Nygren is out ...

Late last month, I finally sold Bill Nygren's Oakmark Select Fund (OAKLX). The most important reasons for doing so are:
(a) I was running a loss on the fund and did not see any point in not realizing that loss at the end of the year. After all, I needed something to offset capital gains from other transactions.
(b) The fund was due to make distributions - and this was almost 10% per share. No point in paying capital gains on a fund where I was running a loss.

So I sold the fund and will consider buying it again next year. Morningstar continues to pump up OAKLX, and its performance over the last 10 years is nearly twice as good as the S&P 500. So why the "maybe" - here are the main reservations against buying OAKLX:

(a) It has a concentrated portfolio of 25 or so stocks - that is fine, but its very skewed in its weighting. The biggest holding, Washington Mutual, is more than 13% of the portfolio and has been absolutely crushed this year's subprime debacle. Even as I type this, it is down about 8% after announcing severe dividend and job cuts. WaMu has been the single biggest reason that OAKLX is under performing the S&P 500 by almost 15 percentage points! Some say the bottom has been reached for the financial stocks - who can tell? Value pick or value trap? In addition to WaMu's situation, it would be good if Nygren didn't overload so much on a single stock.

(b) Absolutely no energy exposure - this is fine, since I have a pretty large exposure to the energy sector through other funds. But the fact that Nygren didn't see any "value" plays there seems strange.

Here are a few snippets about Nygren/WaMu/OAKLX from old-timers on the Morningstar forums

I don't think Nygren can unwind his OAKLX position without inevitable carnage in the stock, WAMU's intrinsic woes not withstanding. Even if WAMU was going up and Nygren started selling, people will notice and follow him out the door putting downward pressure on the stock.

Admittedly Nygren is in a tough spot. Regardless of how revered a manager is, excuses made normally circle around, "held on to housing stocks too long" (Muhlenkamp), or "did not invest in energy stocks" (Miller? and perhaps Nygren as well?). But with Nygren, he is insisting that WAMU is excellent value. Dunno what Nygren's average cost is for WAMU in OAKLX. But I have to believe he has been buying it for some time and his value must be lower than his cost. Wonder how he keeps shareholders from exiting his fund. [note - Ron Muhlenkamp of MUHLX and Bill Miller of LMVTX]

Here is one more:

Concentrated funds is a problem for a jackass manager simply investing in the top 20 stocks at any given point of time. Now if you give the same manager the mandate to invest in 50 stocks, he'll still do bad, because he is not really doing money managing. Managers like these are the usual suspects, Robert Loest, Kevin Landis, Van Wagoner, etc. These managers suck without necessarily having concentrated folios. I don't think I will say that about Bill Nygren and Muhlenkamp belong to the above category. I mean I can have 5% of portfolio in each stock and that gives me 20 stocks. Those who invest in stocks themselves instead of funds - how many stocks do you think they own?
The problem is with implementation. Clearly there is something to be said about having conviction in your ideas. So I presume maybe Nygren started with a 5% position for WAMU in OAKLX and he let his winner run eventually hitting 15%. The point is, when you stop and say enough is enough. The problem with this implementation is less with Nygren holding 15%. I mean if WAMU was 50% YTD, we would all be fawning over Nygren. The problem then IMO is that you cannot run a concentrated fund AND have too many assets. Because then, the games up. You cannot compensate when the market moves against you. (Therefore my move from OAKLX to OAKWX, not that it necessarily helps too much even though WAMU is 5% of assets here instead of 15%)
Let's look at CGMFX portfolio. I see 22 stocks with top holding of 7%. A tad high perhaps. Regardless, the difference is that Heebner is allowed to hedge his fund. Nygren doesn't - not that he wants too. Concentrated + Large Assets + No Hedging = Increased Market AND Individual Stock Risk. LMVTX could suffer from similar problem. Its top holding is also 7%. It happens to be Amazon which has done well. It might has well could have done badly. I dunno if LMVTX can protect itself by hedging.
And the final nail in the coffin - the mandate to be fully invested. You have a concentrated fund, unmanageably assets, unwillingness to hedge AND want to stay fully invested. Big Problem. I have mentioned on the boards in the past that I thought Turner Investment Partners were IMO the best growth managers in the business. Problem - they are always 100% invested and don't hedge. I wil just not invest in a fund like that. In retrospect, perhaps OAKLX was a mistake. Maybe OAKWX is too. I sold my THPGX at one point because inspite of having the flexibility the manager stayed fully invested - no can do.
So maybe, just maybe the way to buy a concentrated fund is to look at flexibility - either to go cash, or to hedge. Lower asset base can only help. So look at FAIRX, JORDX, CGMFX, WGRNX (though it has 50 stocks now), FMIRX, PVFIX, etc.
In summary, concentrated funds IMO is not by itself the problem. OAKLX has paid of handsomely for shareholders by being fully invested in few stocks. So has CGMFX. The difference I think is that CGMFX moves on when the market proves it wrong. And doesn't pay itself on the back too much the market proves it right. OAKLX on the other hand does the reverse on both ends. Kind of like M* who refuses to change their opinion on a fund for the most part. Give me concentration rather than over-diversification (translation : I dunno WTF I'm doing, but just maybe I'll beat the index) any day. But give me flexiblity. That is KEY.

