We have met the enemy and he is us - Pogo

I wanted to write this post about how an average investor, who is not prepared to put in the time and effort to learn about stock picking, should invest. I came across some well written blog pieces and articles on the same subject who have put it more succinctly what I have wanted to say. 

The average retail guy should just do an Index or a large cap MF SIP, have some bonds in his portfolio and one term insurance. What he needs is simple advice but the most important thing is sticking with this plan for 20-30 years especially in a vicious bear market when all theory and good advice is ignored and thrown out of the window because the investor panics. Therefore what he should do is to at least learn the basics of how stock markets work, history of financial markets, and above all hire a advisor whom he will trust. Rest is not too complicated. But in today’s world of instant gratification who thinks of 20-30 years down the line. However, the same person will be willing to buy and hold a plot of land or flat for far longer than he will hold a stock. 

Am putting a small relevant except from Safal Niveshak's latest blog and the link to that blog along with links to some other articles.

Simple Ideas on Wealth Creation, the Subramoney Way – Part 2

“Vishal : What according to you is the biggest problem why most investors don’t succeed in the stock market?

Subra: I think patience. Go back to what Pascal said, people can’t sit tight. But look at it this way, you don’t need to do anything else than put money in an index fund. Today you have an index fund at 0.15%. Believe me, it matches with the best cost in the world. You can always argue that Vanguard is at 0.02%, but then those volumes have not built up. So all you do as a kid when you are 23-25 years old, and you can start with say Rs 2,000 per month, just do an SIP in an index fund. You will make money in the long run, as the economy grows and the market rises. Even when the market goes down you will make money as you will get more units. And look at it over a 10-15 years period. Unfortunately, people cannot do this. I think they watch too much of TV.

Just don’t do anything and keep investing in an index fund, and pick up one stock every year after doing some research and studying say 20-30 companies. It’s not very difficult to do that.

All you need is one term insurance, one savings bank account, one index fund, and that’s it. Then, anybody comes and tells you buy this and buy that, you just need to say no. And I see portfolios of people who’ve put money in 100+ mutual fund schemes without understanding what they are doing. You don’t need to do all this! This is bound to give you sub-optimal returns. Either you be in an index fund or you pick stocks. If you can’t pick stocks, be in an index fund. That’s fine. Concentrate on your career.

What is your biggest asset? Today when you are 25, your biggest asset is the present value of your future earnings. So that could be say Rs 15 crore for a 25 year old guy. So that’s your human capital. That is your biggest asset. The most important thing is to protect it. How will you protect it? You take term insurance, and you take care of your health. Because if you fall ill, you will eat into that if you are unable to earn for 1-2 years. That is your most important asset – your human capital.

Now, if that asset is in a government job, you’re sure it is like a bond fund. Nothing will happen to it. You’ll get an indexed pension. So, then your portfolio can be in equities. But if your human capital is in running a website or courses, things like you and me do, then that is behaving like equities as your earnings might fluctuate. Then your portfolio has to include some bonds.”

Excerpt ends here

So if your main income is like equity, you have to have bonds in your portfolio. And if your main income is like a bond, then your portfolio has to be equity.

There are some good "robo advisors" in the US like marketriders, betterment, wealthfront and liftoff. Even fidelity and charles schwab are now getting in to this space. The basic service of these advisors enables you to pick a portfolio of low cost ETFs or MFs as per your preferences and risk appetite. They then monitor your portfolio and alert you if you need to re-balance your portfolio at any point. This kind or service is slowly making its way into India now and I think will be a large space in the next 5 years.  

So to a young person starting off with their first job in their early 20s, I would say that you have the most powerful weapon in your hands to beat inflation and that is Time. Use the first 3-4 years to build discipline of investing a fixed amount on a monthly basis. In your late 20s or early 30s you will probably get married and have more responsibilities. And it is at this time that the benefit of having cultivated the habit of investing systematically which will come to your aid.

Don’t let your own beliefs, actions and behavior be your own enemy. Also watch less of financial tv channels and read some good financial magazines like moneylife. They are one of the best magazines in this space and provide good and clear analysis.

