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“The Chinese government wants to let a few businesses fail to rein in a bigger problem ... The situation is similar to a controlled detonation. For all practical purposes, a default of Evergrande has already been priced in,” says the Founder of the brokerage.

Devina Mehra is one of the sharpest minds in the Indian stock markets. An IIM-A gold medallist and Founder of institutional broking firm First Global, Mehra had led research at the broking firm. Her more recent accomplishment is to have built the machine-plus-human approach to investing. First Global is one of the first Indian brokerages to start tracking US stocks way back in 2001, and Mehra has a keen understanding of global markets, and, yes, when it comes to market predictions, she has several firsts to her credit.

In an exclusive interview with Moneycontrol, Mehra talks about the default of Chinese property developer Evergrande, its impact on the Indian market, First Global's top stock and sectoral picks and more.

Q: How big an issue is Evergrande?

A: In our view, the issue is part of a deliberate move by the Chinese government to let a few businesses fail, to rein in a bigger problem. So, they will not let it go out of hand. The situation is similar to a "controlled detonation". In a relatively controlled-economy like China, this is entirely possible. This is in contrast to several somewhat sensational reports and videos floating around.

And for all practical purposes, a default of Evergrande has already been priced in and not just its own bonds - even overall high-yield bonds in China/ Asia have already reacted. So, there's not much further downside there.

Apart from real estate, tech and consumer discretionary, which have also been areas of government crackdown, other parts of the Chinese economy continue to be robust. That is where we are placing our faith.

The primary casualty of the contagion, if any, will be the banking sector. That is a sector we are anyway underweight on.

Q: How much China allocation do you have in your global portfolio?

A: Overall, our exposure to China is just 2.3 percent, well below its representation in the benchmark indices, where the weightage is close to 4 percent. We are in sectors that are more robust -- like clean energy, semiconductors, footwear and chemicals.

We have not taken any direct exposure to the finance and property sectors in China. We also cut out the consumer internet/ tech stocks. A few months ago the government pressure increased in various ways on companies like Alibaba, Tencent, etc.

We will be watching the developments very closely, but one way or the other, it is not going to affect our global fund/ portfolio, materially.

Q: You clearly do not think the Chinese real estate crisis is comparable to the US financial crisis … Like you mentioned, there are some voices comparing it to the Lehman crisis.

A:  We don’t think anyone realistically sees Evergrande as a Lehman, but we’ve also seen these periods of China deleveraging weakness before and they aren’t fun. We don’t need the 0.01 percent tail event to be concerned.

However, given the amount of publicity it has already received, property developers and financiers who have already seen credit spreads widen - people are struggling to find even a single bank to sell them a CDS on Evergrande. Effectively, a default risk is already built in, with its bonds trading at 20-30 cents on the dollar.

Q: How do you see this news playing out in the near term? It seems to be impacting sentiment, at least for now…

A: Beijing's focus is on reining in the property sector, which has been highly levered for some time now. But Beijing does not want consumers to suffer. So, the only solution is restructuring and a slow burn in the property sector.

As of June, Evergrande's inventory (consisting of largely unfinished projects) accounted for about 60 percent of its total assets. Properties under development, in particular, ballooned to 1.3 trillion yuan ($202 billion) -- a 54 percent jump from three years ago.

If only Evergrande could offload some of these projects to, say, a cash-rich state-owned enterprise, its immediate liquidity crunch would be resolved. Beijing would then have some breathing room to gradually scale down this beast.

Meanwhile, this would, by extension, impact the construction space and industrial commodities in China. Steel and iron ore are already under pressure due to Beijing's "Blue Skies" mission for winter Olympics. In order to reduce emissions, they're restricting steel production. Iron ore is anyway trading below $100 now. Australian miners can take a big hit and they already are.

Q: What kind of trades are you recommending to investors with a global risk appetite?

A: Our basic stand is always to err on the side of caution and risk-control.

