Again a set of investors, mostly amateurs and newcomers would lose money. They are investing not out of conviction but out of desperation of being left out. Fear of losing opportunity driving all types of investors into market, into Mutual Funds and into myriad advisory services (we also run one and really having good time!).

But are you sure you are making right choices in selecting your investment? Be it on your own, be it based on TV reports, be it on a friendly tip, be it by trusting a Mutual Fund or be it by trusting people like us, the investment advisers, who deal purely in Equity?

Based on my experience, I feel, people at large, still feel Equity Investment is risky but easy. What people understand by risk is

“stock prices move randomly, so whatever I buy will either up or  down. When market is going up, it must be a good time to invest and whatever I buy have higher chance of going up than down.” 

Similarly, people think, when market is going up investment is easy … Anyone can invest in anything and can expect stock prices to move up and up only, at least for a while. Intuitively, they may know that it’s not possible but their instinct tells them that he is smarter than others and can come out of market with a decent profit ahead of everyone else in the market. So, in effect, the feeling is

“I am smarter than the market and continue to remain so at least in this round of the game”                               

Unfortunately we all together constitute the market. All can not collectively outsmart the market. It is simply not feasible and there would be people standing (and too many) when the music stops in this round of the musical chair called market “upmove”.

You can only prepare yourself in two ways….. Do it yourself if you have sufficient amount of time, experience, passion, understanding, knowledge, skill, conviction and network within market ecosystem. Or you can depend on someone whom you can judge as the right person or company who can discharge the responsibility effectively.

If you are not following a “methodical approach” in selecting your Investment vehicle or investment adviser, then you are not investing but speculating in some or other form.

Here is a checklist which you may think through:

1) What are the differences between an investment in a Mutual Fund and in Direct Equity? Which serves your purpose better? Does over diversification of a Mutual Fund portfolio ably justify the fees you pay to them?

2) What is the effect of compounding on your wealth? Money growing per year at 8% vs. at 10% vs. at 15% vs 20% vs 25% over 5 years makes dramatic impact on your overall return for every dollar or rupee you invest — Check it yourself (alternatively check at our website homepage by clicking on tab “the power of investing”)

3) What are the Risks or incremental added “risk” of investing in Direct Equity through a dependable Portfolio Advisory Service firm? Do they take your money under their control? Do they leave the money with you so that you have full control over it? Are the charges reasonable and at par with Mutual Fund industry? If yes why? And if not why not? What exactly they can do which is better than Mutual Fund or your own investment of your own money?

End of day, it is your money and you are in the market for generating higher return than risk free return (bank rate) and return which you yourself could have generated simply by investing in Index (passive index fund). Why pay any fee to a Mutual Fund or an Adviser if he / she fails to generate consistent market beating return? And if you at all pay, why don’t expect a higher return than the Index or Market return?

If you are not considering these points before putting your money in market to earn you more money, your are not investing but speculating in some or other way.

Speculation is not bad if you are doing for the fun and excitement of it!!

Author is the Founder & Chief Adviser at http://flowria.com — Equity only Portfolio Advisory Firm.

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Here I would try to discuss, based on my years of reading Howard Marks (HM), that how risk is perceived by common investors and how it is different from actual, real or potential risk of losing money in stock market investment. So, does high risk mean high return? And can anyone generate it consistently taking high risks?

Firstly, Howard Marks was quite clear that everyone can’t be a successful investor just by learning investment … There is no simple, step by step learning process for investment. It needs second level thinking and insights which is not common, can’t be taught and requires massive mental workload. Success of investing is an anti-thesis of simple…. Only three types of people think investment success is simple….. a) Those who teach investing; b) some well-intentioned practitioners who overestimate the extent to which they are in control and c) Those who simply don’t fathom the complexity of the subject. Who in HM words are “first level thinkers”.

All investors can’t beat the market as collectively they constitute the market. To quote HM…. “Many people are misled into believing that everyone can be a successful investor. Not everyone can. But the good news is that prevalence of first level thinkers increases the returns available to second level thinkers.”

Now, what he really means by second level thinking?

Here what he primarily means is the ability to go against the consensus opinion with clear and unbiased understanding of the merits of the “consensus opinion”. It doesn’t mean to be eccentric or egoist but to ask questions which most people possibly are not asking or started believing that the relevance of those questions are no more valid since nobody else is asking too.

Biggest RISK of investment comes when everyone thinks market can’t go down or when everyone thinks market can only go down. Very frequently, we see these collective euphoria or despair engulfing us. There are times when all your sensory organs are bombarded with positive news from all corners (party won’t end ever!) or with negative news of impending collapse of financial system (party can never start ever again!).

In the first case you lose money by believing the story and in second case you lose opportunity by fearing too much. If it happens to you and people around you often, then the right question for you to ask is “Who are on the other side of the trade?” “What they knew which I don’t?” Guess you yourself would get an idea of a “second level thinker” by asking these first level questions!! Both sides of the trade have same sets of information, but a “second level thinker” process the information differently. Possibly he or she is on the other side of your trade.

Next, another type of risk comes from our general day to day observational bias that “if something is costly, it must be good” or “if something is good, it must be costly”. For our daily life, both assumptions work for us in very useful ways to rank things and to value things…. But in equity investment, where collective emotion of participants play most important role in determining price of something, this assumption is often flawed. Many times, people quote a price for something much beyond its intrinsic worth and in other times they price it much less than its intrinsic worth. Here intrinsic worth mean the range of possible future cash flows from a given investment, which I am referring as actual “Value” of an investment for which you paid a “Price” while buying an equity. “Value” and “Price” mismatch happens like a see-saw in market not very infrequently.

