Investing in the stock market: is investing luck or skill?
Introducing a fictional character – random! Random’s bio describes her as a “Stock Market Enthusiast, Buffet Follower, Charts, Bhav Bhagwan Chi, Elliot Wave, Quant, FnO, CoffeeCan, Crypto!”
Random has done the following every month since 2000. From a pool of stocks that are within 90% of the total market capitalization of listed stocks (thus avoiding small capital and other illiquid securities), Random creates 1,000 random portfolios equal weighted to 50 companies. Similarly, Random creates another 1,000 portfolios whose individual stock weights vary from 0.5% to 9.5%. Thus, running a simulation of 1,000×1,000 (one million portfolios of random stocks and random weights) and holding these portfolios for one year, gives a wide range of returns distribution for these portfolios. Alongside this revenue breakdown, we put the total NSE500/Nifty returns and come up with their percentage scores.
A percentage score close to 50 for the Nifty50/NSE500 will broadly reflect a market where the randomized portfolio distribution has equal chances of higher and lower returns than the Nifty50/NSE500 returns. (Thus, equal measures of luck and skill). Similarly, the very low percentage of Nifty50TR/NSE500TR means that almost all random portfolios have given much higher returns, giving a sense of luck or high tide lifts all boats. Conversely, the Nifty50TR/NSE500TR’s very high percentage score meant a period of massive frustration, with most portfolios underperforming the Nifty50TR/NSE500TR.
in the NSE500/NIFTY50TR Celsius for the past 22 years. There have been phases of luck replacing skill – such as 2010-11, 2014 to 2017, and more recently post-Covid recovery until the end of 2021.
Then there are phases like 2012-13 and 2018-19 where investors’ ability to beat the NSE500/Nifty50 was painfully tested.
So the verdict – 18 months (until the end of 2021) has been one of the best returns for any of the Random wallets – has all worked out: Buffet, Charts, FnO, Elliott Wave, Crypto, Coffee Can, Quant etc. Beautifully, most portfolios have outperformed the NSE500TR/NiftyTR. Already, in the past six to seven months, the “luck” factor has lost some shine, with recent scores for NSE500/Nifty50 reaching 53%/59%, respectively.
This is, of course, the story of Random’s millionaire governor. In fact, most portfolios are not generated randomly, but by coordinating any particular theme/style/factor etc. So obviously there will be wallets in the real world that will have significantly different distribution ranges than Random. However, the idea of this exercise is to show that the rising tide of the market lifts most boats, and instead of confusing the skill, it would be wise to thank Lady Luck for Random’s fortunes. Such phases do not last forever.
“Risk hay toh ash hai hai” etc. sounds fun on TV, but quitting work and joining the markets full time works for very few, if any. Enjoy the spoils of the market, but don’t let stray returns get your head around.
(Harish Krishnan is Senior Fund Manager (Equity) at Kotak Mutual Fund. Opinions are personal)