to keep the party going with low interest rates to finance even more construction.


This is a dangerous cocktail and could have spillover effects on other currencies and markets. We can already see from the chart above that most emerging market currencies have depreciated against the dollar from the start of the year as trade tensions have escalated globally.

India too has not been spared, with the Rupee hitting 69 today. Even though currently our macros are stable and we have sufficient FX reserves, our economy is faced with an expanding current account deficit, rising inflation and a banking sector saddled with NPAs.

How does currency depreciation feed into equity market? Ben Inker at GMO had a great chart last month on the correlation between emerging market currencies and their equity markets:

In his own words:

Emerging assets had a lousy quarter of the classic variety. In the face of falling currencies, local stock markets moved lower as well. This is par for the course for emerging equities, even if it is not obvious that the fundamentals support such a correlation. While the currency fall predicts nothing about future returns for emerging assets, the stock market declines do suggest there may be some more short-term pain to come, given the historical power of momentum to predict emerging returns. On the other hand, both emerging stocks and currencies are cheaper than they were three months ago, and historically cheaper valuation has been a plus in both the short and long term. Exhibit 12 shows the margin of superiority for our favorite asset relative to our next favorite asset through time on our asset class forecasts. Emerging market value stocks are the best asset we can find, by a margin that is just off of the largest we have ever seen.


Quarterly Equity Valuations: August 2018

Friday, August 10th, 2018

We take a look at equity valuations and find that they have moved into even more expensive territory.

We use data from the NSE website starting from when it is available in January 1999 to look at the P/E Ratio, P/B ratio and the dividend yield of the index and compare it to past history.


Price to Earnings (P/E)

Equity Valuations


In the chart above, the red areas highlight when the PE ratio is significantly higher than normal implying that markets are expensive and future returns are likely to be lower than in the past. On the other hand, green areas show when the PE ratio is significantly lower than normal implying that markets are cheap and returns from equities should be higher than average.

On 10th August 2018, the Nifty PE Ratio was at 28.1 which is more than two standard deviations from the historical average of approximately 19. Market valuations have moved into even more expensive territory from an earnings point of view.


Price to Book (P/B)

Similar to the PE chart above, red areas in the PB chart denote times when markets are expensive whereas green areas show when markets are cheap relative to history.

The price to book ratio of the Nifty has moved a little higher to 3.7 but is still roughly around the long term average. On the basis of book value, markets are trading in the normal range. The difference between valuation indicators in the PE and PB could be due to the fact that capacity utilisation is very low. Therefore, even though the price is expensive on the basis of current earnings, it could be that an increase in utilisation levels could give a significant bump to earnings in the future and normalise the PE.


Dividend Yield


The dividend yield chart denotes value in a manner that is opposite to the PE and PB charts above. When the dividend yield is higher than normal, it means that markets are cheap. Similarly when the dividend yield is lower than normal, it is a sign that markets are expensive. The dividend yield is around the same levels in the last quarter, at 1.2 per cent. This is still close to the long term average of 1.5 per cent.

Zero Cost Funds

Thursday, August 9th, 2018

This is an interesting development: Fidelity has launched two zero cost mutual funds.

The global trend is toward lower expense ratios and fee structures as investors shift more aggressively toward passive management. The idea behind these zero cost funds is that Fidelity can probably use these funds as loss leaders to get more clients and then cross-sell other products to make money.

David Snowball at the Mutual fund Observer comments:

It might even be economically sustainable.

  1. Fidelity isn’t giving up much money. Passive investing accounts for just 16% of Fidelity’s fund business, about $400 billion, a far smaller fraction than many of its competitors. With many broad market cap weighted funds charging 10 bps or less, Fidelity loses $1 million in income for every billion that migrates from a “regular” index to a zero cost index. If these funds attract $40 billion, Fido loses $40 million. It is, meanwhile, pressuring competitors more dependent on index funds to give up more of their corporate income.
  2. Fidelity can make money by lending the funds’ securities to other investors. Professors William A. Birdthistle and Daniel J. Hemel of the University of Chicago College of Law argue that mutual funds are increasingly finding that they can generate income from non-fee sources. In fiscal 2017, the Vanguard Total Stock Market Index Fund earned more than 63% of its expenses by lending securities. The demand for securities loans has limits, but growth in that market will allow an increasing number of funds to offset some or all of their expenses through loan income. (“Next Stop for Mutual-Fund Fees: Zero,” Wall Street Journal, 6/10/2018).
  3. Fidelity, like your grocery, can bank on the fact that you’ll end up buying some high-margin products once they’ve got you in the door. Birdthistle and Hemel predict that “Wise financial institutions will realize that offering a free mutual fund can attract customers to whom they can cross-sell other products, like life insurance and annuities.” Morningstar’s Russel Kinnel pretty much agrees, “Fidelity has lots of ways to make money from customers once they are in the door.

We may even see other brokerage houses following suit. So in this global race to the bottom, who will have the edge and win?

I think this comprehensive report by Morningstar on fee trends gives some good insight:

Asset-weighted fees are lower than equal-weighted fees for nearly all these fund sponsors. That’s consistent with the trend of investment dollars moving toward low-cost funds. It’s also evidenced by the fact that the firms represented in Exhibit 1 control about 94% of U.S. index mutual fund and ETF AUM, but account for a relatively smaller share (80%) of run-rate fee revenue. This also means that there is still room for small players to extract relatively larger fees in niche market segments.


The trend is clear with respect to fees. On one hand, investors are voting with their feet and moving to low-cost fees. On the other hand, because the least-expensive index mutual funds and ETFs attract the lion’s share of investors’ dollars, comparing fee-level differences as they approach zero becomes an ever less-meaningful endeavor. Don’t get me wrong: Fees are important, but investors should keep their focus on funds with strong investment processes (as defined by the makeup of their underlying indexes and how well portfolio managers can track them). As fees reach the zero bound, the investment process will likely have a greater impact on investment outcomes going forward.

And this also makes a lot of sense. Going from expense ratios of 1 per cent to 0.1 per cent will have a large impact on returns if compounded over time. But given the inherent volatility of markets, the fall from 0.1 to near zero will not have as significant an effect. The difference to end investor returns will be the investment process which they follow and how closely their managers can deliver on their mandates.

India is still to see investors move aggressively toward passive funds. But it is a matter of time; alpha is becoming increasingly difficult to come by in the more efficient segments of the market and regulations are forcing expense ratios lower. It may be a while before we get there, but the trend is clear. Interesting times ahead for investors and for asset managers.