Jason Zweig

Of Suckers, Mutual Funds and the Old Rs 10 Per Unit Trick

There is a sucker born every minute. I was reminded of this earlier in the day today, when late in the afternoon, that time of the day when I snooze after having had my lunch, I got a random call. For some reason, truecaller didn’t pick up the name of the incoming caller, and I took the call.

The call was from a financial planner’s office and a female was talking at the other end. She said a new fund offer (the technical term for a new mutual fund scheme) from a mutual fund was being currently sold, and that I should invest in it. (Why in the world would I invest in a new scheme and not in something tried and tested, is a question that I didn’t bother to ask).

She started with the usual bull about the long-term returns on the mutual fund expected to be very good (Again, I didn’t bother to ask, if she knew the future, why is she making a living making calls. That would have been very mean).

I replied like I usually do when I am not interested, with a polite hmmm, which doesn’t mean anything.

And then she let it slip, very casually: “Sir, units are available for just Rs 10 per unit.” That caught my attention. It had been years since I had heard that.

The oldest mutual fund misseling trick, something I had made my career writing on during the days I used to write on personal finance, ten to fifteen years back.

It took me back to 2004 to 2007, when stocks were rallying big time and new equity mutual fund schemes were launched dime a dozen. I was reminded of one scheme which had a theme of investing in stocks depending on where the head office or the registered office of the company was (some such thing). Those were the days my friend. Anything sold.

Hoardings on bus stands across Mumbai were plastered with the advertisements of new mutual fund schemes, with the Rs 10 price at which you could buy a single unit of the scheme, being prominently displayed. Even the mutual fund was trying to anchor the prospective investors to the price of Rs 10 per unit.  

As Jason Zweig writes in Your Money and Your Brain in the context of anchoring:

“That’s why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a “cheap” price at the beginning. In the financial world, anchoring is everywhere, and you can’t be fully on guard against it.”

The stupid me had assumed that all these misseling tricks would have been replaced by newer ones by now. But I guess with every bull run a new set of suckers are produced and India is a big country.

Anyway, I told the caller, madam no money. She then made some polite noises about this being a good opportunity and I should invest in it, and that was that.

For people who don’t know about this misselling trick this is how it works.  When a new mutual fund scheme is launched, the price is set at Rs 10 per unit. Investors buy these units. If the mandate of the scheme is to invest in stocks, the mutual fund collects the money and invests it in stocks.

The price of a unit at the launch is set at Rs 10 per unit. This creates a perception of a cheap price in the mind of the investor. The older schemes, given that they have been around for a while, have higher prices.

Let’s say an older scheme which has been around for a while has a price of Rs 100. This higher value is because the scheme was launched many years back and the stocks that the scheme invested in over the years have gone up in value. In the process, the price of the scheme has also gone up.

Now let’s say you invest Rs 1 lakh in the scheme with a price of Rs 100. Assuming no expenses for the sake of simplicity, you will get 1,000 units (Rs 1 lakh divided by Rs 100) of the scheme. Now let’s say instead of investing in the old scheme, you end up investing in the new scheme at Rs 10 per unit.

You end up with 10,000 units (Rs 1 lakh divided by Rs 10) in the new scheme. 10,000 units is ten times 1,000 units. This creates the perception of a cheap price in the mind of the investor, thus misleading the investor into buying the new scheme and not the old scheme.

But does it really matter? Let’s say the new scheme invests in exactly the same set of stocks as the old one. The price of these stocks goes up 10%. Thus, the price of a single unit of the old scheme goes up to Rs 110 and that of a single unit of a new scheme to Rs 11. But the value of the overall investment in both the cases is Rs 1.1 lakh (Rs 1 lakh plus 10% return on Rs 1 lakh).

