Commentary | Portfolio Yoga

Learning the Wrong Lesson from Bogle.

Human Life Expectancy today is 79 years. Most of us live out the lives in a fashion that none other than family members can remember one after we pass away from this world. Those who achieve greatness in their lifetime are generally remembered for at least one more generation before the memory stats to fade away.

Peter Houston, invented the first roll film camera but it was George Eastman who was well known thanks to he being the licensee of the patent on roll film and starting Eastman Kodak Company. Anyone born in the last couple of decades will barely remember roll film based cameras while the coming generation will mostly know camera as something that is part of a phone.

Throughout history, very few innovators have also been able to make a name by building a business around it. Exceptions to the rule are people like Henry Ford who founded the Ford Motor Company in 1902. Thomas Alva Edison was another for who hasn’t heard about General Electric.

John C. Bogle who passed away recently will be someone who will be remembered for a very long period. But will he be remembered right is the question that haunts me today as I read through the Eulogizes.

Yes, he was not just the founder of Vanguard which today ranks among the top fund houses in the world. He is celebrated for founding and popularizing “Index Funds”. Today, his view that rather than attempt to beat the Index, it’s far better and wise to just mimic the index performance through Index funds and Exchange Traded Funds is fast becoming mainstream with even Warren Buffet, the guru of active investing advising investors to go “Passive”

But is that what Vanguard stands for today? While billions of dollars have flown into passive funds in the recent past, Vanguard as of June 30, 2018 was managing just over One Trillion Dollars invested in active funds. Yep, you heard that right – the apostle of Passive Investing runs over 80 active funds.

Recently, one of the better writers of our time, Morgan Housel came to India to deliver a lecture at the India Investment Conference. He is a fantastic writer with focus being on behaviour finance. In one of his earlier interviews with Vishal Khandelwal, he mentioned that his investment consisted of only Vanguard Total Stock Market Index. He talked about the same in an interview to ET Now a few weeks back as well.

Morgan works at Collaborative Fund. Collaborative Fund is a Micro Venture capital that has through 4 funds raised $250 million from investors for investing into start-up’s. If active investing were to be graded based on the risk profile of the investment, active investing would be right up there along with Private Equity and other new age investing beliefs.

“Don’t look for the needle in the haystack. Just buy the haystack!” wrote John C. Bogle in his book, The Little Book of Common Sense Investing.

David Swensen, the chief investment officer at Yale University writes,

“Understanding the difficulty of identifying superior hedge fund, venture capital, and leverage buyout investments leads to the conclusion that hurdles for casual investors stand insurmountably high. Even many well-equipped investors fail to clear the hurdles necessary to achieve consistent success in producing market-beating active management results.”

In his book, Unconventional Success, he presents the following table;

In other words, most investors in PE funds, Hedge Funds and Venture Capital funds will generate sub-par returns. Yet, Trillions of Dollars chase the fantasy of being able to invest in the fund that may fund the next Facebook or next Alibaba.

I am a great fan of Morgan Housel’s writing yet wonder if he truly believes in what he says & I quote “I don’t think investing needs to be complicated so I keep it as simple as I possibly can” – needs to be dished out to investors of their own funds.

I think the biggest contribution of Bogle was not the fact that its impossible to beat the market – its tough, but not impossible but showcasing the fact that fees has a very high impact on returns. Lower the fees, higher the returns – its that simple.

Vanguard’s own active funds charge a median fee of just 0.05%. This low fee ensures that the fund manager need not take unnecessary risks to generate Alpha.

Just to give a comparison with mutual funds in India, most of them charge on an average around 2.05% for regular funds and 1.20% for Direct Funds (Asset Weighted). Easy pickings in the past have meant that even post high expenses, many a fund manager has been able to handsomely beat the benchmark.

New rules combined with huge inflow of funds seem to rock the gravy train as funds will find it extremely tough to outperform the passive indices. Cutting down on fees is the easiest way to generate better performance, but why bother when funds are flowing into active funds like no tomorrow.

“Kitna deti hai?” was a campaign launched by Maruti to showcase our obsession with mileage. Then again, how can we be blamed given the high cost of fuel thanks to loads of government taxes. Every car manufacturer wishes to maximize the miles per litre. While a lot of savings come from optimizing the engine, one of the ways to add mileage is by reducing the drag of the vechile.

The higher the resistance a vehicle offers to the wind, lower the mileage. Car Manufacturers spend big money trying to optimize the design that reduces the same while still adhering to the overall design concept. A Formula 1 for example has the lowest amount of wind resistance but is unlikely to in favors if introduced as a family vehicle.