Thoughts from a Fund Manager

Bill Nygren manages the Oakmark Select Fund (OAKLX) portfolio, and has been doing so since the fund was started more than 10 years ago. His fund has significantly outperformed the S&P 500 over this period (more than twice the index performance!). I was reading through the fund manager's quarterly commentary on fund performance - Nygren makes several important points about his (and the fund's) investing philosophy, and tries to explain his style to the investors. An important exercise, it allows the investor to understand how his money is being put to use. According to Nygren,

At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.

Of course, one might argue that this is nothing but the classic definition of a value investor. So if Nygren is running a value fund, then what's so special if he is sticking to what he said would do. But then that's precisely what is important for me - to find out how closely is he following the fund's proposed plan. The sheer 'boring' nature of value investing can be excellently summed up as:

... successful long-term investing is much closer to "three yards and a cloud of dust" than it is to the West Coast offense!

In response to the stock market plunge of February 27 (when the stock market fell by 4%), Nygren clearly emphasizes his flair for value investing, sticking with basics in the face of panic:

Following that drop, I had several calls from reporters, all asking the same question: "The market is down 5%, what does that mean?" My answer, which not surprisingly wasn't used by any of them, was that five-year compound annual returns were now going to be 1% higher than they were before the market fell. That answer didn't convey quite the level of fear they wanted.

Nygren's commentary is a delightful read - as long as I believe that he can pick undervalued stocks correctly, I will hold the fund. I don't have to worry about his adherence to the value investing philosophy.

YTD

just checked ... the YTD performance of my MFs is as follows, ofcourse the numbers have no meaning in isolation - the context is set by the benchmark. for comparison, overall benchmark - S&P500 index is up 8.07% YTD

a very good year so far, but everyone is predicting a correction coming up this summer (it hasn't materialized yet, but its 'sell in May and go away' time!!). This is what Chuck Royce said in the Spring report from Royce Funds,

I’m more than pleasantly surprised by small-cap’s strong returns, especially since the Russell 2000’s low in October 2002. I am also very concerned because market cycles normally don’t run this smoothly. A look back at the current cycle shows two corrections that fell in the 10%-14% range—one in 2004-5 and another in 2006. These have been the most significant small-cap corrections during the past five years, with other downdrafts in the 7%-9% range. However, at the end of the day stocks can only elude history for so long. Although the market has seen fit to prove me wrong over the last few years, I remain convinced that a more historically typical correction of 15% or better is in the near future.

[all numbers as of 05/23/07]
FBALX - 8.82% - Fidelity Balanced
FCNTX - 8.14% - Fidelity Contrafund
FSENX - 21.3% Fidelity Select Energy
JETAX - 10.9% - Julius Baer International
MINDX - 14.8% - Mathews India
OAKLX - 7.05% - Oakmark Select (Large cap value)
RYVPX - 12.85% - Royce Value Plus (Small cap growth)
SSEMX - 13.3% - SSGA Emerging markets

-------
following funds in retirement accounts
FPURX - 6.7% - Fidelity puritan (balanced)
FFNOX - 7.7% Fidelity 4in1 index
HLEMX - 9.7% - Emerging markets
UMESX -21.1% - Energy
UMBWX - 10.6% - International

p.s. It was too good obviously - as soon as I wrote this, the market crashed :)

What makes Buffet tick?

At the recent Wesco Financial Corporation meeting, Chairman Charlie Munger talked about key aspects of Warren Buffet (and hence Berkshire Hathaway) that have made him so successful over the years. Munger is also Vice-Chairman of Berkshire Hathaway, which owns more than 80% of Wesco. Very simple and basic points -

• Mental Aptitude - no substitute for smarts, but of course smarts aren't enough.
• Intense Interest - a strong interest and a passion for investing is necessary - but isn't that true about being successful anywhere!
• Early Start - the power of compounding ....
  
