Aequitas, DFA and the Case for Clarity

(1/5) When I first heard of them...

I was frankly underwhelmed. And it was obviously not about their chart-busting performance. I guess it was the purist inside me who had seen enough of the click-bait messaging they too were using - "10 year CAGR" returns of 33%.

*compounded average growth rate

But that message did stay with me (so the click bait worked) and I started to follow Aequitas Investments. And then, when I realised that they have built their entire AUM (Assets Under Management) on their own and that they have stopped taking fresh funds, my interest was more than piqued. Its very rare that people say no to "Lakshmi" and even rarer, that fund houses decide to slug it out on their own and say no to any (distribution**).

** Please see the last section on page 4 for my take on distributors.

A month or two later (in March24), I heard the founder Siddhartha Bhayya calling out the excessive valuations of the Indian markets. Now this was just a few months before the Lok Sabha elections. I cant think of any one on the street who had a contrarian view. Or if anyone indeed had, was expressing it. This was around the time when some of the wealth managers I was in touch with (on account of the families we work with) were singing non-stop peans on India story. The noise levels were deafening. I wonder sometimes if this lot is getting specially paid for selling the India story as why else a wealth manager, whose job per se is to help clients right-size their allocation decisions (based on their risk tolerance & capacity), will get carried away#

# cue - find out how they and their firms earn

In September of that year (24), I got to know that Aequitas had gone almost fully into cash and had been buying Gold. (This did bring back sordid memories of a fund manager) who had done something similar 16 Septembers back (in 2008) - but unfortunately for him and his investors, he got so carried away that he stayed in cash even as governments around the world stepped in to bail out the world economy. The markets that had fallen like nine pins galloped back like there was no tomorrow. It was not only the end of his fund but the end of a good franchise built over years).

Aequitas had taken another contrarian bet by launching a China (Far East) fund. Now this was super-interesting as almost no one on the street were ready to even spell the word China. And for good reasons. As they had spelt it many times over back in 2018-19 (classic herd mentality) and got clients to buy China funds only to see the NAVs fall by 50%.

(2/5) I decided to meet the Aequitas team ...

One of my first questions to them was on their cash call. It was not about their thesis. While I am no expert on markets, the frothiness and the drumbeats (bordering on jingoism) were indeed signs that a long overdue price and/or time correction was around the corner. My question was on an ideology I have come to believe in**.

** now what ideology am I talking about? Please see the last section on page 4.

That is when I realised that they do not consider themselves to be a typical Equity fund house which will willy-nilly go up/down with the markets. They think & operate like a hedge fund.

Aequitas does not employ leverage. At least until now. However, they have indeed taken a huge & bold call on their India strategy by going into nearly 100% cash and moving a large part of that cash into Gold. Which means they are expecting a significant price and / or time correction. And they are sticking to it.

The key in any such binary call is the thesis, and the research behind that thesis. And importantly the temperament of the team. Whether it is a collective decision or a solo-show. Based on my several meetings with Aequitas and their detailed monthly notes, what became clear was a clear & cold method behind these bold calls. Hence, when they started to accept funds again in January25, we decided to introduce clients to them. Their minimums at INR 25 crores are though very high. Which means not everyone can invest.

They have now decided to launch another offshore fund - though unlike their Far East fund, this fund would invest in opportunities across the globe. They are calling it the G.O.A.T - Global Opportunities by Aequitas Team. https://youtu.be/zQ6FPT-xpc

The minimum threshold is USD 1 million, lower than their minimum threshold for their India strategy but high enough nonetheless. Their fee structure is also pricey. A 2% per annum management fee and a 10% profit share without any hurdle rate! However, what I like about them is that they "price their products with pride". Something, us the fee-only advisors need to take a leaf out of.

(3/5) Diversification is the only free lunch ...

At Serenity Wealth, as a thumb rule, we have been suggesting a minimum 10% allocation to global assets. Or at-least 5%. I do not have a crystal ball to say that global assets will yield higher return than Indian assets. The suggestion stems from our belief in diversification (across asset classes and geographies), which as someone* said is the only free lunch available in investing.

*this someone was a Nobel Laureate - Harry Markowitz, father of Modern Portfolio Theory.

Hopefully, with the poor performance of Indian markets in the last one year, and the significant out-performance of global markets, more and more Indians will consider diversification of their portfolios. I am not sharing any data (on market performance) as I believe that diversification decisions should be strategic in nature, and not tactical, and I do not wish to use the near term under-performance of Indian equitys to push my case for diversification.