You can go through these links to read more.

If Warren Buffett Is So Popular, Why Don’t More People Invest Like Him?

Indian retail investors tend to lose in stock markets: Study

Retail investors are missing the equity action

On my gravestone I hope they write that "He was a cloner" - Mohnish Pabrai

Below is a summary of talks that Mohnish Pabrai gave at ISB and MDI in Dec 2013. For those who are not familiar with him - Mohnish is a classic value investor in the tradition of Warren Buffett, Charlie Munger and Seth Klarman. He currently manages an approx $500 mn fund which is highly concentrated. And also has a bedroom in his office where he naps when he gets tired of reading or cloning.

Mohnish started Pabrai Funds in 1999 with $ 1mn which had his own $100,000. From 1999-2007 he compounded at 37% p.a. and 29% p.a. after fees. Before that from 1994-1999 $ 1mn compounded at 44% p.a (before fees). After 2007 compounded at -47.5% . Last 4 and half years compounding at 25.8% a year. He says he still has 11.5 years to go to compound at 26% a year. The reason he wants to compound at 26% p.a. is because that rate of compounding doubles equity in 3 yrs and turns a million dollars into a BILLION dollars in 30 years. He talks about that by narrating the parable of how the game of chess was invented to illustrate the power of compounding. Buffett was on the 18th square on the chess board when he first heard of him. He had compounded at 26% approx for the last 31 years.

Strategy

Charlie Munger once told him that a good investment operation can be built by focusing on 

• Cannibalization (Buyback of shares)
• Cloning (Aping successful investors)
• Spin offs (De-mergers)

What stuck in his mind was the cloning part and he went about putting that in action with single minded focus. In Swami Vivekananda's words - Take a simple idea and take it seriously.

Cloning Warren Buffett's (WB) portfolio. 

If an investor had just followed WB when he bought a stock and publicly disclosed it and bought it at the highest price that day, and sold it when he did and publicly disclosed it , that portfolio would have beaten the S&P by 11% say Gerald Martin (American University) and John Puthenpurackal (University of Nevada). Also contrary to popular belief, they found that Berkshire Hathaway invests primarily in large-cap growth rather than "value" stocks. Here is the link to the paper - Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway. 

(Another interesting paper is on the way Buffett uses leverage - Buffett's Alpha). 

How is WB's portfolio replicable ? if its so simple why does no one do it. He says that it took him a long time to come up with this insight. There is something strange in the human genome that makes humans very averse to being copy cats. most humans do not consider cloning as they think of it as beneath themselves. Microsoft (most of their revenues comes from windows and office which were cloned or bought) is not even a great cloner but they are big. Sam Walton was not a high IQ person. Walmart for the first 20 years did not come up with innovation. They just copied K-Mart and Sears. Burger King just opens up where McDonald's opens up. It has worked very well for them.

Fascinating insight on Auction Markets Vs Negotiated Markets

By nature auction driven markets which have faceless buyers and faceless sellers, are set up for distortion. If WB were to just invest in private cos he would have not been able to beat the market. Negotiated markets have a informed buyer and seller and deals happen over protracted negotiation. This results in lesser distortions. 

(And this I think is what is happening in the Indian PE industry today. An Indian promoter knows very well that there is too much money chasing too few good deals even now after a number of PE funds have left or are going slow. Also perhaps explains that fact why a number of PE funds like Chrycap , Multiples, Sequoia, WestBridge to name a few are doing PIPE deals rather than private investments.)

Circle of Competence

Figure out the business and buy it at less than intrinsic value. 98% of the time you are not going to understand the business and it better to keep away from those businesses which you dont understand. Its ok to have a small circle of competence and still do very well as investing. Gave example of a developer and RE investor who invests only within 2 sq miles of San Francisco.