• Constant Learning - the ability to learn continuously, reinvent, and change with the times.
• Concentration - I am not sure what Munger was trying to say here - but from what I understand, he means to say that concentrating Berkshire's strategy in the hands of someone as astute as Buffet as paid off handsomely.

Again - simple concepts - hard to follow, and easier said than done.

Munger also doled out advice for 'living a well-examined life':

• Many smart people handicapped themselves with "nuttiness." One example is being an "extreme ideologue," which is the equivalent of "having taken your brain and started pounding it with a hammer."
• Your life must focus on the "maximization of objectivity."
• "You must learn the method of learning."
• "It is totally unproductive to think the world has been unfair to you. Every tough stretch is an opportunity."
• "You can get away with more than you deserve in life by being slightly more rational."
• "I'm not going to complain about my age because without it, I'd be dead."

Certainly plenty of food for thought right there ...

Investment mistakes

A very nice article from Morningstar.comabout common investment mistakes - however straightforward these rules seem to be, its just easier said than done:

• Don't rely on the past too much - as every mutual fund prospectus will tell you, past performance is no guarantee of future returns, don't extrapolate too much ....
• Overestimating yourself - Everyone likes to think of themselves as being above average - that's statistically impossible, but being average is good in investing! Don't trade too much - you might be better of buying and holding, and just matching benchmarks.
• Discipline - be systematic, be regular, be disciplined.

He closes out with a quote from Warren Buffet

Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

A humbling one indeed ...

The trouble with India is ...

India is front and center stage these days - the world is keeping a close eye on developments in India, on the economic front and also on the political front (as it relates to the economy). Last month, The Economist had a cover story feature about India's overheating economy, and now Businessweek is following that up with its own cover feature on India titled The Trouble with India. The article calls attention to one major drawback - inadequate infrastructure, including crumbling roads, jammed airports, and power blackouts. There is of course plenty of bureaucracy and red tape - getting things done is not easy. It cites examples of investments lost to China, Vietnam and other emerging countries. And add to all of that - corruption siphoning away large chunks of government budgetary allocations before they reach their intended goals.

A cover story like that is certainly unwanted publicity for the Indian economy .... but a reality check against the sugar coated stories of India Shining. The fact however remains that the Indian economy continues its march - the Indian Economy Blog has an excellent summary on whether the economy is sizzling or just right ...

The power of expat money

India received $23.4B (yes billion!!) in remittances last year, the single largest player now - and the amount has more than doubled in the last five years.

Some staggering statistics:

• Remittances account for 3% of India's GDP
• Remittances are more than both FDI ($4.7B in 2005-06) and FII ($12.5B in 2005-06) combined!!
• Source of all this money - about 111million migrants from India worldwide! (and to think that we still have more than 1 billion people still left over in India ...)
• Fate of these dollars: about 54% spent on family, 20% in bank accounts and about 13% invested in land and property

To put that in perspective - thats about $2.5B invested in real estate - no wonder that property prices are just not coming under control. The endless supply of liquidity into the system is pushing up prices to no end ... and about $5B in bank accounts - no wonder everyone's screaming inflation inflation ... and all this without even considering the increase in the purchasing power of the people as a result of local economic growth!!

No wonder the RBI is having fits trying to curb inflation ...

Section 3(d) - Indian Patent Act

In the previous post, I mentioned about the court case Novartis has filed challenging the provision of the Indian Patent Act under which its patent application for Glivec was rejected. This provision is precisely Section 3(d) of the Indian Patent Act (2005). This provision is quite unique to Indian law - similar rules are absent in the laws of most countries. It was created primarily in the interest of public health, and refuses patent protection to new forms, uses or minor modifications of existing drugs unless they differ significantly with regard to efficacy.

The Economic Times has an interesting editorial comparing two opposing points of view on this issue - one by D.G. Shah, Secy-General of the Indian Pharmaceutical Assn., who supports Section 3(d) and the other by Prabuddha Ganguli, CEO, VISION-IPR, Mumbai who thinks that a change should be made. Both make good well-reasoned arguments, making the case a lot more grey than I initially reasoned. But given how the situation in India is, my socialist side seems to dictate policy in my head, and side with Shah intead of Ganguli! The Indian law disallows the following:

Changes in the physical properties (shape and size) of a drug substance, without any significant change in its efficacy; change of dosage form (tablet to syrup) for ease of administration among children; development of a tablet containing three drug substances (triple therapy) for better compliance among the AIDS patients.

