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​What I read this week: Want to beat the Sensex? Just buy stocks the index discards

The index components keep on changing but it is not necessary that the companies included in indexes outperform those, which exit the indices. In fact, India has seen many stocks performing better after their exclusion from the index.

The next article mentions about Japanese population coming down at the rate of 51 people per hour. By this rate, the total population of Japan would be 300 in 300 years!

There is also an article on naked brand in finance and how companies and portfolio managers can differentiate from the herd.

Major central banks of the West have been on the tapering spree. Not many know that Japan has also quietly been on the tapering mode. Well, statistics indicate that.

This contrarian strategy works well in India
Source:
Want to beat the Sensex? Just buy stocks the index discards

Stock indices are an indicator of the overall sentiment of the market. Many investors invest only in index funds, as they believe that they represent the market.

But if BSE Sensex and the NSE Nifty were viewed as investment portfolios, then their fund managers would be a strange lot. That’s because the stocks they discard deliver far greater returns compared to the stocks they add to the index. The data shows that such a contrarian strategy pays off handsomely for investors.

So what’s behind this phenomenon? Whether it happens consciously or not, managers of the Sensex and Nifty follow a so-called momentum style of investing, where stocks that have done well in the recent past are included in the index, while laggards are dropped. As a result, the additions are coming in at relatively higher valuations, while the discards may well be good value picks.

Sometimes, it so happens that the stocks that are dropped off are caught at the bottom of their business cycle. This is also a reason that when the business cycle picks up, these stocks tend to do well. This phenomenon is not always the case reflected in many stocks falling over 50 per cent since the time of their exclusion from the indices. But the fact that the overall discards portfolio still generates relatively higher returns shows that the value more than make up for the laggards.

The experience with India’s flagship indices is somewhat different from global trends. Studies on changes in the S&P 500 Index suggest there is a positive correlation when it comes to additions to the index. Not only does the inclusion of a stock in the index increase its awareness, developed markets have a greater proportion of index-linked funds which drive up the prices.

Japan's population degrowth not good for its economy
Source:In 300 years there are only 300 Japanese left

Imagine a country like Japan left with a population of only 300. The statistics are devastating: every hour Japan’s population is dropping by about 51 people. The fertility rate has declined steadily from 2.1 in 1973 to 1.26 in 2005. Nowadays, the fertility rate has improved although it is not sufficient to maintain the population.

The Japanese are accustomed to living a comfortable life and often they choose a career over family. One in four men and one in seven women remain unmarried at the age of 50. They prefer professional life over personal life reflected in number of hours they work. Also, employers do not support mothers. Costs of raising children are high which cannot be afforded by many young people.

Women are encouraged to have a professional carrier, which enlarges workforce and productivity. On the other hand, the declining and aging population translates into a drop in workforce and lesser consumption which would result in slowdown of economic growth. If the nation’s total tax revenues decrease, there would be little money to pay for the maintenance of the infrastructure.

The demand for healthcare will be higher, which would lead to increasing costs. The real-estate market, the traditional driver of credit creation, could collapse. There can be more and more abandoned buildings and empty places. Its western peers have a similar problem, although they have dealt with high immigrants every year. If Japan succeeds in having immigrants settle down in their country, then the Japanese race, culture, and traditions could be under threat. The Japanese government may not opt for such a solution.

While the population de-growth would happen gradually, these signs are not good from a growth point of view of any economy. While the authorities are taking action to increase the population, they need to expedite it before things go out of hand.

Use of technology may worry fund managers
Source:Are money managers a commodity?

Many investors analyse a lot before they select their money managers. They take a bet on the fund manager that they believe would satisfy their desired risk return requirements. After all they would be providing their hard earned money to the fund managers. In many parts of the world, money managers have become a commodity.

The rise of quantitative investment strategies (computers), more equal access to information (the internet) and other factors have levelled the playing field. The threats posed by low cost investment vehicles and the abundance of talented managers are challenging the ability for the traditional asset and wealth managers to deliver value. Active managers are handicapped by higher fees, transactions costs, and taxes. Due to this cost hurdle, active managers, on average, have been unable to outperform passive indexes. Due to talent and technology, it has become more difficult to beat the market. The level of absolute skill has never been higher, but the dispersion of relative skill across managers is shrinking. As a result, luck, and not skill increasingly explains the success of active managers. Passive investments now total $6 trillion, according to Moody’s. That’s a steep increase from less than 1 per cent 30 years ago.

Passive funds are outperforming the active fund managers mainly in the developed world. India is slightly different with many managers generating handsome alpha over the benchmark. However, as there are more and more fund managers managing money, and with increasingly use of technology, alpha generation could become difficult by the day.

Is it end of quantitative easing cycle in Japan?
Source:Bank of Japan Tapers (Quietly), QE Party Over

This year has been the year of tapering across the globe. Right from the US to the Euro region, the central bankers have been taking about tapering. Although not in the news, Japan is no different.

Bank of Japan has been in the forefront of quantitative easing. It disclosed that it held a total of 521.6 trillion yen as of recently which amounts to about 96 per cent of Japan’s GDP.

Now something else has been happening: Starting in December 2016 – the month the Fed raised rates and a few months after some Fed governors started to kick around the idea publicly that QE should be unwound – the BOJ began to curtail its asset purchases. Assets are still increasing but at a much slower rate. During peak QE – the 12-month period ending December 31, 2016 – it added 93.4 trillion yen (about $830 billion) to its balance sheet.

Over the 12-month period ending November 30, 2017, it has added only 50.8 trillion yen to its balance sheet. Though that’s still a good chunk of money, that addition is down 46 per cent. In terms of percentage change, the tapering is even clearer. In early 2014, the BOJ exploded its balance sheet by 47 per cent year-over-year. In November 2017, the year-over-year increase was just 10.8 per cent.

With the major central banks of the world opting for tapering, these would be interesting times for the investors, especially the bond investors. As I have been highlighting, if there is volatility in the global markets, India may not be immune to it.

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