Will Bottom Fishing Help You To Maximise Returns?
The investment world is all about making wise investment decisions and optimising returns. To achieve this, investors use various investing strategies and styles, depending on the market situations. There are two type of investors, one who believes that past performance is the right way to gauge the future performance and, therefore, funds with a demonstrated track record of higher returns will continue to do so.
The other type of investor believes in the cyclical nature of the performance of funds and hence the funds with lower, or rather, lowest returns can turn into a multi-bagger for the investor. But these investments can be riskier at the same time.
The latter strategy is known as bottom fishing. Bottom fishing is the technique of investing in assets that have witnessed a sharp decline in their values due to intrinsic issues and external factors. The art of bottom fishing is all about speculating on the recovery in the prices of the depressed asset classes. So, this strategy is nothing but a way to invest in underperformers that are expected to witness an upturn in the coming period.
In the current market scenario where the equity markets have become choppy, many aggressive investors are looking for potential opportunities to buy into funds. Long term wealth creation requires lot of the patience and consistency. During periods of volatility, one can even invest into the underperforming funds to grab them at lower values. But will such investments yield better returns for the investors? Should you invest into funds that are underperforming the market? Is such bottom fishing helpful? To find answers to these questions, we analysed 254 funds irrespective of their categories. First, we calculated the yearly returns of these funds based on their NAVs for the period between March 2009 to March 2018. These funds have been ranked into quartiles according to their returns. This means that first the funds have been sorted based on their returns and then the funds appearing in the top 25 per cent are marked as quartile one, the next 25 per cent are marked as quartile two, which is then followed by third and fourth quartile.
To check if bottom fishing is beneficial for investors, we analysed the funds which are lying at the bottom of the returns , that is, in the last quartile and their prospective returns in the coming one, two and three years.
Positive turnaround
Investors are usually more concerned about the turnaround in the returns of the scheme. They want to know whether they had invested in the underperforming funds that are lying in the fourth quartile and the chances of the turnaround of those funds in next year. According to our data analysis, on an average, there is a probability of 0.21 or 21% that the underperforming funds of last year would be the top performers next year, that is, they become part of top quartile in terms of performance. We did this study every year starting with 2009 and ending with 2018. On an average, the chances of outperformance of the underperforming schemes of this year in next year is 21%, considering the last nine financial years. If we consider the scenario for two years and three years, in these cases too the probability remains almost the same at the level of ~20%. So, in a layman's language, out of every 10 underperforming schemes, two schemes will show an exceptional turnaround in the next 1, 2, and 3 years.
The case of continued underperformance
Every coin has two sides. Even though we have observed that almost 20% of schemes leapfrog from being underperformer to becoming outperformer in the time frame of 1, 2 and 3 years, there are funds that remained at the bottom of the performance. That is, the underperformance of these funds continued for at least three consecutive years. In this case too, the probability is high. On a yearly basis, the probability of this is observed to be around 29%, which is further enlarged to 36% when we take two years of study. So, buying losers can also be quite risky. The multi-year bad themes are also the reason for such continued underperformance. The pharma and IT space, which is witnessing a turnaround in the last couple of months, had witnessed long-lasting two bad years in the recent past. This was also observed with the infrastructure theme during 2009 and many years ahead.
Hence, your chances of winning can be improved if you can weed out the sectoral themes that are set for a prolonged underperformance. So, post analysis of the various condition sand parameters, we can see that the chances of losing seem to be more than the chances of making profit.
Even though investors can make decent returns out of the perfect choice, this can be a bad gamble with the investment if the choice goes wrong as the investor may suffer huge losses. The bottom fishing strategy is expected to underperform in the rising market as it is more like value investing which underperforms during a bull market. From the above study, it is very clear that bottom fishing is an attractive short-term strategy.
However, it can be a risky game since even the most seasoned investor will find it impossible to account for all the factors that will help him to identify the winning fund. So, considering all these aspects, investors should use bottom fishing wisely and only when he is totally confident about the fundamental attributes of the fund, otherwise the chances of losing money is much higher. Investors who can bear the high risk can be rewarded with high returns by this strategy which takes a contrarian approach to investing into the underperformers.
However, for the risk-averse investors, bottom fishing is a very risky affair, so it is advised that they should stay away from this and use the regular strategies of investing to reap returns.