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Dalal Street Rules – Year 2011

World Cup is getting hot, Dhoni hits the winning shot. 
Kalmadi thinks we are retards, Raja gets a "go to jail" card.
Anna fasts for Lokpal,  Mamata wins her first election in Bengal,
S&P Downgrades US Treasuries, adds to our miseries.
We didn't start the fire, it was always burning, 
Since the world's been turning.
(with apologies to Billy Joel)

2011 – This year Indian cricket team had the Midas touch. They could do no wrong. Yuvraj was having one of the best seasons ever in his career and (was battling with cancer even though he didn’t know it at the time), Gambhir was in sublime touch, Kohli was emerging and most important of all SRT was playing in his last world cup. The only one he didn’t have on his resume. And the Gods of Cricket, smiled on him, one last time. This was that smile.

The only time MSD smiled in World Cup 2011 – After hitting the winning shot

Fans all over India, especially in Mumbai poured out on the streets. It was a night where decades later, you had a story to tell your grand kids – where were you that night when India won the World Cup in Mumbai?

Bollywood’s biggest hit that year was the Vidya Balan starrer – The Dirty Picture. However, the year politically and for markets was any thing but entertaining.

Anna, Jan Lok Pal and Scams keep the UPA Govt busy in 2011

Anna Hazare with his core team in 2011

In April 2011, Anna Hazare started his fast for the passing for the Jan Lok Pal Bill. His core team was Arvind Kejriwal, Kiran Bedi, Prashant and Shanti Bhushan. He was also supported by many other organizations like the Art of Living, Baba Ramdev and parties like BJP, Left etc. Anna however did not allow politicians to share the stage with him. He was widely seen as a non-partisan leader. He got massive support on the ground from ordinary Indians. The 2G scam, CWG scam and Coal Block scam only increased ground support. This movement ironically gave birth to the politician in Arvind Kejriwal. But that is for 2014. And the UPA made one misstep after another. 2011 was supposed to be when the eternal PM-in-waiting, RaGa, would finally be made PM. But now in this environment, with so much back lash against MMS personally and the Congress, it wasnt the right time for the crown prince. By the year end the Jan Lok Pal Bill was passed. But would it be implemented.

The economy and markets in the mean time were taking a hit. As we saw in the previous blog – Year 2010, index was on the cusp of entering a down trend by the end of the year. And in 2011, the trend further accentuated. In Aug 2011 – the unthinkable happened – Treasuries or US Govt bonds lost their AAA rating. The US sovereign rating had been down graded by the S&P. Weeks later Deven Sharma – CEO of S&P was fired. But the unthinkable had already happened. Ironically, the downgrade prompted a flight to safety into – you guessed it right – US treasuries. Yields fell further and equities were in a funk

MIDAS (R) goes into Cash

The year started with 12 positions and ended with only 2 positions

MIDAS (R) the system which was being run by Rahul Mehta, in his personal account, also had a market regime filter. You can read the rules again hereAnd as per design the system started getting out of longs as one exit after the other was hit. By the end of the year, MIDAS (R) held only two positions in its portfolio. The system didn’t know that there were going to be scams, downgrades, slowdowns. It just followed its rules. More importantly, Rahul followed the rules and executed the system. Even though there were a number of times when he had the urge to override the system and hold on to “good stocks”. But then that would not be fair. And so he persevered. And by the end of the year he saw the fruits of following the system.

MIDAS (R) and MIDAS Performance – 2011
Portfolio – MIDAS (R) – December 2011
Biggest Winner in 2010-2011 cycle was Rallis India
Biggest Loser in 2010-2011 cycle was Federal Mogul

As the Nifty Midcap Benchmark went below the 200 DMA, the market regime filter mentioned above kicked in. No longs were allowed as per the rules. Exits were taken as they came. By the end of the year above is what the portfolio looked like, with only two positions. It was 12% invested and 88% in cash. (An important point to mention here is that in the backtest we have not counted interest on cash. So net of brokerage and slippage, interest income would be an added bonus which has not been built into the backtest.)

Year 2011 performance and Performance since inception to 2011. (Returns are per annum)

Ajay Kaul was reviewing the results and was quite satisfied with the outcome. While MIDAS did have a down year, in terms of relative performance, it had comfortably beaten its benchmark. Both on the upside as well as the downside. MIDAS (R) had a even better year because of the market regime filter. It reduced volatility and drawdowns. He decided to observe it for another year before implementing it for the account that traded the firm’s proprietary capital. Spoiler alert: Its not a holy grail, as we will discover later.However it was a big downer for investors who were action junkies.

Psychology of Quant Investing

Founder, and CEO of Winton Capital Management, David Harding pictured at their west London offices. Picture by Daniel Hambury/Stella Pictures

But he could not help but wonder what would have been the psychological challenges of running a fully automated rules based system for investing. In a recent article, David Harding, founder of Winton Capital (AUM $30 bn), had made some very good points about being a systematic quant investor. He said, ” Being a big successful quant fund manager is hard as being a successful non-quant fund. Most [quants funds] won’t be successful and quite a few investors have had bad experiences and dismiss these guys as rocket scientists – but it’s the same with people who invest based on good stories.” Harding, however, was not omnipresent in the media, with clever sounding sound bytes on the latest fed policy, or where the gold, dollar etc where going to do in the near future. This short interview of his – Wizard of Winton – on CNBC is almost hilarious. His systems and machines did the investing, so he and his team would have no views on the events and scenarios about to unfold. Not that other investors (talking heads on tv channels) knew. But they had a narrative, which would change as prices changed and added no value to the viewers except giving them the comfort of listening to so called experts.

Harding said,” Let’s face it. Could you come up with a less interesting story? Its so boring – whether 12 people will change the interest rate by a quarter of a percentage point.” And in this respect Harding’s investing process was very much like a long term investor like Buffett, who doesn’t care about what interest rates have done or are about to do.

It slowly dawned on Kaul, that quant investing requires the fund manager to conquer himself or as Harding eloquently put it, investing is an “personal internal psychological war”, even if one is a systematic investor. One has to surrender one’s self to the system. Keep researching, keep tweaking but overall one has to commit to the philosophy.

It was time to have a detailed debrief with Rahul, and the head trader who were running the system. What kind of challenges did they face – internal as well external in executing the system ? How did they ignore the noise around them ? How did they spend their day? Had they identified their own behavioral biases? He knew that they followed the system, because a monthly review system had been put in place where the system trades and actual trades, and many other parameters were compared. With that thought, he picked up a copy of Daniel Crosby’s , The Behavioral Investor and started reading it.

(With inputs from Aayushi Shah)

Disclaimer: Nothing in this blog should be construed as investment advice. This is purely for educational purposes only.  Please consult an investment advisor before investing