Ganguli makes a strong stand against these being able to patent these incremental inventions:

1. Inability to meet the patentability requirement of newness - because the changes are obvious to any chemist. It is precisely this point that Shah challenges.
   
2. Confers monopoly for what cannot be considered an invention.
3. Allows patent protection beyond the stipulated 20-year period.
4. The incremental changes (he even refuses to recognize them as inventions!) present a very attractive proposition to pharmaceutical companies in terms of their risk-reward valuation - which will cause big pharma to turn to them instead of trying to focus research resources on real innovation and core drug discovery research. It seems like a stretch - but the point is very well taken.
5. Eliminating Section 3(d) would allow companies to patent molecules that were discovered before 1995. As per its TRIPS agreement, India has no obligation to provide patent protection to these molecules. A very compelling point - Novartis's fight to eliminate this provision seems more like a strategy to try and do an end run around this.
   
6. Deleterious impact on prices of drugs in India, their access to the population and the impact on healthcare costs and public health as a whole.
   

On the other hand, Shah clearly defines the requirements to be classified as a patentable invention: should be novel (new), the inventive step should be non-obvious to a person skilled in the art, and be useful (capable of industrial application). He argues that the so-called incremental changes are in fact not obvious even to the trained professional - such as the exploitation of the differing properties of derivatives (eg salts) or different crystalline structures of drug molecules for effective drug delivery, production of stable formulations, etc. As a result, the incremental looking inventions are far more than that. He says that such changes do make far-reaching impact and should be patentable so that companies are encouraged to pursue them. He makes the same argument as Novartis - that Section 3(d) stifles innovation, reduces competitiveness of industry and is a step in the wrong direction.

Section 3(d) has certainly become center stage - I for one am all or it - more so from the point of view of the needs of Indian society than for the protection for innovation. Lets see if the Chennai High Court feels the same way

Novartis v/s the Government of India

[Originally posted at Transport Phenomena]

In my freshman year in college, i had a course on "Perspectives in Society, Science and Technology". It was essentially an introduction to the social and ethical ramifications related to the technology as I started on getting a Chemical Engineering education. It dealt with situations such as pollution, plastics, DDT, cleaner pesticides, Rachel Carson's Silent Spring, severe mercury poisoning of Minamata Bay in Japan, the Bhopal disaster, and last, but not the least, the far reaching implications of the Indian Patent Act of 1970. The law had far reaching consequences for the Indian pharmaceutical industry. According to the law:

In the case of inventions-

(a) claiming substances intended for use, or capable of being used, as food or as medicine or drug, or
(b) relating to substances prepared or produced by chemical processes (including alloys, optical glass, semi-conductors and inter-metallic compounds),

no patent shall be granted in respect of claims for the substances themselves, but claims for the methods or processes of manufacture shall be patentable

In other words, this act prevented issuance of product patents in India for pharmaceuticals and drugs, while only processes to make drugs could be patented. This led to the development of India's formidable generics industry, which could reverse engineer manufacturing processes with remarkable efficiency, without having to spend billions to discover the drugs - today, this industry is led by Dr. Reddy's Laboratories, Ranbaxy and Cipla.

While the act ensured that pharma industry in India was sheltered from the fierce competition from big pharma worldwide, India's entry to the WTO has changed all that. The WTO entry has resulted in the adoption of a new Indian Patent Act in 2005 - one which was supposed to spur the generics driven pharma sector from reverse engineering to innovation. While the rise in prices of new drugs was anticipated, it turns out that the new patent act seems to be very carefully designed to take into account the socio-economic situation in india and tries to enforce a lot of protections for the common individual to prevent big bad pharma from coming in and exploiting him. Kudos to the Indian government for ensuring this. I was not aware of this ...

In the aftermath of the new patent act has risen another controversy. Currently in the eye of this storm is the situation with Novartis' drug Glivec, which was denied a patent by the Indian Patent Office. The reason given was that the law does not allow patents for marginally modified drugs, which do not constitute a novel molecule or original invention. In response, Novartis has challenged the ruling and filed litigation against the Govt of India saying that some of the provisions of the new patent act be scrapped, because they violate WTO rules. Indian generic manufacturers are already selling generic versions of the drug at 10% of the price that Novartis was charging for Glivec.

