1 Year Anniversary: How Algo-based investing prevailed in COVID times
Wow, what a crazy year it has been for the markets. The NIFTY50 last year around this time was rebounding from one of the worst financial crashes since 2008, and the first recession in 12 years.
And what a rebound it has been! From a low of ~8000 in April the Nifty rebounded to 11,000 in July. And today it has climbed to an all-time high of ~16,000. And the market seems to be still optimistic about the post-Covid recovery.
The anxiety of investing
Whether the current valuation is too high is something that we can debate, but would you risk selling today and losing out on the possible rise of the markets? Or would you buy today, even while markets are so high? How long will you keep holding? Should you sell a stock that's falling or buy more of it? These are all questions that come to mind...
Benjamin Graham, the father of modern-day security analysis has said "The investor's chief problem, and his worst enemy - is likely to be himself".
There are numerous examples of people who have bought and held shares even as they fell all the way to zero (example Reliance Naval), and of people who have doubled their money and exited, only to find that the stock kept doubling and doubling (case in point, Infosys). And you know the worst part? The anxiety kills you. Our own emotions eat at us and we are too scared to make the wrong decision, that we end up making a random decision.
This is why people invest in mutual funds, to get rid of the headache and anxiety.
Now, the problem with mutual funds, is that the returns are limited. Historically 85% of funds don't beat the index. They are usually over-diversified or have such huge volumes that they can't buy or sell at a stable price. And after all, most mutual funds are run by humans with emotions.
Can we get higher returns without losing our peace of mind?
That's where Algo-investing comes in. To get the emotion out of the decision-making. You define the set of rules you will use for buying and selling, before you buy the share.
Just to remind everyone, our flagship models are algorithm-based and were launched on 13th July 2020.
Let's compare how they have done vis-a-vis other funds.
Most mutual funds have done well in this period. A favourite is the Axis Bluechip fund, which gave a 40% return since last July. Another is Parag Parikh Multicap fund, which gave almost a 60% return. In fact, the Nifty50 has also given a return of ~50% in the same period.
But our models have done even better.
Model 1 & Model 2 have given a 105% and 93% return respectively from 13th July 2020 to 12th July 2021.
And we believe that Algorithmic investing will be the future of investing.
Detailed Portfolio Returns
Let's take a look at the chart for Model 1 & 2 versus the NIFTY50 and NIFTY500.
Let's also see a stock wise return. The chart below lists the returns of all the shares chosen by the models.
Some stocks have given a positive return while others have negative, but on average, the ratio of return of positive to negative is 2.96 for Model 1 & 5.24 for Model 2, with a 64% and 55% win rate respectively.
(Win Rate is no of stocks that give you a profit vs a loss, and Payoff ratio is the % profits you get from the winners divided by % losses you get from losing stocks)
You can read more about Model 1 & Model 2 here.
Reducing your risk
Most people assume that investing in shares is very risky. Well, they are right, it is risky, but at the same time, not all stocks are equally risky. Large-cap funds generally carry lower risk while smaller companies have a higher risk.
And there are ways like correct position sizing and risk management (Exit) to reduce your risk. These methods are quite common and well known to everyone, but what is lacking is the conviction to stick with your strategy.
What algorithmic trading does is remove the emotions, and gives a set of rules to follow. Now, remember, no one can crack the market and define a set of rules that will keep giving you profits forever. And we don't claim that you will always be in profits. The set of rules we have created, just help to stick to a certain strategy and see it through.
The strategy itself is proven to work over the long term, and it has been around for the last 200 years of stock market existence. You can read more about Momentum investing here.
Model 1 & 2 apply this momentum strategy to a mix of mid-cap, small-cap, and large-cap shares (Stock Universe is NSE 500). You can see the composition below:
We have found that the mid-cap index is promising in India. They are not as risky as small caps and at the same time deliver higher returns than large caps. You can invest in mid-cap companies and use other ways to reduce your risk. The easiest way is to divide your money into more companies than bet on a single horse. Here you must play a balancing act on how much you diversify without risking over-diversification and miss out on returns.
This is the idea behind our newest model. Introducing, Model 3! (We are very innovative with names, as you can tell).
This model invests in 10 stocks, with a mid-cap composition. This has the potential to grow more than a mixed cap portfolio, without too much-added risk.
In fact, we've launched this on the eve of our 1 year anniversary on the 12th of July 2021, and we will continue to track Model 3 in our future reports.
The (not so secret) power of rule-based investing
Benjamin Graham has said in 1976 "In general I am no longer an advocate for elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook was first published. But the situation has changed a great deal since then".
Here he is talking about hidden opportunities that are waiting to be found just based on fundamental analysis and research. But in times of easy information access, it is no longer a valid strategy, as everyone has access to the same information.
Momentum strategy, on the other hand, has still held true and delivered great returns. But there is a price of great returns, there are moments of drawdown and moments of all-time highs. You must stay invested through the cycle. And rule-based investing helps remove the emotional ambiguity of making those difficult decisions.
Anyway, we have made our case for a rule-based Momentum strategy with a real-life example. It has outperformed the NIFTY during the last 1 year, which was a bull market, and we believe it will outperform the NIFTY in future markets as well.
We hope that our results convince you too!
