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In January 2018, my portfolio hit a new all-time high. The next time I would hit an all-time high was in November of 2020. 1051 days of living in a draw-down is a pain. What was more painful than enduring the draw-down was the changes I made.
As a systematic investor, my system gave me a list of stocks from my PF to sell and buy an alternative set of stocks. While the portfolio consists of 30 stocks, I sold 220 stocks in the same period and bought 220 different stocks. Almost no repeats.
What if I had not done this and instead stuck to the Portfolio I held in January 2018. How would this be looking in November 2020?
My Portfolio would have been down 50% instead of being back to square one.
After 4 glorious years of barely interrupted bull run, the markets are experiencing an experience with gravity like it hasn’t done in a recent time. My portfolio hit an all-time high in September last year. In terms of the length, it’s still a baby compared to the last time around.
This correction is already proving to be different from the one I experienced last time around. While I had just one instance of a four percent drawdown in a single day between 2018 and March 2020 and just one more before the portfolio made a new all-time high, this time around, this time around I have had two.
In the back-test I have done, the longest period of drawdown was of 1960 calendar days. Jan 2008 to May 2013 to be precise. Being a full-time participant during those times, the despair has to be seen to be believed. The last time one saw such despair was during the dot com bust.
Every such fall has removed from the marketplace quite a few well-endowed investors just to be replaced by equally well-endowed new investors. Lots of stocks which were supposedly the best investments prior to the crash were nowhere to be found by the time the market had recovered. Some like DLF while not haven’t conquered their high of 2008 are still around, others like Unitech disappeared
When death comes to companies, what is uniform is the fact that majority if not all of the equity in the company is held by individual investors. When Naren made the most controversial statement one has seen in recent times, one word caught my attention. His reference to OTCEI.
If one pools a random set of 100 investors today, I wonder if even one had heard about OTCEI. OTCEI, the acronym for Over-the-Counter Stock Exchange of India was set up with the purpose of providing small companies an ability to raise funds without having to bother with the compliance requirements of large exchanges. Sounds familiar?
Every few years, the market teaches everyone some old lessons that get forgotten in the heat of a bull market. Every bull market has bottomed out with Nifty being way lower than its 1000 day moving average. Currently that stands around 19,600. Question is how deep this shall be and how long the next recovery. Only the prepared survive.
When I first came into the Industry, I wasn’t sure of what I wanted to become. Within a year or two though, I knew that I wanted to be a stockbroker. The reason – money. I could see good brokerage firms earning a lakh or more per month. This at regional stock exchanges. Brokers of National Stock Exchange which had just started to gather momentum after being born a few years ago were multiples of this. A lakh today is small change but in the late 90’s, this was big.
Of course, there is no free money, and neither was the brokerage earned. In the days before dematerialization made transfer of shares not just simple but zero risk to the stockbroker, it was a circus out there. When a stock was sold, the seller in the transfer deed form would put his signature and along with the share certificate give it to the broker.
The broker then forwarded them to the clearing house of the stock exchange. He would then give this to the buyer who would by then have been debited the amount for the purchase. The purchase amount was routed to the broker who would pay the client. The whole process took 15 to 21 days.
The risk to the broker who sold the shares actually began now. The shares sold would need to be transferred to the buyer. But if the company did not close the books (aka Record Date), this could be further sold. The stock certificate with the transfer deed could hence be floating around with no one transferring. This could last as long as a year. Every company closed it books at least once (Dividend / Corporate Actions) at which time, the last buyer would send the same to the company for transfer.
Now, companies took their own sweet time. The best companies took a month, the worst, you would need to follow up to get back the shares. Most of the time, the company would send back the certificate with your name in the back showcasing that you are now the proud owner of the certificate. Once in a way, the company would send back the share certificate along with the transfer deed and an accompanying latter that said, Seller Signature doesn’t match.
When this happened, the stock certificate along with the transfer deed would be given back to the stock broker he had bought from. The stock broker inturn would submit the same to the stock exchange who would then send it to the broker whose name first appeared on the transfer deed.
This could as explained taken as much as 11 months from the time of selling between which the price could have gone anywhere. Now the broker after receiving the said bad delivery had to rectify it within 21 days. What this meant was to get back to the seller, have him sign again and this time have it validated by a Bank Manager and send the Stock Certificate with the new transfer deed back to the stock exchange who would then send it to the buyer.
Many brokers faced an issue here. What if you could not find the seller. Remember, he has already taken the money. Quite a few brokers lost their membership because of bad deliveries which they could not rectify. All for around 1.5% of the selling price value.
