Buy and hold is the default way to invest for wealth creation. Mutual funds love it. Distributors also love it, because they earn full fees so long as the investor is holding the fund.
To be fully invested for long periods of time requires investors to ride an emotional rollercoaster, which while exciting when you are making money, is a terrifying prospect when markets are falling. It’s no surprise then that a majority of investors fail to follow the buy and hold method. In trying to do so, they often end up earning lesser returns than the underlying fund itself.
We have seen enough of this behaviour over the years to recognize that the investing experience needs a significant improvement. It’s disastrous to make financial plans with a 12% CAGR assumption and end up with say just 9% in return.
An alternative method that is gaining popularity is a more active-passive approach to managing risk, rather than an attempt at ignoring it. Asset allocation strategies focus on protecting capital at opportune times, rather than suggesting one be fully invested always, irrespective of market conditions. The bigger your loss, the harder your money must work to recover.
Risk is not to be managed by gut and instinct—we are attempting to move away from emotions as a base for decision-making! The adoption of quant is a natural emergence of our times, and it requires a probabilistic mindset to best appreciate it.
Access to data permits us to search and identify patterns of collective human behaviour. Investing in equities is an extremely emotional experience and history shows that investors tend to buy when the price is high and sell when the price is low. This behaviour, this edge, will always persist in the future.
An edge can be seen like a lever to a model. It’s an indication of a higher probability of one thing happening over another. What’s important to appreciate is that an edge need not have an immediate predictive element associated with it. Long-term market timing means that your bet can play out over extended periods of time.
Short-term market timing by nature is speculative. But over longer periods, if you can execute high probability opportunities with unnerving consistency, then eventually the odds will stack up in your favour. But achieving superior outcomes does demand commitment to stick with your strategy.
Our emotions compel us to act even when probabilities are unfavourable and against a prescribed winning strategy. That’s the gap. That’s how quant models can assist investors with managing their emotions and actions. When a condition is fulfilled, a rule must be applied. When you get a buy signal, you buy. When you get a sell signal, you sell. Simple as that.
Buying and holding your way to wealth creation will become even harder still. Media and mobile apps will ensure that. Also, its inherent laziness means that the majority who have demonstrated discipline and patience for longer time frames are earning less than they should be.
The answer lies in adopting quant. The question that remains is how can investors benefit and apply such smart beta strategies to their own investments?
While mutual funds in India have recently started to set up small, internal quant teams, the usage of quant and its judicious implementation has been largely restricted to stock elimination and selection.
Over the past few years, a new breed of advisers have zeroed in on an acute insight that many money managers already know—that significant portfolio alpha is derived not from stock selection but from being in the right asset class at the right time.
Armed with sustainable edges and disciplined investment processes, these cost-effective models seek to enhance returns with lower risk; a conceivable outcome, given that the buy and hold philosophy is a bit hampered by its own inefficiencies.
In the availability of such solutions at least, we are atmanirbhar.
Kushal Bhagi is director and co-founder, Tortuga Wealth Managers.
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