Let me explain this in even simpler way. Let’s say you have Rs 10,000 cash lying with you. You can have it in five notes of Rs 2,000, 20 notes of Rs 500, 50 notes of Rs 200, 100 notes of Rs 100, 200 notes of Rs 50, 500 notes and/or coins of Rs 20, 1,000 notes and/or coins of Rs 10, 2,000 coins of Rs 5, 5,000 coins of Rs 2, 10,000 coins of Re 1 or in different combinations of these notes and/or coins. 

But at the end of the day, the total amount of money would still be Rs 10,000. It wouldn’t matter what denominations of notes and coins you have that money in. In the same way, the number of units you own in a mutual fund doesn’t really matter. What matters is how well the money you have invested in the mutual fund scheme, is invested further, and at what rate it grows (or falls for that matter).

Which is why, it makes little sense in investing in new schemes. But it makes absolute sense in sticking to old schemes which have had a good track record. Of course, for the mutual funds it makes sense to rely on these subtle misseling tricks because more the money invested with them, more the money they make. 

Anyway, I didn’t think I would need to write this in 2021. But as the old French saying goes (and I don’t know how many times I have ended a piece with this), “plus ça change, plus c’est la même chose.” The more things change, the more they remain the same.

Of course, whether you want to be a sucker  or an informed investor, the choice is clearly yours. As the old Delhi Police ad went, marzi hai aapki aakhir sir hai aapka.

PS: An added bonus the legendary Baba Sehgal’s all time classic, mere paas hai mutual fund. 

Why I Watch Cricket on Mute

cricket

Over the four-day long weekend between March 24 and March 27, two exciting cricket matches were played. The Indian cricket team won both the matches.

I saw both these cricket matches end to end, but I had my TV on mute. I do this because I strongly feel that on most occasions TV commentary does not add any value to the visuals on the screen. And honestly, if there was an option which allowed me to just listen to the noise coming from the stadium, without the commentary, I would choose it.

Most cricket commentary and analysis is full of hindsight bias. And what is hindsight bias? As Jason Zweig writes in The Devil’s Financial Dictionary: “Only perhaps a half dozen market pundits saw the financial crisis coming before 2008, but you can’t swing a Hermès necktie on Wall Street without hitting someone who claims to have predicted it. That is typical of hindsight bias, the mechanism in the human mind that makes surprises vanish. Once you learn what did happen, your mind tricks you into believing that you knew it would happen.”

Take the match between India and Bangladesh. Bangladesh had almost won the match and needed to score two runs of three balls. They lost three wickets of the last three balls and India won the match by one run. Of these three wickets, two batsman got out trying to finish the game by hitting a six.

I think the Indian captain Mahindra Singh Dhoni summarised the situation best in what he said after the match: “At times, you look to finish it with a big shot. When you are batting well, you go for it. It is a learning for him [Mahmudullah] and others who finish games. That is what cricket is all about. If it had gone for six, everybody would have said what a shot.”

The trouble is that the Bangladeshi batsman Mahmudullah got out trying to hit a six and win the game for his team. And the commentators immediately pounced on him and declared that he should not have gone for the glory shot. The Bangladeshi cricketers were also called chokers. Nevertheless, if Mahmudullah had been able to hit a six, the same set of commentators would have had good things to say about him.

As Dhoni further said: “In-form batsmen often try to play big shots to finish the game. If that shot by Mahmudullah had crossed the ropes, he would have been hailed as a courageous gutsy batsman. Now he will face criticism for playing such a shot.”

An almost similar thing was at view when Virat Kohli single-handedly helped India beat Australia. After India won, the commentators kept talking about his aggression and how it helped him play the innings that he did. The point is that if he had gotten out, the same aggression would have been blamed for his and the Indian team’s downfall.

The outcome of the game determines the analysis that follows. And the confidence with which the commentators speak makes you believe that they had really seen it coming. Of course, the fact that they have played the game in the past, adds to the confidence that they are able to project. But do they really see it coming? I don’t think so.

They day batsmen get out trying to hit shots, the analysis blames them for hitting rash shots. On days these shots come off, the commentators feel that taking a certain amount of risk is a very important part of modern day cricket.