So, risk of investment is not constant — it varies with the perception of risk others have about the situation — To be successful consistently, you need to think counterintuitively consistently for long term success.

But the most important question remain unanswered which is — How to determine the “possible” future cash flows of a given investment and how to value it with reasonable approximation?” — Determination of this is not a part of risk but your ability to understand the business and its present value which is not a part of risk analysis. We may cover the broad pointers, without any financial jargon, in some other time.

So, in a nutshell, what HM tried to convey is “risk and return” are not two directly related stuff …. One doesn’t need to take higher risk to generate higher return and rather higher return can be generated when everybody else believes the risk is very high. History of successful investment unfailingly shown it over the years.

There are other very important learnings from Howard Marks writing on risks and we plan to cover it sometime soon.

Thanks for reading and look forward for your valued opinions.

6th February 2017

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Can macro risk affect individual stocks? Is it important? —- I find, a lot of Value Investor find macroeconomics analysis is a “fool’s errand” but I think these thought processes were developed and practised in USA in a non-globalized era. To use it in Indian context (an insignificant third world country) and in a globalized era for a FII dependent market we can’t ignore the macro factors like INR / USD rates, CAD situation, Bilateral and multilateral trade agreements, GDP growth rate, international interest rates, political / social / economic stability etc.

Let me give some examples….. Many companies gone from “hero to zero” or had to withstand excruciating period of pain in 2007 to 2012 period when INR depreciated from Rs. 40/- to Rs. 55/- due to their ECB (External Commercial Borrowing) exposure (Aban Offshore, DRL, 3i Infotech, Usha Martin, Uttam Galva, Jubiliant Life Science, Motherson Sumi, Bharat Forge, Rain Commodities, Mercator Lines, Gujarat NRE Coke, Auro Pharma etc to name a few) …. Quite a few have surely bounced back very smartly but if you analyze full list, many just perished in that episode.

It may not be irrelevant to share a personal experience…. During 1997 – 2000, for a period, I was posted in Bangkok and entire Thai Baht crises happened suddenly in a matter of 15 – 20 days when companies closed shop, winded operation and dismissed people overnight and INR appreciated against Baht by 100% within one month. During this period Tata, Usha Martin, Indo Rama (which I know about and few more possibly) bought assets at prices 50% to 75% less than their book value (in US$ / Baht terms) very very quickly by leveraging heavily taking dollar loans (as their Balance sheets were bankable to foreign lenders) ….. Just in 6 months entire business scenario from ownership point of view changed for many Thai and Indonesian companies. Suddenly companies stopped trading in stock market and never reappeared. I was involved in two deals and seen the distress of selling promoters and portfolio managers first hand. If you analyse the problem, it was a political, military and macroeconomic problem as withdrawal of credit lines and calling back of loans by banks happened due to specific strictures from IMF and had absolutely nothing to do with individual companies. From then on I started realizing the importance of focusing on macro issues as economic vulnerability of developing countries increased manifold due to globalization of money flow and lack of military muscle. Any economic rule at times of crises are enforced by muscle power and not by economic rationale. Read about crises of Argentina which happened previous to it. And you may think through how India withstood the contagion risk from a neighboring country in 1997 but failed to come out of 2008 Lehman crisis even after 8 years of its happening?

Let me elaborate another live example of macro instability which may be unrelated to any specific business — Indian northern belt is having highest proportion of youth population and worst sex ratio. Almost 50% + of this population is functionally illiterate, unemployable in modern business, grown up in a strange casteist societies and generally bit aggressive in outward behaviour. Now imagine this population passing through their best periods of life with aspiration, without a job to remotely meet these aspirations and no woman in their lives to channelize the emotions and physical needs (north India sex ratio is 1000 to 800 almost) ….. Now add to this, all sorts of extreme ideas which are phoney, perverted and spurious are pumped in by political establishments or ideologues of assorted varieties on these youths to polarize the vote based politics of “first past the post” into different groups based on their perceived “selfish” conveniences …… How this heady cocktail can play out in the economic scenario? Add to that the extreme inequality an average ill educated and malnourished youth experiences every day and reasons for which he may not have an iota of idea! ……. All these won’t add up in any positive way I suppose.

Maoist, Jats, Patidars, Bodo,, North East, Kashmir, Minority, Mathura violence — India has too many problems which are fiendishly complex and any one of the above can have a contagion effect at any point of time (remember Mandal Commission) unless we keep a fine balance in mediation and negotiation and power display as we are also surrounded by two adversarial countries out of which one is politically, socially and militarily much more powerful than us.

Think through other risks like Environment / Water / Clean Air / Healthcare / Drought / Disaster Management Response (Chennai Flood, Uttaranchal Fire, Kedarnath Earthquake are recent major examples). Our unpreparedness for emergency response on one side and lack of meaningful and holistic development on the other can give some pointers to macro concerns ….. Can a business operate and can investments pour in without paying any premium for these risks? How these risks are embedded in business?

My spiel may sound meaningless or remote to many younger people and also to many others who are only in stock investment in India for last 8 – 10 years or so but to me “event risk” for India are many and it’s increasing in social / political level more than what gets captured through economic data. But as a very resilient country we would overcome these with our collective sagacity and past records. But we can’t completely disregard these.

Your valued and reasoned comments will help us learn together.

2016-06-08

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