Investing in the stock market: is investing a chance or a skill?

Over the past few years, many new investors have entered the financial markets lulled by promises of “easy money”, “quick returns”, etc. a function of your skill. Is there a way to gauge whether investment returns are more due to luck or skill?

Presentation of a fictional character – Random! Random’s tweet bio describes him as “Stock Market Enthusiast, Buffet Enthusiast, Charts, Bhav Bhagwan Che, Elliott Wave, Quant, FnO, CoffeeCan, Crypto!”

Random has done the following every month since 2000. From a universe of stocks that are at less than 90% of the overall market capitalization of listed stocks (thus avoiding micro-caps and other illiquid stocks), Random creates 1,000 random portfolios of 50 equally weighted stocks. businesses. Similarly, Random creates another 1,000 portfolios with individual stock weightings ranging from 0.5% to 9.5%. Thus, running 1,000 x 1,000 simulations (millions of random stock portfolios and random weights) and holding those portfolios for a year yields a wide range distribution of returns for those portfolios. Alongside this distribution of returns, we place the NSE500/Nifty total returns and arrive at their percentile scores.

A percentile score closer to 50 for Nifty50/NSE500 will broadly reflect a market where the random distribution of the portfolio has equal chances of returns above and below the returns of Nifty50/NSE500. (And so, nearly equal measures of luck and skill). Likewise, a very low percentile of Nifty50TR/NSE500TR would mean that almost all random wallets gave much higher returns, giving a sense of luck or a rising tide lifting all boats. Conversely, a very high percentile score of Nifty50TR/NSE500TR would signify a period of massive frustration, where most portfolios underperformed Nifty50TR/NSE500TR.

As a percentile score of NSE500/NIFTY50TR over the past 22 years. There have been lucky phases that have replaced skills – like 2010-11, 2014 to 2017 and recently the post-Covid recovery until the end of 2021.

And then there are phases like 2012-13, 2018-19 where investors’ ability to beat NSE500/Nifty50 was put to the test.

So the verdict – the 18 months (to the end of 2021) was one of the best performers for any of Random’s portfolios – all of Buffet’s expertise following, charts, FnO, Elliott Wave, Crypto, Coffee Can, Quant etc. performed beautifully, with most wallets outperforming NSE500TR/NiftyTR. Already, over the last 6-7 months, the luck factor has lost its luster, with recent NSE500/Nifty50 scores being 53%/59% respectively.

This is of course the story of Random’s million wallets. In reality, most portfolios are not built randomly, but based on a particular theme/style/factor etc. It is therefore clear that there will be wallets in the real world that will have distribution ranges very different from those of chance. However, the idea of ​​this exercise is more to show that a rising market tide lifts most boats, and rather than confusing it with skill, it would be wise to thank lady luck for Random’s fortune. And such phases do not last forever.

“Risk hai toh ishq hai” etc. sounds like fun on TV, but quitting a job and joining the markets full-time only works for very little, if any. Enjoy the loot from the market, but don’t let the dizzying returns go to your head.

(Harish Krishnan is Senior Fund Manager (Equities) at Kotak Mutual Fund. Opinions are personal)


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