In fact, hindsight bias impact even the commentary that accompanies every ball that is bowled and not just the analysis accompanying the overall result of the match. In the India versus Australia game, I was listening to the Hindi commentary and I think Shoaib Akhtar was speaking (though I am not sure about this) at that point of time. Virat Kohli hit a ball in the air and from the initial looks of it, it seemed that the ball would not cross the boundary and an Aussie fielder would take the catch.

So the first thing Akhtar said was “Kharab shot (A bad shot)”. Just a second later the ball had sailed across the boundary, Kohli had hit a six, and Akhtar said: “behtareen shot (what a good shot)”. Akhtar’s commentary immediately took into account the end result (i.e. Kohli hitting a six) and what was a bad shot suddenly became a terrific one.

The question is why does this happen? The Nobel Prize winning psychologist Daniel Kahneman has an answer for this in his book Thinking, Fast and Slow. As he writes: “The mind that makes up narratives about the past is a sense-making organ. When an unpredicted event occurs we immediately adjust our view of the world to accommodate the surprise. Imagine yourself before a football game between two teams…Now the game is over, and one team trashed the other. In your revised model of the world, the winning team is much stronger than the loser, and your view of the past as well as the future has been altered by that new perception.”

Then there is this other point that Dan Gardener writes about in Future Babble: “After a football team wins a game, for example, all fans are likely to remember themselves giving the teams better odds to win than they actually did. But researchers found that they could amplify this bias simply by asking fans to construct explanations for why the team won.”

This is precisely what happens to cricket commentators and the analysis that they have to offer after any game of cricket is over. Given that they have offer explanations of why the team wining, actually won, they end up amplifying the hindsight bias.

Depending on the result, the commentators offer an analysis. Some of it can be as banal as the winning side fielded better, batted better and bowled better (Something that Mohammed Azharuddin used to say all the time in his post-match comments when he was the India captain).

This is not to say that this analysis is incorrect, but why do we need a commentator to tell us this. It is very obvious. On most occasions a team that bats better, bowls better and fields better, is likely to win.

The hindsight bias also impacts stock market experts and analysts who try and make sense of the stock market on a regular basis. After a crash you will hear all kinds of pundits trying to claim they had seen it coming all along. And believe me they will make a very compelling case for it.

Nevertheless, it is important to keep in mind what Jason Zweig says. As he writes: “Contrary to popular cliché, hindsight is not 20/20; it is barely better than legally blind. If you don’t record and track your forecasts, you shouldn’t say that you knew all along what would happen in the end. And if you can’t review all predictions of pundits, you should never believe that they foresaw the future.”

And that is something worth remembering.

The column originally appeared on the Vivek Kaul Diary on March 29, 2016

Why you get cheated by friends and relatives



rupee
One of my abiding memories of growing up in a small town is of my father and his friends talking about insurance agents and chit fund agents taking money and disappearing. Usually the agent used to be someone known to them. One story that I remember is of the local dhobi’s (washerman’s) son raising money for a chit fund and then disappearing.

The present day version of this plays out when people invest in wrong kind of insurance policies where the agent commissions are very high or in Ponzi schemes which promise high returns. Ponzi scheme are essentially financial frauds where the money being brought in by the new investors is used to pay off the older investors whose investment needs to be redeemed. They collapse the moment the money leaving the scheme becomes higher than the money entering it.

One version of the Ponzi scheme is a Ponzi scheme masquerading as a multi-level marketing scheme. Those who invest in such schemes end up investing through relatives, friends, neighbours etc. These are essentially people they know and they trust.

One reason why people end up investing money in such avenues is financial illiteracy. While people work hard at earning the money that they do (in most cases), they are very lazy when it comes to investing this hard earned money. They don’t like to carry out any basic research and just hand over their hard earned money to others who they trust.