If a broker failed to rectify the shares, the stock exchange would buy the same in an auction and debit the broker who had sold. For the broker who had already given the money to the client, he would then find himself holding a worthless certificate while being debited twice for it.
Brokers got caught on the wrong foot during bubbles like Harshad Mehta and the Dot Com bubble. Shares sold for a few rupees were suddenly worth a few thousand. One bad delivery that they could not rectify would lead to huge losses.
In many ways, it’s amazing how far we have come. While brokers are very safe, it has come at a price. Where once there were multitudes of exchanges throughout India and hundreds of thousands of brokers, 80% of today’s business I guess is concentrated among the top 25 brokers. NSE prevailed over everyone. While BSE survived, they aren’t thriving.
Brokers of the past also acted as advisors to their clients. While there have always been bad apples, there were a lot of excellent brokers who helped their clients to invest better. Today, it’s each investor to himself. Strict rules by SEBI have meant that there are hardly a few advisors who shall lend a ear.
Everywhere I see consolidation. It started with stock exchanges, moved to brokers. Advisors who survive will be far and fewer than even the few who are around today. With more transparency and costs that can be charged to investors being curtailed for Mutual Fund houses, smaller firms will have an issue sooner or later and once again, consolidation is bound to happen.
Only bright spark for now seems to be in the arena of Portfolio Management and Alternative Investment funds. Interesting times ahead
Something I have observed and one I wonder if the one thing that is unique to the stock markets is the need for external validation. If you ask a small businessman how business is, more times than not, he will have a list of complaints and how it’s getting tougher. An investor / trader on the other hand mostly cannot stop himself. He may have 9 stocks that are under water but his focus and happiness comes from the one above. Look how I was able to pick this stock up at X. This kind of validation adds little value than making oneself seem superior.
On Twitter, this is more pronounced. Fund managers who have been successful managing tens of thousands of crores barely have much followers or speak about their achievements. On the other hand, you find guys who have bought bluetick (to seem to showcase themselves better than the cattle class) whose timeline is filled with how great they have been.
External Validation has its uses. Guys posting their Profit / Loss on Twitter are seeking to show that they have been able to crack a system that is very hard to crack. This approval can then be converted to money by conducting webinars or simply managing money of others. The top financial influencers I assume earn more than what even a fund manager with a couple of hundreds crores would make.
From the time I remember, one of the first things to arrive on the doorstep of our house was the newspaper. In some ways, reading newspapers also inoculated me to reading (though unfortunately it did not help me with my actual educational reading). While much of the newspaper is written by journalists, there is this small column “Letters to Editor” which posted letters written by readers. I wished I could have my opinion published too so I could showcase I too knew something.
Arrival of the Internet and Social Media meant that we did not have to depend on a gatekeeper to get our views out. We were our own newspapers in a way. But when a billion people start writing, curation goes out of the window and noise easily overwhelms the signals.
Not all validation is wrong either. If you have thought that you have developed a strategy that seems to be interesting, sharing it with others provides feedback that helps overcome one’s own blind spots. Most traders though think themselves more in line with Jim Simons and feel that spilling out the secret would doom the prospects itself.
The other day, I was with an acquaintance who claimed he had developed a strategy that showed gains of 200%+ in a year and without any deep drawdowns. When asked for details, he said “Proprietary”. A couple of years back, a leading advisor launched a positional trading strategy that showed massive outperformance. Details again were “proprietary”. Few months down the lane, it had lost so much money for his clients that it was shut down.
In programs like Amibroker, optimization is just a one click process. This is pure data mining with very few indications that this would work in the future
Of course, if you are a believer in Jim Simons, you then would also know that many of their strategies are based on correlation that makes little sense. If I can predict with say a 60% accuracy, if Nifty will close positive or negative tomorrow based on the weather in Bangalore today, why not make use of it till it works?
Compared to technical / momentum guys, I find value guys more open. The feedback loop helps them figure out things they are missing. The Valuepickr forum has allowed access to the best ideas as well as deeper views on companies they feel is a worthwhile buy. The ability to meet greet and discuss with the best is absolutely priceless
When I started off with Momentum, I shared the details of the strategy with my friend, collaborator and guide @jace48 who helped me a great deal in refining the same. One year later, I more or less posted the strategy on the blog Momentum Investing – An Experiment with Real Money | Portfolio Yoga. Rather than harm, it has proved very beneficial.
Generating Alpha is tough for Individual investors with limited time and resources. Feedback loops hence become very useful. Having someone whom you feel has the same thought process as you can be very helpful in providing feedback. The hard thing though is sharing the idea fully as well as being able to appreciate the pro’s and con’s of the advice received.
As I wrote in my previous post, choose your companions with care.
When I first started going to the stock brokers office, my idea of investing was closer to value investing. But at the brokers office, all I encountered were people who were trading. In due course of time, that is where I ended up as well.
Trading regardless of whether you are profitable or not can be very addictive. The ability to see gains coming in based on a simple positioning one has taken is seductive. More so when one’s capital is small and limited. Yes, it’s nice to think that with compounding, even a small sum of money can end up being a significant sum in the long term, but one wants it today not tomorrow.
Data suggests that most trading is a negative sum game. Add taxes and it becomes a deeply negative sum game. Ed Thorp won money on a consistent basis in the Casino, but the Casino owner knows that at the end of the day, the house always wins.
Most of us wish to be rich and yet very few actually achieve it. When you study the ones who have achieved success, there are virtually none who have achieved from speculating. But speculating is as old as the hills and it keeps beckoning.
Children learn the most from their parents because their parents are with whom they spend the majority of time. In stock markets, I feel that the best ideas come when surrounded by people who are not only as knowledgeable as you but also as curious about the world as you.
I have been around folks in the investment business from around 1996 onwards. But when I look back, the period when I learn the most comes down to just 4.5 years. This mostly due to 2 friends who have helped and influenced me a lot. Surprisingly both are not full time market professionals.
When one looks back on the career of Warren Buffett, the few things that really stand out are the company he kept. Before starting his partnerships, he worked under Benjamin Graham. Then at more or less the right time, he came in touch with Charlie Munger. Oh, he is also friends with Bill Gates.
Luck and Serendipity I think plays a large role in one’s career. Also, being open to change. This I think is different from thinking oneself as open minded. People claim to be open minded but only open to spilling out ideas for others and never accepting that any other way can exist. Tough to learn from those.
On Finance Twitter, Influencers with their mindless ideas make the most noise. That noise in many ways overwhelms the excellent views expressed by others who may not be as articulate but know their stuff. Whom you spend time with matters a lot in the long term. Choose Wisely 🙂
When podcasts first got started, it was interesting to hear. Great investors we knew about only in books or articles came to talk about a variety of things. Learning became interesting.
Today, we are overwhelmed by content, and this includes podcasts. On any given day, I assume there are hundreds of new podcasts that are churned out. some good but most barely worth the time. Since a hour is these days the standard length, its tough to go through even the ones that come well recommended for there is so many of them.
Excess Returns is an investing podcast hosted by Justin Carbonneau and Jack Forehand, partners at Validea. They have had some great guests and some great discussions. But over 3 years, I would think they have talked to guests for more than 140 hours of discussions.
Recently they came out with a summary of the advice given out by 70 of their guests. Just this is two hours long but more importantly, it’s tough to remember. I have tried to reduce their advice to one to two lines. It’s amazing that despite them being a diverse set with diverse beliefs, how when it comes to advise, there is so much of overlap between them.
Pick a strategy and stick with it come high or hell water. Good strategy that you can stick with is better than a Great strategy that you cannot stick with
Don’t confuse information with knowledge. Any strategy that invests in risky assets can go through long periods of underperformance. Diversify across factors.
Many years ago, someone had recommended The Zurich Axioms by Max Gunther and I remember reading it though I doubt I took home any lessons. Recently I got a physical copy and decided to read it once again. Much water has flown since my last read and while I doubt it has influenced me, experience helps me understand the book better today.
There are some good lessons. What I have tried to achieve in this long post is to provide a synthesis of the Axioms and how it relates to us.
Axiom 1: On Risk: Worry is not a sickness but a sign of health. If you are not worried, you are not risking enough.
The basic thought process behind this chapter is that one should risk big enough that if right it makes a difference to the portfolio / net worth. Nothing disagreeable in this statement and this is also something I believe and implement at a personal level.
Where I disagree with is how to take such bold risks. He asks the reader to resist the allure of diversification and instead take not more than 4 positions. For my mother, I have invested in a Value ETF, a Momentum ETF and an International ETF. In theory, this is concentrated while in reality this is a very well diversified portfolio.
My own personal portfolio is 30 stocks. That may sound too diversified until one also learns that it’s also 90% of my Networth at which stage it appears way too concentrated. So, is this Concentrated or Diversified?
Concentrated positions are what can make big money but unless you are running the show at the company where you have invested, the risk is enormous for you have no control (even if that alone won’t make a difference).
A retail investor is better off with just one equity fund – Nifty Index Fund. In theory, it’s a concentrated position, in reality, it’s more diversified than most other investments.
A quote I loved in the Chapter –
All investment is speculation. The only difference is some people admit it and some don’t
Gerald Loeb
Axiom 2: On Greed: Always take your profit too soon.
It doesn’t matter if you are an investor who buys based on fundamentals or an investor who buys on Momentum, one quote from Warren Buffett that applies everywhere is.
Selling your winners and holding your losers is like cutting the flowers and watering the weeds.
Finding winners is tough and when you find one, why cut down the position way early in time. While I buy on Momentum with willingness to sell the very next month, I am happy to hold a stock as long as it’s going up. Why book profits on what is working out well.
There is a well-known saying, “No one ever went broke taking profits”. Again, looks good in theory but the issue is that big profits come out of very few stocks one picks up in his career.
In my own experience, 90% of my portfolio returns are driven by just around 10% of the stocks I picked up. Rest 90% of the stocks were more or less meaningless positions. If I had cut those positions early, I would basically have a performance that would have been beaten by IDFC Savings Bank returns.
This logic may work if one has a winning hand in a roulette wheel (the book has an example using this) where the reason for the win is pure luck. But where there is skill involved, getting out early can be disastrous in the long run.
Axiom 3: On Hope: When the ship starts to sink, don’t pray. Jump
This chapter is about getting out when things go wrong. Risk management is the key to staying in the game and one can win only if one continues to play.
For the stock investor, the book says that Gerald Loeb’s rule of thumb to sell whenever a stock has retreated 10 to 15 percent from the highest price is a good place to sell. I myself use a 25% filter, so in a sense I agree.
But even with a wider level, I have observed that there is risk that I may get out of a good stock well ahead of time. I look at this price filter only once a month and hence in a way reduce the risk of getting out due to normal vagaries of the market.
To give an example, my biggest winner is a stock I have been holding since June 2021. Look at the drawdown chart from my entry level
A 10% or 15% cut off level may have cut off my position way before today. Even the 25% was nearly tested one time but since it came in the middle of the month, I survived. The tradeoff is that some stocks may continue to go down and I will hold to the same till the end of the month. But based on data, I think this an acceptable trade off.
You take small losses to protect yourself from the big ones is a good approach to have.
A good quote from the chapter
“What makes a good poker player?
Knowing when to fold”
Sherlock Feldman
Axiom 4: On Forecasts: Human behavior cannot be predicted. Distrust anyone who claims to know the future, however dimly
Most of us associated with the stock markets are guilty of forecasting. Kya lagta hai market is an often-asked question to anyone who is in the market. Friends ask me this repeatedly even when they know that my view is no better than theirs. When I differ with their view, arguments follow to try and showcase whose forecast is better.
Business Channels have forecasts broadcasted day and night. From where the Index can go to where a particular stock can move to what Inflation and Interest shall do. There are experts who can predict everything. If only someone collated to showcase how bad most of these predictions are. But then again, Television should be used as Entertainment and nothing more.
While predictions in itself are totally a coin toss game at best, they do provide some succor to the investor. When markets cracked during Corona, I had a lot of people call me up to try and understand what to do. My own portfolio was down 30%, so in many ways I was in the same boat.
All I could repeat to many of them was “All izz Well” from the movie 3 Idiots. All I tried to emphasize is that the world is not ending and not to panic sell during these times. While in hindsight I was right, It was not evident to myself let alone others. But the prediction of good times I hope ensured that at least a few of them stuck to their investments and reaped the benefit of the bounce we saw later.
A lovely quote from the chapter
“It’s easy to be a prophet. You make twenty five predictions and the ones that come true are the ones you talk about” – Dr. Theodore Levitt
Axiom 5: On Patterns: Chaos is not dangerous until it begins to look orderly.
Mixed feelings about this book where he trashes Mutual Funds (even those that have done well), Technical Analysis and even Momentum. Interestingly there seems to be a old book by Lewis Owen called How Wall Street Doubles My Money Every Three Years: The No-Nonsense Guide to Steady Stock Market Profits where Owen says one should buy stocks that are nearing or hit their twelve month high. This book was published in 1969, just a few years after Warren Buffett had purchased Berkshire Hathaway.
The author believes that Luck plays an oversized role in all investments and that much of markets are all Chaos with no Order. But how far is that true? Commodity Trading Advisors should not have existed for decades if trends were nothing more than an illusion.
Jim Simons once said that he himself did not understand why certain patterns continued to make money year on year. Fundamentally they made no sense and yet, they made money and he was happy with it.
Discarding patterns without testing its validity is like throwing the baby with the bathwater. Not all patterns can be fully explained and this includes things like Momentum.
Axiom 6: On Mobility: Avoid putting down roots. They impede motion
The name of the chapter is a misnomer. What he actually talks about is not falling in love when it comes to stocks. Great many fortunes have been whittled away because the emotional attachment when the time to sell was right was too high. Once a stock starts to fall, our own behavioral biases such as Anchor bias ensures that we may never get out of the stock.
One of the biggest advantages an asset class like Equity offers is the ability to exit and move to cash with ease anyday. Physical Gold too can be sold and converted easily to cash except for the minor fact that the fee for conversion is pretty high. With Real Estate, one maybe a seller for a year and more and not find a buyer unless its sold at a deep discount.
“Only buy something you’d be perfectly happy to hold if the market shut down for 10 years” says the sage of Omaha
The issue is, how much of your money will you be willing to invest if you cannot sell something for 10 years. The general view will be a small amount for we don’t know how the future shall unfold and when we may require the sum invested. But this clashes with Axiom 1 view. If you are not betting enough, the gains, even if huge in percentage terms, may not really move the needle.
Liquidity is very important regardless of whether you are a short term investor or long term. Robert Nou of Punch Card Capital who has a excellent track record while investing based on long term approach had this to say
“I used to think that the liquidity of an underlying security didn’t really matter, because if you plan to hold it for a long time, it shouldn’t matter that you can’t trade in and out of it every day or month,” he said. But, as he discovered in 2008, illiquidity makes it difficult to swap out of a position when you find something better to buy. “I don’t avoid illiquid things now, but there is a potential opportunity cost that I now take note of that I previously did not place any weight on.”
Axiom 7: On Intuition: A hunch can be trusted if it can be explained
From here onwards, I felt that the book started to go down. The author believes that it’s a mistake either to laugh at hunches or to trust them indiscriminately. He suggests that it can be useful if handled with care and skepticism.
As is the case with all the chapters, he provides examples to show how someone had a hunch that worked out in her favor. With a sample size of 1, he then suggests that hunches aren’t meaningless dreams but based on all the data we have observed and absorbed but one we may not be fully aware of.
Gut feel is the world I have seen a lot of investors and traders use when taking a position. Just today I was talking with a friend who lost quite a bit of money because his gut told him that the fall in the market had happened when in hindsight, it was just the start.
Gut feels aka Intuition is untestable. We only remember the ones that came right, never ones that went wrong. This in many ways tilts the way we think, making us feel superior when the reality may be the other way round.
Atul Gawande wrote a wonderful book titled The Checklist Manifesto: How to Get Things Right which talks about how the mind plays tricks and how the best way to protect oneself is to have a checklist that one can check to see that one is not really missing out.
Being a quantitative based investor has been the best decision I myself have made. Quantitative investing doesn’t guarantee success but at the same time, it’s easy to perform a post-mortem to understand why we fail if we fail. When our Intuition / Gut fails, we have no way to learn from the mistake.
Axiom 8: On Religion and the Occult: It is unlikely that God’s plan for the Universe includes making you rich.
Outside of Bangalore Stock Exchange premises for a long time I saw a tarot card reader. Not once in the nearly 20 years I have spent there did I see him seeing someone who was associated with the stock market. His clientele was a different breed.
One of the controversial men who have left their mark in the world of Finance is W.D. Gann. His trading methods among other things included Astrology.
While Indians are strong believers in such stuff, other than for making a customary purchase on Dhanteras day, I barely saw much importance given to Astrology or any other beliefs when it came to investing.
This is an Axiom that I doubt has many takers in the world of finance, at least not in India.
Axiom 9: On Optimism and Pessimism: Optimism means expecting the best, but confidence means knowing how you will handle the worst. Never make a move if you are merely optimistic.
Being an optimist, I actually like this chapter which talks about the risk of unbridled optimism. Most businessmen are optimists. Same is true for Fund Managers too.
Keynes is supposed to have said, “In the long run we are all dead”. Long Term charts of any markets have gone only one way – Up. What about Japan you may ask. Well, here is the long-term chart of Japan’s Nikkei 225 Index. Chart is in log scale.
The Great Depression in the 1930’s in the US. On a long enough scale, it looks tiny even though the high of 1929 was broken only in 1954.
