Active Investing is Uncomforting

Investors for most part want returns that are higher than what the market offers. But Investors also hate doing things differently from the crowd. There is a certain comfort in being part of the crowd – when they are happy, the investor is happy, when they are sad, the investor is sad. 

Owning a Value stock such as ITC is seen as a sin while owing an out and out Momentum stock such as Adani is seen as a Sin too. Between these two extremes lies the portfolio of most investors. 

Market rewards investors for both doing things differently as well as doing things the same as the markets. To do something similar to the market is easy – buy an Index fund. To do things differently though is hard. 

In the last one year, companies have gained in terms of market cap astronomically. Yet no group has gained as much as Adani. Motilal Oswal talks about 10x in 10 years. Most Adani companies achieved this in the span of just one year. Adani Enterprises, the parent company had a market cap of around 17 thousand crores last year. This year it’s worth 1.7 lakh crores. 

A Momentum Investor is expected to hold such stocks. The risk though is when stocks fall off suddenly and ferociously as it happened with Adani on Monday. While how the investor reacts to such events may be different, the Momentum Investor should be mentally prepared for the same.

A Value Investor faces a different kind of pain – the pain of the market not recognizing the true value of the stock for a long period of time. Adani Enterprise adjusted for the spin-offs it has seen in the past has had its stock price go nowhere.

The stock was trading at 115 Rupees in 2010 and was available at 121 during the recent covid crash. The 10 year CAGR at the lows was below 5%. Today the 11 year CAGR is at 30%. One year has made all the difference to the investor who was able to stick with the company.

We can argue whether the stock is a value or not, but good stocks can go through a long period of doing nothing before doing something extraordinary in a short span of time. In the past we have seen Reliance, Hindustan Lever, Nestle among many companies with similar trends.

There is this famous Martin Zweig quote,

“It’s OK to be wrong; it’s unforgivable to stay wrong.”

When does one know it’s wrong? The views one forms is mostly a form of resulting. Writing in her book, Thinking in Bets she says, Resulting  is our tendency to equate the quality of a decision with the quality of its outcome.

Momentum Portfolios for most part spent 2018, 2019 and half of 2020 without hitting the highs they saw in early 2018. How long does one give before deciding the strategy is wrong? 

Relative Returns are how most fund managers get judged. This brings to mind the famous cartoon

Returns of every strategy gets benchmarked to the returns generated by a broad based Index. The Index represents the opportunity cost to the investor. An investor choosing a specific factor is not choosing the same to try and maximize returns. Instead he aims to maximize his ability to deploy as much capital as possible in the strategy.

Twitter for me is a window to the world. Yet Twitter can be many a time unnerving. Value Investors ridiculing investors who believe in Quality. Momentum folks ridiculing Value and so on and so forth. 

Conviction cannot be built in a noisy atmosphere and yet there is no escaping the noise. Bull markets make it easy to build conviction. It’s the bear market that tests one’s conviction. 

Lately I have been testing with a few microcap stocks. Truth be said, the exercise is uncomforting given the knowledge that once the music stops, there may be no easy exit. But it’s fascinating from the angle to crowd psychology and behavior to not just observe but to actually take part in the madness.

As Shane Parrish paraphrasing Charlie Munger wrote

If you want to improve your odds of success in life and business, then define the perimeter of your circle of competence, and operate inside. Over time, work to expand that circle but never fool yourself about where it stands today, and never be afraid to say “I don’t know.”