Hence, trust is another factor at work. In many cases where individuals end up making wrong investments, they invest through an agent who is either a friend or a relative or perhaps someone known to them. This situation is termed as an affinity fraud.

Jason Zweig defines affinity fraud in his book The Devil’s Financial Dictionary as “a financial crime committed by someone with an affinity for doing terrible things to his friends, as when a crook promotes a bogus investment to members of his church, social club, ethnic group, or other close-knot community.” In the Indian context Ponzi schemes masquerading as chit funds or multi-level marketing schemes and being sold to members of a closely knit community are a very good example.

So why do people become victims of the affinity fraud. As Zweig writes about people who victims of the affinity fraud: “They trust him [the agent/the crook] because they know him so well. In return, he trusts them not to notice that he is stealing their money.”

In fact, the human need to trust others and be social is a direct impact of evolution and the fact that human beings are born prematurely in comparison to other animals. As Yuval Noah Harari writes in Sapiens—A Brief History of Mankind: “Humans are born prematurely, when many of their vital systems are still underdeveloped. A colt can trot shortly after birth; a kitten leaves its mother to forage on its own when it’s just a few weeks old. Human babies are helpless, dependent for many years on their elders for sustenance, protection and education.”

And this led to a situation where human beings have had to be social and in the process trust the people around them. As Harari writes: “Raising children required constant help from other family members and neighbours. It takes a tribe to raise a human. Evolution thus favoured those capable of forming strong social ties. In addition, since humans are born underdeveloped, they can be educated and socialised to a far greater extent than any other animal.”

Hence, for human beings to survive and progress in the society, they need to be social and trust the people around them. And this as Harari writes “has contributed greatly both to humankind’s extraordinary social abilities and to its unique social problems”.

One of these social problems is the affinity fraud where we trust others with our money. And sometimes this turns out be a huge blunder. So, the next time you lose money by making a wrong investment through someone know you know, you can blame evolution for it.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column was originally published in the Bangalore Mirror  on December 30, 2015.

What business news channels have in common with Chacha Chaudhary


Chacha_Chaudhary_with_his_dog_Raaket
I normally don’t watch business news channels given that I find them quite flaky and get put off by their lack of depth. Nevertheless, these days with nothing better to do while having lunch, I sometimes do end up watching these channels discussing the vagaries and the volatility of the stock market.

And one of the things I have noticed is that the anchors as well as the stock market experts who offer their opinion on these channels speak with a lot of conviction and confidence. They appear to be in control of things. They appear to know what is happening, when the world around them is probably going crazy. We never hear them use words like probably, maybe or phrases like I don’t know. Further, they seem to have this uncanny ability to understand and explain something just as it has started to unravel. Their story telling abilities are simply terrific.

The uncanny ability of these anchors and experts to explain things at the speed of thought reminds me of a thought bubble in the Chacha Chaudhary comics, which used to say: “Chacha Chaudhary ka dimaag computer se bhi zyada tez chalta hai (Chacha Chaudhary’s mind works faster than a computer).” These anchors and experts are perhaps the Chacha Chaudharies of this day and age.

How is such speed possible? If the anchors and experts are so much in control and seem to have so much insight with such clarity, why are they not making money out of it? Why are they offering their advice for free on TV?

As the British economist John Kay writes in his new book Other People’s Money—Masters of the Universe or the Servants of the People?: “We deal with radical uncertainty through storytelling, by constructing narratives…The reality of market behaviour…relies on conviction narratives – stories that traders tell themselves, and reinforce in conversation with each other. Such narratives are the means by which we cope with radical uncertainty – the unknown unknowns that characterise… business and securities markets.”

The anchors and the experts appearing on business news television are in the business of telling us stories, which offer an explanation for why the market moved the way it did on a particular day. These days the most offered explanation is that economic jitters in China caused the stock market to fall. But this explanation is always offered after the stock market has fallen. No anchor or market expert ever says: “The stock market will fall today because there is economic trouble in China”.