Optimism is good but over optimism is what kills businesses and investors alike. While stockbrokers are generally seen to be optimists, I know a great deal who are skeptical a lot of times if not outright pessimists. Again, going overboard has meant that many never accumulated even the basic gains that markets have delivered over time.
2004 was an interesting year. In 2003, we had one hell of an amazing year with Nifty recording its highest ever gain in any calendar year since its inception. The high of the dot com bubble seemed to have been decisively crossed.
2004 was an election year but one most felt was just a formality for Vaypayee to come back to power. India was Shining they said and most of us drank the kool aid.
The first four months saw not much action in the Index though stocks had started to creep lower. But, this is normal was the feeling of most of us optimistic that the markets shall go upwards as results came in favor of the NDA government.
Personally, I held very little position since much of my capital was locked in the Stock Broking firm I had just taken over. So, it was just munching popcorn while election results came out. Friends of mine with deeper pockets though were fully invested to take advantage of the upcoming rally – a rally that seemed predestined to happen.
The first sign of something was not right came towards the end of April post the day of the 2nd leg of elections. The bigger slide started once exit poll results came in showing NDA in trouble. Interestingly on counting day, 13th May 2004, Markets actually crept up. A stable government was what it was looking for, be it from the Congress or the UPA. All hell broke loose on 14th and then on 17th when in between (14th being Friday and 17th being Monday), when CPI-M Boss, CPI-M General Secretary Harkishan Singh Surjeet said “we cannot afford it (disinvestment programme followed by the NDA). We oppose disinvestment of profit making PSUs. All the mistakes of the NDA government have to be rectified
Ultimately UPA did not totally reverse the policies of NDA though it changed the way disinvestment was done. But for the speculator, the damage was enormous. Nifty was down 36% at the day’s on 17th May and most leveraged positions were squared off.
In many ways, that was a learning lesson for me in having a plan to exit rather than depending on my own view of how the market shall behave. The best thing I have loved about Momentum Investing that I practice today is that in the unlikely case of a market crash, I know I shall be out even if I have to give up a part of the capital as an offering.
Axiom 10: On Consensus: Disregard the majority opinion. It is probably wrong.
Again, a mixed view about this chapter.
The crowd is actually right most of the time. The problem arises when at the end. When markets are bullish, the crowd is generally long and right. When the crowd becomes a mob, it generally lends to the feeling that the end is nigh.
Kevin Kallaugher’s famous cartoon in many ways depicts the change of sentiments by the crowd.
When the markets are bullish, the crowd for most of the while is actually bullish. Going against the sentiment when we aren’t sure that the trend has exhausted is a sure fire way of getting bankrupt sooner than later.
Take a look at the price chart of Tesla, a company that attracts equal attention by believers and naysayers alike.
At one point of time, it was one of the most shorted stocks. But rather than fall, it caused so much untold agony to fund managers that many, while believing that Tesla will die one day, don’t want to bet on it.
The crowd on the other hand was and even today is very bullish on the prospects. Those who have been bullish from before Corona are still in profit even though the stock is today down more than 50% from its peak.
Those who would have lost money or underwater in their investments trying to follow the crowd are almost everyone who entered Tesla from 2021 onwards. What this suggests is that rather than following or no following the crowd, one way to stay ahead is to have a good risk management system ( Axiom 3)
Where the crowd generally gets it wrong is when the stock is trending down. Bottom fishing is the bane of most investors. When you buy because you feel the stock has become cheap, it’s difficult to exit when it becomes even cheaper.
Not all bottom fishing is wrong, just that one needs to understand the risk and have a plan beforehand to deal with all sorts of outcome.
Nearer home, Pharma started to become a hot sector for investors. My own portfolio was having enough Pharma stocks to make me think on where we are in terms of the rally
The rally continued for months before peaking out in October 2021. Once Momentum ended, stocks started to drop off over time. While the sector will have another rally at some point of time, the advantage of having a strategy that removes stocks once it starts to go down has huge merit in terms of managing Risks.
I am reminded of George Soros famous quote on how to deal with bubbles
“When I see a bubble, I rush in to buy it.”
Axiom 11: On Stubbornness: If it doesn’t pay off the first time, forget it.
Current trend is Revenge Travel. Revenge Investing / Trading on the other hand is something that a lot of investors actually implement.
If I lose money buying say Infosys, some traders try to recover the same through trading Infosys and not any other stock. Stocks have no memories or do they have personal agendas.