Friction in finance eliminates returns – higher the friction, greater is the reduction in return for every unit risked. Ritholtz Wealth Management offers Financial Planning and invests their clients money into cheap, low fee products.

But much of the savings they produce to the client are eliminated by their own fee which is a percentage that is many a multiple of the fees charged by actual money managers. This again is friction and the client finally ends up with much lower return.

The biggest fear of Universities and Research Labs are of their best and brightest weaned away from Campuses and Labs to Wall Street. After all, no University or Lab can compete when it comes to the pay Wall Street is willing to offer.

This pay though comes straight out of the pocket of investors. In good years, the fund manager takes not only a management fee but part of the profits as well. In bad years, he is more considerate and takes away just the management fee.

Do that for decades and the investor ends up with just a small part of the overall profit that has been generated using his capital. Mutual Funds aren’t that bad, but their Alpha contracting, the fees over time will eat up into significant returns.

Warren Buffett charges a minuscule percentage for managing the Billions he is in charge of. It’s been calculated that if Buffett had charged what is charged by much of the fund industry – 2% management fee and 20% share of profits, his investors would have stood to lose a lot.

Eliminating friction is a step towards achieving your financial goals faster. The lower the costs, better the return – its as simple as that. The reason to choose an Index Fund rather than active fund lie in the fact that identifying active fund that shall be the winners of the future is incredibly difficult.

Low Fee Active Investing is the path forward. Everything else is secondary.

Expectations, Probability and Reality. Can you really make 100 Crore by Investing 10 Lakh

Most kids coming home from their exams don’t expect anything less than a First Class. Parents don’t expect anything less than their ward getting into the IIT’s of the world. Investors assume that they can easily generate returns that would put even Warren Buffet at his prime to shame.

On Twitter, experts for most of the time seem to showcase how great their stock selection / trade selection was – look at how the stock bounced right off the support. Fundamental biased investors generally are eager to show how easy it was to know that the stock was a fraud, post the event even though when the stock was actually doing far better than the market, there are few sane voices questioning the same with data.

When the market was running up in the years prior to 2018, Mutual Fund managers were more than happy to show how great investing is. Now that the Large Cap Index in itself is still doing good but stocks have crashed, the excuse is that it’s “darkest before dawn”.

The reason investors aren’t able to stay the course is not because they are greedy or lack discipline but because they were misled on the expectation of the returns they could achieve for the risk they took.

Thousands of home buyers today have either paid or still paying for houses that may never be delivered. They weren’t greedy other than being dreamy about owning their own house – they were misled when it came to the risk they took when they signed on the dotted lines.

On the very long term, markets have gone up and hence if you keep investing, you will do well is the mantra of every analyst in town.

Take a look at the chart below – this chart is the Total Return Index of S&P 500 since 1871. The growth is just amazing with hardly any drops.

But the reality wasn’t so easy queasy. Can you see the small dip during the early 1930’s? Well, that was what is today known as the great depression. A famous pic from those times

By the time, the low was made, the Dow was down a preposterous 89% from its peak. US hadn’t seen a crash of that magnitude before or later. Yet, the Index recovered and those fortuitous to be holding on to the survivors would have made it back. But do we really expect ourselves to survive such a carnage without a change in the way we invest?

While the Bombay Stock Exchange is the oldest stock exchange in Asia, we don’t have data on stock prices of historical years. Sensex which is the bell weather index came into life only in 1986. Since 1986 to today, the Compounded Growth rate has been 13.50%.

To make that 13.50%, you should have been able to participate in the Sensex for the last 32 years and going through long periods of negative return. In other words, you would have been required to be a Saint. Of course, all this is theory since there was no easy way to participate in the Senex other than to construct the same on your own in the same weights. The first index fund came into life only in July 1999.

Acclaimed Guru and Stock market expert, Ramesh Damani recently gave a talk with the clickbait topic

“How to make 100 crore by investing 10 lakh: Ramesh Damani”

He talks about the huge advantage of starting to invest early and has the following side

Staring to save early is good but does that really provide the edge. There are two things worth noticing in the slide – One, the period of Savings and two, the small number at the last which says “Interest Compounds at 15%”.

Sensex has compounded at 13.50% and since this doesn’t include Dividend Yields which can come to 1%, 15% seems pretty much achievable. But does the static convey the real picture?

While I don’t have data on Sensex PE in 1986, in January of 1991, Sensex was trading at trailing four quarter price earnings ratio just below 10. We have seen this low a number only once post 1991 and this was in 1998. Neither the crash of 2000 nor the crash of 2008 brought down the market to such a cheap level.

Ramesh seems to have taken the 15% number from Sensex of the past 30 years. But the larger question is whether the last 30 years is representative of the next 30. No one knows how the next 30 – assuming you are saving for your retirement will generate.

But was Karishma really able to out-perform Kareena? Lets run it through real Sensex numbers to see how they performed. Remember, Karishma saves for just 7 years while Kareena saves for 27 years. If both invested in debt yielding 15% CAGR, this holds true – but markets don’t give out 15% or even 13.50% returns year on year.

Since we have only 33 years of clean data, lets give Karishma the first 7 years (1986 to 1992). For Kareena, we shall start investing in 1992 and invest till 2017. So, how do they fare by end of 2018?

Karishma has invested 50 thousand for 7 years which is equal to 3.5 Lakhs. This is now worth a fabulous 1.58 Crores – in other words, her investment has generated a XIRR return of 14%.

Kareena started off in 1993 and invested until 2017 for total investment of 12.50 Lakhs. Her current value is a mere 70.50 Lakhs. XIRR comes to 11.50%.

So, what happened. How did Kareena beat Karishma even though she invested for a longer period and through multiple bull and bear markets? Is this all the magic of Compounding?

The reason is simple – from when Karishma started to invest till date, index had a CAGR growth of 14.13%, for Kareena this number comes to 10%. In other words, much of the difference can be accounted by the timing.

Karishma started to invest when Sensex was around 500 levels and ended her investment when Sensex was around 2500. For Kareena, the start point was at 3350 and ending at 34,000.

Since both of them investe in the same instrument, we can get a better understanding by looking at how many Sensex units Karishma got for her 7 years of investment and how many years it took Kareena to accumulate the same.

Karishma over the seven years accumulated 440 Sensex units (Investment divided by Sensex). Kareena was able to accumulate just 195 Sensex units over her entire investment.

It’s similar to someone investing 50 thousand in Eicher Motors when it was a small cap stock versus investing 50 thousand when Eicher became a large cap. Return generated by the early investor is tough to match. As the adage goes, the early bird get the worm.

Personal Finance blogger, M. Pattabiraman had a very interesting video where he showcases how timing can influence returns for SIP’s.

Mutual Fund SIPs will not work without luck!!

Given what we now know and understand, what then should one have expectation of returns. Let’s assume if you were to invest a sum of money with a horizon of 10 years, what expectation you should have at the end of 10 years.

A lot depends on where you invest, but for simplicity sake let’s assume that you invest in a large cap fund that shall mirror Index returns.

Lets start with a much smaller time frame than 35 years – 10 years is seen as Long Term and if we can get things right in this time frame, we may as well have a chance to get things right on the longer time frames as well.

For this analysis, I shall use Nifty 50 weekly data which starts in mid 1990. Using weekly gives me more data points than monthly and hence better granularity. What is the range of returns we have seen for a period of 10 years?

The answer is that it can range between a negative 1.60% to a positive 20.28% with average return being 11.65%. That range of returns is just too wide to use it for figuring out how much can we get for our investment ‘n’ years later.

Here is a chart that plots the data (n = 959).

How to read the chart?

The chart showcases the percentage of weeks where investment would have yielded the returns as shown in the Horizontal (x-axis). To get a better measure, you can simply cumulate to the bar you think is the return you need and subtract the same from 1. This is your probability of getting such a return.

So, the probability your return is greater than -1.58% will be 99.69%, the probability that your return would be somewhere near 20% is 0.52%. If you were to take a view of a coin toss, the 50^th percentile so as to speak will lie at around 13%.

While just blindly investing in a growing market will at some point of time provide you with strong positive returns, the inability to project the same can hamper our ability to stay the course. When we are hit with draw-downs, the last thing we calculate is that if the current return is well within the overall bell-curve of returns possible.

Assuming that 6% is the minimum returns we wish to generate from equity, what were the historically bad years to start a 10 year investment in Nifty 50?

We had 156 weeks where investing would have yielded a return of less than 6% after 10 years. The worst years to invest were 1994 followed by 1993 and 1992. Compared to this, 2007 / 08 which too makes a presence was a walk in the park. Investing in almost any day of 1994 and greater than 80% of the days of 1992 and 1993 would have generated returns below 6%.

Comparatively, just 7 weeks of 2007 (bunched around November and December) and 2 weeks of January (first couple of weeks) were the worst weeks.

As much as we think we know the future, it’s one thing to know and quite another thing to live through the same. Draw-downs take a toll not just in terms of money lost (notional or not) but also has a massive impact on our confidence.

The great Stephen Hawking was diagnosed with ALS when he was 21. This being a non-curative disease, Doctors at that time gave him a life expectancy of 2 years. He lived for 53 years more.

In an interview to New York Times magazine in 2004 he said

“My expectations were reduced to zero when I was 21. Everything since then has been a bonus.”

From Warren Buffett to Rakesh Jhunhunwala to Ramesh Damani, I doubt anyone invested with intention of using the proceeds at the end of ‘n’ year for specific purposes. Having zero expectations from your investment in markets can be tough, but if you were to accept that, the task of becoming a better investor becomes easier for nothing the market throws at you will impact you negatively.

In God we Trust, Rest bring Data

The position of the RBI Governor is one of Prestige than Comforts. While the RBI Governor draws a Basic Salary of 2.5 Lakhs per month, the CEO of HDFC Bank, the premier most private sector bank in India draws a Salary of 80 Lakhs per month in addition to perks such as ESOP’s which can add a lot to the tally.

Allan Greenspan will be known by millions of people more than those who knew who the head of Citibank was during his tenure. Same is the case with RBI, the Governor’s are those willing to sacrifice a nice salary that could be obtained for being in charge of driving the decision making process at the RBI.

One of the perks of being the head of the Central Bank in most countries is that while they are answerable to the government of the day, they enjoy a very high degree of freedom in exercise of powers that accompany the office.

Yet, clashes between the Central Bank Chief’s and the Elected governments aren’t rare. Just last week when State Bank of Pakistan hiked Interest Rates, the Prime Minister expressed surprise and while talking about maintaining autonomy of State Bank of Pakistan (which is the Central Bank of Pakistan), he asked that in future no such decision be taken without taking the government into confidence first.

Recently, Trump accused Federal Reserve Chairman Jerome Powell of endangering the U.S. economy by raising interest rates.

Politicians around the world are the same. They wish that they have a Central Bank that is Autonomous to the outside world and yet follows the dikkat of the government. From Modi to Imran to Trump, all of them want their Central Banks to lower Interest Rates.

The biggest borrower in all countries remains the Government and a high interest rate means that much of the government budget gets eaten away by interest payments. Lower the interest rate, better the ability of the government to borrow more without feeling the pinch.

For a moment assume India to be a Company and RBI to be the Auditor. If you are long stock of India and the Auditor after fighting the management for some time resigns due to “personal reasons”, how trustworthy do you think the accounts are – especially since a recent growth number brought out by the company was riddled with deficiencies.

Resignation of the governor of RBI is not the end of the world, yet it’s an important pivot and one that could well define how India fared.

The reason fiat money works is because of Trust – you remove or even start questioning the Trust and the Fiat currently starts looking more like an ordinary paper than a value of exchange. The last time an RBI governor quit in protest due to “differences with the finance minister” was in the 1960’s when we were a much smaller and closed economy.

Emerging economies including India have had a great time in recent years thanks to the low interest rate and ballooning balance sheets of the Central Banks of US and Europe. But that easy money supply has more or less ended. US Fed is already well on course to contract the size of its Balance Sheet by removing 50 Billion from its Balance Sheet every month. ECB too will be starting the process most likely at the meeting to be held 3 days from now (December 13). With easy money on the way out, attracting FDI / FII money will become tougher for India is not the only emerging economy that is seen as attractive.

When a company loses the confidence of the investors, its tough but bearable to a extent. But when it loses the trust and confidence of the Bankers, it can be a death knell, especially if the company requires outside finance for growth.

India is at a stage where we require tremendous amount of foreign capital to enable the country to life itself from the emerging nations to the developed nation state. This money though doesn’t come easy and instances like these will have people questioning the Risk Reward characteristics of investing in India in the first place.

“This too shall Pass” is a favourite phrase used by many to describe events that seem big at that juncture but will be all forgotten in time – anyone remember the Greek / Cyprus crisis that was supposed to doom the Global markets for instance? Yet, the markets don’t simply sail over such events – there is a opportunity for those willing to take the risk and threat to those who are already overexposed to the risk.

Markets will go through a tough period – weak hands will be thrown to the wolves while the strong hands will endure the pain to see the light of the new day. As long as you can sustain the pain and have invested in stocks that themselves can survive the oncoming tsunami, All izz Well.

But day’s like this aren’t forgotten for the lessons that could be learnt are too important and timeless to be overlooked by future historians. For Investors, the ride is about to get a lot more volatile.

Saying No to Yes

Yes Bank has been in all kinds of bad news in recent times and that has shown up in its stock price % with the stock falling 60% from its peak in a matter of months. From being one of the most expensive Private Sector Banks it’s now one of the cheapest around – and all this without a sniff of a scandal of the sort that bring down companies.

Yes, there is the issue of deviation in NPA recognized by the Bank versus what RBI thinks is the right number, but this has been known for quite some time now. Yes, Rana Kapoor not being given an extension which was the first negative trigger in the current episode is negative for the bank for he was a key guy in the Bank’s growth.

But that doesn’t mean end of the story. Yes Bank is a fairly large bank with a good second line of leadership that can take up the mantle and grow the bank.

The fact that the one of the promoter has pledged in an indirect way their shareholding is wrong for it asks the question of what more is hidden. But in terms of risk, this is negligible since the risk lies with the lender who has no recourse to the asset on which the lending has been carried out.

Retail Investors love fallen angels and Yes is no different. Since 1st September of this year, 93 Crore of Equity has changed hands in NSE alone. Assuming that the promoters haven’t sold anything, that is equivalent to 50% of Yes Bank shares changing hands.

It will be quite a while before we know who bought and sold during this period, but I would assume that Retail holding would have bumped up quite a bit from the 11.19% stake they held at end of September 30. This itself was a bump up from 8.83% retail shareholders held at the end of June 2018. Given that the stock saw a huge fall in September, this isn’t surprising.

Every company operates on the basis of Trust, break that Trust and it’s easy to bring down a company faster than any other event ever can. When it comes to finance, the Trust factor is even higher for a small spark can set alight a raging fire that destroys the company in no time.

Long back, I had analysed stocks that fell a large percentage in a single session / short time frame. Most of the stocks never recovered its earlier glory. But then again, there are stocks like Satyam where investors who bought it on the final low double or tripled their money in no time.

Betting on stocks that fall down is not Value Investing even though the company may seem to be valuable when looked at using historical numbers. While there is no change fundamentally, Rating Agencies have now downgraded the Bank.

Unlike other companies, I would be surprised if the government or RBI didn’t swing into action at some point of time if this continues. After all, which government will wish to go into Elections with a Bank going down taking investors’ money with it.

“What you find is there’s never just one cockroach in the kitchen when you start looking around,” said Warren Buffett on Wells Fargo when the Bank was beset with issues, many of it its own making. Well Fargo has survived and thrived, so that may have been one hell of a opportunity

Yes Bank may recover and prosper from here, but unless you know better that anyone else on the street, it makes no sense to bet big on it at the current juncture. Better for more clarity to come and while you may miss catching the bottom, better evidence lets you bet bigger since there is a higher factor of comfort.

Or if you are technically inclined, I would suggest waiting for it to cross the 200 day EMA and if that is too much of a wait, at least wait for a higher high, higher low formation. Let the markets show the path rather than one speculating on the path before its formed.

Then again, I may be biased since I myself so thoroughly believed in Global Trust Bank that even today I hold its worthless share. Once burnt, Twice Shy as the saying goes.

What is your Philosophy when it comes to Investing?

For a long time, I was a drifter when it came to investing philosophy. Value today, Quality tomorrow and Momentum the third day. The disadvantage of being a drifter is that one never is able to convince himself that when the chips are down, the strategy is still as valid today as it was yesterday.

Out goes the baby with the bathwater in search of a new medicine that can soothe these wounds and seem to be the perfect match until it hits its own roadblock that makes one once again shift gears.

We understand that everyone cannot be an expert on everything and yet somehow exclude ourselves from that limitation with the belief that we can somehow traverse the diverse fields with the agility that can lay Usain Bolt to shame.

When investors select mutual funds to invest into, the key criteria many look for is the short term returns of the fund. Higher returns from known funds have generally meant an enhanced flow of funds.

Higher the amount under management, higher the incentives for those at the top and that itself is generally enough to motivate fund managers to switch philosophies based on the flavour of the day. While this in itself isn’t wrong, what it means that the investor has nothing other than performance to back-up his investments rationale.

Churn is a factor that is dependent on the strategy being deployed. My own momentum strategy requires a much higher churn than a value strategy where churns are much lower. But when you look at the mutual fund turnover ratio’s, they tell a different story altogether.

While some funds do have a very low churn ratio, many a fund which either in name or through brochures and advertisement claim to be followers of one sort of philosophy have a turnover that is replica of another.

It hence isn’t surprising to see that investors keep getting returns lower than the fund returns for the whole logic of investment was based on returns and when returns fail, they are unable to understand the reasoning and would rather abandon ship than take the risk of sailing through the stormy seas.

Momentum, Value, Quality and Size are well known factors with tons of documentary evidence that point out to its longevity. But in such long periods are periods where the strategy under-performs other strategies and the market as a whole.

Small Cap stocks have been under the weather in India for nearly 10 months now. While last Diwali picks by experts were more in the Small and Micro cap space, this time around, most of the recommendations are in the large cap space.

But has Small Cap really been a disaster like everyone loves to point out. Here is a relative comparison chart that compares Nifty 50, the large cap Index with Nifty Small Cap 100, the small cap Index.

As you can see, from the chart, while the path has been varied, the results have been the same. A small investor would have been the object of envy of the large cap investor for a long time but once the crack came in, the large cap investor feels vindicated that his style was the better choice.

Momentum Strategy can be applied on any subset of the market. For my personal investment, I am agnostic to market capitalization which means that the choice of stocks is based on the flavour of the moment. Yet, despite the churn, the portfolio has seen a draw-down – one that will be a long time from getting back to all time high.

In earlier days, like the experts of today, I would have loved to shift to a strategy that offered more robustness in these times. Maybe Quality for the Nifty Quality Index is still making new highs even as the rest of the market seems to be immersed in its own poo.

But many a Quality stock is even today more expensive that it ever has been historically been. This means that while they could be resilient for now, their future returns will not be in-line with others as and when the market recovers – and the market always recovers.

Success in markets doesn’t require one to follow the herd when it comes to the most popular style or strategy. Success instead comes when we are able to stay the course even as the airplane hits a air pocket and there is turbulence all around.

If the current market behaviour is making you clamour to change your path, my humble advise would be to step back and see your portfolio for what it aims to be rather than what you want it to be.

Stocks, Sectors, Industries, Countries all move in cycles – sometimes in favour, sometimes out of favour. As long as you understand that, investing becomes much easier since changes are not driven by the heat of the moment but an in depth understanding of the strategy itself.

Whatever you do, Wishing you all the Success in the coming year. Wishing you a Happy & Prosperous year ahead. Happy Deepavali.

Run with the Herd or Go against the Tide

Most of us make millions of decisions, small and big over our lifetime. As much as we believe in being individualistic, most of the decisions aren’t really different from decisions taken by the vast majority who are facing similar questions.

We hate to be told that we are following the herd when the reality is that we are part of the herd. Once in a way, some of the decisions one makes can go against the herd but unless the outcome is better, the decision is held up as the reason for not to sway away from the path taken by the majority.

But being part of the herd itself is not wrong by a long way. While Billionaire’s who dropped out of college are celebrated, not everyone who drops out of college actually succeeds by any distance let alone become a noted celebrity.

Being part of the herd also means that when one fails, one fails with the majority. Fund Managers for instance don’t want to go down the rocky path for what-if the path meets a dead-end. Career Risk means that most are more than happy to follow the path laid down by others for if there is a failure, he isn’t the only one caught in the storm.

Unfortunately the reason for such mockery for those who follow an alternative path is because it can be a long time to be seen as right. Warren Buffett was ridiculed for being old and unable to understand technology which would the driver of everything and was hot during the dot com bubble. Once the bubble popped, he of course was celebrated for being right.

But was he really right. 18 years post the dot com bubble, Infotech stocks are the leaders when it comes to the US Markets. Buffett missed them out before the bubble, during the bubble and post the crash as well.

Raghuram Rajan is celebrated for calling out the risks being taken by Banks and Insurance firms in the housing bubble. But it was 2 years before the issues he posed started to become a reality and nearly 4 before the world understood the implications of the risk he had laid out in his paper.

Timing the Top isn’t tough, it’s nearly impossible. The top happens due to a plethora of factors including sentiment and money flow that cannot easily be foretold. In fact, there is a saying that the bull market ends when the last bear gives it up while the bear market ends when the last bull throws in the towel.

There are people who are wrong some of the time, most of the times they being just early – being too early is as bad as being too late and there are another set of people who are consistently wrong.

One famous US bear is John P Hussman who has been bearish on the US Market since 2009. Everytime US markets go through a short term correction, his timeline becomes hyperactive as he tries to showcase how large this current bubble is and how based on earlier history, this is clearly not sustainable.

His charts aren’t the average technical charts for they are deeply interesting. But the reason they don’t work is that many of them are nothing more than curve-fitted and hence more liable to be wrong than right.

Earlier this month, he posted a chart which used a signal derived from 5 conditions. Since 1992, the chart showed 3 Signals – one at the peak of 2000, one at the peak of 2008 and the final one just before the intermediate peak of 2015. The final signal was now (October 2018).

Anyone looking at the chart and the accompanying narrative would be hard pressed not to agree with Hussman. Finally here is a indicator which has had great success in the past, has a logic that is tough to disagree with.

Yet, once again it was a curve fit chart. Someone who is a very well-known used the same conditions to test for a longer period – from 1932 to date and guess what, these were the only signals that you could find.

John Hussman not just preaches but practices what he preaches and the results aren’t surprising. He runs 3 funds targeted towards Equity and their 10 year returns are -7.27% and -7.60% even as S&P 500 ten year returns has been to the tune of 11.60%. Do note that S&P 500 returns are positive while the fund returns are negative – there is not even am iota of resemblance in between those returns.

Bad fund managers destroy capital. They seek out to be different from the herd but fail to recognize that in their pursuit to be different, they can also be wrong for so long that even if they are finally proven right, it makes very little difference for no one has the time frame or the ability to hold onto their investments for so long.

Hussman is an exception like none other. Most fund managers who end up losing money for their clients aren’t as consistently bad as Hussman. Some of them deliver incredible returns over a period of time but get carried away and end up destroying a large part of their client’s funds when the tide goes out.

The last few years have been a period of high tide and high returns for the vast majority. 2018 has turned out to be vastly different for those who mistook the tide for the sea for the sea never goes out, only tide does.

Caught in the draw-down of a nature many have only experienced only in charts and books, it’s interesting how every small straw is being clutched at, the government pleaded to act and those who were right (even if wrong for a long time) ridiculed.

Saurabh Mukherjea who came to fame in India during his stint with Ambit Capital is some- one who seems to be abhorred by the bulls. He is famed for his Sell call on BFSI (banking, finance and insurance) segment and even though he may claim to be right as BFSI’s stock keep tumbling, the fact remains that most of the stocks he disliked are still way way higher than where he gave out a sell call.

But that is not his only contribution. He was also instrumental in bringing the Coffee Can Approach to the retail audience. While he is no longer part of Ambit, the very fact that Ambit has chosen to use Coffee Can as a PMS product goes out to show the worthiness of the idea.

In his recent newsletter, he talks about Non Banking Financial Firms which are facing headwinds and claims that Investing in them is like playing the European Roulette because their basic model is leverage and they go bust once in a decade (historically).

If one were to talk to any Bitcoin fanatic, I am sure he has the same thing to say about the whole money supply system – the fiat money is a farce and is unsustainable. I don’t know how this NBFC crisis will play out but one thing is for sure, the best of the companies will be able to wade through the crisis and emerge stronger.

The Dot com bubble killed many a me-too dot com firm but Amazon came out stronger. The Housing bubble nearly killed the Banking system but Goldman, JP Morgan among a couple of others came out stronger.

Closer home, the 2000 bull-run ended the life of many an Infotech company but Infosys came out stronger and better. Wipro the golden boy of those days survived but has never thrived (even today 18 years later, it’s still well below its all-time high set in 2000).

When bubbles burst, it provides a opportunity to pick dollars for nickels. But of course assumes you have the ability to differentiate between a Zimbabwe Dollar and a United States Dollar. It’s not even worth spending nickels on the former while it’s a great opportunity in case of the later.

If you have such expertise, now is the time to start digging for the proverbial pot of gold. If you don’t, you would save a ton of money not to speak about sleepless nights by waiting for the dust to settle and pick the winners.

The goal of investing isn’t to come first in a 100 meter race, it’s to finish (not win though everyone tries and wishes to win) the Marathon. That in itself is an achievement that very few can claim to achieve.

Discipline through Shorting

I admire Elon Musk. I believe he is one of the greatest Entrepreneurs of the 21^st Century, no doubt about that. Yet, he can be devastatingly wrong – for like when he recently railed against Shorts and called them to be made Illegal.