The good news is that many Indian Asset Management Companies are also setting up offshore funds out of G.I.F.T. city (Indias global & tech hub which also has an International Financial Services Centre). In addition, there are broking platforms like Interactive Brokers which provide access to Global ETFs (Exchange Traded Funds) to Indian residents who wish to diversify beyond India.

So yeah, while a manager like Aequitas might be out of bounds for many, there are options aplenty. The key is the decision to allocate moneys to global assets. In the very long run - the underlying scheme should matter less. You do however need an experience fee-only advisor next to you to guide you through this process**.

**please see the last section on page 4 why you must have a fee-only advisor for such decisions

(4/5) Poles apart - Dimensional Fund Advisors & Aequitas Investments ...

I recently discovered this US based fund house (DFA), which positions itself at the other end of fund management capabilities. While a firm like Aequitas prides itself on its prowess to identify trends and valuation gaps in stocks, sectors, and countries and thereby outguess the markets; DFA on the other hand humbly submits itself in trusting the markets and using market data & a systematic approach to target higher expected returns. So unlike Aequitas they do not go through realms of macro data & balance sheets. They instead create market portfolios using scientific theorems & evidence based frameworks built and carried forward by award winning academicians and economists.

Its early days & we need to dwell deeper, but seeing their multi-decade performance charts and the resoluteness of sticking to these theorems and frameworks, our instinct tells us that if you ought to repose your faith on a human led model, find a firm like Aequitas but if you much rather invest your equity allocation (in a fill-it-shut-it manner), DFAs funds deserve more than a closer look.

The one common feature between these two is their apparent lack of belief on distributors, evident by the former not relying on any and the latter following a rigorous training program before onboarding one. From whatever we have seen so far, DFA seems to be working with fee-only & registered investment advisors. Firms such as ours, but located in different parts of the globe.

(5/5) Finally, the last section ...

My take on distributors: Its actually a simple, common-sensical take. The person (wealth manager) who is supposed to take care of your interest should be compensated by you alone. In other words, you should take care of their interest, not the funds or schemes they deploy your money in. The latter implies a conflict of interest. Equally important is that the end fund or scheme you invest, is the last of a series of decisions you must take in your investment journey. At Serenity, before we get to Product, there are 5 more Ps we cover: Purpose > Personality > Policy > Process > Portfolio construction (or reconstruction). The fee you pay to us is for these 6 Ps, not just the last P. A distributor by law is not allowed to dwell into these strategic conversations. So we really do not get the logic of a distributor earning a commission on your money year after year. A one-time introduction commission? Yes. All through the period you hold the investment? No.

My ideology when it comes to equity fund managers going into cash: The decision of how much equity one holds is that of the investor. For example, based on an extensive exercise done by a fee-based advisor, let us assume that it is agreed that you should invest half in equity - say on a 100 Re portfolio, 50 Rs is in equitys. Of this 50, say 20 was given to Aequitas. The investor had signed up to remain invested in equity and only re-balance when needed. Now when a firm like Aequitas goes into full cash, the investor has only 30 Rs (50 minus 20) invested in equity. You might argue that it is their call and it has worked well as markets are down in the last one year. But what if their call had gone wrong? And instead markets had gone up. It could have affected your long term plans of how much return you were seeking from your investments. Hence, you will see most of the equity funds remain more or less fully invested as that is the mandate for them. As clarified earlier, Aequitas has positioned itself as a hedge-fund. So the investor knows in advance what to expect.

Why you must only consult a fee-only advisor for any strategic decision making: You might have a fee-based advisor (but not a fee-only, there is a marked difference) but he or she is employed with a wealth management firm which has a distribution arm and / or has its own in-house funds. Typically, and this is lived experience (having seen the industry from up-close for over two decades) such firms derive a large % of their revenues from distribution commission. Now let us say there is a fund out there which has a good track record and which does not want to entertain distributors. So naturally this fund will not be on the "sell-list" of this wealth management firm. Hence, its clients who have signed up on fee-basis will not get to see this fund. Whether they invest or not is another matter. Worse still, if this firm has its own funds, there will be a natural tilt to put forth their own funds.

With respect to global funds, there are wealth management firms who are launching their own global funds. One of the Johnnys Come Lately had the audacity to even mis-represent their fund managers track record! How do you expect such firms to do justice to your global allocation or to any allocation? It is possible that they might just pull off a good performance. But we should really care about the process and the ethos. Hence I always suggest that - you are better off investing in the equity of such firm (if they offer you, i.e.) as many would fall for their chutzpah, but you should be wary of investing through them.

The information provided in this note, the opinions expressed, is for general informational purposes only and should not be construed as advice and is not to be relied upon as the basis for any investment or other decision. Please also note that investments in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.