October has quite the monopoly on “black” market days.
Don’t worry, we’re not implying anything. Interestingly, guess who was unaffected in the ‘29 depression? Russia, because they were quite disconnected from global markets. So it’s only fitting that the “game” they invented - Russian Roulette - should give us an investing lesson.
The principle involved is called ergodicity. Imagine six people flipping a coin at the same time. Now compare the outcomes to you flipping a coin six times. Each flip, yours or someone else’s has a 50% chance of being a head or tail. Now imagine the same process in a game of Russian Roulette. Clearly, six people playing Russian Roulette once isn’t the same as one person playing it six times. Flipping a coin is ergodic. But Russian Roulette is non-ergodic, just like the markets.
- The markets are turbulent, largely because of global factors. The uncertainty over the US stimulus, combined with the consistent commentary that the markets are not in sync with the economy, and a second wave of Covid cases, meant that investors are nervous about business growth.
- On the other hand, the market watchdog has been anything but subdued. Doing a commendable job as an active regulator, SEBI first extended the “true to label” philosophy to multi cap funds, specifying changes in the minimum weightage. If you missed our communication on this, the tl;dr version is “no action required”.
- More reason to feel indebted? SEBI is setting up a committee to design a framework that determines minimum liquid assets in debt funds, and a stress-test methodology that factors in liquidity, credit, and market risk. Transparency and safety, both good bets.
- And betting the farm on reform is what the government has done in a bid to revive the economy. Broadly, the thrust is on deregulating the “mandi system” that includes the sale, pricing and storage of farm produce. Being able to sell to private players can be seen as a positive, but the long term effect of the free market in terms of (not having) minimum price guarantees, and rural inflation is what worries the farmers.
So, how does the market’s non-ergodicity affect you? Imagine you and a friend have the same mutual fund in your portfolio. The fund is now at a 52 week high. Would both of you be equally happy? Not necessarily. It would depend on the price at which you bought it, your expectations, its percentage allocation in your portfolio and so on.
The market is made of millions of such individuals (and institutions), and these variables would impact their outcomes too. At any point, a market high or crash will affect everyone differently. The markets may have a herd mentality, but the individual investor doesn’t really get any herd immunity! Non-ergodic.
What’s a good way to dodge the market’s non-ergodicity bullet? Effective diversification. Fund diversification through asset allocation, and time diversification using staggered investments.
Black, where we started. On Black Monday - October 19th, 1987, markets the world over inexplicably crashed. This time, the USSR was busy playing Russian Roulette with the economy - from centrally planned to mixed socialist to free markets! Thank you for reading.
Indices and benchmarks in September
Indian Mutual Fund Industry as of August 2020