Since we run long-only strategies, even stocks or areas we do not like, we just steer clear of them rather than shorting them.

With that caveat, our view is that if you were to go with the proposition that Chinese banks can blow out in a tail-risk scenario, you're better off betting against Chinese banks/NBFCs with a high exposure to property-related sectors and the least support from the People’s Bank of China (PBOC), i.e., private banks.

We don't think the PBOC will let big banks collapse, considering each of the Big Four banks remain wholly or predominantly state-owned and headquartered in Beijing.

Another possible pessimistic trade is to bet against investment grade names in the real-estate space. The Bloomberg China HY USD index is 66 per cent-real estate. Hence, when you look at the aggregate index, it is mostly a real-estate picture you get.

If you dig into the other parts of the index, the message is quite different, at least for now. It is hard to find big companies outside real estate that have seen significant spread-widening. So far, we think this a China real estate- specific problem. This is not to say that 'everything is fine'. It is just to be precise about what type of contagion we are observing.

Q: What do you think will be the impact of the Chinese government efforts to rein in Chinese real estate on global commodity demand, supply and prices? Do you think Indian metal stocks, like Tata Steel, have over-run their course?

A:  Metals, including steel, had been big winners in our India portfolio from the third quarter of 2020 but we had started trimming these a few months ago.

One reason is that we estimated that the US would try to curb commodity inflation by strengthening the dollar, which actually happened. China has been curbing its own steel consumption for environmental and other reasons.

However, I think the primary impact of this has been and will continue to be on iron ore prices and stocks - especially, Australian miners. Indian steel stocks, while no longer the best bets in the market, don't appear particularly bad either.

Q: What are the key variables you will be watching over the next few days and weeks to see if things may get out of hand?

A:  Our systems continue to monitor all macro and market variables for all major economies as well as industry-level data. Like a hare, we remain alert, scanning the environment and ready to change direction if the situation so warrants.

As of now, we are not worried about a contagion from this particular event, but we continue to monitor potential risks.

Q: From an Indian market perspective, how do you think the risk-reward is poised for overall markets?

A: Someone recently shared the BSE SENSEX historical data with me, which shows that in the past decade, we have seen the lowest compounding (See chart).

Inherent in these numbers is the risk-reward in the market. Prior to this run, the whole decade gave very sub-normal returns.

As per our Lake of Returns Theory (LORT), returns crash and a bear market comes when the returns have been substantially above trend for a reasonably long time.

As this table shows, we have not had a sustained bull market. Hence, the risk of a sustained bear market is also lower. We have not even come to normal trend returns.

Hence, while corrections can be expected, our systems do not indicate risks of a significant bear market.

Q: Do you think the risk to Indian markets hereon is more local or global? Could you elaborate with data points?

A:  We don't think we are through with the pain points in the domestic economy, with recovery still some way away when you benchmark with pre-COVID levels. Consumer distress also remains. To that extent, we are still lagging many other countries.

Globally, for now, COVID-related news remains a risk area. Inflation is not out of hand, at least in the developed world. Hence, the tightening cycle there remains some way away. 

Some of the emerging market players, however, have already been tightening. If India does not follow suit -- my bet is that it will not -- currency could be a risk area.

Q: What are your top stock and sectoral picks right now?

A:  We have a very diversified basket, with no outsized bets on any single sector. Currently, our relatively higher weights in the India portfolio will be IT, chemicals, cement, and, more recently, telecom. We continue to be underweight on financials as we think the risks there remain relatively high with considerable pain in the economy.

(A version of this article first appeared in Moneycontrol)

From the desk of 

Devina Mehra

If you want any help at all in your wealth creation journey, in managing your Investments, just drop us a line via this link and we will be right by your side, super quick!

Or WhatsApp us on +91 88501 69753

Chat soon!

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Volume 102 (September 25, 2021)

By: Le Grand Fromage

Email: [email protected]

Are You Ready to Be the Hundredth Monkey?

A few days back, I got a call from a cousin, who happens to be in his mid-30s and recently became a first time father.

