Day 21: Invest for a cause

And just like that I am on day 21. 

Today I am going to just talk about one point and that is please understand the difference between investing and speculating. Its not a simple trivial point. There are also no value judgements being cast about being a speculator. But unfortunately society tends to overrate investors and look down upon trader or speculators. 

Graham and Dodd many years ago said: Investment "is a convinient omnibus word, with perhaps an admixture of euphemism - i.e., a desire to lend a certain respectability to financial dealings of miscellaneous character."   

Investors provide long term patient capital and speculators provide short term liquidity and price discovery. We need both for markets to function efficiently. 

Warren Buffett is an investor and George Soros is a speculator. Both are very good at what they do and they are very successful at what they do. But they dont pretend to be what they are not. 

Warren Buffett offers a simple yet insightful take on this. Investment as Buffett explained: "And I say, the real test of how you - what you're doing is whether you care whether the markets are open. When I buy a stock, I don't care if they close the stock market tomorrow for a couple of years because I'm looking to the business - Coca Cola, or whatever it may be, to produce returns for me in the future from the business.” On speculation he said, "It's a tricky definition. You know, it's like pornography, and that famous quote on that". (Supreme Court Justice Potter Stewart famously wrote that, regarding whether something was pornography or not, that, "I know it when I see it.")

In short, Buffett basically argues that what separates and investor from a speculator is the intent of the person engaging in the transaction. However, upfront it is very difficult to provide a precise definition of both.

What is important is to know what your intent is: 

• Do you care the about price every hour or do you look at price once a month or quarter and evaluate your portfolio. 
• Do you buy because your friend is buying or are you buying because you understand the business and have done your homework. 
• Do you intend to hold on to the investment for atleast a few years or are in only for the next few days or weeks.

If you are able to answer these simple questions upfront before buying then you would know what you are doing.

Given below are list of blogs which have received the maximum page views, so I assume they have resonated with a lot of people.

1. Day 6 - Understanding Greed and Fear
2. Day 18 - Buy a home beta!!
3. Day 1 - Introducing "Behavior Gap"
4. Day 11 : Understanding Greed and Fear: Herding Bias
5. Day 19 - Mutual Fund - Index or Active Management

I have really enjoyed writing these blogs over the last twenty one days. I would be continuing to write on a weekly basis now. And I hope to be regular.

I would also like to say thank you to all the people who have contributed so far to my campaign for the Nudge Foundation. They are doing a wonderful job. I hope many of us come forward and support this cause.

You can contribute here: http://thenudge.ketto.org/anishpteli

Regards
Anish
QED Capital

Important Disclaimer: Please do not treat anything on my blog as investment advice. I do not provide any recommendations of any stocks or securities. Any stock mentioned may be merely by way of an example

Day 20 - Buying stocks - If you must

Its a full time business. Not a hobby. But most people treat it like one. Remember, you never make money off a hobby, you only spend it. 

Stocks are have a very high internal correlation than any other asset class. For eg the correlation between Tata Motors and HDFC Bank will be much higher than steel and crude oil. So I personally think obsessing with stock picking is overrated. If you pick the right sector and get the direction of the stock market broadly, your job is done. Even if you get the market direction right and buy good stocks, you are done.  

However here are some guidelines from Security Analysis by Graham and Dodd.

There are three aspects to consider while constructing your stock portfolio
1. The value of a stock depends on what it can earn on the future.
2. Good common stocks are those which have shown a rising trend of earnings. 
2. Good stocks will prove sound and profitable investments. 

Now lets do a very simple exercise. We will see the returns of Nifty of the past 5 years. And then i randomly picked some stocks to represent each sector.

So we see above that nifty has given annual return of 10.4% for the last five years. Now recount all the events that the market has seen to get here. 

1. Coal Scam and other UPA Scams 
2. Modi elected in 2014 
3. Three years of Raghuram Rajan
4. Taper Tantrum in the US
5. Ben Bernanke leaving and Yellen taking over
6. Start of rate hikes in the US
7. Greece crisis and talk of Grexit
8. Oil price collapse by 75%
9. Brexit
10. Trump election

I picked Sun Pharma, Infy, HDFC Bank, Hindalco L&T and Zee to represent Pharma, IT, Banking, Materials, Industrials and Media. 

