I'll Select These TWO Mutual Funds for my Lifetime Investing Portfolio

Summary

This video explores the optimal two-fund portfolio, focusing on a unique combination of momentum and value funds. The speaker explains market anomalies and the contrasting investor profiles for each strategy. Emphasizing their negative correlation, the video presents data showing the potential of combining these funds for enhanced returns and risk management. Various investment techniques, including rebalancing and switching methods, are discussed to optimize portfolio performance, concluding that a balanced approach between momentum and value can significantly outperform traditional indices.

Takeaways

• 🤔 The speaker was asked to recommend two funds for a portfolio, which led to a challenging exploration of various fund types and investment styles.
• 📊 After extensive research, the speaker concluded that a momentum fund and a value fund would be the best two-fund combination for a portfolio.
• 🏏 Momentum investing is based on the idea that investments that have performed well will continue to do so, similar to a player's form in sports.
• 💰 Value investing focuses on identifying undervalued assets, akin to the Rajasthan Royals' strategy in the IPL, where they picked underpriced but high-performing players.
• 🔄 Both momentum and value strategies are based on market anomalies and investor reactions, and they don't always work, but they can be negatively correlated.
• 📈 A simple 50-50 portfolio allocation between a momentum and value index has shown strong performance over the past 17 years, outperforming popular indices.
• 🔄 The concept of rebalancing was introduced, with annual rebalancing slightly improving returns, although the tax implications were noted for more frequent rebalancing.
• 📊 A 'momentum-based switch method' was proposed, which involves switching the entire portfolio between momentum and value based on market movements, resulting in higher returns.
• 📉 An alternative 'PE ratio based switching method' was less successful, with a lower CAGR compared to the momentum-based switch, indicating the complexity of market timing.
• 📝 The speaker encourages further exploration and experimentation with different combinations of momentum and value, and the inclusion of other variables like PE ratio, volume, and moving averages.
• 👍 The speaker believes that a combination of momentum and value is well-suited for a two-fund portfolio due to their individual performance and weak correlation, offering asset allocation benefits and potential for improved performance without increased volatility.

Q & A

What was the interesting question posed during the webinar?

The question was about which two funds, from a selection of actively managed mutual funds, index funds, ETFs, or a combination of these, should be included in a portfolio if one could only have two.

Why did the speaker find the question challenging?

The speaker found the question challenging because even within the category of equities, there are multiple categories, different capitalizations, and investing styles, which complicates the decision-making process.

What was the speaker's initial approach to answering the question?

The speaker initially did not have an immediate answer and asked for some time to research different parameters such as returns, volatility, drawdowns, and existing research.

Which two types of funds did the speaker ultimately recommend for a 2-fund portfolio?

The speaker recommended a momentum fund and a value fund as the two types of funds for a 2-fund portfolio.

What is the concept of momentum in investing as explained in the script?

Momentum in investing refers to the tendency of investments that have performed well to continue performing well for some more time, and similarly, those that have not done well to continue performing poorly in the short term.

How does the value investing style differ from the momentum style?

Value investing focuses on identifying investments that are currently priced lower than their true worth, with a focus on research and long-term investment. In contrast, momentum investing looks for short-term price movements and trends.

Why are momentum and value strategies considered to be negatively correlated?

Momentum and value strategies are considered negatively correlated because they are based on different market behaviors and investor reactions. Momentum follows the trend of investments that are already performing well, while value seeks undervalued investments that may not be currently popular.

What is the significance of negative correlation in a 2-fund portfolio?

Negative correlation in a 2-fund portfolio can help achieve a balance between returns and risk management, as the funds may perform well in different market conditions, thus potentially reducing overall portfolio volatility.

What was the result of the study comparing the performance of a momentum index and a value index?

The study found that over a 17-year period, both the momentum index and the value index performed well independently, with the momentum strategy leading in terms of lumpsum and SIP performance as well as volatility.

What is the 'momentum based switch method' mentioned in the script?

The 'momentum based switch method' is a strategy where the investor switches their investment between a momentum index and a value index based on the performance of the Nifty 200 Momentum 30 index. If the index goes up by 20% over a three-month period, the investor switches to the momentum strategy, and vice versa for a 20% drop.