He wanted to start a systematic investment plan (SIP) on an equity mutual fund and wanted to know what I thought about it. (He obviously had no idea that last 10 years; I'd worked on a troll farm, where the term SIP stood for Systematic Intimidation Plan).

“If you want to start an SIP, you better be invested in it for at least a decade", I replied. Rather grandly.

“But ten years is a long time”, he yelped, making what he thought was a great observation and what I thought was bad small talk.

And if that wasn’t enough, he explained. “I started SIPs five years back. I also started investing in cryptos three years back and have made a good amount of money quickly, and you want me to invest for at least ten years. My hair will be all gone by then. Give me the next big idea. I am willing to take risk.

He had moved from SIPs to the next big risky idea in a matter of minutes.

That’s what a good bull market does to our thinking capabilities, which aren't worth writing home about, even without the ravages of a bull market.

The rising tide lifts all boats or to put it more simply a beginner’s dumb luck which is a real thing, turns into extreme individual confidence and people start believing that high risk means high returns all the time.

And this makes tremendous psychological sense as well. As William J Bernstein writes in The Delusion of Crowds – Why People go Mad in Groups: “Human beings intuitively seek outcomes with very high but very rare payoffs, such as lottery tickets, that on an average lose money but tantalize their buyers with the chimera of unimaginable wealth.”

My cousin is no different on this front. He wants to get rich as effortlessly and as quickly as any other person. As the economic historian Charles Kindleberger once famously observed: “There is nothing as disturbing to one’s well-being and judgment as to see a friend get rich.”

Or, as a character puts it in the cult movie, 3 Idiots: “If your friend fails in an exam, that causes great pain to you. But it's nothing compared to the pain you feel when he tops the class".

Now, as I have aged and developed some patience, I have learnt that telling people what exactly I think about them isn’t always a great idea. (I tried that on Duterte and he sent a hit squad after me.)

So, I decided to tell him a little story, which I had recently read in a crime thriller written by Louise Penny and rather oddly called The Madness of Crowds.

The story is called the One Hundredth Monkey. And this is how it goes.

Sometime in the 1950s, sweet potatoes were dropped on a Japanese island. The monkeys that lived on that island loved their taste but hated the fact that sand covered their food.

One day a young female monkey behaved smartly, went to the ocean, and washed the sweet potato. A few other monkeys copied her. But most monkeys continued to eat sandy sweet potatoes.

“That’s not much of a story,” my cousin interrupted.

He didn’t want any theory-sheory and waste his time on it. There was only one life and only so much time and money had to be made quickly.

Ignoring him, I continued.

Over the months, the number of monkeys who washed their sweet potatoes in the ocean before eating it, continued to grow, but at a very slow pace. Then one day, the one hundredth monkey as per the scientists’ count, washed the sweet potato in the ocean before eating it.

After this, as Penny writes: “Something broke. By nightfall all the monkeys on the island were washing their potatoes.” In fact, it was soon discovered that monkeys on other islands were doing the same.

The anthropologists carrying out the study termed it as the hundredth monkey effect.

“So, what’s the point?” the cousin interrupted again. “100 monkeys or 99 monkeys, they are still monkeys. How does it matter?”

I almost felt like saying, it doesn’t matter because he was a monkey. But as I said earlier, it’s best to keep things to ourselves.  These days, specially.

Honestly, the number doesn’t really matter, but the broader point here is that after a tipping point is reached and a certain number of people start believing in an idea, it takes off, it explodes and takes on a life of its own.

“Is this really a theory?” the cousin asked looking at us rather dubiously. “If I hadn't wasted time with you, I would have got three good money-making ideas on telegram by now.”

Well, to be honest, the theory has been questioned over the decades, I replied.

But then, who are we to come in between a good story and a ready listener.


“And what do you think about that IPO?” the cousin asked.

Dear Readers, we guess by now you must be scratching your head wondering where we are going with this. So, let’s get to the point.

