Over the past week, I made a switch in my portfolio. Once
again, this is my attempt to document the rationale for the following decision.
I’m selling out of China, making the decision to buy into
Russia.
Reason 1: Russia looks
cheap
So says JP Morgan in their 2Q
2014 Guide to the Markets publication.
From the same source,
Russia’s current PB ratio is 0.6x versus the 10 year average of 1.4x. As a
general rule of thumb, if it’s selling at less than 1x PB, it’s cheap.
But we know what is cheap,
can get cheaper, especially if it finds itself under pressure from financial
shocks.
But it’s not like Russia is in danger of a shadow banking-fuelled debt
crisis.
Reason 2: Russia’s survivability looks okay
I’m not going to try to argue
that Russia’s going to have a fantastic time in the next few years. People with
crystal balls bigger are welcome to project as far as they want. But what I see
is Russia looks sufficiently buffered to handle a fair amount of economic
whoopassery before they really crumble.
Source: World Databank, World
Development Indicators , last updated 9 April 2014.
Having said that, that’s
pretty much all the reason I’d have for putting my money in the hands of a Russian fund. The question now is really,
which one?
Three funds, three track records
To bring the question into
focus, I need to know what exactly I’m looking for, and that is the fund that
is most likely to deliver outperformance over a market cycle. I haven’t much
idea where in the market cycle the Russian market is (although valuations
suggest it’s closer to the bottom than it is to the top) but I do have some
idea that the market will still be intact once it turns up.
So I’m looking for is a fund
that has the greatest likelihood of delivering outperformance over a market
cycle. The way I’ve chosen to approach this question is to look at historical
3-year returns of the underlying market, and compare each fund’s corresponding
return in each period.
Here’s the 3-year rolling
return of the Russian market, represented by the FTSE Russia TR USD. All total return
data in SGD terms unless otherwise specified.
It’s a pretty ugly picture if you bought Russia around
October 2010, as 3-year returns of the market since then have been increasingly
negative. If you had entered in March 2011, 3 years later in March 2014,
chances are you’re looking at a negative 40% return or so.
But let’s rearrange history a little bit by sorting returns
from high to low, giving us a smooth curve.
The chart above shows the historical 3-year returns every day
for the past 5 years (end-March 2009 to end-March 2014). Returns have been as
poor as -40% or so, to as high as 60% or more.
Here’s the fun part, taking the corresponding fund excess returns
(arithmetic difference between fund returns and market returns) for each
period, and throwing them against the market return to see when the fund
delivers what sort of excess return.
Three funds: H, J and P are plotted
against the sorted historical returns of the FTSE Russia TR USD.
H: Could be worse. Fund tends to underperform most of the
time, but keeps underperformance to around 10% to 15%. Noted outperformance in
the region 15% to 30% when the market rallies strongly.
J: Looks pretty high beta. Like H, tends to underperform
most of the time, but unlike H, underperformance seems worse when markets are
not doing much, returning as much as -20% excess return at some points. Upside
is noticeably higher when market rallies – in the range of more than 40% excess
return in a strong market rally. I guess that’s what keeps investors coming
back for more.
Lastly, P: Of the three, arguably the steadiest downside
management. By some market voodoo hoodoo, fund has kept performance positive
most of the time, across positive and negative conditions. The most the fund has
underperformed over a three year period is less than -10%. Meanwhile, upside is as high as 40% in some cases.
On this basis, I’m
going with fund P.
I’ll review this decision three years down the road, in March
2017.
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