Novartis has certainly stirred up a major situation, given how much the indian generics have managed to impact the availability of low cost drugs in third world economies. In fact - Indian generics companies supply 84% of the AIDS drugs that Doctors without Borders uses to treat 60,000 patients in more than 30 countries. Given this situation, its going to be very interesting (and important) to see how the judgement comes out in this case. The New England Journal of MEdicine has a very good 'Perspective' article on this - its a very good 'plain English' discussion on the situation. This issue has drawn a lot of attention in the pharmaceutical industry and among lawmakers around the world. US Congressman Henry Waxman wrote to the Novartis CEO Dr. Daniel Vasella saying “I do not dispute your right to apply for a patent or appeal a denial. I am concerned, however, that your attempt to influence domestic Indian law could have a severe impact on worldwide access to medicines.” He concluded his letter by urging Vasella, “to reconsider your position in this case.” He highlights the critical role played by the Indian generics industry in providing low cost drugs to the entire developing world, and making health care more affordable to a large number of people.

The case brings to the forefront an important issue - the role of governments in trying to protect the interests of their people seemingly in conflict with their role in driving innovation and development through the protection of intellectual property. Another fact highlighted is the strategy tried by large corporations to ensure that they reach their profit goals even at any cost, irrespective of the consequences. While I have clearly come across as a socialist in this matter, I don't quite disagree with Novartis' right to get appeal their patent denial or even the claim from pharma cos. that IPR protection is needed to spur innovation and improvements in treatments. I am actually quite supportive of the position that Waxman has taken about Novartis' challenge to the Indian law itself. I would however be quite keen to know how folks feel about this issue in general - esp Indians working in the pharma industry in the US.

The progress of the Novartis vs the Govt of India case will be closely watched all over the world, and the outcome will certainly have far reaching consequences on the future availability of low cost pharmaceuticals. I bet this will certainly be discussed in the "Perspectives in Society, Science and Technology" course for several years to come.

The day after ....

It was a blood bath on Wall Street yesterday - the market had the single worst day of losses since 9/11. Actually I find it surprising that such a major drop had not occurred in these past 5+ years.

Here is some food for thought (for the day after):

I think this is the key question casual investors should ask themselves. "Do you have the time to monitor your portfolio on a regular basis to sell some of your securities when they are at the high end of a valuation range and to buy them back when they are low?" You should also add in the time needed to read newsletters and investment reports for the companies you own so you are well informed about them. You will still have the occasional Enron, WorldCom, Lucent, Tyco etc. meltdowns where the business looked good and analysts loved the stocks and were wrong. Getting slaughtered in a stock pick now and then is a given for investors. If all this is too much for you, then I think following John Bogle's advice to buy index funds with 95% of your assets is the best advice out there.

Source: Misconceptions: Market Timing verse Stock Picking

My experiences with investing

[Disclaimer: I am no financial advisor, and the opinions expressed below are mine alone. Follow them at your own risk - I am not responsible for the consequences]

I started investing a little more than one year ago. Last week, a friend asked me how the experience has been - I replied saying that its not been too bad, but there were a lot of things learnt - including stuff about myself (primarily about attitudes and tolerance to risk). Immediately came the next question: why don't you write a blog post about it? I figured, that wasn't such a bad idea - I'm sure there are several in a similar state to what I was a year ago, who really could use some basic pointers - especially folks with a similar background as mine (desis working in the US), who could use a primer on where to start and things to avoid (if possible)! I myself could have used one when I started last year - ofcourse there is a ton of self-help books and websites out there, but nothing helps like someone who is (or has been) in the same boat as you have ....

Personally, it does not matter to me whether someone really is benefited from what I have to say, but its just interesting to recall and write about anyway - so I will go ahead and unload my thoughts regardless.

NOTE: I consider myself as a moderate investor, not too aggressive, not a big risk taker - some might even consider me very conservative! I would consider my opinions listed below as commensurate with that position. Folks reading this may not be of the same or even similar mindset. Nothing wrong with that - to each his own!

Basic considerations before you start to invest:

1. How much do you want to invest ($)?
2. How long are you planning to invest (investment horizon)?
3. Tolerance to risk?
4. Other exposure (Roth IRA, 401k etc.)?

#1 and #2 above are very important - probably THE most important considerations of all. For an average person in the US - the answers to #1 and #2 are very generally straightforward - they would read "does/should not matter" and "till retirement" (which would generally be more than 30 years away, i.e. a very long term investment horizon). The exceptions to the latter would be a situation where there is an impending need for liquidity (e.g. downpayment on a house or a birth of a baby etc.). In that case, the situation changes - all bets are off, and you are perhaps better of either considering holding on to cash [consulting a financial consultant would be a credible option, but generally not needed or too expensive].