The stock market is like an island. Investors are like innocent monkeys who inhabit that island. And if enough investors start behaving in the same way, by buying into an idea behind a stock, we reach a tipping point, like it happened on the Japanese monkey island, and the price of the stock shoots up. If more monkeys keep coming along, the price keeps going up.

Of course, since March 2020, investors have bought into multiple ideas that have been shared and a lot of money has been made. But the stock market is always about the future and not the past. And in the next few months a good number of initial public offerings (IPOs) by companies are lined up.

Many of these IPOs will be exorbitantly priced, with the promoters and their VCs, trying to make a quick buck, trying to take advantage of the high valuations that currently prevail.

The IPOs will be promoted big time by its investment bankers, the pink press, the business news channels, the social media influencers, the brokerage analysts and so on. They will do anything and everything to justify the high valuations.

One fashion-cosmetics retail company going public, has had brokers justifying valuations, based on 2041 earnings and I kid you not: "Fashion business is trading at just 10x FY2041 earnings", one broker wrote analytically in their IPO note. Recommendation? Subscribe. Obviously!

Stories will be told over and over again.

Because as human beings who have already made a lot of money in the last eighteen months, the prospective investors in the IPO will prefer to be told stories that tell them that a lot more money will be made in the time to come.

Facts & logic will take a backseat. (Maybe they should. They are so 2019).

The idea here will be to get enough people interested in the IPO, so that there is huge demand for a limited number of shares. This is another version of the hundredth monkey effect. The insiders will talk up the IPO in the hope that many investors get interested and a tipping point is reached.

Once a tipping point is reached, everybody won’t get an allocation in the IPO. The investors who don’t get an allocation in the IPO will then try and invest in the stock on the listing day, leading to an IPO pop. The insiders or those selling the idea of the IPO will end up making a lot of money. So, will the anchor investors and everyone who gets an allocation in the IPO and sells out on the listing day.

As far as the investors who invest after the IPO, it all depends on how many investors continue to be sold on to the idea behind the stock in the days to come. Of course, many a time, this doesn’t end well. If you don’t trust us, do check out what happened to some of the big IPOs in 2008. I will leave that research up to you.

At the end of the day, why should I spoil what has been a good a story after all. Let’s not let the facts come in the way and let the world label us as old fogeys who have been around for a while “with memories long enough, to have seen the play before and to know how it ends”.

Before you start wondering what happened to the cousin, he walked out saying: “This time is different”.

The trouble is it rarely is.

Or maybe it is.

Go figure.

Because I surely can't.

(Le Grand Fromage can be contacted on email: [email protected])

If you want any help at all in your wealth creation journey, in managing your Investments, just drop us a line via this link and we will be right by your side, super quick!

Or WhatsApp us on +91 88501 69753

Chat soon!

From the desk of Le Grand Fromage,

Unemployed at First Global

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Every single PMS fund manager keeps talking about how great their PMS investment returns are. That is great for them because that is their business. But how do you as an investor understand whether their returns are good?

Look at this example from cricket:

In 5 innings:
Batsman A: has scores of 50, 50, 50, 50, 50
Total: 250 runs
Average: 50

Batsman B: Scores of 0, 0, 0, 0, 250
Total: 250 runs
Average: 50

Even a lay observer of cricket will know that Batsman A is a far better player than Batsman B because he is delivering consistent returns even though his total and average are identical to that of Batsman B. Similarly, it is visibly clear that Batsman B is delivering a lot more pain for the 250 runs that he has scored.

One can easily apply the same logic to PMS Fund returns. There is a simple PMS return calculator to help you understand your Gain to Pain Ratio.

Let us take the example of 2 PMS funds

Fund A: Has monthly returns (%) of 5, 8, 5, -6, 8
Total Returns: 20%
Total of "Pain Months": 6%
Gain to Pain for Fund A: 20÷6=3.33

Fund B: Has returns of 2,-2, 15, -8, 13
Total Returns: 20
Total of "Pain Months": 10
Gain to Pain for Fund B: 20÷10=2

Now you see exactly how easy to calculate the Gain to Pain Ratio is!

The higher the Gain/ Pain Ratio, the better that Fund Manager is.

Talk to Our Expert Fund Managers

You can get monthly investment performance data for every single Portfolio Management Service  easily. Sitting in the comfort of your living room, you can easily calculate this intuitive and amazingly insightful ratio for various types of PMS investments.

Therefore, do not look at total returns only. Apply this simple ratio to give you insight into how much pain that fund manager is making you endure, in order to get to the gains.

Investment portfolio management becomes more systematic and clear with the Gain to Pain Ratio.

As you can see, a particular batsman can deliver a high series total just as a fund manager can deliver a high return over a period, but when it comes down to your hard-earned money, what is important is to look for a fund manager that delivers high returns but with low pain.

After all, you cannot take chances with the fund manager who is batting like batsman B, can you?!

I Want to Invest with First Global

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The Occasional that talks sense... most of the time

(September 02, 2021)

By: Le Grand Fromage

Email: [email protected]

GDP is a tad like the Body Mass Index…

What it reveals is arousing, but what it conceals is  dampening

India’s gross domestic product (GDP) growth for the period April to June this year came in at a record breaking 20.1% , the highest since 1996, when the country first started publishing quarterly GDP growth data. GDP is a measure of the economic size of a country. When calculated right, that is.

This one figure was enough to get India’s most successful industry ever - the edtech-meets-messagingtech sector -  cutting edge firms and individuals in the business of manufacturing WhatsApp forwards -  firing on all cylinders.

WhatsApp University Economics Majors, proclaiming an economic victory, are going around quicker than Ghani's escape from Kabul.

Those in the business of giving a technical spin to these forwards (read many economists) are calling it a V shaped recovery. Still others have justified it by saying: why else is the stock market going up.

The trouble is that the GDP growth figure viewed in isolation is like looking at just the Body Mass Index (BMI); what it reveals is significant but what it hides is very important. Allow me to explain.

As Kit Yates writes in The Maths of Life and Death – Why Maths is (Almost) Everything: “Theoretically, individuals who are overweight have a higher mass than their height would suggest and hence a higher BMI. Underweight people would have a correspondingly lower BMI.”

For most people looking at BMI as a means of figuring out how fit (or unfit) they are, this is where it probably ends. The trouble is BMI cannot distinguish between muscle and fat. As Yates writes: “This is important because excess body fat is a good predictor of cardiometabolic risk. BMI is not. If the definition of obesity were instead based on high percentage body fat, between 15 and 35% of men with non-obese BMIs would be reclassified as obese.”

The point being that if you are looking just at BMI in figuring out how fit you are, you are wrong. Plain and simple.

The same stands true for GDP growth. If you are looking at just GDP growth to figure out the real state of the economy, then you are either in the edtech business of manufacturing WhatsApp forwards or you are a wide eyed innocent, with zero clue about the way WhatsApp University works.

Let’s dig deeper than WhatsApp Edtech.

GDP growth during April to June 2021 was at 20.1% because the GDP contracted by 24.4% during April to June 2020. The so-called base effect was at work.

Also, the GDP during April to June this year was Rs 32.38 lakh crore. This was lower than the GDP during April to June 2019, which was at Rs 35.67 lakh crore. It was also lower than the GDP during April to June 2018, which was at Rs 33.84 lakh crore.

In fact, private consumption or the stuff you and I buy, and which forms a bulk of the GDP, varying anywhere between 55-60%, stood at Rs 17.84 lakh crore. This was very close to where it was during April to June 2017, when it was at Rs 17.63 lakh crore. The point being that the amount of money that Indians spent on buying things in the first three months of this financial year was almost the same as they did four years back. At the Indian WhatsApp University, that qualifies as a positive.

Hand on your heart ( this isn't the Sahara Pranaam, nor is it intended to be the Sangh Parivaar oath taking pose. We are strictly apolitical), would you call this an economic recovery, V-shaped, K-shaped, U-shaped or even O-shaped for that matter?

Does this call for opening the champagne ?

Naah...

It’s time to open that new jaljeera packet you had splurged on, the last time you went visiting your parents and were holding on to it for a special occasion.

This is that occasion.

Like much of modern macroeconomics, the formula to calculate the GDP emerged after

the Great Depression of 1929. And like it did when it was first invented, it still measures only monetary transactions.

For example, the GDP figure doesn’t measure the unpaid household work, everything from cooking to childcare to cleaning to washing utensils and clothes and so on. And to that extent, the GDP calculation is a sexist one.

As Diane Coyle writes in GDP—A Brief But Affectionate History: “The main reason for not counting unpaid housework as part of “the economy,” while paid housework is counted, is the difficulty of measuring it. Well, difficulty is not the right word. It can be measured by surveys, like many other economic statistics, but generally official statistical agencies have never bothered—perhaps because it has been carried out mainly by women [emphasis added].”

And at the end of the day, economics, like much of finance, remains a field dominated by the male of the species.

In fact, this is a problem that is impacting India in a big way right now but very rarely gets talked about anywhere. As per the Centre for Monitoring Indian Economy, the labour participation rate among Indian women as of August 2021 stood at just 9.6%.

What does it mean? The labour participation rate is the ratio of the labour force to the population greater than 15 years of age. And what is the labour force? As per CMIE, labour force consists of persons who are of 15 years of age or more, and are employed, or are unemployed and are actively looking for a job.

Basically, for every 1,000 women who are aged 15 or more, only 96 are employed or looking for employment. In absolute terms, of the 50.19 crore women aged 15 or above, as of August only 4.82 crore were employed or actively looking for a job. The situation is much worse in urban areas than in rural areas.

Five years back in September 2016, the labour participation rate among women had stood at 16.6%. In absolute terms, of the 44.88 crore women aged 15 or above, 7.44 crore were employed or looking for a job.

This basically means that in the last five years nearly 2.62 crore (7.44 crore minus 4.82 crore) women have dropped out of the labour force. Also, many women who have crossed the age of 15, haven’t bothered looking for a job. Some of this can be attributed to girls studying more. But beyond that no reasonable explanation of this very disturbing trend has been found.

So, more and more women are doing free unpaid work at home, which the GDP number revealed every three months doesn’t really capture. As a nation we are letting our young girls down and we have no idea of why things are playing out the way they are.

As the old jungle saying goes (No, this isn't manufactured by the Profs at WhatsApp University):  Only when you don’t know where you are going, the journey is the reward.

And  there is a glass of jaljeera waiting for you at the end of it.

Maybe.

(Le Grand Fromage can be contacted on email: [email protected]

Le Grand Fromage is not on WhatsApp.)

If you want any help at all in your wealth creation journey, in managing your Investments, just drop us a line via this link and we will be right by your side, super quick!

Or WhatsApp us on +91 88501 69753

Chat soon!

From the desk of 

Le Grand Fromage,

Unemployed at

First Global

Trusted Financial Advisors to some of the world's largest Funds, Institutions & Family Offices, for 30 years

Regulated by FCA in the UK

Regulated by SEC in the US

Regulated by SEBI in India

Regulated by Cayman Islands Monetary Authority (CIMA)

https://firstglobalsec.com

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Last week, I was watching Rajiv Bajaj's interview where he mentions going to the village where his grandfather, Jamnalal Bajaj, was born. The latter was born in a poor family and once while playing outside was seen by a wealthy Sethji and adopted (for details of how that happened, you've see the interview). On that trip, he also met an employee - a security guard at Bajaj Auto - whose home was also in the same village and at that time it struck Rajiv Bajaj that he had made up so many stories about the reasons for his success like his hard work, skills as an engineer and a manager and so on but really if it had been that guard's grandfather playing outside on that fateful day, maybe that guard would have been the owner of Bajaj Auto and Rajiv would have been the guard!