Buffett is a multi dimensional investor and does lots of other deals which are not just moat based deals. He also does a lot of arbitrage deals. So obviously, he does not blindly replicate what Buffett does, but he uses that as a high level filter and looks for opportunities which fall within his circle of competence. Also a number of opportunities like the GS and GE deals made during 2008 were exclusive to WB and would not be available to anyone else.

The Checklist 

In the great crash of 2008, his portfolio got decimated and had a huge drawdown. Compounded at negative 47% almost a year and half - 2008 and 2009. He attributes this to hubris as he didn't have negative returns even in 2000 during the dotcom crash. He says that he completely missed the housing bubble.

He then drew upon the idea of a checklist from a NYT article and read The Checklist Manifesto by Dr Atul Gawande. Got the idea from the aviation industry where checklists were used to lower the number of human errors. He studied his own investing errors and asked the question as to were there factors which were clearly visible before the investment was made. In most cases where the investment went bad, he found that the factors were visible. He looked at his own portfolio as well the portfolio of investors like WB etc. and studied their mistakes and if these mistakes were identifiable at the time the investment was made. He then came up with his check list which has about 97 questions.

Checklist focuses on 

• Leverage: one of the mistakes in 2007 was buying a high quality mortgage lender but the co was highly leveraged. Do not buy a business which is dependent on the kindness of strangers. 
• Debt covenants
• Moats
• Union and Labor relations
• Pre-investment talk with a peer fund manager (also got this from Munger)
• Management and Ownership
• • How much stock do they own
  • Do they act like owners
  • Track record of promoters

He also had had a 21 month period where a number of investments went to zero. Post implementing this checklist his Max PERMANENT CAPITAL LOSS has been below 1% of investment - $ 5 mn.

He also does not go meeting management or kicking the tires approach. His view is that managements in US are much more transparent and honest than Indian management and have much longer operating history. So if he was focusing on Indian businesses, he would look at potential of becoming 10x-20x in the next 10 years. But even then if he was investing a large sum, then he would need to be more active and move to India. (post that though he has recently picked up a stake in South Indian Bank. )

Portfolio strategy since 2009

• 1st 75% of cash - 2-3 x in 2-3 years
• Next 10% - min 3x in 2-3 years
• Next 5% - min 4x in 2-3 years
• Next 5% - min 5x in 2-3 years
• Last 5% - more than 5 x in 2-3 years

Make lesser decisions. Take out sized bets. Also the last 10% usually stays in cash because of this portfolio construct strategy. 

How to go about screening stocks?

Become a shameless clone. Make a list of investors you admire and who have done well and make a list of their investments. 

Portfolio construct

Munger feels 4 large stocks are enough. However, one can build portfolio from 10-12 large stocks. Don't focus on all industries and sectors. Buy full position at one go. No need to stagger. Too much diversification is a hedge for ignorance. In bad times (2008, 1929, 1987) the correlation goes to one and the diversification does not help.

Why do super investors invest alone and dont have a large team?

Even a 10 member team cannot evaluate more than a few hundred public companies every year. There are about 50,000 companies listed globally. The investment manager will end up taking shortcuts with or without a team as the data set is too large. Hence having a large team , where ultimately the decision is made by the fund manager is not different from a small team with the same fund manager. Other reasons could be differing circles of competence, large motors are not good at grinding away without result-less action. There is a natural bias for action. Also how do you compensate anyone who generate zero ideas. [Ask the MF and PE guys in India. :-) ]

Resources

Gurufocus.com, valueinvestors.com, sumzero.com, corner of berkshire and fairfax, the manual of ideas, edgar online, graham and doddsville (news letter of Columbia Business School), ibillionaire.com and dataroma.com & oid.com 

However the single most quality is patience. John Templeton said that the best analyst will not be right more than 2 out of 3 times. No one can escape a loss. 

Exit criteria

Write down your exit criteria before you enter. It should fit in 5-6 sentences. Basically price should be above intrinsic value. Evaluate intrinsic value every 3-6 months and not every day or week as businesses go through ups and downs. If a share you bought at $10 and you thought the intrinsic value is $40 at the time of entry. Say it goes to $ 40 in 2 years and you reevaluate that the business is now worth $ 60 then hold. If you think the intrinsic value is lower then you no longer hold and you sell. 