What was the performance of the 'momentum based switch method' over a 17-year period?

The 'momentum based switch method' resulted in a 17-year Compound Annual Growth Rate (CAGR) of 22.2%, which was 6% higher than the 50-50 combination method without switching.

What alternative approach did the speaker try using the PE ratio for switching between momentum and value strategies?

The speaker tried a PE ratio based switching method where the investor would switch to a momentum strategy when the Nifty 50 PE ratio goes below 18 and switch to a value strategy when the ratio crosses 24.

What was the performance of the PE ratio based switching method over a 17-year period?

The PE ratio based switching method resulted in a 17-year CAGR of 15.1%, which, while respectable, did not perform as well as the momentum based switch method.

What is the final recommendation for a 2-fund portfolio based on the script?

The final recommendation is to have a combination of a momentum and a value fund in a 2-fund portfolio due to their high performance in isolation, weak correlation, and the potential to improve portfolio performance without adding to volatility.

Outlines

00:00

💡 Choosing the Best Two-Fund Portfolio

The speaker discusses a challenging question from a recent webinar about which two funds to include in a portfolio if limited to just two. They reflect on different types of funds and eventually determine that a momentum fund and a value fund would be the best choices. This decision was made after analyzing various parameters like returns, volatility, and existing research. The combination of these funds is unique and somewhat unconventional.

05:01

📈 Understanding Momentum and Value Investing

The speaker explains the concepts of momentum and value investing using cricket analogies. Momentum investing relies on the principle that investments performing well will continue to do so in the short term. Value investing, on the other hand, focuses on buying undervalued stocks and waiting for their prices to reflect their true worth. These two strategies are based on market anomalies and are negatively correlated, which can be beneficial for portfolio diversification and risk management.

10:03

🔍 Analyzing Historical Data and Portfolio Performance

The speaker examines historical data from 2006 onwards for the Nifty 200 Momentum 30 and Nifty 500 Value 50 indices. They find that a portfolio split equally between these two indices performs well, achieving a CAGR of 16.2%. Rebalancing the portfolio annually or semi-annually can slightly improve returns. The speaker highlights the importance of understanding performance differences and negative correlation between the indices to achieve better asset allocation and risk management.

📊 Exploring Advanced Portfolio Strategies

The speaker introduces a 'momentum-based switch method' and a PE ratio-based switching method to enhance portfolio returns. The momentum-based switch involves reallocating funds based on market movements, while the PE ratio method uses predefined cutoff points. The momentum-based switch method yielded a higher CAGR of 22.2% over 17 years, but the PE ratio method was less effective. The speaker emphasizes that these methods require further refinement and experimentation.

📈 Encouraging Further Exploration and Learning

The speaker encourages viewers to experiment with different combinations of momentum and value strategies and other variables like PE ratio and moving averages. They provide a worksheet with historical data for further analysis. The conclusion reiterates that a combination of momentum and value funds is well-suited for a two-fund portfolio due to their high performance in isolation and weak correlation. The speaker invites feedback and suggestions for improving the strategy.

Keywords

💡Portfolio

A portfolio in the context of the video refers to a collection of investment assets such as stocks, bonds, mutual funds, ETFs, etc., held by an individual or entity. The video discusses the concept of creating a simplified portfolio with just two types of funds, which is central to the theme of diversification and investment strategy.

💡Momentum Fund

A momentum fund is an investment vehicle that seeks to capitalize on the continuation of trends in the prices of stocks. It is based on the idea that stocks that have performed well will continue to do so. In the video, the speaker finds that including a momentum fund in a two-fund portfolio can contribute to achieving the portfolio's objectives of returns, asset allocation, and risk management.

💡Value Fund

A value fund invests in undervalued stocks that are believed to have strong potential for long-term growth. The video emphasizes the inclusion of a value fund in a two-fund portfolio, highlighting its potential for capitalizing on market inefficiencies and the contrasting investment style compared to a momentum fund.

💡Equity Funds

Equity funds are a type of investment fund that primarily invest in stocks or shares of companies. The video assumes the question about the two-fund portfolio is in reference to equity funds, which are a significant category within the broader investment landscape.

💡Volatility

Volatility in the context of the video refers to the degree of variation of a fund's value over time. It is an important consideration in portfolio management as it can indicate the risk associated with an investment. The speaker mentions looking at volatility as one of the parameters when evaluating the two-fund portfolio.

💡Drawdowns

Drawdowns are used to measure the decline in the value of a fund or portfolio from its peak. The video script mentions considering drawdowns as a parameter for evaluating the performance of potential funds for the two-fund portfolio, which is crucial for understanding the risk profile of the investments.

💡Negative Correlation

Negative correlation describes a relationship between two variables where one variable's increase is associated with the other's decrease. The video discusses the negative correlation between momentum and value funds as a unique attribute that can contribute to a balanced portfolio by potentially offsetting losses in one with gains in the other.

💡Rebalancing

Rebalancing is the process of adjusting the weightings of assets in a portfolio to maintain the desired level of risk and return. The video mentions the impact of annual and semi-annual rebalancing on the performance of the two-fund portfolio, suggesting that it can lead to slightly improved returns.

💡Asset Allocation

Asset allocation is the process of allocating investment funds among different asset classes to achieve diversification and meet investment objectives. The video argues that a two-fund portfolio consisting of momentum and value funds inherently has an asset allocation strategy due to the different investment approaches of the two funds.

💡Risk Management

Risk management in investing involves identifying, evaluating, and controlling potential risks to minimize any negative impacts on the portfolio. The video discusses how the combination of momentum and value funds in a two-fund portfolio can aid in risk management by potentially reducing overall portfolio volatility.

💡Investing Strategies

Investing strategies refer to the methods or plans employed by investors to achieve their financial goals. The video explores different investing strategies, such as a simple 50-50 allocation between momentum and value funds, as well as more dynamic strategies like the 'momentum-based switch method', to enhance portfolio performance.

Highlights

The speaker was asked which two funds they would choose for a portfolio consisting of only two funds, which sparked a challenging discussion on the topic.

The question assumed an equity focus, but the speaker noted the complexity due to the variety within equities, such as different capitalizations and investment styles.

After considering various parameters like returns, volatility, and existing research, the speaker chose a momentum fund and a value fund for a two-fund portfolio.

The choice of momentum and value funds was based on their market anomalies and the tendency of investors to over or under-react to information.

Both momentum and value strategies are not always effective, as shown in previous videos on factor investing.

The investor profile for value and momentum investing is different, with value investors focusing on long-term research and momentum investors on short-term price movements.

A key observation was the negative correlation between momentum and value factors, which is rare in equities and could be beneficial for portfolio diversification.

The speaker presented a study examining the performance of a momentum index and a value index from 2006 onwards, showing both strategies performed well independently.

A simple 50-50 capital allocation between the momentum and value indices resulted in a 17-year CAGR of 16.2%, higher than popular indices.

Applying annual rebalancing to the 50-50 portfolio slightly improved returns, while semi-annual rebalancing increased the CAGR to 16.6%.

The speaker introduced a 'momentum-based switch method', a strategy that dynamically allocates capital based on market momentum.

This switching strategy, over a 17-year period, resulted in only four switches and improved the CAGR to 22.2%, outperforming the static 50-50 allocation.

An alternative PE ratio-based switching method was also explored, but it did not perform as well as the momentum-based switch, with a 17-year CAGR of 15.1%.

The speaker encourages viewers to experiment with different combinations of momentum and value, incorporating variables like PE ratio, volume, and moving averages for superior models.

The conclusion emphasizes the belief that a combination of momentum and value is well-suited for a two-fund portfolio due to their high performance, weak correlation, and potential for improved performance without added volatility.

The video includes a worksheet in the description with closing monthly values of the indices discussed, inviting viewers to conduct their analysis.

The speaker offers a course on Quantitative Investing Strategy for those interested in building foundational skills in back-testing, logic, and screening, as well as understanding rule-based investing strategies.

Transcripts

So I was asked a very interesting question at a recent webinar and the question went

like this

If my portfolio comprised of just two funds and this can be an actively managed mutual

fund, index funds, an ETF or a combination of these, but if I could have only two funds

then which ones would those be

Now I typically ignore such kaunsa mutual fund kharido’ type questions but this one

was a bit challenging because and I’m assuming this question was around equity funds but

even within equities, we have multiple categories, different capitalizations, many investing

styles and so on which obviously complicates things

Anyways, I did not have an immediate answer for the gentleman

I asked for some time and over a couple of days I looked into different parameters like

returns, volatility, drawdowns, any existing research I could find etc. and after looking

at a few combinations and to my surprise, the two funds I was most comfortable having

in a 2-fund portfolio were a) a momentum fund and secondly, this portfolio would also have

a value fund in it

Now you must be wondering why momentum and value

I could have chosen a Nifty 50 and a Nifty Midcap or maybe a Smallcap fund and the Nasdaq

100 could have been an interesting combination

But no!

I chose this odd combination of momentum and value and because like Christopher Nolan I

have already given you the prestige, it’s time we look at the pledge and the turn

Let’s begin

Allright, so very quickly, let’s understand momentum and value 101

So when Yuvraj smacked that fifth six against England in the 2007 T20 World Cup, the commentator

Ravi Shastri could be heard saying

So what Mr. Shastri meant is that Yuvraj was on fire which means he had the forward momentum

to continue doing what he was anyways doing and was very likely to hit the sixth six in

that over

In more technical terms, momentum is the tendency to exhibit persistence which in simple language

means - investments that have performed relatively well, will continue to perform well for some

more time and likewise, those that have not done well, will continue to perform poorly

atleast in the short term

To many of us, this concept might seem a little counterintuitive because conventionally, we

are used to believing that all investments should be bought low and sold high

It was particularly difficult for me as I had started my education with the value style

of investing which in cricketing terms is like the Rajasthan Royals, who in 2008 spent

less than 60% of the maximum budget, it was a team without superstars with players like

Asnodkar, Tanvir and Pathan stepping up and yet they shocked the cricketing world by winning

the inaugural season of Indian Premier League

In what can be described as the Royal’s moneyball moment, the management there had

picked players who were priced significantly lower than their real value and this gap between

the current price and the true worth is what the value factor identifies

So if you look at it broadly both, momentum and value are based on market anomalies which

happens when investors over or under-react to information

We know that both these strategies don’t work all the time and we saw this in a previous

video of mine on factor investing

Thirdly, the investor profile is completely different with the value investor focussing

on research and the long-term while the momentum investor looks out for short-term price movements

But the one characteristic that really caught my eye is that both these factors seem to

be negatively correlated which almost never happens in equities

So in this exercise, because my entire portfolio is just 2 funds I felt this unique attribute

could help achieve all three objectives of my portfolio which includes returns, asset

allocation and risk management

Infact let’s start with this and examine the results of a study where I looked at data

from the year 2006 onwards for a couple of representative indices

The first index is the Nifty 200 Momentum 30 and currently, there are quite a few mutual

funds that have this option

The second one is the Nifty 500 Value 50 index which I think is being offered by just one

AMC

Now over these last 17 years, our momentum index and the value index have independently

done rather well with the momentum strategy leading the race on a lumpsum and SIP performance

basis and also in terms of volatility

Infact it’s very tempting to conclude that momentum is the better strategy but

But there’s a good amount of research that says that a combination of momentum and value

can together give even better results and that’ll be our focus over the rest of this

video

OK, so let’s do the easy stuff and start with a portfolio where 50% of our capital

goes into the momentum index while the value index gets the remaining 50%

Understandably, the result is nothing but an average and over a 17 year period this

comes to a respectable 16.2% which is a lot higher than the more popular indices such

as the Nifty 50, the Midcap 150 and even the Microcap 250 index, about which we recently

learnt in a dedicated video

But because we have learnt even more stuff on my channel and especially the importance

of rebalancing, I applied an annual rebalancing on our 50-50 combination which gave me a tiddly-bitly

improvement of 0.2% in returns

Infact, I even tried a 6-month rebalancing which further improved the combination CAGR

to 16.6% but because the tax rate on short term capital gain is a bit higher I think

the post-tax returns for all three options i.e. without rebalancing, annual rebalancing

and a 6-monthly rebalancing will all come to pretty much the same level

I also looked at the 50-50 combination on a rolling return basis and there are enough

historical indications here that this strategy can offer anywhere from 15 to 16% per annum

