Keep expenses low - its as important as generating returns

Keeping expenses low can become as important in the overall growth of a healthy portfolio, as choosing the right investment avenues. Any investor looks at two aspects - one is whether he can generate excess returns in his investments and two, whether these returns can be generated at a lower cost. Statistics dont lie - over a long period of time, say thirty years, a one per cent expense ratio on your investment which earns you around ten percent returns compounded can result in returns getting reduced by as much as twenty five percent, compared to an investment which does not have an expenses. 

A zero expense investment is a mirage, or a rarity. Hence investors should try and do the next best thing, which is try and keep expenses low. Portfolio, this week, spoke to experts from Ambit Capital and Kunal Bajaj of Clearfunds about how is it that an investor can keep these expenses low, particularly while investing in Mutual Funds. Mutual funds or stocks or any good investment made for a long period of time benefits because of the power of compounding. While the Power of Compounding is your best friend, compounding costs are tyrannical, and act like cancer that eat into your portfolio. Hence, felt the experts, buying mutual funds direct, and trying to get the expense ratio as low as possible, is one terrific idea to reduce the expenses.

Kunal Bajaj said that over 30 years, if you pay just 1% fee for your investment in mutual funds, you are left with 25% less. And this money goes to the distributor or the advisor or the bank relationship manager. This money is your money, and someone else kids are going abroad to study on the back of your savings.

Ambit Capital felt that with an assumption of large cap mutual funds giving similar returns as Nifty ETFs from here on, a lower expense ratio will end up working in the investors favour. Saurabh Mukherjea went on to say that out of the 100 large cap mutual funds, 3-4 funds have proven ability to generate consistent alpha. The rest, he said, meant buying a glorified tracker fund, whether one likes it or no

The authors' math brings out a comparison between two funds. The illustration assumes an investment of Rs 1 lakh over forty years, earning a return of 15%. The first fund has an expense of 2.5 per cent per annum while the second has an expense ratio of 0.1 per cent per annum. 

The First fund's corpus exceeds that of the first fund by 

24 percent after ten years

53 percent after twenty years

80 per cent after thirty years 

133 per cent after forty years

Can you believe the difference??!!!!!

A twenty year old who invests Rs 1 lakh in a fund, with an assumption that the fund can earn 15 percent returns on average through the cycle, will end up getting 1.1 crores from the first fund against earning 2.58 crore from the second. The funds may not return 15 percent, and may end up returning lower or higher, but the impact of the expense will still be meaningful.

Buffett’s 2017 letter to shareholders

The 2017 annual letter of Berkshire Hathaway Inc, an annual release awaited by millions of investors and shareholders, has the usual flair and wit of Warren Buffet, the Oracle of Omaha. Be it his views on what he called a purchasing frenzy of businesses by CEOs, and Buffett tearing into investment bankers applauding such moves with a "Don’t ask the barber whether you need a haircut", or a jab at hefty fees-charging fund managers with "Performance comes, performance goes. Fees never falter", the letter had it all, just like the previous years. This time though, it is conspicuous by the absence of a few mentions that a lot of people anticipated, some correctly and some not so correctly. It was amusing to see a few people believe that there will be some indications about who the successor to Warren Buffett will be, when both were elevated to positions of Vice-Chairmen as recently as January. However, almost everyone believed that we would have the Oracle of Omaga speak about the joint healthcare venture with JP Morgan and Amazon, which didnt find any mention, as also his thoughts on Wells Fargo, Apple or IBM. Yes, he didnt speak about Bitcoin either, but he has voiced his opinion on Bitcoin a number of times recently, and thus not out fo the ordinary for him to skip that subject entirely. 

Warren Buffett's comments on the drought of acquisitions were interesting. 

"In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price. That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

By the comment above, as also by some other references, Warren Buffett seemed to be emphasizing on the run up in stock prices over the last 12 months, and the need for investors to be careful with investing in the current times, though not mentioned in as many words. He did bring up the ideal investor behaviour required during periods of greed and fear, stating his vintage opinion that investors need to focus on a few simple fundamentals while the mob fears or is over-enthusiastic.

"Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential"

Buffett devoted three pages of the letter to his 10-year bet with Ted Seides of Protégé Partners. In Berkshire’s 2005 annual report, Warren Buffett had argued that active investment management by

professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still. He had explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund. Ted Seides took up the bet then, and as things have turned out, hWarren Buffett won the bet. His winning of the bet was not emphasized as much as the message that the outcome of the bet has thrown, according to Warren Buffett. He plays out his thoeory clearly when he concludes the mention with two lines titled the bottomline.

The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers

who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds

Warren Buffett predicts that the outcome would not differ materially in the future, according to his estimates. "The disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the

future"

From a Berkshire Hathway ahsareholder's perspective, Warren Buffet predicts volatility in reported earnings going ahead. All of Berkshire Hathway results will now come on a Friday eveningor saturday morning, due to a new accounting rule which forces them to report the net change in unrealised investment gains and losses, which they say can see swings of $10 billion or more within a reporting period. Having said that, Warren Buffet did emphasize that investors of Berkshire Hathwat should focus on increases in the normalized per-share earning power, something that both he and Charlie Munger focus on. And in a very modest way, he credited the re-writing of the US Tax code for a large portion of gains in 2017.

Confidence inspiring rally?

Does this set of winners give you confidence?

The move in the midcap space in the last one month is hardly awe-inspiring. The set of stocks which have gained recently arent exactly the names which inspire confidence in the nature and safety of the rally.

The question mark really is - can this last? Well, the famous saying is that the markets can stay irrational for longer than you can stay solvent. However, I am writing this piece after being surprised by the movement in select stocks for a few days now, and I finally reached a point where I had to highlight the trend.

As you read this, some high beta names are starting to correct. This may be short-lived and my words my come back to bite me if the rally continues. I am sure people at various stages of the runup in the stock of R Com would have said that the move is unsustainable. And yet the stock continued to rise.

Sample this - the combined M-Cap of the Anil Dhirubhai Ambani Group moved up from about slightly less than 10 billion dollars to over 12 billion dollars in a span of less than 15 trading sessions.

	M_cap on 19th Dec	M-Cap on 2nd Jan	% Change in M-Cap
Reliance Comm	3173	9015	184
Relaince Naval	2626	4344	65
Reliance Power	10379	16087	55
Reliance Capital	10723	15078	41
Reliance Infra	11657	14806	27
RNAM	16536	17604	6
Reliance Home Fin	4378	4520	3

And while a clutch of these names have fundamental developments, I havent yet seen any notable fundamental reports about how strong would these stocks become fundamentally. Sure, they are under-owned and they are not expensive (mind you, I am not using the term çheap valuations' here), but that is not enough to have massive rallies on stocks. I can show you a clutch of stocks that are underowned, cheap and still not finding buyers. 

Will the broader markets correct then? Well, I have heard is that the P/E multiples of the Midcap and the Smallcap Indices are sky high, and that these levels are not sustainable. Been that way for a while now, but remember that the interest of almost all PMS schemes, AIFs and well as the plethora of Midcap and Smallcap funds from AMCs are looking to invest in value names in the Non-Nifty/Non-Sensex area. So the bottom-up story will likely continue. However, it might be healthier for the market to have a fundamentals-driven rally, as that kind of rally is sustainable. It would be very unfortunate to have people lose quick money by investing in non-fundamental driven rally names if the markets were to see the much-awaited healthy correction in what promises to be a volatile month. Did I forget to mention that India Vix typically rises in the month of January?