What is common between CAT and capital markets?

I’m writing this article exactly a year after my CAT 06 results had come and when a lot of my friends are eagerly awaiting their CAT 07 results. When you are attempting the “all elusive” CAT for the first time, then the day of result is one which you can never forget. My memories are fresh even after a long gap of 365 days. I was eagerly awaiting my ‘Verbal Ability’ scores because my scores varied with each and every ‘Answer Key’ published by various coaching institutes. I still remember my various scores. My scores as per PT, CL, TIME and IMS keys were 31, 26, 16 and 16 respectively. Finally I got a shocker of my life when I got 6.25 in the ’IIM’s (Decider) Key’ (0.25 was ‘grace!!’ score since they had eliminated a question since 2 options were not printed for a question)

Let me delve a bit upon the capital markets at this juncture. I was thinking about investing in the markets and was analysing certain options. I was thinking about the returns of the mutual funds and that of the equity markets themselves. For those who don’t know much about mutual funds let me explain a lil on that. Mutual funds, in short are those funds (funds of ‘aam’ junta) which the “smart” fund managers invest in the equities (most common instrument) in the capital markets. There are funds like the ‘blue chip’ funds where the fund managers invest only in the blue chip stocks of the BSE sensex (India’s popular stock market index). When I was looking at the return on these mutual funds, I was in for a surprise. What I observed was the mutual funds on most occasions gave lesser returns than that of the markets themselves. Then I convinced myself thinking about fundas like diversifying the portfolio and risk mitigation in mutual funds and stuff like that. Generally mutual funds invest in debt and equity instruments and hence the returns are lower. But the funds that I observed invested only in the ‘sensex’ blue chip stocks and still gave lesser returns than the market’s return indicated by the sensex. Why is this happening? This is scenario not only in India but across the globe. Then I realised that markets as a whole comprising millions of traders are better of than the fund managers. It was a hard fact even for me to digest, but again this is the reality and power of markets. Collective wisdom is far superior to an individual’s intelligence. For those who want to research more into this you can google on topics like ‘behavioural explanation for stock market fluctuations’ and stuffs like that. In fact behavioural finance itself is a wonderful research area.

Coming back to the CAT stuff, what IIMs should have done when there was so much of an ambiguity in the answer keys? I bet even if all the IIM profs are separately asked to come up with the keys, there would have been at least 10 versions of the key. What IIMs should have ideally done is to evaluate all the answer paper on the basis of all these 10 versions of the keys and then look at the distribution of scores across the 10 keys and should have finally selected that key which gave a better 90 percentile cut off score. It was very sad to know that the 90%le cut off was around 20 last year. And doing this in definitely not a laborious process since all the answer sheets are initially fed into the system and the responses of the candidates are digitised. It takes time to feed these answer sheets into the system’s scanner and evaluating doesn’t take any time. It takes hardly a few hours to evaluate once the responses of the candidates are scanned and digitised. The logic behind this is very simple. Collective wisdom is always better than that of an individual’s intelligence the same funda of the mutual funds and markets. This is applicable to cases as that of CAT 06 English paper where different experts came up with different answers and all the CAT 06 takers would agree to me with the fact that the answers were very subjective and not objective. In fact there are a lot of statistical distributions which can be used to analyse these 10 keys. For simplicity I’m not getting into those nitty-gritties, but a simple way would be to choose that version of the key where the score corresponding to the 90%le mark is the highest. I had been thinking about this for a year, but I thought about the correlation between this aspect and the mutual funds – markets paradox and this CAT stuff helped me getting more clarity on that paradox.

For those God level profs in the IIMs who teach statistics and those mighty fin profs who are an adept at behavioural finance, please put in your thoughts in solving a real time problem like this where careers of thousands of serious aspirants are at stake! All the very best to CAT 07 takers who are eagerly awaiting their results!