The return that this portfolio made is 16.5% which was a big surprise to me also. Inspite of having laggards like Infy, Hindalco and L&T  the portfolio has done quite well. This is not a recommendation but just an example. A real portfolio should have atleast 10 stocks but not more than 15. Over 15 there is diminishing return from adding more stocks.

The important thing is not in the stocks picked but holding them through the events that we have witnessed. Temperament trumps intelligence any day in the investment business. 

Buy and hold doesnt mean never sell. Even Warren Buffett evaluates his portfolio and sells losers or books profits in stocks he believes are over valued. But thats the tough part that most people dont focus on - When to sell ?

Regards

Anish

QED Capital  

Important Disclaimer: Please do not treat anything on my blog as investment advice. I do not provide any recommendations of any stocks or securities. Any stock mentioned may be merely by way of an example

Day 19 - Mutual Fund - Index or Active Management

Occam's razor ( "law of parsimony") is a problem-solving principle attributed to William of Ockham (c. 1287–1347), who was an English Franciscan friar, scholastic philosopher and theologian. The principle can be interpreted as stating Among competing hypotheses, the one with the fewest assumptions should be selected.

Picking mutual funds is perhaps even more difficult than picking stocks for me. You cant talk directly to fund managers to find out what they are like. So you have to evaluate the fund house, fund returns and a bunch of numbers. Basically you are picking the guy who is going make decisions for your money but you have very little knowledge about him. When picking stocks, there is a lot more information available about the promoter of the company, media interviews and the fact that they have been managing the company for a certain time frame. Here you dont know how much skin the fund manager has in the game. While recently there have been disclosures in India about fund manager investments and their salaries, it is still not enough.

And then most of them dont even end up getting average returns.

In the US mutual funds, the S&P Index vs Active Report June 2016 reported that:

• Over the five-year period through June 30, 2016, 91.91% of large-cap managers, 87.87% of mid-cap managers, and 97.58% of small-cap managers lagged their respective benchmarks.
• Similarly, over the 10-year investment horizon, 85.36% of large-cap managers, 91.27% of mid-cap managers, and 90.75% of small-cap managers failed to outperform on a relative basis

You can read the entire article here

The good news is that in India the numbers are better. But its still about 50:50 chance. A coin flip. And the edge will diminish as the market becomes more institutionalised. 

So by Occam Razor's principle, I would pick an Index MF or ETF for the average retail investor. Now make no mistake an Index ETF is sold as a passive investment. It is not. It is a very basic trend following system where a committee lays down a set of rules and criteria of including and excluding stocks in the index. Stocks which fulfil the criteria stay and those which fail, go. Similar to trend following where winners stay and losers go. Remember our friend: Disposition effect - Holding on to losers and cutting winners. An index and trend following strategy do the opposite.

You can read more on this topic here:

1. The future is passive

2. Index Fund or ETF

3. MFs are not hands off investments

Another decision to make is whether one should make lumpsum investments or do an SIP. I would say do an SIP for your regular savings and if you do get a lumpsum windfall like a bonus or from sale of another investment, then invest that amount over 6-12 months and not immediately.

There is no need to have so many mutual fund schemes. There are perhaps more schemes than there are investible stocks in India. 

Regards

Anish

QED Capital

Day 18 - Buy a home beta!!

Upfront disclaimer: I may be suffering from a full blown case of confirmation bias and I may be looking only for information that suits my belief. So bear with me. 

Rent hai paraya, aur EMI hai hamara. Thats how homes are sold in India and world over. Playing on our primal instincts for shelter, this social construct is now an industry so large that the global economy can be bought down with it. 2008 is still fresh in our minds.

Germany is perhaps the only developed country where home ownership is not encouraged. Germany’s home ownership rate remains quite low at 43% in 2013 vs 66% for Britain in the same year and much higher in most other EU nations. The only populace that rents more than the Germans is the Swiss populace. And we all know that the Swiss and Germans are quite logical and rational albeit boring maybe.

You can read more here. Most Germans don’t buy their homes, they rent. Here’s why

The only reason one can perhaps buy a home if it is available at a reasonable price (as a thumbrule your house should not exceed 2-3 years of gross annual income at the time of purchase) is to use it as a piggy bank to save your surplus income. I doubt most homes in Mumbai would qualify. If you are not savvy enough to invest in equities and mutual funds, then perhaps a home is ok. But it would be stupid to buy one, especially at these rates, if you are a decently savvy and well informed investor.