In many ways, we as investors and traders are stubborn when it comes to our beliefs and notions. Stubbornness isn’t an entirely bad philosophy for every strategy goes through its good times and bad. Investor behavioral gap comes from the inability to stay the course when the strategy isn’t working.
I recently asked Swarup Mohanty on how long one should stay invested in an underperforming fund if the fund itself is sticking to the strategy. His answer, 3 years.
While there is no hard and fast rule on how long one should give time for a strategy to perform before pulling the plug, being stubborn even as data shows that more time may not resolve the issue benign faced will only result in permanent opportunity costs and one that over time can add up to a decent bundle.
Meb Faber for instance believes that a reasonable time frame to evaluate a strategy or a manager is 10, if not 20 years.
Cutting down exposure to a strategy too early is as bad as cutting down exposure too late. One could always argue that with wide diversification, one can give a longer rope. But this will violate Axiom 1 – bet enough that it matters if it wins.
Axiom 12: On Planning: Long-range plans engender the dangerous belief that the future is under control. It is important to never take your own long-range plans, or other people’s, seriously.
A current trend and one that is advocated by many is to plan for one’s goals as early as possible. Thanks to Microsoft’s amazing software called Excel, punching in a few numbers is all it takes to say, if one were to invest X per month every year for the next 20 or even 30 years, every goal you have in mind today will be fulfilled.
In some ways, this gives a comfort to the mind but how true are such projections. 12% long term returns are seen as a conservative number to be used for such plans. Nifty 50 long term returns too are in the same range. But if you break it down to say 5 year rolling returns, you can see that Nifty 50 also had times when the 5 year return was negative.
If you are a young investor, you should wish for a Bear Market. A bear market means low stock prices and hence when you are starting off, it helps you buy more or so goes the logic. Bear markets are most of the time accompanied by weak economic conditions.
Would you want cheap prices while at the same time having a hard time finding a job or worse. In the movie The Matrix, there is this wonderful dialogue on what good is a phone call if you are unable to speak
In life, most of what we do is fluid. Be this related to our Jobs or our Expenses. Some risks work out exceedingly well, some don’t. When advisors ask investors to eschew risks, they are correlation risk and return in a way that doesn’t really work in the real markets.
Leverage can be either good and bad not on where it was deployed but more importantly on the end outcome. Anyone who took leverage and invested in Real Estate has seen his net worth swoon up while many who took a much lower leverage but in the financial markets have seen their net worth get eroded.
All in all, this is a decent book for someone who is new to markets as also someone who has a fair bit of experience. But like everything else, nothing is to be taken as gospel. Questioning helps provide perspectives and understanding.
Contrarian investing is described as buying when no one wants to buy and selling when no one wants to sell. Much of value investing in many ways is contrarian investing.
In the book, Contrarian Investing, the Authors say that any stock that fulfills 2 out of the following 4 criteria can be considered as a buy
A PE Ratio less than12
A Price to Free Cash Flow ratio less than 10
A Price to Sales ratio of less than 1
A price to book value ratio less than 1
Not too different from a Value Investors screener for choosing stocks. When you search for Mutual Funds whose fund names have “Contra”, on ValueResearch, they are bundled with Value Funds.
Talking about the Berkshire Annual General Meeting, Morgan Housel wrote this,
It’s 40,000 people, all of whom consider themselves contrarians. People show up at 4 am to wait in line with thousands of other people to tell each other about their lifelong commitment to not following the crowd. Pluralistic ignorance at its finest.
Being contrarian is doing something that goes against the grain of logical thinking. Much of investing is not really contrarian. This is not to say Contrarian investing is not possible. Investing in a sector when it’s facing bad times for instance is often seen as contrarian investing.
I myself have done this more than a couple of times, the last being
I think investing against the herd gives off the zing that doesn’t come with normal investing. Here is the comparison chart of Nifty Realty with Nifty 50 and my own personal Momentum PF.
Lot of times, Contra Investing can also overlap with Distress investing. Wanna buy Pakistan Bonds?
The biggest issue with Contrarian investing is position sizing. Bet too small and even if right, it may not move the needle. Bet too much and if things go wrong, your returns shall never make it to the benchmark for years.
But there is a certain fascination / ego to say one is a contrarian for it suggests that one is better than the herd. But we are in more ways than one always part of the herd.
Recently I finished reading “Samurai William: The Adventurer Who Unlocked Japan”. It’s an impressive book that looks at the first Europeans who landed in Japan. But what the discovery (for Europeans for Asians had trade relations with the country going back centuries) was the fact that this was financed by risk talking gentlemen sitting in London.