As Kay writes: “The ‘explanations’ provided…by…market commentators…are little more than rationalisation of the noise generated by…market volatility.” And given this, it is worth asking that how useful is it for investors to listen to these explanations and make investment decisions after that.

Bob Swarup calls this phenomenon the illusion of explanation. He defines the term in his book Money Mania as: “Believing erroneously that your arguments…explain events.”

Further, how is it that the anchors and the market experts have an explanation for everything that happens in the stock market? And what is even more surprising is how they are able to come up with explanations so quickly. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Commentators…provide a neat post hoc explanation for every rally, every sell-off, and everything in between…Because so much information is available—business pages, companies’ annual reports, earnings expectations, alleged scandals, on-lines sites and commentary—something insightful can always be said.”

Over and above this there are many data releases which can also be used to come up with explanations. These data releases include inflation as measured by the consumer price index and the wholesale price index, index of industrial production, export and imports numbers, bank credit growth, and so on. And if all this does not fit into a convincing narrative you can always blame the Reserve Bank of India for not cutting interest rates.

Investing in specific stocks is not easy as it is made out to be by business news television. In fact, what anchors and market experts specialise in is making things simplistic rather than simple, given that they have limited time at disposal to say what they want to say. In this situation, where everything has to be said in thirty seconds to a minute, it is hardly surprising that things ultimately become simplistic. And this is clearly not good from an investor point of view.

What works for these anchors and experts is the fact that while coming up with explanations and predictions, their past record is not available for examination.

As Jason Zweig writes in Your Money and Your Brain: “Whenever some analyst brags on TV about making a good call, remember that pigs will fly before he will broadcast a full list of his past predictions, including the bloopers. Without that complete record of his market calls, there’s no way for you to tell whether he knows what he’s talking about.” This is a very important point that needs to be kept in mind when listening to anchors as well as experts on television.

Also, it is worth remembering here that which way a stock market will go is impossible to predict regularly on a day to day basis.  Nassim Nicholas Taleb in his book The Black Swan—The Impact of the Highly Probable lists a certain category of experts who tend to be…not experts. In this list he includes economists, financial forecasters, finance professors and personal financial advisers.

As he writes: “Simply, things that move, and therefore require knowledge, do not usually have experts, while things that don’t move seem to have some experts. In others words, professions that deal with the future and base their studies on the nonrepeatable past have an expert problem…I am not saying that no one who deals with the future provides any valuable information…but rather that those who provide no tangible added value are generally dealing with the future.” Given this, the stock market experts clearly have an expert problem.

Hence, the next time you switch on your television to try and understand what is happening in the stock market, do remember all that has been pointed out above.

Happy investing!