Why It's Plain Stupid To Buy A House In India

A blog on this by well know finance advisor Subramoney : Should you buy real estate?

A table is worth a thousand words. So look at the post tax returns below. Assuming you can sell your property at will at the price you want, you would still make a much lower amount than equities and just as much as gold. 

But if you had bought Asian Paint shares versus a home, you would not have called people home for a Griha Pravesh and got some social rub off of owning a home. Imagine how the conversation would go: Your mother/father calls up your relatives and invites them home for a puja because 10,000 shares of Asian Paints are going to be credited to your demat account. So buying equity and mutual funds woudnt get you social prestige but it can make you rich if you are willing to postpone that gratification. 

The 14% of smart money that could exit between 2000 and 2013 has generated a mind boggling 2% IRR. And if the balance 86% smart money below could not exit, I doubt the average retail guy has much of a chance.

I may be completely wrong but thats my view. 

Next three days I will cover, picking mutual funds (which is even more difficult than picking stocks) and buying equity. 

Regards

Anish

QED Capital

Day 17 - What chance does the small guy have ?

One of the biggest myths prevalent in the stock market is the small retail investor is at a significant disadvantage to the professional investor be it a mutual fund manager or hedge fund investor or HNI. However that is not the case.

Size: WB has famously said in 1999 in an interview to BusinessWeek: "Its is a huge advantage to not have a lot of money. If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

Career risk: Keynes said that it is better for career prospects to fail conventionally than to suceed uncoventionally. If you take risk and it pays off, in a fund, you may still get fired for taking too much risk. No one will fire you for buying HDFC Bank but you may get fired for buying a risky bank which may still turn out to be right. However as a small investor you have no such risk because you are your own client.




Institutional imperative: When you work as a fund manager in a professional capacity, you are paid for activity. You need to come up with new ideas all the time and keep on meeting company management or researching an industry and be active for the sake of it. The biggest asset in investing in being able to think for yourself and calming your selves down in this day and age of noise. Man's biggest problems come from not being able to sit in a room quietly or in some cases keep their fingers from tweeting randomly. Investing is watching paint dry. Its very boring. If you sit by yourself and come up with 2-3 good ideas a year, you wont have have that job for long. 

So the next time you think the market is tilted in favor of the big guys, think again.

Regards

Anish

QED Capital

Day 16 Check Check Check Mate !!!

Mohnish Pabrai 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. In the great crash of 2008, his portfolio got decimated and had a huge drawdown. It 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.

Pabrai then drew upon the idea of a checklist from a NYT article and read The Checklist Manifesto by Dr Atul Gawande. Dr Gawande got the idea from the aviation industry where checklists were used to lower the number of human errors. 

An excerpt from the article:

"In 2001 a critical-care specialist at Johns Hopkins Hospital decided to give it a try. He didn’t attempt to make the checklist cover everything; he designed it to tackle just one problem: line infections. He plotted out the steps to take in order to avoid infections when putting a line in. Doctors are supposed to (1) wash their hands with soap, (2) clean the patient’s skin with chlorhexidine antiseptic, (3) put sterile drapes over the entire patient, (4) wear a sterile mask, hat, gown, and gloves, and (5) put a sterile dressing over the catheter site once the line is in. Check, check, check, check, check. These steps are no-brainers; they have been known and taught for years. So it seemed silly to make a checklist just for them. Still, Pronovost asked the nurses in his I.C.U. to observe the doctors for a month as they put lines into patients, and record how often they completed each step. In more than a third of patients, they skipped at least one.

The next month, he and his team persuaded the hospital administration to authorize nurses to stop doctors if they saw them skipping a step on the checklist. This was revolutionary. The specialist and his colleagues monitored what happened for a year afterward. The results were so dramatic that they weren’t sure whether to believe them: the ten-day line-infection rate went from eleven per cent to zero."

Pabrai 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 Warren Buffett 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.

He also talks to a like minded investor, who has no vested interest in the outcome, and runs him through his investing thesis. This is a good way to check confirmation bias.

So depending on whether you invest directly in equities or indirectly in mutual funds, you must have a written down checklist of factors that you must keep in mind while making any investing decision. We may think that we have covered all factors, but very often we miss a few often. 

I have my own checklist and I urge you all to make yours too. 

If you want help on making one, please email me and I shall be happy to help you with it. 

Regards

Anish

QED Capital