There is another one which he gave at Columbia university. Will blog on that next week.

Link to the ISB talk:

https://www.youtube.com/watch?v=xa1CH2nK1cM

Would love to get some feedback on the blogs.

Tks

Kenneth Andrade ke investing funde

In his interviews, Kenneth comes across as someone who has got his investing basics really ingrained and a very clear and consistent thinker. I was reading an article on him published in Forbes in 2011 and listening to his interview on CNBC two days ago and he almost used the same words in talking about his investing style and philosophy.

So here is what I think sums up his style:

1. It is important to be on the right side of the longer term trend: He said in his interview on 16th July 2014, " If I step back into history midcaps have never lost money for a lot of people. They have actually been the better part of the market to be in if the cycle is in your favour." (emphasis mine) This is very basic but key long term trend following principle. Remember Patridge from Reminiscences of a Stock Operator: "Its a bull market". My guess is if Kenneth were not a long only MF fund manager he would be clearly be a trend following trader/investor using price as a key input in his decision making. There is another line in the Forbes 2011 article which supports this - "Andrade has become a bit more aloof, choosing to retreat inside his cabin on the sixth floor. There, he stays put for hours, poring over historical charts."
2. Stay within your circle of competence: The mid-cap universe comprises around 1,500 companies, whereas close to about 700 companies are invest-able or can be invested by mutual funds or large institutional investors. “Of the 700 companies you have to bring them down to about 60 companies, which is 10 percent of your invest-able universe. If you have been able to do it in a fairly regimented manner for a very long period of time it is not dangerous at all,”. 
3. Pick companies that respect capital: If companies are able to consistently maintain strong ROE/ROCE it would mean that they are efficient users of capital and have pricing power. In his own words - "Don't buy underlying businesses, buy profitability.". Other things he looks for are virtual monopolies, financially sound companies that are preferably debt free and leadership position of the company its sector/industry. Things he does not necessarily look for is cheap valuation. He says, "Monopolistic companies make all the money. Be prepared to pay a price for it." 
4. Be patient and wait for price to be right to buy a stock: He says, "I have never seen a company at a value I wanted to buy that I could not buy. Stock prices always swing and correct. If you wait long enough you will invariably get them at the value you want." So there is definitely an element of market timing. Has to be for someone whose move will have impact on prices. 

Kenneth also talks about how he goes about picking a winner and how he constructs his portfolio. When ever, he identifies a new space, he buys all the leading stocks in that space and then uses the performance data put out by these companies to evaluate how to re-balance his holdings. As the winner in the pack breaks ahead of the rest, he then lightens down his position in the other stocks and focuses on the winner. Winners stay, losers go.

Now none of the above are some major innovations or new ideas, but they provide a clear framework of what he looks for. Its rare to come across someone who speaks consistently about his process and criteria over years. Regular Biz TV journos are always asking market men for their "big idea" or "big call" but that is probably the wrong question. The better question or bigger takeaway for someone trying to be a better investor is to look at their investing principles and try and emulate them.

Now how to implement the above. That is probably an idea for another post.


( Disclaimer: i am an investor in his funds so my views may be biased. This should not be construed to be investment advice of any kind)

Don't fight the trend

Don't fight the trend and don't try to get perfect in your timing. However, you do need to get your timing approximately right. And you absolutely need to get the direction of your trend right. If you are on the right side of the trend then it is unlikely that you will lose. Modi got the nation's trend bang on and the Cong tried to force fit its view of the nation on its election campaign and we all know by now what the result is. BJP - All Time High and Cong - All Time Low. The Cong strategy of subsidies and doles did not help it any of the assembly elections post 2011 - UP, Rajasthan, Gujarat, MP and Delhi are those that come to mind. Cong's Stop Loss kept getting hit but they refused to exit their position and kept holding on to it. The BJP in contrast read the country's mood right, which had changed from 2011 onwards post the Anna - Arvind movement. They adapted their strategy. For eg in  Delhi  when they changed their CM candidate at the last moment and refused to indulge in horse trading to form a govt it was a new way of doing politics. They hit small SLs in order to capture the big trend. They took small volatilities in their stride and made their strategy anti-fragile. They benefited handsomely from the great big shift made by the indian voter. 