The column originally appeared on The Daily Reckoning on September 25, 2015

The curious case of Mr Jain

prashant jainVivek Kaul

 Sometime in late October I went to meet my investment advisor. During the course of our discussion he suggested that my portfolio was skewed towards HDFC Mutual Fund and it would be a good idea to move some money out of it, into other funds.
“Don’t put all your eggs in one basket” is an old investment adage. While, I try to follow it, I also like to believe that if the basket is good enough, it makes sense to put more eggs in that basket than other baskets.
HDFC Mutual Fund has been one of the few consistent performers in the Indian mutual fund space. And a major reason for the same has been Prashant Jain, the chief investment officer of the fund, who has been with it for nearly two decades.
Jain has been a star performer and due to his reputation the fund has seen a huge inflow of money into its various schemes. Some of these schemes HDFC Prudence, HDFC Equity and HDFC Top 200 became very big in that process.
These schemes haven’t done very well over the last three years. Their performance has been significantly worse in comparison to other schemes in their respective categories(Value Research has downgraded them to three star funds from being five star funds earlier). And this has surprised many people. “How can Prashant Jain not perform?” is a question close observers of the mutual fund industry in India have been asking.
One explanation that people seem to have come up with is the fact that the size of the schemes have become big, making it difficult for Jain to generate significant return. This is a theory that is globally accepted, where the size of a scheme is believed to be inversely proportional to the return it generates.
As Jason Zweig points out in the commentary to Benjamin Graham’s all time investment classic, The Intelligent Investor, “As a (mutual) fund grows, it fees become more lucrative – making its managers reluctant to rock the boat. The very risk that managers took to generate their initial high returns could now drive the investors away — and jeopardise all that fee income. So the biggest funds resemble a herd of identical and overfed sheep, all moving in sluggish lockstep, all saying “Baaaa” at the same time.”
While this may be a reason for the underperformance of the schemes managed by Jain, it is not easy to prove this conclusively. Jain feels there is no correlation between size and performance of a scheme, or so he told the Forbes India magazine in a recent interview. He pointed out that there are no large mutual fund schemes in India, and the largest scheme is less than 0.2% of the market capitalisation, which I guess is a fair point to make.
So how does one explain the fact that Prashant Jain is not doing as well as he used to in the past. John Allen Paulos possibly has an explanation for it in his book A Mathematician Plays the Stock Market. As he writes “A different argument points out to the near certainty of some stocks, funds, or analysts doing well over an extended period of time.”
Paulos offers an interesting thought experiment to make his point. As he writes “Of 1000 stocks (or funds or analysts), for example, roughly 500 might be expected to outperform the market next year simply by chance, say by the flipping of a coin. Of these 500, roughly 250 might be expected to do well for a second year. And of these 250, roughly 125 might be expected to continue the pattern, doing well three years in a row simply by chance. Iterating in this way, we might reasonably expect there to be a stock (or fund or analyst) among the thousand that does well for ten consecutive years by chance alone.”
But one day this winning streak comes to an end. And the same seems to have happened to Prashant Jain. In fact, William Miller who ran the Legg Mason Value Trust fund in the United States, beat the broader market every year from 1991 to 2005. In 2006, his luck finally ran out. Miller once explained his winning streak by saying “As for the so-called streak…We’ve been lucky. Well, maybe it’s not 100% luck—maybe 95% luck.”
If Miller was lucky so was Jain. Any significant deviation from the norm does not last forever. As Nassim Nicholas Taleb writes in Fooled by Randomness “In real life, the larger the deviation from the norm, the larger the probability of it coming from luck rather than skills…The “reversion” for the large outliers is what has been observed in history and explained as regression to the mean. Note the larger the deviation, the more important its effect.”
This is not to suggest that Jain’s performance has only been because of luck. Not at all. But it was luck that pushed him up to the top of the charts. Luck was the “icing” on the cake.
Michael Mauboussin discusses a very interesting concept called the paradox of skill in his book The Success Equation – Untangling Skill and Luck in Business, Sports, and Investing. “As skill improves, performance becomes more consistent, and therefore luck becomes more important,” is how Mauboussin defines the paradox of skill.
The Olympic marathon is a very good example of the same. Men run the race today about 26 minutes faster than they did 80 years back. Also, in 1932, the difference between the man who won the race and the man who came in twentieth was 40 minutes. Now its less than 10 minutes.
Now the question is how does this apply to investing? “As the market is filled with participants who are smart and have access to information and computing power, the variance of skill will decline. That means that stock price changes will be random and those investors who beat the market can chalk up their success to luck. And the evidence shows that the variance in mutual fund returns has shrunk over the past 60 years, just as the paradox of skill would suggest,” says Mauboussin. “I want to be clear that I believe that differential skill in investing remains, and that I don’t believe that all results are from randomness. But there’s little doubt that markets are highly competitive and that the basic sketch of the paradox of skill applies,” he adds.
And that is what best explains the curious case of Prashant Jain and the recent non performance of the mutual fund schemes that he manages.
The column originally appeared in the Wealth Insight magazine edition of December, 2013 

(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek)