Thursday, May 04, 2006

Sensex and Sensibility

In 2004 end I has posted a report Exclusive report on Sensex underperformance on the poor performance of Sensex and reason behind that. The summary of the report was that BSE has done rather too many changes in the index and has gone more ‘with the momentum‘ which has made it a speculative portfolio which can never beat a long term portfolio.

Though it is too early to say, but the Sensex has become more stable as a portfolio. The number of changes per year have come down and have become sensible. In last 2 years they made only 3 changes with Maruti, NTPC and TCS taking place of MTNL, HPCL and Zee tele.

The following stats would give you the idea about this.

1996 - 15 changes

1998 - 4 changes

2000 - 4 changes

2001 - 1 change

2002 - 4 changes

2003 - 5 changes

2004 - 1 changes

2005 - 2 changes

The results are showing up. I can bet that they wouldn’t have done any better by making more changes to the indices in last 2 years. In fact the number of changes in popular global indices is very low. Dow had 7 changes between 1999-2006. S&P 500 typically has 15-20 changes per year. If an index has to become worthy of tracking by the index funds then it should be like a long term portfolio.

Its very difficult to beat a well diversified index with minimal changes. Princeton University Professor Burton Malkiel found that the S&P 500 beat 70% of all equity managers retained by pension plans over the 1975–1994 20-year period. Another study by Robert Kirby, former Chairman of Capital Guardian, indicated that out of 115 U.S. equity mutual funds that were in business for 30 years or more, only 41 (36%) beat the S&P 500 by some margin, and only 23 of the funds (20%) beat the index by 1% per year or more. Report

But why should it be so difficult. For example if you want to beat S&P then all you have to do is to find JUST 1 stock which you think would perform worse than performance of S&P next year. Then you should divide the money in rest 499 stocks as per the index weightage. If you turn out to be correct then you will beat S&P 500 and you would be doing better than 70% well paid finance managers.

It looks good as a theory but in reality the only god damned stock which you removed turns out to be the stock which outperforms the index. (remember m&m’s expulsion from Sensex in 2002)

That’s why its such a fun to race against indices. I envy the pleasure Buffett gets while beating S&P 500 year after year. I hated Sensex because it could be beaten hands down with value investing approach. If it continues on the path of stability (buy and hold) and it would be fun to compete against it.

1 comment:

QUALITY STOCKS UNDER 4 DOLLARS said...

Lot of things do not make sense.