Do we really understand it?
“Only when the tide goes out, we come to know who is swimming naked”
We reiterate this saying again today with a reason. The tide, today, has gone out. And those who were swimming naked- the optimists who thought that the rally would never end- are clearly visible.
We don’t blame them. It is the way how most market participants typically behave. They believe that it is a risk worth taking in the quest for superior returns.
However, are they aware of the real meaning of these two terms: Risk & Return?
Risk in Rising and Falling Markets: Perceptions & Outcome
This demonstrates that layman’s understanding of risk is misplaced. Where they should be afraid, they are greedy and where they should be greedy, they are afraid. A correct understanding of risk will let an investor know when he should be afraid, and when he should be greedy.
Let us explain how. Risk, in its simplest form, is what could go wrong in any decision (not just financial or investment related). To correctly understand risk, therefore, we should think of all scenarios- optimistic, realistic & pessimistic. Let’s say that today I plan to write five pages on a topic. Now, to understand the risk to this operation, I should ask these questions:
What would come in my way of finishing those 5 pages?
Am I busy in other important activities which would not give me time to finish my write-up?
Even if I manage the time, do I have sufficient expertise to write on that topic?
Am I in the right frame of mind to produce the right kind of material?
Questions like these force us to look at the operation from the opposite side and think hard on how it can fail. This will allow us to take better decisions.
If we look at investment decisions in a similar fashion we would ask the right questions. These questions could have been asked in the calendar year 2017.
Will this rally last?
Is it a bubble that would burst any moment?
If the share prices reflect company’s performance, are companies really performing that well that their prices would continue to go up?
Have we seen anything like this in the past?
If I put all my savings today into equities to take advantage of the rally, what are the chances that I would lose my capital?
Should I blindly believe what is appearing in the financial media or should I take a second opinion?
Questions like these force us to take a balanced approach to the process of investing in stock market. The idea is not to get afraid and leave it altogether. All we are saying is that investment decisions should be taken in an informed state and not an ignorant state. So, if people had followed this approach, they wouldn’t have been swimming naked today.
A layman’s fuzzy understanding of return in stock market
It shows that expectations of returns, like risks, are often ill-informed.
An adequate return varies from investors to investors based on their risk profile and varies from operations to operations depending upon the risk involved. Most investors fail to get this thing right and hence their understanding of both risks and returns remain hazy throughout their investment career.
Benjamin Graham, acknowledged as the father of Value Investing, confirms this by saying,
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.”
Due to this misconception about risk and return, most participants face a very difficult time when the tide runs out, like it has in the first three months of calendar year 2018. All major indices and portfolios are down significantly from their December 2017 levels.
Theme Agnostic Investment
There is a difference between managing your own money and managing another people’s money. In fact, in the true sense, fund management business is more about managing your clients’ perception and less about managing his/her money. We do not want to label us as any kind of investors. We do not aspire to be known as only “Growth-oriented” or only “Value-oriented” or only “Buy and Hold” or only “Arbitrage Experts” or “Swing Traders”. We believe we are a little bit of all.
Our theme agnostic philosophy has resulted in our owning a diversified portfolio of good businesses bought at reasonable valuations, capable of giving our clients an adequate risk-adjusted returns of 16-18% per annum in the long run.
We believe that being agile and flexible is the most important feature of our philosophy. Since we are not married to any style or genre of investing, we approach each investment opportunity with a clean slate of mind. Our investment decisions are made purely based on risk assessment and return expectations. So, we prescribe and advice our clients to not to be sold on a style of investing but be focused on risk and return only.
The legendary American economist, John Kenneth Galbraith once rightly remarked, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” We certainly do not try to forecast anything with precision. And we bundle this thought with the opinion of a world-renowned investor and author Howard Marks, Partner of Oaktree Capital, who says,
“While we never know where we are going, macro wise or market direction wise, we should have a good sense of where we are. I think this is very important. And it is possible to enhance your investment results by making practical decisions suited to the market climate.”
We believe that our agile and informed theme agnostic philosophy and the risk-return approach help us live in the present while being cognizant of the past and future.