For desis, the situation is quite different. The following important factors come into consideration: wanting to return to India, or a even requiring to send money to India or other commitments in India, possibly even purchasing a house in the US or in India. In that case, the answer to #2 is no longer "long enough" and should be considered very seriously. A lot of financial folks will tell you that if you are investing for a horizon less than 4-5 years, then you are better off holding on to cash. The reason for this is obvious - bear markets can last 2-3 years. So if you have wretched timing, then you would need atleast 4-5 years to sort of guarentee (a bad word to use when it comes to investing, nothing is guarenteed I agree, but you get the point!) a decent return on your investment. For example, the last bear market that accompanied the recession brought about by the dotcom bust lasted about 3 years and ended in late 2002. Since then its been a strong bull run (see the chart below for the S&P 500).

So does that mean that if you are investing for a 2-3 year period, you should not invest? I don't think so - but I would not invest more than a small percentage (small is relative of course!) of available money. In such a situation, cash is king (especially in today's environment of high interest rates, where cash will get you at least 5% in a savings account like HSBC Direct). In that case, you would probably consider holding on to at least 70-80% as cash and investing the rest. Others who don't have immediate financial commitments and can stomach a bit of risk can consider investing a higher percentage of their money.

Now that you've figured out if you should consider investing - if the answer turns out to be yes, here are some of my thoughts on how to go about it. Its based on my personal experiences, and is not an authoritative user manual of any kind. And I will also tell some of the experiences that I have had:

* First and foremost, there is no substitute for doing your own due diligence, i.e. your own basic reading about the ABCs of investing - basic terms, definitions etc. Yahoo Finance is an excellent resource to learn the basics. If you think you are better off reading a book - here are two that I have read, and will certainly recommend to anyone wanting to start off. The first one is called Straight Talk on Investing by John Brenner (Chairman of the Vanguard Group), and the other one is called Charles Schwab's Guide to Financial Independence by Charles Schwab (obviously!), who pioneered the discount brokerage concept. Both these books are very well written, in simple language, easy to read and are precisely meant for those who are starting out. Both these gentleman have had enourmous experience helping people invest and back up their thoughts with appropriate data and charts. If a lot of what will follow here seems to be similar to what you will find in these books, its because it is.

* When I started investing, I was gung-ho about investing in stocks. I figured it must not be that difficult to outperform the S&P 500 index - so I dedicated a portion of my investments to a 'do it yourself' approach to investing in stocks. I knew all the statistics - about 70% of all large cap funds fail to beat their benchmark index (S&P 500), and yet I still believed I could outperform the market. In 2004 or 2005, that might have been true. But 2006 was the year of transition, there was a new Fed governor (Bernanke), and the inflation was high, the economy was slowing down, and the housing market crash was coming up, the Fed was getting more and more hawkish. Bottomline - there was volatility in the market, and lots of it!! So outperforming was not trivial!! And needless to say, I learnt it the HARD way!! Here are some of the problems:

- how to pick stocks? you think you can read newsletters, and analysis, and books and websites and figure it out? easier said than done - understanding a stock's fundamentals is nontrivial and takes up a LOT (and I mean a lot) of time.

- how to pick entry points into stocks? and even worse, how to pick exit points? Understanding technical analysis is almost out of the question for me. And I cannot rely on instinct alone to guide me through this

- buy and hold is the mantra ofcourse! Warren Buffet does the same - but its easier said than done. How do you hold a stock through its decline (and precipitous decline at that) with the firm belief that it will come back up!! this is where your tolerance to risk is severely tested, and you realy understand what you are made of.

- economy of scale: with the amount of money that I was investing, stock trading was not a very bright idea. WIth the low investing amounts, you really spend a serious % of your money in trading fees. In addition, you will probably purchase your entire position in a single trade, not muc opportunity to average down.

BOTTOM LINE: If you are investing less than about $30K (even more according to some), avoid investing directly in stocks! Stick to mutual funds - more about that later.

COMMON MISTAKE: Most people have a tendency to think they are above average (I did so too ....) - but when it comes to stock investing, being average is an achievement. It will put you above the 70th percentile - so there is certainly no shame in being average! If you don't want to believe this simply because I am telling you, go ask any professional, and he will tell you exactly the same. If you ask the best professional (Schwab), he will tell you exactly the same!!

