Let me share an interesting story with you all. It all started in 1973 when Princeton University professor Burton Malkiel claimed that a “blindfolded monkey could throw darts randomly and select a portfolio that would do just as well as one carefully selected by experts.”

Then in 1999, a chimpanzee actress named Raven rose to fame when her ten dartboard picks reportedly quadrupled the performance of the Dow and doubled the performance of the Nasdaq composite.

In 2010, a Russian circus monkey named Lusha picked an investment portfolio that “outperformed 94% of the country’s investment funds” to great acclaim. In 2013, Orlando the cat, a fierce new competitor, joined the rest of them in stock picking.

Hearing these stories added fuel to the lockdown boredom, powered by the rise of DIY platforms and trading apps. Thousands have started dabbling in the stock market actively. Most of them have made a killing from the one-way ride over the past 18 months.  More often than not, many confuse this winning streak for talent. As a result, many investors prefer to invest directly in stocks. 

However, nothing lasts forever!! Consider the other side of the story of our dartboard investors.  Where there is extra return, there’s usually an additional risk. For instance, in 2000, when the trend in the market reversed, Raven faced severe losses than the professionals.

Here, I agree with Chris Sacca

It makes the trick behind this dartboard investing clear. Any portfolio of randomly selected stocks from the universe is bound to include mostly smaller companies. Since small companies have more risk than the market as a whole, they were able to beat the market in the bull run.

Academia recognizes the small-cap premium (Fama French asset pricing model eloquently deconstructs it). Small stocks offer an extra return for taking the additional risk. These companies may not be well known, global, or well-capitalized. They often pay more for borrowing money.

More often than not, bull markets are characterized by irrational exuberance. Psychological effects and speculation also play a prominent role in the markets. Typically, companies that are a few notches below in the quality curve run the fastest in a bull run.

If you are someone who is longing for experimentation and turning life experiences into learnings, then maybe this time around, you learn from someone else’s mistake (and avoid making expensive errors yourself)

We simulated the dart-throwing monkey model for Indian market by randomly selecting stocks from the one listed on the exchange over 2015 till now. In the next step, we create equally weighted portfolio and repeat this exercise over different periods. Next, we compare the average return of the random stock portfolio with a portfolio of  ten diversified mutual fund schemes and the market benchmark – Nifty 50.  Results are offered in the table. Amazed? Shocked? Surprised? We all were.

I would request your attention to 3rd row (Jan 2018 – March 2020), which was different from all the other periods and which highlighted the huge drawdown in random portfolio. 

Till the time market rally continues, investors with a random portfolio may benefit. Still, as soon as the trend reverses, one should be prepared for the volatility to play out.

Another figure to note is the return 10 MF scheme portfolio offers for Jan 2015 till now. It will not be wrong to say that 10 MF scheme portfolio gives consistent return with lower volatility vis a vis random portfolio (as per expectations)

To cut a long story short, invest in asset classes that reflect your personal ability to withstand volatility. It’s not about a choice of investing directly (DIY) or indirectly. Both approaches are not at odds with each other. You can do both focusing on how to derive maximum benefit. Identify gaps in the current portfolio and fill them with exposure to countries and sectors that the portfolio currently lacks. Current euphoria is scary; Play it safe, plan how you will act in a bear market.

 
Dr. Tarunika Jain Agarwal Ph.D.

Supported by Manjeet Singh for Data Analysis

Alpha Research