Shorts for all their claims and prophecies aren’t gods descended from heaven who have the ability to make or break companies. While they do push those companies on the edge to the other side, the companies that aren’t so precariously positioned have been able to devastate the careers of more than one such bear.

In India, shorting stocks other than those in the Futures and Options list is next to impossible. There is no easy way to borrow stocks to sell short with the intention of covering later. Yet, way back when derivative market in India was well in its infancy, it was Shorts who short circuited the market and the career of Ketan Parekh and his friends.

Mathematician Carl Jacobi came up with the term “Invert, always Invert” but it was Charlie Munger who popularized the same when it comes to the market. At its root lies the thought that if you are bullish on a stock, you should also be able to argue on the bearish side for this shows that not only have you worked on the positive side but also have the understanding of the risks that the investment can bring forth.

New age bulls while chanting the mantra’s of Warren and Charlie though seem to have forgotten that it’s more than just a theory, it’s the reality. Not surprisingly, as markets kept seeking lower lows, we have had bulls railing against everyone who they believe are responsible for the current situation – the government to RBI to Media to those who Short.

The other day, a recently famous option expert commented that Put option buyers want India to be destroyed just because they want to make some money. Not very different from saying that Life Insurance policies are being bought to bankrupt the Insurance company.

Shorting is not a piece of cake for even the most accomplished of fund managers – Jim Chanos the supposed King of Short Selling was revealed in a recent long form article that appeared in the Institutional Investor to have lost around 0.7% in his Short only fund since Inception which was in 1985.

Yet, his long short fund has generated a net annualized gain of 28.6% since launch in October 1985, more than double the S&P 500. As a fellow hedge fund manager commented, if the numbers are true, “It’s one of the greatest records ever”.

As investors, we abhor the short side. The long side gives us plenty of comfort since we know that the worst we can lose is only our capital already employed in the trade. A short on the other hand can lose an unlimited sum for a stock can theoretically go to Infinity and beyond.

Its isn’t easy for the small investor to create a Long Short model either for the capital requirements for a short are much higher and demanding. But the shorts don’t just demand money – they demand attention and continuously question our beliefs and methods.

We are optimists by nature and yet when the market turns against us, we become the worst pessimist – from wondering whether we went wrong to whether the whole world was loaded against us.

In markets, most of us aren’t optimists in the first place and therein lies the problem. We are at best opportunists who think we can piggy back on the market for some easy money. But when thing goes south, we find ourselves wondering if optimism is over-rated. Technical Analysis works on the fact that human psychology doesn’t change & every cycle proves the same.

Investors these days are better informed than those of us who started out in the pre-internet era. They have a better understanding of allocation, behaviour biases, market psychology among others and yet, I find them not immune to excesses and when things go sour, most seem to follow the path of those who haven’t studied history or human behaviour or cycles – rail against the system first and throw the towel at the worst possible time.

As much as it’s important to read more – especially financial history and human psychology, I am beginning to believe that portfolio construct needs to form the basic foundation. A good portfolio needn’t be made up of longs only for shorts do have their own space.

One doesn’t need to have a short position as big as the long position, but even a small short position keeps the investor on his toes and asks him to take the tough calls. A short challenges ideas and views like no longs can ever do.

The other day, I heard Safir Anand claim that 90% of investors lose money – by lose money I don’t think he meant that they actually lose money but many lose by missing out on opportunities or missing out on getting market returns.

But in the age of everyone being above average, it wouldn’t be surprising if the percentage of investors who despite the best efforts not just underperformed the markets but actually lost money by buying high and selling low – the exact opposite of what they wanted to achieve is 80% or so {Pareto Principle}.

I incidentally run a Long Short Portfolio on my personal books – the short position being placed not by way of understanding, intent or thought but by accident. Yet, when markets were booming and the short was losing money, it kept me thinking about the range of possibilities and where and how far I could go wrong and the likely remedies for soothing the pain.

While the initial thought was to close out the short as soon as got back to my Anchor bias level, deeper or 2^nd line of thinking now seems to suggest to me that shorts can be a very effective instrument against one’s own biases going off tangent.

As Jim Chanos has experienced, the shorts may not actually make money for you but can be an efficient risk management tool that helps manage your Risk at a level that ensures survival in the deepest of bear markets.

Shorting is Risky, no doubts about that – yet, Investors, many of whom are down 40 to 50% in the current down cycle didn’t really anticipate such risks when they came into the market. We accept risk ex-post, why not accept it ex-ante.

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