Investing in Mutual Funds

Here is how to do it:

- setup a brokerage account, stick with one of the big four (Fidelity, Vanguard, T Rowe Price, Charles Schwab). I have used Fidelity and Schwab and certainly prefer Fidelity over Schwab. Vanguard is THE place to go if you want index investing only - anything else costs money. Not a lot of money, but there is a fee (if I remember right, its $30/year, but why pay even that?) So unless you are buying only Vanguard funds, go with Fidelity and TRowe Price. I have not used TRP, but have heard some very good things about it. Their own mutual funds are good, and they also have a good selection of no-load, no transaction fee mutual funds. So does Fidelity - I like their own fund selection, and they have a very good selection apart from their own funds. Fidelity's award-winning website also won me over. Its simple, good looking and easy to use. My personal vote goes for Fidelity. Do not use Ameritrade, Scottrade or other brokers for buying mutual funds - use those for stocks alone. Trust me on this one.

- buy mutual funds. Always invest only the minimum amount to start with (~$2500 for most funds at Fidelity), and if you have more to spare, add it at regular intervals. [More about selecting funds in a separate article]

- set up automatic investing, take advantage of no-transaction-fee, and enjoy the power of dollar-cost averaging. That is one of the biggest benefits of mutual fund investing - do not lose out on it.

- how many funds? always the big question. Obviously, you want enough to be diversified, but not spread too thin. If you have 5K, I would suggest buying only 1 (2500$ + periodic incremental investing). If you have 10K, about two and so on. But no more than about 5-6 would be needed to ensure appropriate diversification across different styles (large/mid/small cap or value/growth, international and emerging market funds). The percentages obvously depend on your investing style (aggressive, or moderate or conservative etc.)

- build a core portfolio of 1 fund with atleast 40% of the holdings, and then spread the rest around. The core fund could be an S&P 500 index fund or a Russell 2000 index fund. Or it could be a balanced fund with a good blend of stocks and bonds, such as the Fidelity Balanced Fund (FBALX) or the Fidelity Puritan Fund (FPURX).

- always select funds with no load, low expenses, good fund managers, and long term track records. Do not be influenced by short-term past performance. Look for atleast a 5 year window (if not more). Look for funds that are at least within 80% of their benchmark indices (over the long term).

- be careful when you select funds - you should consdier holding at least 2 years once you buy a fund (if not more tha that)

- rebalance your portfolio once every 6-8 months.

- be disciplined, and stick with the plan, even if the markets are not doing so great, thats when the automatic investing will earn you the power of dollar cost averaging

Also see my mutual fund picks if interested.

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Additional (Feb 26, 2007)

* Watch out for capital gains and losses - till you actually sell something, they are only on paper. But mutual funds give out distributions (dividends, long term and short term capital gains) that you have to pay taxes on. So you will have tax liabilities every year even if you have not sold shares of the mutual fund. So, if you are just starting out, avoid buying fund shares at the end of a calendar year - because you may be hit with tax liabilities from distributions even though you only held shares for a short time. This is different from the system in India, where mutual funds pay taxes at source and so the shareholders don't pay tax.

* Income generating funds (in the form of dividends) are often suited for retirement accounts (such as Roth IRA or 401K), where the tax liability is absent (Roth IRA) or deferred (401K).

* Stocks give you plenty of information about companies that you see everyday - you are more informed about the world around you. You also learn a lot about companies that you never knew existed. For an information hungry guy like me, its fun! You learn so much even about common names we see every day - most commonly about stores that we see every day - JC Penney, Target, Walmart, Best Buy, etc. - to other brands like Nike, Intel, Apple and Microsoft.

* Remember - every time you sell anything - there are tax consequences - always consider tax liabilities before you sell.

My Mutual Fund Picks - Part 1

A quick note about my fund picks - they are heavily biased towards Fidelity funds, and those available as NTF (no transaction fee) funds at Fidelity. Obviously, all of them are no-load funds.

Fidelity Balanced Fund (FBALX)
Moderate Allocation, FBALX has a conservative blend of about 60-65% stocks and about 30-35% of bonds. The stocks have the usual suspects - conservative value stocks such as Bank of America, Citigroup, JP Morgan, Altria, General Electric, Proctor and Gamble etc. But its a Fidelity fund - chasing high energy growth stocks is a natural instinct. Therefore no surprises to see the growth stocks in there - especially in the energy space - Valero and National Oilwell Varco (this is infact the #1 equity holding for this fund!!). Its rated as a 5-star fund by Morningstar - and a solid reputation to boot. If there is only mutual fund I had to buy, this would be the one.

Fidelity Contrafund (FCNTX)
Largecap Growth, FCNTX is now closed to new investors, and has been heavily criticized for asset bloat (more than $60B in an actively managed fund!!). But it does have a super star fund manager - William Danoff. So till then, it continues to get attention and a second look.