Infact the more I look at this, the more convincing I am of my two-fund portfolio because in addition

to strong performance there’s an in-built asset allocation with two investing strategies

that are at opposite ends of the spectrum

I mean, look at this data where I’ve mapped the yearly performance of the momentum and

value indices and it isn’t difficult to see that these two are not cut from the same

cloth with a performance difference of atleast 15% in the year 2006, 2009, 10, 11, 13 again

in 2014, 15, 16, 18, 2019 and 2022

It’s the understanding of data like this that gives investors like you and me that

little edge and if you want to sharpen that edge then do explore enrolling for this short

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Do check out the course details on Fisdom Academy and if you like what you see then

do register using the link in the video’s description and don’t forget to apply the

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All right, so we’ve seen something very simple so far i.e. we put 50% in a momentum-based

fund, we put 50% in a value-based fund and we are good to go!

But what was a slight botheration for me was that we’re not really using the up and down

movement that both these factors go through wherein, in some years momentum does well

while in other years, value is a lot better

So I tried out a couple of techniques of my own just to see if complicating matters can

help me with a little extra returns

OK, the first method I used is a “momentum based switch method”

I’m sure you have never heard of this one before and that’s because I just invented

this phrase for the purpose of this video

Now the way this switching method operates is a lot like how price momentum works

So if the Nifty 200 Momentum 30 index goes up by 20% over a three month period then we

assume, quite fairly that there is positive momentum in the markets and therefore, it

makes more sense to be invested in the momentum index

For instance, the months of February, March and April of 2021 saw a healthy move-up in

the momentum index which means per my strategy, I should now put all my eggs into momentum

And likewise, a 20% drop in the Jan to March period of 2020 would have prompted a switch

to the value strategy which would have stayed this way until the next switch that happened

in April of 2021

As I said, it’s a bit complicated with periodic switchings but when I did this exercise over

a 17 year period, it all came to only four switches that needed to be done which happened

in the months of February 2008, May 2009, March 2020 and again in April of 2021

Honestly, I was a bit surprised to see only 4 switches but then I realised why because

although we always think of ups and downs in terms of the Nifty 50, I was actually using

the momentum index to figure out when to invest and when to exit

Infact there was another surprise and this one came on a performance basis when this

momentum based switching strategy gave me a 17-year CAGR of 22.2% which is a good 6%

higher than our previous 50-50 combination method

I think a little more work is required but I liked what I saw and because I didn’t

want to disappoint Mr. Value, I also tried an alternative approach using a PE ratio based

switching method

Now just like how we used PE-ratio bands in the Superman video in this case, I defined

the cutoff as 18 and 24 for switching in and out of the momentum and value index

So if the Nifty 50 PE ratio were to go below 18, then I would switch to a momentum strategy

and when the ratio crosses 24, then I become value-oriented

Honestly, I had big hopes for this approach but it didn’t work as much as I expected

and the 17-year CAGR came to 15.1% which is still quite respectable

Anyways, this was a very interesting experiment and just to help out, I’m attaching a worksheet

in the description where I’ve mapped the closing monthly values of the Nifty 50 and

the two indices we’ve discussed in this video

If this content has made you a little curious, then do try out different combinations of

momentum and value and feel free to bring in more variable like the PE ratio, volume,

moving averages etc. that can help you present a more superior model

So just to recap and conclude

It is my belief, my belief that a combination of momentum and value are perfected suited

for a 2-fund portfolio

What makes these two factors a perfect marriage is their high performance in isolation and

the fact that they are weakly correlated which adds an asset-allocation element to our portfolio

And thirdly, an investor can improve the portfolio’s performance without adding to volatility and

we looked at a few ways of doing that in this video

If you liked this video then do give it a thumbs up and also leave me a comment on how

this strategy can be improved further

As always, thank you for your time, do subscribe to my channel, please share this video with

your friends and I’ll see you three days from now

Until then