In a similar vein, I think in today’s world, the true contrarian investors are “Angel Investors”. Unlike PE funds or VC funds, Angel Investors are risking their own money in investments most of which they very well know shall fail.
In the secondary market, I think one of the most hated strategies has to be Momentum. BAAP takes the limelight because of just one fund manager there to be bashed.
When one speaks about Momentum, most confuse Discretionary Momentum Trading and Systematic Momentum Investing. While both try to buy stocks that are going up, the key difference is in risk management. Systematic has a set of rules to ensure that when things don’t work out, and they don’t 50% of the time, we have an exit to end the agony.
In discretion, we are left to our own devices and given our behavioral biases and heuristics, the probability of cutting down when things aren’t working out is much tougher. Many traders for instance have a concept called “Mental Stop Loss”. Rather than placing the order on the terminal, the idea is to have the same in the mind and execute when it’s triggered.
Most of the time, stop loss means that the trade is already at a loss. The probability that the trader will actually go ahead with the trade is less than 100%. Most of the time this leads to bigger losses but once in a while, the trade rebounds to profit and the mind registers this as a reason to not place the order.
At the end of March 2020, my portfolio had been devastated by the markets. On 1st April, my strategy told me to sell 25 of the 30 stocks I held and buy 10 as replacement (50% went to Cash due to paucity of stocks to buy).
Despite practicing Systematic Investing for nearly 3 years and Systematic Trading for more than a decade by then, my first instinct was to override. Why not hold onto the stocks given my view that the worst could be over. Being overweight in financials, a few of my investments were down 40% and more – not easy to book losses of that nature especially when the holding period was just a month or two for many.
Thankfully I choose to follow the system. Thankful because as I wrote in my previous post, The Itch”, the cost isn’t just about money. In this case, in hindsight, sticking to the system gave a better return than if I had just stuck with the stocks even though many did recover in time.
The toughest issue with Momentum Investing is not just behavioral. Buying at highs and selling many a time at what seems to be the low point is tough. Tougher is the lack of a convincing argument on why the action needs to be performed.
Jim Simons had started to taste success in his fund. But that did not stop him from trying to influence what trades to make. Thanks to his team, he was not allowed to mess up the system.
There is this misconception that systematic trading or investing is easy when in my own experience it’s not. The reason is that a system asks you to jettison all your own thoughts, views and just follow the machine. But we are not machines.
Systematic strategies are easy to follow when the going is good. The utopia of making money, even if it’s inline with the market allows the mind to feel it’s in control. But the trouble starts when one has a losing streak and regardless of systems, every system shall have its downtime.
Mulvaney Capital runs a systematic trend following program. It has had a blockbuster 2022 with a return of 89% for the year. Since its inception in 1999, it has generated a CAGR of 14% vs 4.50% for S&P 500. A fabulous outperformance indeed.
But long term returns can hide short term pains and it’s the same here too. The fund had a fantastic 10 years since its inception. 2000 to 2010, it generated a CAGR of 19% vs a negative return of 1.4% by the S&P 500.
But in the next 10 years (2011 Jan to December 2020) yielded a CAGR of just 2.88% vs a return by S&P 500 of 11.55%. Talk about underperformance. Two short years later, the CAGR since 2011 Jan is now greater than S&P 500.
Most CTA’s have low assets under management with the management most of the time having their own money greater than the rest of clients combined. The pressure the fund manager faces during those trying times is unmeasurable.
Momentum strategies will have similar periods of no returns too. In the back-test, we saw that the 2008 peak was not comprehensively taken out till late 2013. The returns were inline with Nifty 50 but that is of little help to someone who has to keep managing the portfolio (Weekly / Monthly as the model maybe).
Compatibility between investor and investment style is one of the most overlooked concepts in the investing field. What works very well for one investor may be disastrous for another. I think that’s why a lot of investors fail. They may have a good investment strategy or technique, but they’re not comfortable with it because it’s not compatible with their natures. The result: they don’t stick with it.
Much better to temper enthusiasm when things are good and develop enthusiasm when things look bleak. This is what contrarians do and it helps them stay the course.
All good investing is Value Investing, says Charlie Munger. I would add that all good investing is Contrarian in nature.
PS: As I was writing this post, I was also listening to songs from the Telugu Movie Shankarabharanam. In many ways, the movie was a contrarian. It featured a debutant for the key role while also allowing a newbie singer, SPB, to sing the fabulous songs. The movie broke records and is seen as one of the best Telugu movies ever. Risk many a time can pay off very well.
