Mexico, 1968, Summer Olympics. It took 10 seconds and 2.24 metres for a 21-year-old Dick Fosbury to change the history of high jump forever.
He bagged gold in the event and did so by redefining physics. All he asked before the jump was, “Can I do it differently?”
Fosbury changed the course of history by doing only one thing differently: changing the angle of the jump. That stayed with generations and became famous as the ‘Fosbury Flop‘.
If you look at any invention that has changed the landscape of time, you will see that each of them had one thing in common – they questioned what was going on and made one change to it. They all had their Fosbury Flops.
Today, we are part of an industry that is changing its shape, nature and scope every day. Service, which used to be the differentiating factor, is now a different game altogether. The ‘application pick-up boy’ is gradually being replaced by the browser, and the decentralization of information has made the ‘top performing funds of the past year’ known to all.
So, what is your Fosbury Flop?
Of course, one obvious road is nurturing your client relationship. This, I believe, is a subjective area and must be left to individual judgement. But the other space where one can do a lot is portfolio mix innovation. Let us talk about an idea around that today:
Fosbury Flop: Low correlating pieces in the portfolio:
It’s time to repeat something which we have been saying for a long time now: in the long run, equity is the best return generating asset class.
And what happens when we define ‘long term’ on our own terms (sometimes, even 1 year!)?
- The probability of loss goes down from 33.3% to 2.2%. Good. Again, expected.
- The median does not however fluctuate much. The range is 4.3 (11.9-7.6).
- The annualized return range goes down from 274.7% to 25.6%.
So clearly, the main differentiator in experience is the swing. More the swing = more the nausea = premature death of a portfolio.
What can we do to keep the swing low?
The same thing you would do in any other field. If your coffee is too strong, you add sugar to it; if you have a very tiring day, you get some rest i.e. you do the exact opposite.
In financial literature, this translates to adding two asset/sub asset classes which do not move in the same direction at the same time.
I believe when we vouch for multicap funds, a part of that comes from the belief that not all market cap segments fall/move in the same direction, i.e. banking on low correlation among them only! But let’s not forget, all of them share a large part of the Indian microeconomical set as their backdrop. Let’s try and walk beyond that limitation.
Let’s take an example of a sub asset class which offers a lot of swing: sectoral funds. BSE Healthcare, for example, has a standard deviation (the unit of the swing) of 16.60%.
And US Healthcare has a standard deviation of 15.93%. What is magical and yet logical is the fact that if you add these two with a 75-25 ratio, the swing (=the volatility) becomes 13.68% which is lower than both, dropping by almost 20%! That is because the correlation between these two stands at as low as 0.33.
But this is a product innovation (recently DSP IM has come up with its offering in the healthcare space with this).
Can you do this mix on your own? Yes, you can!
For example, DSP Small Cap fund and DSP US Flexible Equity fund have a very weak correlation of 0.14. So, it’s quite normal that they have their respective performance peaks at different times:
For a year like 2018 so far, where the small cap has a -18.1% YTD return (as on 31.7.18), the other part of the portfolio mix, US Flexible Equity, more likely would have given you a breather (in this case a breather of 11.6%), thus pulling the swing towards the median return.
When we do asset allocation, one of the fundamental reasons we base it on is the fact that different assets run on different correlations among themselves. Interestingly, within equity too, you can do the same.
Remember what Buffet said about eggs and basket?
I am just taking that at edition 0.2: