Buying & forgetting in stocks vs mutual funds investment
What is buying & forgetting way of investing?
It simply refers to the method where people invest in shares of a company consistently following a systematic approach and forget the investment with a view that these investments will come handy at some point of time. The approach was quite prevalent in the US market initially before Robert Kirby a portfolio manager, in 1984 introduced investing in a basket of consistently performing companies against single names. In India, a similar approach was followed but only for companies that offered high Return on Capital (ROCE) while growing at a healthy pace.
Was this approach successful?
In the US, where the investment environment is highly developed, an individual, on an average, saves nearly 50 percent of his/her portfolio in mutual funds which is over 10 times their savings in general savings bank accounts With sizeable fund flows in the industry, the markets have matured which has created difficulty for fund manager to generate the alpha from active investing. Individuals then started moving away to passively managed funds, index funds, buy and forget among others. Thus, the method has become quite prominent in the US due to better-cost adjusted returns when compared to mutual funds.
One of the American mutual funds that adopted the strategy was Voya Corporate Leaders Fund. The fund started in 1935 and invested in 30 stocks that they thought were the best companies at that time and bought equal amounts of shares of each. The fund held the stocks for a long time and made no changes to its portfolio for 82 years. The number of stocks reduced from 30 to 21 due to the merger and other corporate action of 30 names. The fund has beaten the markets by a huge margin by generating 10.6% a year that is about 3600 times. During the same period, Dow Jones Industrial Index generated 6.7% per annum or 200 times. We believe once good stocks are selected; no more action may be required for long period.
Buying and forgetting is also known as coffee can approach
The Coffee Can approach
Another real incident that gave the buying and forgetting strategy the name of Coffee Can approach happened in the US when Michael J. Mauboussin, earlier Chief Investment Strategist at Legg Mason Capital Management wrote about the strategy and stated that an investor bought $5,000 worth of stocks and had put the share certificates in a safe deposit box. The investor did nothing for a long time and after his death, it was found that while some investments turnned into losses others gained as much as $800,000. We believe while this real-life incident would elicit different reactions among investors adopting the strategy would also be dependent on how mature the capital market is in an economy.
Should an equity investor try this kind of a buy-and-hold strategy?
Well, no individual can have an 80-year horizon. However, buying carefully chosen companies and then forgetting about it for a couple of decades is not a bad idea. For example in Indian market while IT major Infosys might not be a favorite stock for investors now but it has been one of the stocks to own a decade back. If you had bought Rs 1 lakh worth of Infosys 10 years back and did nothing with it, today, in spite of all the negatives, the investment would have fetched nearly 5x returns something which is marginally over the Sensex returns during the period.
Is the same approach prevalent in India?
Well, a straightforward answer is No. India is a market where mutual funds are better than buy and forget approach. Let us see why:
- Few quality companies: Only a few companies meet the criteria of high growth and high ROCE. Thus, the availability of quality companies constrains the investment opportunity. One of the critical factors is the Coffee Can approach is buying and forgetting companies that are fundamentally sound and has the potential to become one of the leaders over the long term. By long-term here we mean over one decade and not a business cycle of 3-5 years.
- Likelihood of selling early is high: During bear phase or period of long stagnancy result in increased likelihood of investors’ selling of non-performing or loss-making stocks. This beats the purpose of buy and forgets strategy. Early selling often results in weakened performance when compared to equity mutual funds. People generally tend to get carried away with market fluctuations and do not stick to their investments. One of the essences of Buffett’s investing style is being lethargy with investments. Quoting Buffet from his Annual Letter to shareholders in 1990, “Lethargy bordering on sloth remains the cornerstone of our investment style.” Thus due to low stickiness in India, the coffee can approach is not suitable instead active mutual funds are the sought after investment instruments.
- Alpha generated by mutual funds – Actively managed equity mutual funds have consistently beaten their benchmark by as high as 5-15% annualized returns that are lower than the alpha generated from buying and forgetting strategy.
Should you consider buy and forget strategy for mutual funds?
It is a good investing concept but only a handful of investors succeed with the strategy in real life due to investor bias and lack of financial expertise. Should you wish to try the strategy of buying and forgetting, you should ideally do it on 10-15% of your total corpus and not the entire money and the remainder should be invested in mutual funds.
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