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The capacity to learn is a gift; the ability to learn is a skill; the willingness to learn is a choice”   Brian Herbert

Mr. Market (Master) is happy to teach you every day. As investors (Students) all that is needed is a willingness to learn and more importantly a willingness to act on the lessons learnt. This piece is a reflection on a few lessons learnt over the last two decades of my investing journey in the Indian stock market.

I have consciously tried to steer away from the obvious lessons: Invest within your circle of competence, Always seek a margin of safety, Invest but do not speculate and so on.

Key Lessons Management is the Key

I cannot emphasize this enough.

Dishonest managements, creative accounting, siphoning of funds, Insider trading, Conflict of interest, Related party transactions, poor corporate governance standards are not just some pieces of fictitious imagination but the history of corporate India  is replete with many such examples.

An investor must realize that they are part of the “outsiders” or minority shareholders and the management as the insiders will have a great influence on the actual returns a shareholder eventually enjoys.

There are two aspects to this: Competence and Integrity.

One without the other is not useful for long term wealth creation. Competence without integrity as well as integrity without competence produce mediocre results for the long term investors.

An investor is best served by investing in companies that are run by competent management with an impeccable track record of integrity.

In the beginning and for a short while such stories are wonderful and gullible investors jump into the band wagon. But the ending of such investing stories like Satyam is invariably  really a painful one for an individual investor.

Forget Satyam, let me give you a recent example. Vakrangee Software until very recently was a darling of Dalal Street. It has been a stellar performer (multi-bagger) for many years with lots of media coverage.

What happened in the last few months, the stock has fallen 90% as its auditors quit citing concerns about the books of accounts and corporate governance. Earlier, this company was also under investigation from the regulator in 2012 for alleged insider trading.

 

And it’s not just Vakrangee. Gitanjali Gems, Shilpi Cables, Manpasand Beverages are few of the companies where the management honesty has been questioned.

The point here is that irrespective of the returns (multi-bagger) a scrip is delivering, management integrity and corporate governance matters a lot for an individual investor. When you can’t be certain about the integrity and honesty of the management, investors are better served giving the scrip a pass and watching the party from the sidelines.

Compounding works best only with outstanding companies

Albert Einstein famously said that “Compounding is the 8th wonder of the world”.

But before you submit yourself at the altar of compounding magic, be sure about the stocks you are hitching your financial dreams to. If mediocre companies or good companies turned mediocre are left untouched expecting the power of compounding to work its magic then the results will be counter-productive.

Investing in mediocre or good companies is like speed dating or having a romantic one night stand. The fun may last for a short while but after that you are mostly left to regret.

On the other hand, staying invested in outstanding companies for a long time is like being in a traditional Indian marriage. If the going is good then you are in it for the long haul through the various ups and downs. Actually, the party never ends and it actually gets better with time.

Be like a gardener who removes the weeds regularly so that the plants can grow to become trees. As an investor you should also not allow weeds to grow in your financial garden (portfolio)

Keep your Investing Gun always loaded

When it’s raining gold, reach for a bucket, not a thimble” – Warren Buffett.

To reach out for a large bucket and not a thumb sized tumbler when an opportunity presents itself, we must have sufficient capital ready to be deployed at short notice. If you are 100% invested without any surplus to invest then you are at the mercy of market gods.

Mr. Market will not provide the opportunities to match and sync up with your cash flow position. Always maintain a certain percentage of your investment capital as surplus and ready to be deployed at short notice whenever an opportunity presents itself.

Half knowledge is a dangerous thing

Combine half knowledge with a blind belief in Buffett’s catchy phrases without knowing why and in what context did Buffett or any other super-investor say that. What we then get is a fine recipe for financial disaster.

Before you take out your daggers, let me explain:

Let us look at a sample statement which you must have heard a zillion times:  “It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

I have a few questions as a lay man:

  1. How do you decide for sure if a company is really “wonderful”?
  2. With certainty can you tell how long this “wonderfulness” will last?
  3. How can you be sure that a “fair” company will not become “wonderful”?

And I haven’t even come to the subject of price and valuation.

  1. How do you decide what is a “fair” price?
  2. If it’s okay to overpay for quality then how much to overpay?

On the face of it the statement looks fine but when we start making our investing decisions only on the basis of such statements  then it does more financial harm than good.

This leads us to the crux of my point. If you are unaware of the rules of stock market investing and the basic principles of valuation then taking meaningful investing decisions becomes a challenge.

Any field including investing is a specialized field which requires continuous learning, dedication and practice. Do not invest with half knowledge.

Few more short lessons

a) Do not be too rigid with the target price. If you decide to buy a scrip at a target price of INR 450 then you should have a range of values as the target and not an absolute value. The scrip may come down to 455 but may never actually reach 450 in your lifetime. You would not want to miss a great opportunity trying to save a few pennies.

b) Try maintaining equanimity as Mr. Market is fine at teaching humility. Neither get too elated when you make large profits nor be too sad when you make a loss. Don’t forget to learn at both times.

c) An ounce of action is worth tons of theory. You can read all the investing material in the world but if you cannot act and apply the learning when the opportunity arises then all the reading is useless for your investment journey.

d) Not just buying or selling but doing rigorous analysis and then deciding NOT to invest is also an act of investing. Waiting patiently for a “fat pitch in your zone” is one too. Controlling your desire for pressing buy / sell button regularly will be rewarding to your investment journey

e) Good ideas are a premium and you are perfectly entitled to keep it to yourself. Having said that it would be wonderful to have a selfless, genuine friend/colleague (not idea stealers) as a sounding board who will give you an honest feedback and also will enter into an honest debate.

f) Unless required legally, never discuss or disclose your portfolio publicly. A lot of effort goes in justifying your rationale in the future. You can give and share your stock picks but you cannot transfer your conviction.

Confucius said on wisdom “To know what you know and to know what you don’t know, That is real wisdom”. In the world of investing and stock markets this can’t be truer. Those who will understand this will be successful.

Hope you find these thoughts useful.

Keep Learning, Happy Investing.

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 A Single conversation with a wise man is worth a month’s study of books – Chinese proverb

Continuing with my investing chat series with smart minds, I had an engaging and deeply thought provoking conversation with Dev Ashish

Dev is the founder of StableInvestor.com and a SEBI-registered Investment Adviser. An engineer and MBA by education, he has earlier worked in oil and banking sector.

Since last few years, he is professionally advising clients on portfolio management and investment planning. He continues to manage his own and family’s investment portfolios.

This investing chat is a monster at 6000 words and is not for a quick light read. Dev has been gracious to give a very detailed account of his investing acumen accumulated over 15 years of investing in the market to go with many hundred hours spent in reading & thinking on investing.

So friends, grab a cup of coffee, set aside an hour and let’s soak in the distilled essence of Dev’s investing experiences.

Ravichand (S&L):  Hi Dev, Firstly a big thank you for sparing some time to share your thoughts with the readers of Stock and Ladder.

First up, please tell us something about yourself especially the part about how you got into the world of investing and Personal finance.

Dev:

Thanks Ravi, for considering me worth interviewing. My story isn’t very inspirational or anything like that. I am just a regular person.

Being born in a family of lawyers and doctors, chances were high that I would take a similar path. But I have been the odd-man-out in my family. Maybe it was because of the powers above which had a very different plan for me and so, I began my journey in a completely different direction.

Currently, I am a practicing SEBI-registered Investment Advisor.

 But even though I had a noticeable interest in finance since I can remember, I still went ahead and did my engineering. Later, I joined a government sector oil company and got posted in a remote location.

After working there for a few years, I made a conscious decision to gradually align my life and work towards my area of interest – which was investing in particular and finance in general.

This however was not going to be easy as for doing that, I would have to quit my safe government job. It was a tough decision but my family and then-friend-now-wife backed me fully for the decision.

So I quit, did my MBA and then joined a private bank. After a few years, I got a very good job offer from a startup. I was no doubt happy with the offer in my hand.

But I spent some time contemplating whether it was actually what I wanted to do. In the end, it didn’t seem like it. I realized that if I had to do something on my own, I had to take a call sooner or later.

So after having several rounds of discussion with wife, parents and a few people I consider to be my mentors, I quit my job and decided not to join the startup.

I decided to take a plunge into what I really wanted to do. I must mention here that I had sufficient savings by then to make this decision.

I took a license from SEBI to start my Investment Advisory practice and that’s what I am currently doing. After having worked in metros and other cities, I returned back to my hometown Lucknow, where I currently stay with my family.

Though my target eventually is to achieve financial independence, I think I can safely say that I will never actually retire, as is the norm in our family of doctors and lawyers.

As for my interest in investing, it got kindled when I was quite young. My father and grandfather had money invested in shares of a few MNCs. So every now and then, we used to get dividend cheques from these investments.

On enquiring, my father explained that these cheques were dividends – which he was being paid to hold pieces of paper (physical shares then).

This attracted me like anything. I just fell in love with the idea of getting a regular flow of passive income without going to work for somebody else! This was as clear a case of money working for you (rather than the other way around) that there could be.

So you can say that there wasn’t any one single moment when it happened for me. The seed was sown very early on and I tried to gradually align my life towards investing and working for my own self.

Ravichand (S&L):  That’s wonderful Dev.

Not everyone can make their passion the means for their paycheck and many usually end up spending their lifetime helping someone else build their dreams.  Mark Twain’s golden words come to my mind “Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.”

Let’s get into investing proper. Tell us something about your investing philosophy and how it has evolved over the years?

Dev:

I am 33 but have been investing in markets for about 15 years now. But initial few years are a grey area from investment philosophy perspective. Consciously or unconsciously, I was trying out several things then.

And to be honest, I did not even have a philosophy in those initial years. I simply went after ideas where I felt the probability of making money was reasonably high.

Luckily, I have had this inherent bias of being a little conservative when it comes to stock picking. So more often than not, I gravitated towards good companies with proven businesses (this is an approach that I am still loyal to).

I am not exactly sure why I have had this conservative bias. Maybe it was due to my family’s history and me as a child having observed that most of the investments were in mature, dividend paying safe stocks.

But whatever it was, I still made decent money. Maybe I got lucky in several cases. And I cannot ignore that I was amply helped by the rising tide of our great Indian bull run of 2004-07.

Thankfully, I have had an inquisitive mind that tries to look for answers to how things work. Not just in finance but everywhere. And one of the things that I really wanted to understand (after a good experience during the Bull Run) was what actually made the stock markets work and behave as they do.

So this pushed me into reading about markets and investors. Luckily, I got exposed to Warren Buffett and his philosophy at the start itself. And Mr. Buffett led me to Benjamin Graham.

The more I studied these value investors, the more I felt that value investing was best suited for me. Here I must say that I have nothing against other schools of investing. 3 plus 7 is 10 and so is 5 plus 5. So there are several ways of making money. It was just that value-conscious investing attracted me the most.

So from then on and for many years, most of my investments were based on valuation attractiveness. And I loved investing in dividend plays. Being valuation sensitive, my process was numbers driven.

But slowly I started realizing that just focusing on numbers wasn’t enough. Why? Because I was regularly missing out on other attractive opportunities that were not attractive valuation-wise.

So in due course of time and after having missed many good money making opportunities, I decided to gradually tweak my way of investing.

Valuations still mattered for me. But I was now willing to pay up (more than what I was earlier comfortable with) if I could find businesses that were of high quality, had good conservative (or let’s say non-adventurous) management, predictable growth runway and manageable debts which gave them some ability to suffer for extended periods of time.

So from a pure valuation’s guy, I became a valuation conscious investor who was willing to embrace growth. Not too much but still ready to pay up to an extent.

So instead of focusing on the cheapest stocks available, I was going after comparatively higher quality cos. which were not very cheap.

Along the way, I continued buying good companies when they faced temporary bad events. So in a way, I was and still operate as a virtual bad news investor.

This reminds me of a good analogy about why we should stick to good companies. Tennis balls are costlier than eggs. And both the egg and the tennis ball will fall occasionally. But only the tennis ball will bounce back. As for the egg, you know what fate does to a falling one. So when buying businesses, buy tennis balls. At least they will bounce back when they fall.

As of now, my approach is a little more structured than what it earlier was.

I run a core portfolio of about 20-25 stocks. But to ensure that I bet convincingly in my main picks, about 80-85% is allocated towards the top 12-15 stocks.

Remaining are ideas that I am either still working on and/or where I am yet to build full conviction about. I generally try to ensure that none of the stocks hold more than 12-15% of the overall portfolio.

A majority of the stocks in the core portfolio belong to the top-150 universe. So you can say that I am a conservative investor when it comes to stock picking.

Many people think that large caps cannot make money. I don’t agree but I don’t try to convince anyone now. Large caps have worked wonders for me over the years. So I stick with them.

I also run a smaller (call it satellite) portfolio where I enter into short-medium term bets. This is more to take advantage of temporary mispricing’s and other low hanging fruits.

Of course it is easier said than done and chances of being wrong here are immense. But that’s fine. It’s my way to tackling my urge of doing something every now and then and trying to be the next Buffett.

And luckily, the results haven’t been bad and provide for more money to be pumped into the core portfolio.

I also maintain a watchlist of stocks where I keep an eye on businesses that I wish to buy but which still aren’t in my portfolio for some reason or the other.

Over the years I have realized the power and option that cash brings in times of distress. So I ensure that I regularly put aside some money in suitable debt instruments to act as a Market Crash Fund.

You never know when the market might throw up some interesting opportunity. So better to be prepared. This way, I will not miss having CASH, when there is a CRISIS and I have accumulated enough COURAGE to venture out in tough times.

The above point, as you might have guessed, refers basically to the idea of sitting on cash. And I swear it is extremely difficult to do. More so when I see people around me making easy money.

But in the long run, I think restricting the number of bets I make in most convincing ones (in my view) is how a larger part of the wealth will be created. So I try to sit on cash and do nothing if there is nothing to do.

Apart from direct stocks, I have a goal-specific investment portfolio that has equity funds, debt funds, PPFs, deposits, gold, etc. One of my major life goals is to become financially independent by 40. So these investments are aligned towards that goal.

There is one thing that I have learned over the years. And maybe this is because I still pay my respect to valuations.

A good investor knows that it is only occasionally that he has to do something. And when the time comes, he has to and should do that ‘something’. And then, there is no need to do anything else. Money will be made in most such cases.

Ravichand (S&L):  Dev, that was the most detailed way someone has ever shared their process. That’s a great blueprint on which we can build our own investing framework.

As regarding to the way you have gravitated towards value investing, I remembered what Seth Klarman said “It turns out that value investing is something that is in your blood. There are people who just don’t have the patience and discipline to do it, and there are people who do. So it leads me to think it’s genetic”

From philosophy let’s move on to putting the philosophy into action. Tell us, what are the criteria’s or characteristics you look for in a business for it to be considered investment worthy?

Dev:

 I don’t have a very long checklist.

But broadly, I check stocks around 3 things – quality of the actual business, quality of the management and price in relation to my view on valuation of the stock.

Obviously, there are several things to check within these 3 broad heads.

Quality of business is all about doing the typical number-oriented analysis like examining sales and profit growths, margins, etc. – for the company and the industry peers.

Analyzing how industry and economy-specific environmental variables have impacted company’s trajectory in the past. And that of its competitors. Cost and capital structures and power that suppliers and customers have on the company or vice versa.

Then a good return on equity and return on capital are no doubt important. A less leveraged balance sheet is preferable as it makes business more robust in trying times.

I prefer sticking with businesses that have some barrier to entry that is not evaporating at least in the medium term. These are just some of the factors that I try to assess the company on.

Then there is that grey area of having a view on future growth of the business and more importantly, longevity of this expected growth. There is a big possibility to get this wrong but you need to have an objective and unbiased view on this to make your bets.

I will be honest that the quality of management is a difficult one to judge. And quality not only means their business sense but also their integrity.

So no matter how deep I go with analyzing these factors (from various sources), there will always be a chance of being completely wrong. But that’s fine. Sticking to what information is available and what signs the management is sending via annual reports and other ways is what I stick to. I really cannot get it right every time.

Even after several years in the market, I regularly end up feeling like an amateur when it comes to picking stocks. I am improving but there is a lot to learn.

I do run excel models but none of them are extremely complex or fancy. That’s because I feel that if I need a very complex model to prove a stock as a worthy of investment, then maybe it’s not that good after all.

Also, businesses are run by people and not excel spreadsheets. An excel model cannot be an alternative to thinking. And that is where our subjectivity and biases come.

I think that good investment ideas are very simple. And to be fair and acknowledging the limitations of my ability to analyze any and everything, I would say that a stock idea has to be so good on just a few parameters that it should just jump out and find me rather than me trying to find it out.

And last but not the least, and extremely important… there is valuation. It is very subjective and what is undervalued to me might look overvalued to someone else and vice versa. But that’s how it is.

The stock should be in a comfortable valuation range for me to buy it. I generally start buying in small lots and accumulate over a course of time. I am not very comfortable buying large quantities in one go.

Here I will say that I generally avoid talking about the stocks I own or am contemplating owning. It puts unnecessary pressure on me as an investor to defend my position every time there is a news (which may or may not be relevant for me as a long-term investor).

The ability to ignore and filter out the short-termism is I think necessary to operate well as a long-term investor. And there is no competition. So I try to reduce the stress to the extent possible.

Generating alphas is in itself so difficult, so why take on additional stress to justify your picks to people who may have different investment horizons or risk taking capacity. Isn’t it?

Remaining silent is all the more important as a valuation-aware investment strategy does not work all the time. Markets don’t and won’t always agree with you.

So going through extended periods of under performance is necessary and fine with me. I am more than willing to have return-holidays if I can get better longer-term returns.  As they say that as a real investor, you should be willing to be misunderstood in short-term to be right in the long-term.

Talking of investment criteria’s I think I should also share my views on somewhat related and important aspect of cycles.

Over the years, I have come to appreciate the importance of mean reversion. Or let’s say how cycles play out. I don’t have any expert advice to offer on this front as this topic tends to tread in the territory of market timing.

But I believe that we can improve our long-term investment returns by adjusting our portfolio in line with cycle requirements.

Talking of cycles, think of it like this – when recent market returns are high, the attitude of the masses towards risk changes. People forget what their real risk tolerance is and get comfortable taking more and more risk in search of better returns.

This is exactly what sows the seed for future declines. And when the time comes and the delicate balance is disturbed by some external event, it pushes the market off the cliff. That is where the cycle turns.  So if one learns from the past data, then there are indicators which highlight when people are getting irrational. The same case can be built around people’s unreasonable fear after the market falls.

It is at such junctures that some level of portfolio adjustment (by re-balancing or taking cash out or bringing it in the portfolio) can improve future returns.

This requires operating against the herd. This is about being contrarian in real sense and not just for the heck of it. Which is easier said than done but with each passing year, it becomes not too difficult.

Ravichand (S&L):  Completely agree on the point of simplicity and thinking of simplicity, Peter lynch’s famous quote comes to my mind “Never invest in an idea you can’t illustrate with a crayon”.

You also brought up the important topic of market cycles which I believe to be a topic that every aspiring investor should be familiar with.

Howard Marks book Mastering the Market Cycle: Getting the Odds on Your Side is an excellent read on market cycles.

From checklist let’s talk rules. If there were to be “Dev’s 5 rules for successful investing” then what would that be?

Dev:

I feel there are no perfect rules out there for successful investing. Any day it is possible that the bets we make due to all our successful investing framework (that we are proud of) and where we have the maximum conviction, turns out to be super bad.

But if I had to list down few important realizations that I have had, then here are my rules:

Stick with good businesses run by capable and trustworthy management, which have the ability to survive bad years comfortably and operate in industries having clearly visible and reasonably long growth trajectory. As simple as it sounds, this I believe is the most effective filter to reduce the number of potential stock ideas.

Valuation should not be ignored at any cost. But be ready to pay a fair price for good businesses. Every now and then, the markets will surprise by offering unbelievable deals on a platter.

You may have the courage to go out, but if you don’t have the cash, forget about taking advantage of such few-in-a-lifetime events. So be prepared with surplus funds to the extent possible. It will test your patience. But that is the price that you should be willing to pay.

There is a time to be brave and there is a time to not be brave. Don’t try to be brave all the time. Protect and secure what you have earned. Remember Buffett’s 2 rules about losing money. Be willing to be laughed at for your investment ideas. But that is when it will work. In investing, you want others to agree with you…but later.

Ravichand (S&L): Great set of rules, Dev. The importance of protecting your investing capital cannot be emphasized enough. When you read the investing rules of superinvestors, the point that return of money is more important than return on..

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A Single conversation with a wise man is worth a month’s study of books – Chinese proverb

What if on a single day you had conversations with many wise men? This is precisely what I felt interacting with like-minded professionals at 2nd Value Investing Pioneers Summit.

Another Chinese Philosopher, Confucius said “By three methods we may learn wisdom: First, by reflection, which is noblest; second, by imitation, which is easiest; and third by experience, which is the bitterest.”

I am not sure which bucket to put it this in but listening to the distinguished speakers who called on their many decades of investing experiences was a great learning experience and a humbling attempt in gaining wisdom for me.

Below are some of my key notes from the summit:

 

Before you start

Please be mindful of these key points before you read the notes:

  1. Notes from all the speakers have not been included
  2. Only those points which appealed to me has been included here and this in no way a complete transcript of the speeches.
  3. Data, Graphs, Examples have not been included for avoiding misrepresentation.
  4. There may be mistakes of omission in the notes taken due to mental digressions.
  5. There is a possibility of errors of commission too due to my poor handwriting and note taking skills.

With these rules for the road, let’s dive straight in:

Durgesh Shah – “Lessons from Markets”

Durgeshji brought his decades of investing experiences to present timeless lessons from the Indian markets. The presentation filled with anecdotes and analogies was truly a wonderful learning experience.

  1. Factors to be considered while evaluating Managements / Companies
  • Trust – Is the management trust worthy? E.g. TCS
  • Culture – What is the prevalent culture in the organization? E.g. HDFC
  • Focus – Does the management / company have a clear focus (Hero Motors)
  • Scalability
  • Delegation – Does the management hand over power sensibly (Motherson Sumi)
  • Integrity and Passion– Is the management passionate about the business or interests lie elsewhere in fast cars and other things
  1. While evaluating management companies be aware of the “Halo effect”.
  1. Causes of downfall of companies:
  • Arrogance. A thin line separates confidence and arrogance
  • Bureaucracy. A thin line separates process and bureaucracy.
  • Complacency. A thin line separates confidence and Complacency
  1. All of us have bought 100 bagger stocks at some point of time in our career but many of us lack the conviction to hold on to these stocks during the entire time frame. We exit the stock before it becomes a 100 bagger. To have conviction one needs to have:
  • Vision
  • Courage
  • Patience
  1. Success in the markets is also about a bit of luck and being at the right place at the right time. In the end, humility matters.
Samir Arora – “What they don’t teach you anywhere”

Samir’s talk was laced with wit and wisdom sprinkled with a generous doze of humor. He began by listing out some of the popular assertions in investing and then gave examples / justifications as to why these assertions are wrong

Assertions
  1. We buy stocks where we have high conviction.

We have higher conviction in the stocks we reject. On the stocks we buy we go through multiple filters, long checklists, management meetings to convince ourselves.

  1. Our favorite holding period is forever.

Buffett had qualified this statement in the 1988 shareholder letter

“In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever”.

Now it makes better sense ?

  1. You should know everything about the company before you invest in the stock.

It’s impossible to know everything about a company and sometimes even the company top management themselves are unaware. You need to have a fair idea and then learn few things along the way.

  1. Buy stocks with Good management.

Only when things turn sour you realize dishonest managements. Even eminent authors like Tom Peters (Book- In search of excellence) , Jim Collins ( Book- Good to Great) who have dedicated and devoted complete time in studying  companies with good management have themselves  not got it entirely right. What chances do we have as investors to profile for good managements?

  1. Diversification is a protection against ignorance. Wrong
So what you should know
  1. Believe in the power of equity investing.

At an asset class level equities have been the best performing ones across countries. A paper “Triumph of the Optimists” by Elroy Dimpson, Professor London school of Economics looked at data for 16 countries for 103 year period (1900-2002) and found equities to be giving the highest return in every country

  1. Look at the big picture and the size of the opportunity. That will be profitable and worthwhile strategy. 
  1. Focus first on the list of stocks which you want to reject. We tend to have higher conviction on our rejected list of ideas. This gives you
    • A list of shorting ideas
    • Reduces the universe of stock from which you have to do your stock picking
  1. Momentum with Fundamentals and long short are very useful strategies 
  1. Try to gain knowledge and don’t waste your time in gaining more information – As an analyst or an investor, ask yourself if the pursuit of that additional piece of information does really add any value. In many cases, it does not.
  1. How one performs during negative market months matter a lot to your overall performance.
  2. Every stock is given 1 or max 2 years to perform. If any stock under performs beyond this time frame they are sold without any emotions. It will be the same for HDFC bank shares which is now held for 20+ years
  3. A good book to read:        Wealth, War & Wisdom by Barton Biggs
Samit Vartak- “Buy and Forget Vs Active Investment Management”

Samit in his inimitable style presented a data backed presentation on when to pursue active investment management.

  1. Why Quality Matters?
  • Quality companies are consistent and are useful during market downturns
  • Helps you avoid landmines (Vakrangee, PC Jewellers)
  • Fund managers do not want to lose jobs and look foolish picking unfamiliar names
  1. Stock returns are driven by
  • Re-rating of PE
  • Strong returns are a result of earnings growth
  1. You get reasonable time to evaluate an opportunity (1 Quarter or two) 
  • Have strong filtering and screening criteria so that these stocks show up on your screens
  • Analyze those which pass the filter rigorously.
  • Try to see if you get confidence in their earnings growth. One indicator for quality is gaining market share from competitors.
  • Examples of re-rating examples in the Indian small cap / mid cap space
    •     Bajaj Finance
    •     PI Industries
    •     Avanti Feeds
  1. Do not apply theory of American investors blindly.

Do not follow and apply investing literature from other markets blindly. Most of the famous investing materials           are written by American investors based on the US market. The degree of volatility and characteristics are                     different for the Indian markets.

  1. If you are pursuing a 12 to 15 percentage returns, then its best is to stick with quality companies and a coffee can type of portfolio. Active management should be pursued only if you are chasing 5 to 6 percent alpha. This is hard work and not a part time activity by any stretch of imagination.
  1. In active investing stay away from big blunders. This is very important.
  1. A profitable strategy is to follow the 80/20 Pareto principle. For 80% of your portfolio seek market returns and for the remaining 20% of your portfolio chase Alpha.
  1. As a fund manager set your heart on the process and not on its rewards. Clearly communicate what went wrong also to your investors so that they are aware of the process and not fixated with returns.

Hope you find the notes useful.

Keep Learning, Happy Investing.

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A Single conversation with a wise man is worth a month’s study of books – Chinese proverb

Continuing with my investing chat series with smart minds, I had a deeply thought provoking conversation with Safir Anand.

Safir is a keen and accomplished Senior Partner with India’s finest law firm for Intellectual Property- Anand & Anand. He is truly a polymath, an entrepreneur, avid reader, trader, long term investor, fashion aficionado and more.

Safir has a wide breadth and depth of understanding of Indian equity markets from all slants and bends. He tweets @safiranand

When I reached out, Safir was gracious enough to spare some time for sharing his investing thoughts. I believe that many hundred hours spent on reading, thinking and investing has permeated into this conversation.

So friends, please grab a cup of coffee, sit back and (hopefully) enjoy the conversation.

Ravichand (S&L): Hi Safir, Please tell us something about yourself. I am especially curious to know how an actively practicing lawyer cum legal professional ventured into the field of investing and carved out a name for yourself.

Safir:

I am a practicing Intellectual Property Lawyer, a Brand Strategist and someone who is always on the lookout for creativity. Creativity takes several forms such as art, music, and dance on one hand and the exploration of new concepts & ideas on the other.

I belong to the second category where I am guided by an inquisitive mind that is fascinated by how an idea, well harvested and differentiated from other businesses, can result in creating and scaling value to anybody from an individual to a corporate to Government.

I also believe that the pursuit of anything worthwhile should be guided by an essential binding force like a grundnorm. For some, the binding force is necessity (which perhaps led to the expression that necessity is the mother of all inventions), money (some say money can even buy happiness), power (some call power the ultimate aphrodisiac), independence or like.

A term that describes me the best is simply “a pursuit of the passion of learning, improving, improvising and the gratification that the process can result in”.

I ventured into investing initially with the drawback of not understanding how companies were valued and how even on a daily basis, there was a significant dis-connect and disarray between buyers and sellers in trying to find the most appropriate and fair value of a “mystical” number.

The easiest way to start learning is to jump into something and to give it sometime to see whether the indulgence is more of a task or something that starts pulling you towards itself with an excitement akin to a fascinating journey.

I think the fact that investing is an accumulation of facts that may be available to many but a subsequent distillation of human and social behavior in interpretation and in arriving at a likely assessment of the journey of a company vs. an immediate short gratification of price up move or fall implies that the process carries endless opportunities every now and then to:

  1. Learn;
  2. Make mistakes and still learn;
  3. Get it right and learn;
  4. Take no action and learn;
  5. Profit from mistakes of others;
  6. Stand independent and differentiate and then see the work of action;
  7. Develop a character which could be in the form of either patience, self-control or at times getting arrogant, slipping and getting grounded thereafter with a hope of coming back.

I think there is no “Aha” moment that convinced me that I will do well in investing as every now and then there are Aha moments in both winning and learning from mistakes. The word “Aha” itself is a connotation of discovery much akin to the use of the word “eureka” by Archimedes when he was taking a bath in a tub. There are several Aha moments….

There is an Aha moment also when at the end of a process there is a discovery much on the likes of Sherlock Holmes, who after discovery called it “elementary”.

There is also an Aha moment when sometimes even with a combination of part skills and much luck, you get a result like an extra-ordinary “OO7” moment.

Similarly, there is an Aha moment akin to that of a spectator in a cricket match who jumps to joy when he finds a batsman hitting a ball for a six or four or comments on how the batsman ought to have played on a ball when he gets out, as if he could have done better.

Investing is both sitting strong and building connection. It is a battle of the mind without tumbling on overconfidence, euphoria, greed, fear and has a sense of adrenaline flowing alongside in the process that may or may not always have the desired or optimum outcome.

Ravichand (S&L):  That was one terrific opening salvo. A whole bunch of fine thoughts to digest! One thing that really struck me is your inquisitive bend of mind to go along with a strong desire to continuously learn.

William Ward nicely quipped “Curiosity is the wick in the candle of learning” and when you combine continuous learning with a curious mind, voila, you get a fine recipe for success in life and investing.

Moving on, tell us how your investing philosophy or process has evolved over the years? What has influenced your present line of investment thinking?

Safir:

Investing itself is a process.

The best part of investing is that while the process evolves with time and experience and in that sense may be diversified, in reality investing has always been simple and guided by combination of human control over greed and fear and the ability to differentiate between signals and noise.

It’s like meditation in a war. I am a firm believer that an investor must be able to identify his area of competence either in terms of companies that he owns or the businesses he understands or based upon the guiding principles of his investment.

There are investors who excel in buying and holding stocks over the long run and may look ‘out of place’ when markets go against them in the short-term while there are other investors who excel in technical and may sound Greek to those who are in the pursuit of fundamentals / long-term value. (Sounding Greek is not the same as looking Greek!!!)

Similarly, there are momentum and swing investors just as there are investors in India and in international markets. There are also different class of investors with some having specialization in cyclical while others more attuned to what is closest to them (IT/Pharma etc.).

A pharmacist chatting with a social media marketing expert may make an interesting point but each will do better in their respective fields of competence.

I think the essential feature again is something that is known ‘within’. This “within” takes forms- grit, patience, perseverance, ego halting, ability to bear the flow of winds against to even sense of knowing wrong, judgment errors and realizing what was a crush vs a lasting bond.

Most of us are not likely to get that within wrong while we are more likely to err when we try to make the serving more exotic by venturing around the outside- economy, globalization, crude, China, USA, and Currency wars.

Similarly in chasing newer nut untested business models and pursuing a never ending chase under the garb of thinking that we will get the highest returns and win a race run by zillions of people every day in the market.

One should not forget that in today’s well informed and connected investing world, it’s not necessary to have “intelligence” vs “intelligence” but good emotion over bad.

Ravichand (S&L):  Sticking to one’s area of competence and following the process what works best for us is absolutely spot on.

Remembered what Howard Marks said “There are many, many different ways to make money in the investment business and the one I describe as ours, it’s not necessarily the only right one but it’s the one we like.”

From investing process let’s move on to investment criteria. Based on your current thought process you have mentioned, what are the criteria’s or characteristics you look for in a business for it to be considered investment worthy?

Safir:

The most essential criteria is simplicity. The second criteria is durability. The third criteria is competence of the management in keeping it simple, durable and scalable. The fourth criteria is measurability of the business and its size of opportunity. You can add one more if you feel generous- alignment of interests.

Measurement is usually in the form of cash flows and shareholders friendliness. Managements that are more attuned to keeping shareholders part of its journey play it better than those with vested or short term or in investing parlance “cyclical” interest.

I am also fascinated by the concept of vacuum that is when an opportunity is created by any friction that is capable of being filled-in by a new age business model. This is akin to the concept of Value Migration that was propagated by Adrian Slywotzky in his well-known book of the same title.

One of the other concept that fascinates me and guides me is the concept of Zebra in Lion Country where it is well-known that herd likes to eat in the center of the Savanna where the grass is least but there is highest amount of safety while the explorer eats grass on the peripheral where the danger of an attack from the Lion is perceived to be higher but the quality of grass is higher.

The survival instincts of those at the peripheral causes them to become more swift just like a systematic workout of the brain or the body to make a person fit while those in the center get easy and low hanging fruit that has much more limited return but exposes them to the risk of obsolescence.

In effect, businesses that are at the verge of value propositions or multiple value propositions are more preferred and this is combined with the contrast to human psychology where the element of greed or fear is assessed from risk to reward perspective.

Ravichand (S&L):  Wonderful set of criteria and especially delighted that you are equally fascinated by the “Dean” of small cap investing- Ralph Wagner.

On unearthing multi-baggers, Ralph Wagner had this to say:

If you are looking for a home run- a great investment for 5 or 10 years or more- then the only way to beat this enormous fog that covers the future is to identify a long term trend that will give a particular business some sort of edge”

I have a penchant for compiling investing rules of smart investors. To add to my collection, I am keen to know if there were to be “Safir’s 5 rules for successful stock investing” then what would that be?

Safir:

 My 5 rules for successful stock investing:

  1. Keep it simple; Black/White is sexy too and never fails even in formal events though it is simple.
  1. Have some matrix of measurement in qualitative and quantitative terms which matrix has the power of exponential rather than limited effect so that even if you get some calculation wrong, you have enough yards to run.

In a recent movie, BAZAAR, Saif Ali Khan comments “no one remembers a marathon runner but remembers who won the 100 m race”.

I say a marathon runner can afford to slow down and yet win a marathon but a 100 m runner can only win by running. The same 100 m runner won’t win if the path has “unknown hurdles” as he is not used to slowing down.

These unknown hurdles are plenty in a world where too many variables play on a theme. Sometimes you need to slow to see are they friendly or vicious.

  1. To develop a competence involving yourself by knowing your weakness and trying to concentrate on building a strong character of the mind and at the same time not getting choked out by exuberance, over-confidence or by the noise which is isolated with facts. Building immunity is far better than medication taken to tide over.

The validation of facts is the biggest catalyst to conviction and one has to convince that the transformation from a caterpillar to butterfly is a painful metamorphosis that eventually results in a beautiful creation.

Even a child is born almost alike and has some strengths and some weaknesses. His harnessing of his interests leads the way to his eventual stardom or mediocrity. Stars are born in several fields and including new fields but mediocre usually is amongst the herds.

  1. Another success rule is the need to keep reading and to bring in diversity. For example, diversity may even come from travel as you can never solve a problem by being in the same place where the problem exists.

A human brain is wired to appreciate progression and sometimes even the act of moving from one location to another during travel gives a signal to the brain that things are progressing vs. being at a stand-still movement in thick of your problem.

  1. The competence of people that you look at to is equally important with the qualification that the more varied the traits of those people and the more you can imbibe their success and principles while customizing them to your own personality, the better you are likely to get.

Ravichand (S&L):   Great set of rules. I especially loved the one on reading. As Charlie Munger said “In my whole life, I have known no wise people who didn’t read all the time – none … ZERO”.

Reading is a key habit every aspiring investor should have. To help us become lifelong learners with a habit of voracious reading, I am assembling a collection of reading lists on best books to read from some of the best investing minds.

Moving on from rule, tell us what has been your best investment idea (need not be the most profitable) till date?

Safir:

My best investment ideas would center around identification of themes where the scope of the market potential was far in excess of the current size and where this met opportunities in the hands of a company and promoter as was hungry to lead, sometimes laced with brands or technology, or who believed in creating a matrix of the distribution and having power over and above generic players in the same competition.

The examples include early identification of themes in consumer finance such as Bajaj Finance, consumer preference for strong brand power such as Eicher, recognition of huge potential for growth of non-luxury sanitation (Cera) or simple migration from a generic commodity to perception of safety and value in human life coupled with enormous brand power (tire companies like MRF and CEAT).

Ravichand (S&L):  Identification of themes is the strong message I am getting and this would involve some serious thinking.

Alas, as Henry Ford put it brilliantly “Thinking is the hardest work there is, which is probably the reason few engage in it”. But yes, the rewards are sweet.

From master stroke let’s move on to mistakes. Mistakes are sometimes referred to as “unexpected learning experiences”. Can you share any important investing mistake(s) you have made and crucially what lessons can we learn from that?

 

Safir:

 Mistakes are part and parcel of investing and come in several forms. Some of these are centered around misjudgments, some around character particularly when somebody gets carried out by success or fall for a confirmation bias. Sometimes mistakes are only temperament that went wrong.

Mistakes are also made when much of sound overtakes the underlying rationale for investing or where in the race for short-time gain long-term wealth is sacrificed.

The set of mistakes made by investors every time is fairly consistent. The impulsive action and the inability to conquer fear and greed is akin to walking into your own graveyard. Ghost tours may be good for someone selling them but have no repeat value in life. Most pictures you take for memory are only dark!

Lessons are learnt in hindsight including the pursuit of belief that translates purely beyond stock gains and losses and opportunity that goes into stronger beliefs on processes and even supernatural and superstitious beliefs which are part of human character.

Ravichand (S&L):   Peter Lynch wisely opined “In this business if you are good, you are right six times out of ten. You are never going to be right nine times out of ten”.

Doing mistakes are acceptable as long as we learn lessons from it. However, it’s much cheaper to learn from others mistakes.

From mistakes made we move on to lessons learnt. What has been the most important investing lesson(s) you have learnt from your time spent (investing) in the market?

Safir:

 The most important investing lesson that I have learnt is that time is your best friend and all good times are followed by rough and all rough times by good.

However, the human nature wants progression and thus there is a concerted will to solve problems rather than prolong them. It’s like saying “once upon a time….and eventually they all lived happily ever after”.

Ravichand (S&L):   Very true. Neither good times nor bad times stay forever. As they say, in life, good times become good memories and bad times become good lessons.

From lessons we next touch upon advises. What has been the most important investing advice(s) you have ever received on investing?

Safir:

 The most important investing advice’s in no particular order:

  1. Read everything, hear everything, and believe nothing.
  2. Do not attach too much value to information that is sold in mass market
  3. Learn from history, in doing so plan the present and look to the future
  4. In times of falling market, mistakes and failures re-validate the basics- revisit them again and again as things always go back to basics.

Ravichand (S&L):  Wonderful set of advises worth pondering especially the need to learn from the past.

The investing legend Philip fisher had this to..

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The Secret to success in any field is to find what successful people do, think about and act on, and do the same – Anthony Robbins

I started Stock and Ladder with the intention of seeking answers to a key question pertinent to every single investor – How do we invest better?

Since 1998, when I first learned about Security Analysis and Portfolio Management as part of my MBA curriculum, I have been fascinated by the world of investing in general and by stock markets in particular.

Post my MBA, once I began my actual investing journey, I quickly understood the wisdom behind Warren Buffett’s wise words “I did be a bum on the street with a tin cup if the markets were always efficient”.

It clearly dawned on me that the actual world of investing is quite different from the one I was expecting it to be [based on my MBA textbooks]. In my quest to find some real-world answers on “What works in Investing”, I swapped the studying of academic textbooks with the reading of investment classics written by successful super investors.

This helped me find my answers and also showed me the way forward.

Studying Superinvestors

It seems logical that even before thinking of buying any common stock, the first step is to see how money has been most successfully made in the past” – Phil Fisher

The smartest, the brightest and the most successful investors’ a.k.a.  “Superinvestors” have each spent a lifetime in investing, in reading and in thinking for gaining their investing wisdom on “what works in investing” and have used different investing strategies and styles to achieve investment success.

Looking at the careers of the great investors, it is clear that there are many different, often contradictory, ways to succeed. Each has been highly successful in his own way” Roy Neuberger

Warren Buffet when quizzed about Peter Lynch’s wide diversification strategy put the point eloquently “I’ve said in investing, in the past, there’s more than one way to get to heaven”. Similarly, each one of these different investing strategies and styles have been used by superinvestors to successfully make money in the stock market.

The below table shows what one dollar’s worth of initial capital would have ultimately been worth if you would have invested with these great investors from the beginning:

[Source: The World’s 99 greatest Investors]

This table wonderfully highlights the long term track record of investing out-performance achieved by these superinvestors. This is also a clear validation that these strategies are markets proven actionable pieces of investing wisdom and not mere pieces of academic information.

Logically then, the simple yet smart thing to do for normal investors like you and me is to study the successful strategies (investing wisdom) of these Superinvestors and apply their wisdom to our own investing.

 Our life is too short for us to spend it on reinventing the “investing” wheel or in trying to learn investing by committing all the mistakes oneself.

 The Stock and Ladder Way

 Charlie Munger put it brilliantly-

I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting down and trying to dream it all up yourself.  Nobody’s that smart”.

 

Analyze, Adapt and Apply

Analyze the strategies of the successful superinvestors and learn from their success and mistakes. This will make you aware of what has worked in investing in the past along with the tools and techniques used for achieving the success.

The next key thing to do is to “Adapt” this investing wisdom to suit your specific individual scenario and then apply this adapted strategy to your investing.

Do not blindly copy, clone or coattail the superinvestors strategy. Adapt the strategy (wisdom) to suit your temperament, your investing objectives, your investing resources, your skill set and your competencies. These are bound to be different from any of the superinvestors you wish to emulate.

Why Adapt

A 17th century Japanese poet, Matsuo Basho put it beautifully:

When journeying upon the path of wisdom, do not seek to follow in the footsteps of the wise. Seek what they sought. Seek the meaning behind their footsteps, and not upon the steps themselves.

For in seeking the footsteps you shall be glancing only upon the next footprint. And you’re sure to stumble upon an unforeseen obstacle. But in seeking the meaning behind their footsteps you’re sure to see ahead; comparable to looking up while walking.

Thus, allowing you to easily maneuver around the hurdles on the path you walk. …And if you walk like this long enough, you’ll one day, to your surprise, find yourself among the wise.

Final Thoughts

The title of this post “Smart money studying superinvestors” is also the tagline of the Stock and Ladder web site and its key focus area going forward. The motto being:

“Study from Masters, Adapt from Masters, Become the Master”

In the coming days, I intend to share here the investing lessons, successes, mistakes, ideas and insights got from studying these superinvestors.

Hopefully each one of us will adapt this wisdom to suit our individual temperament and our available resources thereby charting our own unique path to investment success.

Keep Learning, Happy Investing.

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“Don’t look for the needle in the haystack, just buy the haystack” – John C Bogle

Many great investors like Buffett, Bogle, Lynch have been consistent in their advice that a low cost index fund is a very good investing option for a vast majority of the investors. This advice was at the top of my mind when I began my search for an equity mutual fund to start a long term systematic investment plan.

A study from BofA-ML had found that only 3 % of the 1,600 equity funds actually managed to outperform the Nifty in first six months of 2018. A 6 % of them managed to outperform Nifty on a relative basis in the last one year and only 16 % outperformed the benchmark in the last three years.

This set me thinking as to what this really meant for ordinary investors like you and me.  Are there any equity funds which have been consistently outperforming the benchmark indices over for a very long time horizon? Or should we just heed to the advice of the investing legends and join the index fund investing bandwagon?

My search for funds to invest duly began by looking for the past performance data. I quickly found that the data for recent periods seem to be readily available but the information became progressively scarce as I looked farther in the past. The maximum tenure for which I could find the performance data was for a 10 year period.

10 years is definitely a long time frame but I believed that even the 10 years time horizon missed two crucial financial events: the tech bubble of the year 2000 and the financial crisis of early 2008. I reasoned that any fund which has outperformed over 15 to 20 years would have had to pass either one or both of these two very difficult tests. And those that have come out in flying colors surely have proved their mettle and stood the test of time. Hence they may have a better chance of  having success even going forward.

But what about the data for more than 10 years? Thanks to Larissa and Himanshu at Morningstar, I could get the performance data for 15 years and 20 years. I spent many hours studying the data to find my answers. Hopefully my search for answers will also provide you with some food for thought.

Fund Criteria

Just as there are horses for courses, different categories of funds like Debt funds / Liquid funds / balanced funds are each suitable for different financial objectives. To meet my long term goal of creating a retirement corpus via the SIP route, I came up with the following fund criteria:

A. Category

Over a long period the general wisdom is that equity as an asset class tends to do better. Hence the focus was restricted to pure equity funds and even within equity funds the scope was further narrowed down to the relatively less volatile large cap funds.

Pure Mid-cap, Small-cap, thematic funds were kept out of the scope. The goal was to build a corpus and hence only growth funds were considered.

So the final scope considered and the fund criteria came down to:

  1. Equity – Large Cap (G)
  2. Equity – Multi Cap (G)

B. AUM

To focus on funds with a reasonable size, the minimum AUM requirement was pegged at 500 crores.

C. Reference Date

All data for ranking the performance of funds over 15 years and 20 years was taken as of 31st Aug, 2018

Rules for the Road

Before we get into fund performance , a few very important ground rules:

  1. The funds discussed here are not any recommendations to buy or sell. Please contact a registered Investment adviser before taking your buy / sell decisions. My findings are posted here for educational and informational purposes only.
  2. There is no reason to believe that the underlying data is not accurate. However, no guarantee is possible towards that end.
  3. The search is a endeavor to find a suitable fund to invest based on my  set of criteria which may or may not be applicable for you nor be the best criteria to decide.  E.g. Pure thematic funds or pure sector specific funds were not considered since they were considered to be inherently more risky.
  4. I am fully cognizant of the fact that past performance is NO guarantee that the future returns may also follow the same pattern. But I strongly believe that funds who have done well for 15 or 20 years have a greater chance of doing well in the future too.
  5. There are other factors too which are pertinent like the fund expense ratio, fund manager’s style , Fund house etc. which has not been explicitly considered in this exercise.

All set, let us dive straight into the findings.

Equity funds: Large cap A. Performance over 15 years

This table gives you the top 5 Equity large cap funds over a 15 year period as of 31st Aug, 2018 and the relative out-performance against the benchmark index (Nifty 50)

  • HDFC Top 100 and Aditya Birla SL Frontline equity fund are the big daddies out there- both in AUM and in performance. A 6% approx. out-performance is massive.
B. Performance over 20 years

This table gives you the top 5 Equity large cap funds over a 20 year period as of 31st Aug, 2018 and the relative out-performance against the benchmark index (Nifty 50)

  • HDFC Top 100 and Tata large cap funds absolutely rock over a 20 year period with an out-performance of 8% approximately
  • Tata’s don’t market their cars well and that seems to be the same theme here with their funds too. Their AUM is only 5% of the second ranked HDFC Top 100 fund’s AUM.
  • Beyond the top 3, the fund out-performance tapers off and in fact the 5th performing fund has not beaten the benchmark. Interesting
Equity funds: Multi-cap A. Performance 15 years

This table gives you the top 5 Equity Multi-cap funds over a 15 year period as of 31st Aug, 2018 and the relative out-performance against the benchmark index (Nifty 500)

B. Performance 20 years

This table gives you the top 5 Equity Multi-cap funds over a 20 year period as of 31st Aug, 2018 and the relative out-performance against the benchmark index (Nifty 500)

  • The Top 3 funds have outperformed the broader index significantly
  • The same set of 5 funds make up the top 5 over both 15 years and 20 years
Equity – Index funds

The next crucial question was how the index funds performed. I looked at the 15 years data as on 31st Aug, 2018 to come up with the top 5.

Key Insights

Having looked at the data for 15 years and 20 years, these are some of my observations:

  1. Top 3 Equity Large Cap funds

Let us get to the heart of the whole exercise. Based on 15 years and 20 years data, the top 3 funds in NO particular order:

A. HDFC Top 100 (G)

B. Aditya Birla SL Frontline Equity (G)

C. Tata Large Cap (G)

A quick look at 10 year performance validates the above choices.

Performance over 10 years

This table gives you the top 10 Equity large cap funds over a 10 year period as of 4th October

(Source: Morningstar)

  • HDFC Top 100 performed consistently well over a 5year, 3 year and 2 year time period too
  • The top 3 funds namely HDFC Top 100, Aditya Birla SL Frontline and Tata Large cap fund continue their out-performance even for a 10 year time horizon to be in Top 10.
  1. Top 3 Equity funds – Multi Cap

Based on 15 years and 20 years data, the top 3 funds in NO particular order:

A. HDFC Equity fund (G)

B. Aditya Birla SL Equity Fund (G)

C. Franklin India Equity (G)

A quick look at 10 year performance validates the above choices.

Performance 10 years

This table gives you the top 10 Equity Multi cap funds over a 10 year period as of 4th October

(Source: Morningstar)

  1. Top 2 Index funds  

Based on 15 years data, the top 2 index funds in NO particular order

ICICI Pru Nifty Index fund (G)

UTI Nifty Index Fund (G)

A quick look at 10 years performance validates the above choices.

Performance 10 years

This table gives you the top 10 Equity Index funds over a 10 year period as of 4th October

(Source: Morningstar)

  1. Actively managed funds have significantly outperformed the benchmark Indices

The question which was in the top of my mind was answered emphatically. In the debate of active vs passive investing, at least in the Indian context, I do not have any more doubt. The top performing funds have beaten the benchmark hands down and with a significant margin.

As seen in the table below, the top fund in the equity multi cap fund category, HDFC Equity (G) has outperformed the benchmark by a whopping 10.74% over a 20 year period.

  1. Actively managed funds have beaten the best index fund too by a wide margin

The actively managed funds have outperformed not just the benchmark indices but even the best performing index fund by a wide margin.

The below table compares the returns of large cap funds Vs the best performing index fund for 15 years, ICICI Pru Nifty Index Reg Gr fund:

Now let us say you had taken the systematic investment route and started an SIP

The below table shows the returns if you had started a monthly SIP of 10,000 for 15 years  on 1st September 2003 in any of the top 5 large cap funds against the returns you would have received if the SIP was done in the best performing index fund:

The result is as clear as night and day. The absolute returns in the top 2 large cap equity funds is in excess of 16 lacs (1.6 million) over the best performing index fund over a 15 year period.

It is also pertinent to note that the out-performance tapers off as we go down the list and for the 5th best fund the excess returns is actually less than 1%. This implies that you have to be get the fund selection absolutely right.

  1. Multi-cap funds have performed better over pure large cap funds

Multi-cap funds by design may invest in mid cap or small cap stocks and that seems to give them an edge over pure large cap only funds. For Long term investors, multi cap funds may also be a good investing option.

The below table shows the total returns of top 3 funds in both Multi-cap and Large cap categories:

As can be seen above, over a 20 year period, the best performing Multi-cap fund (HDFC Equity Gr) has a 3.55 % out-performance over the best performing large cap only fund (25.10 % Vs 21.55%).

Final Thoughts

It is very clear to me now that at least in the Indian context, there are actively managed funds which have consistently beaten the benchmark indices and there is no need to jump into the indexing bandwagon. The best performing actively managed funds have not just outperformed the top index funds by a sizable margin and but also have done that over a very long time horizon of 15 to 20 years.

However, as seen from the data, the excess returns generated seems to be tapering off as we go down the performance list. The key thing then is to get the fund selection decision absolutely spot on. Hitching your financial bandwagon to the right fund is seen to be crucial as to where you will end up in your investing journey. To that end, approaching a trusted financial adviser to help you choose the best fund may just be the fine beginning you can make.

Happy Investing!!!

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A Single conversation with a wise man is worth a month’s study of books  Chinese proverb

Continuing with my investing chat series with smart minds, I had a deeply thought provoking conversation with Anshul Khare.

 Anshul Khare works as software freelancer in the IT industry in Bangalore. He studied engineering at IIT Bombay. Anshul is an avid reader of books from various disciplines including investing, business, personal finance, human behaviour, and decision-making. He is a guest blogger at popular value investing blog www.safalniveshak.com. Anshul has also authored a book called Mental Models, Investing, and You. He can be reached on Twitter @anshul81.

 Anshul is an Engineer, Value investor, Author and Blogger- all rolled into one!!!When I reached out, Anshul was gracious enough to spare some time for a chat. I believe that many hundred hours spent on reading, thinking and blogging has permeated into this conversation. So dear friends, please grab a cup of coffee; sit back and (hopefully) enjoy the conversation.

Ravi: Hi Anshul, Please tell us something about yourself and how you got into the world of investing/behavioral investing with an IIT background.

Anshul:

Hi Ravi. Thanks for inviting me. I come from a place called Bilaspur — a small town in the state of Chattisgarh. In 2003, I graduated with a  B.Tech degree in chemical engineering from IIT Bombay. Few months into my first job which was in a chemical manufacturing company, I figured that I didn’t want to pursue a career in that industry. So I came to Bangalore and joined the IT industry. Since then I have been in Bangalore and have worked with companies like AOL, Symantec, and Paytm. Currently, I work as a freelance software consultant.

Around 2010 I chanced upon a book named The Warren Buffett Way and instantly got hooked to Buffett’s way of life, business, and investing. But do you know what a bigger discovery than reading about Warren Buffett was? Finding Charlie Munger. Munger’s insights on multidisciplinary learning and behavioural finance punched a big hole in my worldview.

The more I studied Buffett and Munger the stronger I felt that my temperament suited to their way of investing — the value investing way. Their philosophy on making investment decisions and the way they defined risk, made a lot of sense.

That way, my initiation into the stock market was a bit unusual. Until I discovered Buffett, my exposure to equities had been approximately zero. I got pulled towards value investing as a result of my fascination with Warren Buffett.

Ravi: There is a popular saying which goes like this “When the student is ready, Master appears”. I believe that is what happened here and completely agree that Buffett and Munger have been an outstanding source of inspiration to investors all over the world.

I am now curious to know how has your investing philosophy / process evolved over the last 8 years. What has influenced your present line of thinking?

Anshul:

I started investing in the stock market in 2010. So I am yet to witness a severe market decline first hand. And I believe, to really call oneself a long-term value investor, one needs to experience one full cycle of the stock market which includes a bull run as well as a severe market crash.  So I’ll only know how fragile or robust my investing process is when I find myself in the middle of a market panic. Which means, it’s highly likely that my investment process might change significantly after I see a crash.

With that disclaimer, let me share a few things about what has changed in the way I invest today as compared to a few years back. I started out looking for bargain stocks. Which means I focused a lot on the numbers and didn’t think much about the qualitative factors. And part of the reason is that it’s easy to focus on what’s easy to measure, e.g., financial numbers. Quality and the intangible aspects of a business are difficult to quantify.

However, that strategy didn’t work well and I ended up investing in quite a few value traps, i.e., businesses that were cheap because they deserved to be cheap. Bartronics is one name that I can recall. Fortis was another. In last few years, I have slowly gravitated towards stocks where the underlying business is of high quality. For example, companies that own consumer brands or companies run by people who are intelligent, smart and have a long history of being ethical and shareholder friendly.

Ravi: Completely agree on investing in quality business run by honest management. Buffett put it best when he said “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

Based on your current thought process you have mentioned, what are the criteria’s or characteristics you look for in a business for it to be considered investment worthy?

Anshul:

Being a part-time investor, if I expect to generate investment returns similar to what Warren Buffett did then I would be fooling myself. It’s maddeningly hard to beat the average market return by more than 10 percent over the long-term. And that’s true even for a full-time investor. Which means it’s virtually impossible for someone like me who has only a few hours a week to spare for investing.

With those constraints, I think it makes a lot of sense to leverage others who I respect for their investing wisdom. Great scientist Sir Isaac Newton once said — If I have seen further, it is by standing on the shoulders of Giants. Which brings me to Cloning — an idea made popular by famous value investor Mohnish Pabrai.

Cloning simply means that you begin with companies which other smart investors are buying and then you see if those investment ideas fit into your own investment framework. Remember, the gap between cloning and blindly acting on a stock-tip is ten miles wide. Still, many investors miss the difference and invest based on the news on what other famous investors are buying and selling without really understanding what they are getting into. Even I am guilty of making this mistake. Copying an investment idea is just the first step.

So that’s the first characteristic I look for — is this company owned by any of the smart value investors that I know? After that, I look at numbers. Has the business grown its revenue and net profits consistently over the last few years? I prefer more than 12-15 percent CAGR over 7-10 years. How does the return on invested capital look like? It should preferably be more than 15 percent. Does the company generate consistent free cash flows and are they growing? How leveraged is the balance sheet? A debt to equity of more than 1 makes me uncomfortable.

All the things that I have listed above are like screening tests. Very few businesses that I pick up for analyzing, pass all the tests. Once a business is through these filters, I read the annual report and try to understand what drives the business engine for the company, i.e., I try to answer questions like — how does it generate revenue? Who are the customers and the competitors? I also try to wrap my head around the industry. Is it growing? Is it an organized or unorganized industry? Who are the major players?

And finally, I try to figure out if the people running the business — the CEO or the promoters — are ethical and shareholder friendly.

Ravi: Scanning the portfolio of successful investors is a great starting point for sourcing of your investment ideas. Corollary to the above question, if there were to be “Anshul’s 5 rules for successful stock investing” then what would that be?

Anshul:

Before we can discuss any rules, it’s important to lay out two things.

First, investing is a field where rules are very subjective. What works for me may not work for others. And part of the reason is that the definition of success differs from person to person. Are you investing to build a retirement corpus? Or are you comfortably wealthy and investing just to preserve the capital? Maybe you are doing it for the thrill because you’re fascinated with the idea of compounding money rapidly. So the term “successful stock investing” is very broad.

That said, my reason for investing is to beat the inflation. So if I can manage to compound my money at a CAGR of 15-18 percent over the long term (30+ years), I would consider myself a very successful investor.

Second, even if you have defined what success means to you, there are several methods and strategies to be successful in the stock market. In this regards, I had an epiphany when I read the book called What I Learned Losing a Million Dollars. Let me reproduce an excerpt to make my point –

“Why was I trying to learn the secret to making money when it could be done in so many different ways? I knew something about how to make money; I had made a million dollars in the market. But I didn’t know anything about how not to lose. The pros could all make money in contradictory ways because they all knew how to control their losses. While one person’s method was making money, another person with an opposite approach would be losing — if the second person was in the market. And that’s just it; the second person wouldn’t be in the market. He’d be on the sidelines with a nominal loss. The pros consider it their primary responsibility not to lose money.

The moral, of course, is that just as there is more than one way to deal blackjack, there is more than one way to make money in the markets. Obviously, there is no secret way to make money because the pros have done it using very different, and often contradictory, approaches. Learning how not to lose money is more important than learning how to make money. Unfortunately, the pros didn’t explain how to go about acquiring this skill. So I decided to study loss in general, and my losses in particular, to see if I could determine the root causes of losing money in the markets.”

This idea — learning how not to lose money — rehashes Charlie Munger’s unconventional advice for dealing with problems in life and business. Some problems, Munger says, are best solved backward. So to answer your question, let me use Charlie’s inversion trick and talk about “rules for avoiding loss in the stock market.” And instead of five, as you asked, let me list only three; for in investing less is more.

First rule: Avoid debt. Personal as well as in the companies that I invest. I never borrow money to invest and I stay away from companies that have unreasonable debt on their balance sheets.

Rule Deux: Avoid bad partners. Remember, a man who steals for you will steal from you. I avoid investing in companies where the management has a history of corporate governance issues. In this context, I consider government also a lousy partner. Not that government has bad intentions, but the government’s interest is usually misaligned with minority shareholders. So I avoid all PSUs.

Rule number three: Avoid dogmatism. All my beliefs, views, and rules can change in the future. The famous British economist John Maynard Keynes is often quoted as saying: “When the facts change, I change my mind. What do you do, sir?” Strong opinions loosely held is a very useful principle to follow.

Ravi: I had previously done a compilation of investing rules by successful investors. I must admit that your set of rules are refreshingly unique. Next up, what has been your best investment idea (need not be the most profitable) till date? Can you also elaborate on the thinking that went behind the investment idea?

Anshul:

Thanks for pointing out that the best investment idea doesn’t need to be the most profitable one. And it took me a long time to understand this concept. Investing is a lot like poker. In the world of poker, the quality of the outcome of each game is loosely connected to the quality of decisions. A right decision can result in an undesired outcome and vice versa. But over a long term, i.e., over several games of poker, the player with better decisions will come out ahead.

It’s not very different in investing. Which means, a better way to think about your investment decisions is to look at them as a series of bets instead of analyzing every decision and its outcome in isolation. Here’s an excerpt from Anne Duke’s book Thinking in Bets which I strongly recommend for every investor.

“Decisions are bets on the future, and they aren’t “right” or “wrong” based on whether they turn out well on any particular iteration. An unwanted result doesn’t make our decision wrong if we thought about the alternatives and probabilities in advance and allocated our resources accordingly…Poker teaches that lesson.

 A great poker player who has a good-size advantage over the other players at the table, making significantly better strategic decisions, will still be losing over 40% of the time at the end of eight hours of play. That’s a whole lot of wrong. And it’s not just confined to poker.”

In light of the above insight, if I were to talk about my best investment idea, I would say it was Noida Toll Bridge. I never made any money on the stock. I ended up selling it at no profit no loss.

It had qualified in all my investment filters which I have mentioned earlier in this conversation. However, it turned out to be a bad investment because of things outside my control. Government intervention was a low probability event in this case, but it did happen. In my view, it was a case of “good-decision-bad-outcome.” In future, if I get to make that kind of investment again, would I do it? Yes. Absolutely.

Ravi: Talking of “Thinking in Bets”, my thoughts went to Michael Mouboussin’s 10 attributes of great investors where one of the key attribute is to “Think Probabilistically” (there are few sure things)

From masterstroke let’s move on to mistakes. Mistakes are sometimes referred to as “unexpected learning experiences.” Can you share any investing mistake(s) you have made?

Anshul:

Mistakes indeed are potential learning opportunities. But when I repeat the same mistake, it means I didn’t learn anything from it. So I want to take this opportunity to talk about those “mistakes.” The ones which I continue making even now. The ones which I should be learning from, but I fail, again and again.

It’s the mistake of omission. There have been many instances where I should have bought a stock, but I didn’t because I let the behavioural bias dictate my decision. Anchoring bias is one where I got fixated on a particular price and waited for the stock to drop to that number. Unfortunately, the stock didn’t know that I was waiting for a certain price tag.

Not allocating sufficient capital to a high-conviction stock is another mistake that I continue to make. Some stocks that fall in this category are Cera sanitaryware and VST Tiller. In both the cases I started with very small positions and then kept waiting for the stock to come back to my buying range.

Mistakes arising out of behavioural biases are hard to correct. But I am working on it. I know I can never eliminate them completely, but I hope I can minimize them.

Ravi: John Templeton put it nicely “The only way to avoid mistakes is not to invest — which is the biggest mistake of all”. Mistakes are a proof that we are at least trying!!!

Related to this, what has been the most important investing lesson(s) you have learnt from your time in the market?

Anshul:

There are many. But let me talk about the one which I keep reminding myself frequently. After a few years in the stock market, I learned that there are broadly three types of edges that any investor can exploit to generate superior returns.

First is the informational advantage, i.e., having privileged information. Earlier only large institutions had this advantage. But today, in the internet era, everyone has access to almost all the information instantly. When everybody has the advantage, it ceases to be an advantage.

Second is analytical advantage. If you can draw unconventional insights from the public data then you decidedly have an edge over others. But very few people (like Warren Buffett) are wired to have that kind of deeply analytical mind. Moreover, the large institutions (with armies of analysts poring over mountain of market data using sophisticated tools) leave very little chance for a part-time investor to discover any unnoticed insight. So that leaves us — the small investors, the part-time investors — with only one thing to capitalize on. The time advantage.

As a small investor, if I am investing my surplus cash, nobody is looking over my shoulder and pushing me for quarterly performance targets. Which means, once I have bought a good quality business, no one can force me to sell it if I don’t want to. That gives me the staying power. And that creates opportunities for small investors. Patience and willingness to hold for the long term — that is our edge.

This is a valuable lesson that I have learned in the stock market in last eight years.

Ravi: Thinking in terms of Years rather than days or months to have a long term orientation is definitely an invaluable lesson for an individual investor. Seth Klarman put it eloquently when he said “The single greatest edge an investor can have is long term orientation”

 From investing lesson let us move on to investing advices. What has been the most important investing advice(s) you have received on investing? How has it influenced your investing process?

 Anshul:

It’s hard to single out anyone as the most important. Developing an investment philosophy is an incremental process. Every book I have read, every investor I have interacted with, every investing video I have watched, had some impact on the way I think about investing.

One that immediately comes to mind is a post that Prof. Sanjay Bakshi wrote a while back. It was titled return per unit of stress. I always assumed that as investor, my primary goal was to maximize the risk adjusted return on my portfolio. However, I never gave importance to intangible factors associated with that goal, i.e., the stress it brings. If have stocks in my portfolio that give me sleepless nights, even occasionally, it’s not worth it. And that may not be true for every investor. It’s was an advice that resonated a lot with my temperament.

Ravi: This is the first time I have come across this idea / advice of thinking in terms of return per unit of stress. Sounds interesting. Moving ahead, Is there any particular investor(s) or author(s) who have had a significant influence in your investment thinking? How? (In terms of say mentoring or inspiration)

Anshul:

I think what I said for the previous question holds equally well for this one too. Consciously or subconsciously, every single investor or author I’ve met in my life has had some influence on my thinking.

But if I had to take few names I would say Nassim Taleb is one author who has influenced my thinking a lot. Although he is a trader, all his books have refreshing insights on value investing and decision making in general. Mohnish Pabrai is another author/investor who I admire a lot. He is a great simplifier not just in words but also the way he has structured his investment philosophy.

Ravi: Next up is one of my favorite question. Let us say a bunch of enthusiastic beginners approached you for advice on how to be a successful stock..

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By Three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and third, by experience, which is the bitterest. “ – Confucius

Inspired by Morgan Housel’s brilliant post “Short investing rules”, I have come up with an own version of short rules for the common man to invest in Indian stock market. By no way are these rules gospels of truth nor have they been validated for their accuracy. These are based solely on my observations, learnings and experiences of investing in the Indian stock market over the last two decades.

  1. Do not follow Warren Buffett blindly. It is equivalent to driving on the Indian streets by blindly following the road signs.
  2. Put yourself in the role of a Sherlock Holmes or a Hercule Poirot  investigating a financial mystery when you are studying the annual reports of some of the Indian companies.
  3. Like the Kurunji flower (Strobilanthes kunthianus) which blooms once in twelve years, finding a truly outstanding company run by an honest and competent management is also a rare event. If you happen to find one such company then bet your house on it.
  4. Investing in the Indian markets solely based on bookish knowledge or the wisdom shared by foreign investing Guru’s is equivalent to appearing for a mathematics exam by reading the science textbooks.
  5. Stock market is like a giant financial Chakravyūha. Easy to enter but difficult to exit. If you enter the markets without adequate investing skills and knowledge then you may end up being a “financial Abhimanyu”.
  6. “Minimum Government, Maximum Governance” is a popular political slogan which is equally applicable for the individual investor. Seek to invest in companies which have minimum Government holding, interference and regulatory oversight.
  7. When you find that the promoters (or their family members) love hobnobbing with Bollywood film stars and celebrities then double up on your normal due diligence before investing in such companies.
  8. Asking stock brokers financial tips for long term investing is equivalent to a sheep asking the butcher health tips for a long life.
  9. Do not blindly join the passive investing index bandwagon; Fund managers in India have routinely outperformed the broader markets and over a fairly long period of time.
  10. If there is a sudden action in a particular stock counter for no apparent reason and you suspect that some trades are being done based on non-publicly available information then probably you are right.
  11. When a market expert or a pundit appears on media and recommends a particular scrip as a “Strong buy” then shorting or even selling that scrip may not be a bad idea.
  12. Just as you would not attempt to do a surgery at home, you should also not attempt to do a financial surgery at home (if you are not professionally qualified). Half knowledge is a dangerous thing and it’s more rewarding in the long run to pay a certified financial adviser for professional advice.
  13. Never discuss your portfolio or your trades publicly even if you don’t believe in the “Nazar lagna” (evil eye) concept.
  14. Seek for a mentor or a true friend (not one with vested interests) to bounce off your investing ideas.
  15. Stronger the connection of a business with a single political party then greater should be the caution you must observe before investing in that stock.
  16. The crowd is mostly right. If you still want to bet against them then better check your facts and reasoning a dozen times before you go contrarian.
  17. If you go contrarian then Mr. Market is more likely to turn around and veer towards your contrarian position as a large cruise ship than like a small speed boat. Be patient.
  18. While analyzing a business let us say you have come up with 5 positive scenarios and 1 negative scenario that might possibly happen; Be ready to welcome the negative scenario as invariably it will be the first to arrive.
  19. If you have analyzed a stock and then decided to give it a pass, be also mentally prepared to face the scenario of your rejected stock idea doing spectacularly well in the short term. Avoid any feelings of regret and move on.
  20. The price of a stock will continue rising while you are still contemplating to buy it. And the price may promptly start falling post your actual purchase. Do not be interested in a stock when everyone else also seem to be interested in it.
  21. There is nothing called as “Free Lunch” across the whole of the financial industry and it’s for you to figure out the hidden and implicit price for things given to you free.
  22. Use television more as a source of entertainment and less as a source for your investing ideas.
  23. Sometimes the accuracy or completeness of your analysis has no bearing on the money you eventually make or lose on a stock. Good luck and prayers do matter.
  24. Whenever someone offers you a scheme for doubling or tripling the money in a short time; remind yourself that they are talking about their money and not yours.
  25. Only a handful of people will really want you to succeed in life and in investing. Find your real well-wishers early
  26. Karma now works in a much shorter cycle time than before , more like T+1 or T+2. Bad things done in the market will come back to bite you pretty quickly. See Good, Be Good and Do Good.

The unwritten rule and the one which has not been mentioned above is that for success in any field including investing “Hard work” is mandatory. All the midnight oil burnt and the early morning lost sleep will eventually pay off.

Hard work + Humility = Success.

John C Bogle famously quipped “Learn every day, but especially from the experiences of others. It’s cheaper.”

Dear reader, I sincerely hope you find my investing rules / guidelines / lessons useful for your investing journey.

Happy Investing

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 A Single conversation with a wise man is worth a month’s study of books  Chinese proverb

Continuing with my investing chat series with smart minds, I had a deeply thought provoking conversation with Gautam Baid.

Gautam Baid, CFA, is Portfolio Manager of Global Equities at Summit Global Investments, a SEC-registered investment advisor based out of Salt Lake City, Utah, USA. Prior to his current role, he served at the Mumbai, London and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams. Gautam is a CFA Charter holder from CFA Institute, an MBA in Finance from Nirma University, Ahmedabad, India and an MS in Finance from ICFAI University, Hyderabad, India. He is a strong believer in the virtues of compounding and lifelong learning.

When I reached out, Gautam was gracious enough to spare some time for a chat. Italo Calvino famously quipped “A classic is a book that has never finished saying what it has to say”. On similar lines, every time I go back and re-read this conversation, something new strikes me.

The distilled essence and wisdom acquired by spending thousands of hours over the years in reading, thinking and investing in the markets by Gautam has permeated into this conversation.

Dear reader, please grab a cup of coffee; sit back and enjoy the conversation.

Ravi: Hi Gautam, Please tell us something about yourself and how you decided to pursue a career as an investment professional?

Gautam:

I am the youngest of the four siblings in my family and my parents, my two elder sisters and my elder brother reside in Kolkata, India. Prior to my relocation to the US in 2015, I served for seven years at the Mumbai, London and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams.

As is typically the starting story of many investors, I got lured into the stock market out of greed during the final euphoric phases of a bull market. In this case it was the 2003-2007 one in India. I invested in Reliance Power Sector Mutual Fund in late 2007 and Ispat Steel in January 2008 as both were in “hot sectors” of the times and both had “recently” appreciated “sharply in a very short span of time” when I had first noticed them.

So, I just engaged in blind extrapolation of the recent price trends in them without paying any attention whatsoever to their valuations. Recency and vividness biases are very powerful but highly costly behavioral mistakes. Both the investments crashed 70%-80% within 12-18 months of my purchase. I had successfully gained admission into the stock markets by paying my tuition fees.

Despite this bad initial experience, my curiosity and interest about the stock markets always remained very high throughout all the years of my investment banking career. We have just this one life to live our dreams and I did not want to waste any further time doing something that I was not passionate about.

I was so keen for a career shift that I relocated to the US (one of my relatives who is an American citizen sponsored my green card) without any job in hand! I thought that I will land a job in my desired profile within a short period of time since I was a CFA Charter holder and this particular degree is generally considered to be highly valued in the investment management industry.

Alas, life is not a bed of roses for those trying to carve their own destiny. I got rejected in my first three stock market job interviews, but I did not give up. I was adamant that I am not going to go back to my previous field of work where the presence of perverse incentives constantly led to incentive-caused bias and conflicts of interests and did not suit my personal nature, so I kept declining all investment banking job interview calls that came my way (even though they would have had very high dollar salaries).

At the same time, I ran out of whatever little money I had brought with me from India and to take care of my living expenses in US, I did not want to sell even a single share from my portfolio of Indian stocks as I did not want to interrupt the process of compounding. So, I took up a minimum wage job as a front desk clerk at a hotel in San Francisco where I used to work during the “graveyard shift” (for the uninitiated, this is the shift that runs from 11pm at night to 7am in the morning).

Even though it was a big struggle for me physically, emotionally, culturally and intellectually, today, in hindsight, I highly value those days of my life because for the first time since the beginning of my professional career, I got some free time for myself to read and learn. This was the phase during which my learning curve really took off from a tiny base.

Little did I realize at the time that I was laying down the strong building blocks for compounding in my life. The pace of work during late night to early morning at the hotel was pretty slow and I made full use of the free time to read every single article published on blogs like Safal Niveshak, Fundoo Professor, JanavWordpress, Base Hit Investing, and Microcap Club among others. The passionate pursuit of lifelong learning had begun.

All of us who discover our calling in life get to do so through a defining moment, event or experience. Let me share mine with you.

During a stormy night in San Francisco in mid-2016, I was at home (I used to rent and live in a single room as a paying guest. I was trying to save every single dime that I could during this phase) reading the 2012 edition of Tap Dancing to Work, a compilation of articles on Warren Buffett published by Fortune between 1966 and 2012. Immediately after finishing the book, I came to know that there was a more recent 2013 edition of it which contained one additional chapter.

I did not want to spend money on buying the newer version of the book, so I went to the local bus stand, got badly drenched (even while using an umbrella) while waiting for over an hour in the midst of the storm, and travelled all the way to a distant Barnes and Noble bookstore to read the final chapter of the book inside the store and save a few dollars. (I had a monthly bus pass at the time, so the bus ride did not cost me anything.)

That night I realized that I had finally discovered my calling in life. It is difficult to express in words the sheer intensity of the emotions, thrill, joy and excitement that I experienced. I could not sleep that entire night. Only the fortunate few who discover their true passion in life will be able to relate to what I am trying to convey.

Luck, chance, serendipity and randomness have always played a big role in various aspects of my life till date. One fine night during November 2016 while working at the hotel, I randomly clicked on the “quick-apply” button on a job application on LinkedIn during the course of my routine online job search.

I unexpectedly received an interview call for the job and that too for a senior role in an investment firm even though I had zero formal work experience in the stock market! And this was the phase in my life during which I was about to experience the power of compounding knowledge in action.

All those hundreds of hours which I had spent during the previous year at the hotel reading the blog articles had built a strong intellectual foundation for me in investing (this is what I was lacking during my first three stock market job interviews in US) and I excelled in all the three rounds of my job interview (body language derives from self-confidence and self-confidence in turns derives from knowledge).

I was offered the role of Portfolio Manager of Global Equities and it was like a dream come true for me. Today, even after achieving financial freedom, I continue to work in my job because I just love the work that I get to do and the icing on the cake is that I get paid for getting to learn and improve every day.

Ravi: WOW, that’s a fascinating story. I completely agree on finding your passion part. As Steve Jobs said “The Only way to do great work is to love what you do”. It is a beautiful thing when passion meets profession.

Moving on, how has your investing philosophy / process evolved over the years? What has influenced your current line of investment thinking?

Gautam:

My personal investment philosophy has evolved over the years with time and experience in the markets. Initially, it was restricted only to secular growth stocks at reasonable to slightly expensive valuations.

But now, it covers multiple areas of the investment universe like commodities, cyclicals, fundamental momentum, deep value, special situations and loss making companies which are turning around as reflected in slow gradual changes (low contrast) in their improving balance sheet, working capital cycle and margins and/or a significant positive change in their industry dynamics.

In a nutshell, I now invest wherever I find “mispricing” of value and a highly favorable risk return trade-off.

Another key area of my evolution as an investor has been in understanding of human nature and the significant role of incentives in governing individual behavior. Always think about the possible incentives involved in any situation before making your final decision.

Ravi: Knowing about your investing philosophy I just remembered what Seth Klarman once said “If only one word is used to describe what Baupost does, that word should be “Mispricing”. We look for mispricing due to over-reaction.”

Based on your current thought process that you have mentioned, what are the criteria’s or characteristics that you look for in a business for it to be considered as investment worthy?

Gautam:

Between low quality businesses at a cheap valuation and high-quality businesses at a fair valuation, my preference is always for the latter since I can have meaningful allocations of my portfolio in them with peace of mind and higher stress-adjusted returns. High-quality businesses typically demonstrate sustainable competitive advantages, known in investing parlance as “moats”.

Strong brands with “share of mind” which confer pricing power, network effects, high switching costs, a collection of patents (as opposed to relying on only one or two), favorable access to a strategic raw material resource or proprietary technology, and government regulation which prevents easy entry – these can confer a strong competitive advantage which in turn enables excess returns on invested capital over the cost of capital for long periods of time (also known as the Competitive Advantage Period/CAP).

Growing firms with high Return on Invested Capital (ROIC), opportunities for reinvestment at those high ROICs, and longer CAPs are more valuable in terms of net present value.

One of the most highly underappreciated sources of a sustainable and difficult to replicate competitive advantage is “culture”, best epitomized by companies like Berkshire Hathaway, Amazon, Costco, Piramal Enterprises, HDFC Bank, to name a few.

To illustrate the critical importance of culture just consider this: From 1957 to 1969, Warren Buffett did not mention the word “culture” even once in his annual letters. Since 1970, he has mentioned the word more than thirty times.

Some of my favorite books on competitive advantage are The Little Book That Builds Wealth by Pat Dorsey, Understanding Michael Porter by Joan Magretta, and Different by Youngme Moon. For learning about how to evaluate the culture of an organization, I recommend reading A Bank for the Buck: The Story of HDFC Bank by Tamal Bandopadhaya, both the editions of Intelligent Fanatics by Sean Iddings and Ian Cassell, and Investing Between the Lines by L.J. Rittenhouse.

Ravi: Warren Buffet famously said “Rule No. 1: Never Lose money. Rule No. 2: Never forget Rule No.1”. Corollary to the previous question, if there were to be “Gautam Baid’s 5 rules for successful stock investing” then what would that be?

Gautam:

  1. Learn to distinguish between investment and speculation. A speculator looks at a stock as a piece of paper. An investor looks at a stock as part ownership in a business.
  1. Mr Market is always eager to hand you great opportunities from time to time on a platter. Stock prices fluctuate far more than the intrinsic value of the underlying business, sometimes wildly on either side – and therein lies the big opportunity. Widespread fear is your best friend as an investor, personal fear is your worst enemy.
  1. Be an ardent student of crowd psychology, cognitive biases, market history and human behavior since objectivity, rationality and temperament are far more critical than raw intellect to succeed as an investor. Your personal behavior matters much more than advanced excel analytics and complex math. Always think quantitatively (numbers and probabilities) and not dramatically (vivid images and futuristic stories).
  1. Develop a working knowledge of accounting as it is the language of business through which you understand how the balance sheet, income statement and cash flow statement tie together.
  1. Always focus intensely on the underlying process rather than obsessing about the eventual outcome. Resist the illusion of control.

And if I had the liberty to add 3 more important rules to the list, it would be the following:

  1. Always consider the outside view which takes base rates and statistics into account rather than only the inside view which makes predictions based on a narrow set of inputs.
  1. The frequency of correctness does not matter; it is the magnitude of correctness that matters. Michael Mauboussin calls this “The Babe Ruth Effect”.
  1. Lastly, and most importantly, for any investment decision (and for all important decisions in life), always take the potential consequences into account instead of focusing only on raw probabilities

 

Ravi:  Those are a great set of rules to follow for successful investing. Next up, what has been your best investment idea (need not be the most profitable) till date? Can you also elaborate on the thinking that went behind the investment idea?

Gautam:

I regard Kilpest India as one of my best investments till date. I purchased shares in it during early 2017 and the story just keeps getting better with each passing month.

Kilpest India owns 97% of 3B Blackbio, a fast growing and highly profitable molecular diagnostics business. So, in effect, for less than INR 25 crores (~$4 million) market cap, we were being given the opportunity to become part owners of a business generating free cash flows and having a return on capital employed of 100% and net profit margins of 20%+, all while having the lowest-cost producer advantage.

When I looked at 3B Blackbio for the first time, it reminded me of these words by Jeff Bezos:

“A dreamy business offering has at least four characteristics: Customers love it, it can grow to very large size, it has strong returns on capital, and it’s durable in time – with the potential to endure for decades. When you find one of these, don’t just swipe right, get married.”

Ravi: Kilpest India looks like a great idea. Reading Jeff Bezos words I remembered what Buffett once said “Opportunities come infrequently. When it rains, put out the bucket, not the thimble”. When a dreamy business does turn up, one should seize it with both the hands.

From master stroke let’s move on to mistakes. Mistakes are sometimes referred to as “unexpected learning experiences”. Can you share any investing mistake(s) you have made?

Gautam:

I have luckily made very few mistakes of omission within my circle of competence till date in my investment career. I can honestly make this assertion based on the prevailing circumstances and available information at the time of my past decisions.

However, I have made multiple mistakes of commission because I fell prey to different behavioral biases at different points of time, notably bias from over-influence of authority, bias from anchoring, bias from liking and disliking tendency, stress-influence tendency, cognitive dissonance and loss aversion.

As investors, we always make our initial purchase based on incomplete information and our own personal biases and highly favorable assumptions about the future of the business. Let’s be honest, endowment effect is deeply embedded within us and we start feeling more confident about the prospects of a business after we have bought its stock. Happens all the time with everyone, we are human after all and we are a messy living compilation of a multitude of cognitive and behavioral biases.

This self-awareness and acknowledgement is the necessary first step towards attaining wisdom.

We cannot avoid biases totally even after being fully educated about them, we can only try to reduce their frequency to the maximum extent possible through the use of checklists, maintaining an investment journal, conducting a pre-mortem, demonstrating intellectual honesty by actively seeking disconfirming evidence to kill our existing ideas (especially our best-loved high conviction ones), consciously thinking about the potential incentives at play in a particular situation, engaging in second-level thinking about “the consequences of consequences” by always asking “and then what?,” and using other relevant tools for improved decision-making as applicable to the individual situation.

The Thinker’s Toolkit by Morgan Jones and The Art of Thinking by Ernest Dimnet are some great books on improving one’s decision-making process.

Ravi: Loved the part on self-awareness which I believe plays a large part on what you do and become as an investor. As Aristotle said “Knowing yourself is the beginning of all wisdom”. Cannot be more truer for our investing journey.

Moving on, what has been the most important investing lesson(s) you have learnt from your time in the market?

Gautam:

The answer lies in your question itself Ravi. It is “time in the market” and not timing the market that drives wealth creation. If I had gotten scared and exited the market during the periodic phases in 2013, 2015 and 2016 when my portfolio value fell 30%-35% (with many individual stocks down 40%-50%), then I would have completely missed out on the big bull market years of 2014 and 2017 which helped me achieve financial independence early in life. The words of Peter Lynch on this subject are noteworthy:

“Whatever methods you use to pick stocks, your success will depend on your ability to ignore the worries of the world long enough to allow your stocks to succeed. No matter how intelligent you are, it isn’t the head but the stomach that will determine your fate.”

Ravi:  Cannot agree more on the perils of market timing. Some people claim to do it successfully but I seem to be terrible with that. I believe more in what Daniel Kahneman said “The average investor’s return is significantly lower than market indices due primarily to market timing”

Next up, what has been the most important investing advice(s) you have received on investing? How has it influenced your..

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