Same goes for life and trading or investing. Take the small SLs and keep your eye on getting the big trend right. Now various market commentators have gone all out around election time and said we are at the cusp of the mother of all bull markets. We don't know that and we will only know that in hindsight. But what we do know for sure that we are in a new uptrend after the market broke through the 2008 and 2010 highs after a 6 year consolidation and that is Bullish. No question about it. 

How far will it go? What is the right time to get in (if you havent already) and what to buy? Depends on your risk appetite and approach. However, be aware that there is nothing called a passive investment strategy. Also investment doest mean certainty or guarantee of returns. If you are SIPing every month that is also active but a different level of activity. And all forms of investment / trading / HFT etc. are different forms of speculation (which comes from the latin word speculates, which means to look at or observe) . For e.g. when you talk to an investor, listen carefully to their choice of words .He/She will say - We are taking a bet on this sector/entrepreneur/product/service etc. If this is not speculation - what else is it? Contrast that when you speak to a trader - A good trader will be focused on managing his risk. Now tell me who is investing and who is gambling? And ironically in most media articles and those by value investing gurus , there is a clear sense of bias against trader or short term investors. And its cleat most of these value guys have never ever read a book on technicals or tried to devise a proper trading strategy. And then they propound that having a an open mind is very important.

Anyways that was a bit of digression. Having seen both sides of the divide - I can only point those with an open mind to learn, to please read the latest paper by Cliff Assnes (CIO of the $105 Bn firm AQR Capital) titled Fact Fiction and Momentum Investing which is backed by clear numbers. Momemtum (or so called traders) beat value (so called investors) in terms of returns and risk. However, no one style works all the time and that a combination of value and momentum has the best risk return profile, In other words you need both in your portfolio. Also if one were to look at the returns of George Soros vs Warren Buffett, then Soros' returns beat Buffett by a mile. The reason why Buffett has more money today is that Soros gave away a lot of his money in the 1990s. And btw, Buffett beats the market by constructing a low beta portfolio and juicing it up with leverage of about 1.6x. (Buffet’s Alpha). And don’t miss the green line. It belongs to John Bogle.

The above graph is from http://hedgefund.blogspot.in/2010/11/portfolio-manager.html

So coming back to where to invest: take cues from the market. Pick a good business, management and a stock that is performing well. Some value/fundamental guys tell me they don’t have the time to spend on managing their portfolio on weekly basis. Spend little bit less time on twitter and Facebook and more time on your portfolio. Spending time doesn't necessarily mean trading in and out. Educate yourself on technicals which are useful also for long term investing. And more importantly back test theories and strategies. Don’t take anyone's word for it. I write the above not to look down on value/fundamental guys - I was and still am one of them - but I have also incorporated technicals and that has helped me immensely in terms of execution. I write it so that they add execution tools to their analytical tools. Knowledge of technicals will immensely improve your execution skills.

So what will most likely outperform over the nest 1-2 years: Good quality stocks in banking, oil and gas, auto, agri. IT and Pharma will no longer have the tailwind of a very weak currency but will do well as the US recovers. The broader market should also do well. However, it is not going to be a straight line up. There will be periods of doubts as the market shifts it attention to macro nos, rbi policy, cabinet formation and global macros. This is healthy because bull markets need a wall of worry to climb. If there is no one out there in the market who is taking the other side then its likely to be a top. 

In terms of levels 6600-6700 is going to be the first level of support for the nifty and the a more longer term and stronger support is at 6300-6400 - which was the previous top and resistance. If it breaks the second level, I would take a re-look at my strategy.

So go long. But if you are wrong, have your stop loss and exit strategy in place and go back with a Modi-fied one. I have mine... Do you have yours?