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Sunday 21 November 2021

Equity Returns Are Lumpy In Nature

Markets were weak last week and both Q30 and Q10 gave back most of the moderate gains accumulated in the previous 2 weeks. We remain about  8-10% down from the peak value in mid-October. While both Q30 and Q10 are outperforming the market handsomely over a longer duration, few members who have joined in the last few months have not seen any gains whatsoever. That may feel disappointing when the Q30 CAGR is 70% plus since inception on March 2020 and Q10 is still up more than 50% for the current FY. 

Here is an excerpt from one of the past quantletters that is relevant to repeat once more: 


Excerpts from May 21 Quantletter: (All figures and numbers mentioned are as written in May 21) 
"While it is very important to follow the process and take what the market gives us without letting our emotions override the Q30/Q10 investing decisions, it is also important to remember that market returns are lumpy in nature. In trending markets, we will make a lot. In a downward market, we will give back some portion of it. In a sideways market, we will bleed a little as the market takes its breath and before starting to move in one direction whether up or down. 

What happens if you start at the wrong time and the market declines thereafter and the momentum doesn’t return for a few months or several months? Framed differently, the question is how long do you need to remain invested to gain a 100% probability of profit? 

If the past is any indication, that period could be anything from a couple of quarters to a couple of years. You must be willing to remain invested and follow the process with discipline throughout these periods to come out of the drawdowns, recover your investment value and then make a decent return on your corpus over a longer time frame of 2 to 3 year rolling return basis. 

To put that into an example from the above table, if one only has a 1-month outlook, one could get anything between (-4%) to +18%. But if one has a minimum 3-month outlook, the probability and magnitude of loss reduce. Returns between 3 months of March 20 to May 20 period is (-0.35%) whereas returns between 3 months of Feb 21 to April 21 is 34.06%. Stretch that time window to 6 months, a year, 2 years and you get the drift. 

The future is not exactly going to mimic the past. The past does however provide an indication of likely scenarios. Based on data from 2007 calendar year onwards, below are a few inferences: 
•1 out of 4 quarters and 1 out of 4 calendar years have resulted in negative returns. 
•There were no 2 back-to-back years of negative returns but there were 5 to 6 back-to-back negative return quarters/months in different time periods over the last 14 years. 
•We may do better than in the past. We may do worse than in the past. The strategy has built in safeguards to gradually go into higher % of cash allocation as we will not get enough stocks to meet our criteria for investments in prolonged conditions of market bearishness. 
•What we also know is trying to second guess when is the right time to invest and when is the right time to sit out usually results in getting out at the wrong time, missing out on the gains and making far less than what we could have if we just followed the strategy. 

When the Corona crisis hit us in March 20, many of us thought markets would not do well for several months or quarters. In the second half of the year, many were still in disbelief that the market couldn't go higher. Over the last few weeks, many have been expecting the market to fall like last year. But Q30 has instead gone up 9% in a month like April 21. 

To wrap it up we should let the market tell us what to do rather than follow our own opinion so far as Q30 is concerned and remain invested for a minimum period for the strategy to play out and let the edge work for us. The longer you follow the process with discipline, the bad periods and good periods even out and the edge of the strategy plays out and whatever the market will do in longer time frames, we expect to do better by a margin and by repeating that over and over again, we let the magic of compounding work in our favour.

Trailing returns for different periods and drawdowns are below: 




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