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Is Coffee Can investing better than Mutual Funds in India?

Coffee Can investing is a sound concept but suffers from practical limitations

What is Coffee Can Investing?

Coffee Can Investing refers to “buy and forget” approach to investing in shares of companies which have performed well consistently. The concept of coffee can investing has originated from the US markets where it is highly successful.

The idea of the Coffee Can portfolio traces its roots back to the American Old West, when people would secure their valuables by putting them in a coffee can. The coffee can was then placed under their mattress for safe-keeping, where it stayed for years, or even decades. A portfolio manager by the name of Robert Kirby proposed in 1984 that investors could the follow the same approach — identify a diversified portfolio of consistently performing companies, invest in their stocks and keep invested for at least 10 years.

In the Indian context, coffee can portfolio has been defined in book “The Unusual Billionaires” to refer to companies which have generated Return on Capital (ROCE) over 15% every year and revenue growth of more than 10% every year, over the last 10 years.

Why does it work in the US?

USA is a highly developed equities markets where close to 50% individuals invest in mutual funds. An average individual maintains 10 times in mutual funds compared to savings bank accounts. Due to a high amount of money being invested in the equity markets, sizeable number of large size public companies and widespread equity research, it has become difficult for fund managers to generate any extra returns (alpha) from active investing. Individuals are moving away to passively managed funds, index funds and coffee can investing to save on fund management expenses. Thus, coffee can investing has become popular in the US due to higher cost adjusted returns than mutual funds.

Why Mutual Funds are better than Coffee Can investing in India?

Let me list out the reasons why mutual funds are the best choice for long term investing and wealth creation in India:

1. Few quality companies: Only a few companies in India meet the coffee can criteria. Out of the top 50 companies in India by market capitalization (Nifty 50 constituents), only 4 namely ITC, Lupin Pharma, HCL Technologies and Asian Paints make the cut.

2. Likeliness for common investors to sell early: A portfolio of companies made with these criteria would have outperformed Sensex by 5%-10% in 15 years duration. During bear phases or long periods of stagnancy in a specific stock, most investors are likely to sell the non-performing or loss-making stocks. This beats the whole purpose of coffee can investing and reduces the overall returns. Hence, the actual returns derived from coffee-can investing in India is lower than investing in good equity mutual funds.

3. Outperformance delivered by equity mutual funds: In India, actively managed equity mutual funds have consistently beat their benchmarks by as much as 8–12% annualized returns compared to 5–7% from coffee can investing. E.g. — a popular diversified equity mutual fund has delivered 11% excess returns over its benchmark in the last 5 years and 8% returns since its inception 7 years ago.

Should you still do Coffee Can Investing?

Coffee can investing is a sound investing concept. However, few investors succeed with coffee can investing in real life because of investor bias and lack of financial expertise. Our view is that if you are really interested to try coffee can investing, try it on 10% of your corpus. For the rest, investing in mutual funds remains the better choice.

Published on February 23, 2018