Fidelity Select Energy (FSENX)
Only sector-specific fund in my list. Many folks will not like owning a sector specific fund, and I myself am not a big fan of this. But hey, I think this sector will be a long term story to look at - I mean look around, we are not suddenly going to switch to solar and wind powered stuff, and oil availability is not increasing at an alarming rate. So energy is a long term hold for me - but you need an appetite for volatility. Extremely volatile sector, and not for the weak-hearted. Ofcourse, both the above listed Fidelity funds have reasonably large energy weightings, so I didn't really need a separate energy fund. But the heart aches last year at the gas pump motivated me to try and build a hedge against it. If I pay at the pump, so I shall hopefully recover some of it in the stock market. And if oil prices go down, I will pay less at the pump - even though the oil stocks will slide as well.

Julius Baer International Equity II (JETAX)
JETAX was launched as a successor to the highly successful international fund Julius Baer International Equity (BJBIX) on the very same day that BJBIX was closed to new investors. It had the same fund managers, and the same philosophy as BJBIX. Its main investments are in diversified international markets (as of Dec 31, 2006 - Europe was ~50%, Emerging Markets ~ 21%, Japan ~ 8%, UK/Ireland ~ 12%, and Asia ex-Japan ~ 1.6%), and it differs from BJBIX in that it cannot invest in small caps (which it defines as $2.5 billion in market capitalization). That strategy had allowed fund managers Rudolph-Riad Younes and Richard Pell to achieve very good success at BJBIX. After about a year or so since inception, JETAX has continued to provide solid results, and has outperformed its benchmark index. It has made key plays in Eastern Europe (Poland, Hungary, Turkey etc.). Another similar fund is the highly successful William Blair International Growth (WBIGX) - also closed to new investors.

Mathews India Fund (MINDX)
A good solid India-focused fund - about a year and half old as I write this. Its expense ratio has been coming down and it is a no-load fund (unlike the other India-centric funds from Eaton Vance, ETGIX and EMGIX). So even with the fund underperforming the BSE Sensex, it is still good one to have - especially given the Indian growth story. MINDX has the BSE-100 as its benchmark and invests in both large and mid-cap stocks (most emerging market funds will have one or more of Bharti, Infosys, Tata Motors, Wipro, TCS, HDFC Bank, ICICI Bank) - but MINDX extends beyond the usual suspect, and owns Dabur Pharma, Glenmark Pharma, Ashok Leyland, etc. But be prepared for volatility, the Indian market is extremely (and I mean that!) edgy, it can swing up and down with a ferocity that is certainly not for the weak of heart. But the long term story for India continues to be bullish, and so the way to play MINDX would be to buy the minimum and slowly increment on a regular basis. Exploit automatic investing for dollar cost averaging.

One more point that has come up with MINDX - an alternative to MINDX would be to invest directly in Indian mutual funds (in rupees), which outperform MINDX - but I prefer to hold my picks in $, rather than in rupees (even though the dollar has really gone down against the rupee in recent times). So consider repatriability issues if you are an Indian guy considering investing in the Indian market.

Royce Value Plus Service (RYVPX)
This is a small-cap fund - and although the name says 'value', its clearly a growth-oriented fund and its Morningstar rating box shows it as such. Its a very solid pick - Morningstar rates it as 5-star, and SmartMoney.com picked RYVPX as its pick for the top small-cap pick of 2006. Marketwatch also likes the fund's managers Whitney George and James Skinner, and has RYVPX among its picks for top-performing low-cost mutual fund options for 2007.

The Oakmark Select Fund (OAKLX)
Oakmark Select is a fund with a concentrated selection of value stocks. It has not had a great run through the bull run of 2003-05, but has enjoyed a solid rebound in the second half of 2006. The fund continues to be highly recommended mainly because of star fund manager Bill Nygren, a favorite with Morningstar analysts, and who successfully navigated the investors through the rough seas of recession following the dotcom bust. Nygren has a reputation of being a 'buy and hold' investor - this can be judged from the fact that in 10 years since inception, OAKLX has held only 80 stocks, and still holds Dun and Bradstreet (DNB), which was one of the 18 holdings with which he started the fund. As the economy slows down, and the market volatility increases, Nygren's value picks may come back into style again!

More picks coming soon .....

apna finance

What is this blog meant for:

* Common way to share resources about personal finance, stock research, investing, economy, India, outsourcing, and other related issues
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* maybe other ways to use this forum

It will also allow me to consolidate some of our research and experiences at a single location, so that I can exchange stuff that I find interesting or even to have discussions. Hopefully it will be a good experience for all. The name apna finance may not universally fit everything that is added here, I may create separate blogs for individual stuff if needed.