This was a moment of epiphany for him and showed him the fallacy in attributing success to his personal qualities and efforts when luck or destiny had played a crucial role too.

This is a lesson that is awfully hard for human beings to learn as it is related to one of our inbuilt cognitive biases: the Self-attribution bias.

This is the fourth in my series on Cognitive/ Investing Biases. The earlier pieces can be read here, here and here

We attribute Outcomes to ourselves...but only if they're Successes!

This Self-attribution is not symmetrical in nature: it is not as if we attribute our success and failures equally to ourselves. Our tendency is to attribute successes to personal skills and failures to factors beyond our control. This, in fact, is the classical definition of Self-attribution bias.

Most of us can think of things that we’ve done and determined that when everything is going according to plan, it’s clearly due to our skill. Then, when things don’t go according to plan, clearly we’ve just had bad luck.

If we ace an exam, it is because of our intelligence, talent and hard work. But if we don't do well, it is because the rating was unfair or the professor did not teach the course properly.

When we are selected for a job, we believe that we have been hired for our achievements, qualifications and excellent interview skills. But if we aren't hired it is because the interviewer was prejudiced or there was some other hanky-panky afoot. That is how the human mind works.

In investing, self-attribution means if I pick a stock and that does well, it's because I'm a genius. But if the stock doesn't do well, then it's because of external factors - the economy, politicians, company management, stock operators, there are plenty of factors that can be blamed.

So success is because of my skill. The failure is because of some risk that could not be foreseen.

Of late, many who have opened accounts in the likes of Robinhood think of themselves as accomplished traders - that too in a foreign market! They don't stop and analyse that maybe I was just lucky enough to enter the US market at a good time. Similarly, those dabbling in cryptocurrencies think of themselves as extremely savvy in digital assets when they make money and curse everyone from various governments to Elon Musk when some news makes their holdings crash.

Investing is a game of luck cum skill

Investing, like most things in the world, is a game of luck cum skill but in the real world investors weight the two differently depending on how well they have done recently. Several studies have shown that this is a real phenomenon.

So if in the past year, you've done very well, and then you are asked that what percentage of your investment performance do you attribute to skill, you are likely to give a much higher percentage than you would if you had not done well - then the luck factor would have been rated higher.

Why does the Self-attribution Bias exist?

As with most cognitive biases, the apparent 'mistake' in our thinking has a positive evolutionary role.

This cognitive bias allows you to protect your self-esteem. By attributing positive events to yourself, you get a boost in confidence. By blaming outside forces for failures, you protect your self-esteem and absolve yourself from personal responsibility.

One advantage of this bias is that it causes people to persevere even after a failure - whether it was a failed hunt or a lost race.

When you can blame luck/ outside forces for it, you're more likely to try again. For instance, an unemployed person may feel more motivated to keep looking for work if she attributes her joblessness on a weak economy or discrimination rather than some personal failing.

Why this can be a road to disaster in Investing (or Trading)

So, anything that boosts your confidence and self-esteem should be good, right? Only if you are in school! In the market it can be a disaster.

Taking credit for successes and blaming external factors for failures underlies and reinforces investor overconfidence. Every success is attributed to great analysis and skill whereas every failure is because of "bad luck".

The result? Taking on inappropriate degree of financial risk, trading too aggressively increasing downside probability, overtrading are all known results. Self-attribution bias often leads investors to trade too much and take on too much risk. All signs of overconfidence.

It can also result in concentrated positions because you're so convinced of the brilliance of your analysis. This bias leads investors to “hear what they want to hear.”

All of the these things to be avoided!

As an aside, studies show that men are much more prone to this overconfidence and overtrading outcome compared to women.

Equally important, not taking responsibility for your errors means that mistakes in thinking, frameworks, ways of analysis etc continue unchecked because you refuse to admit that there was anything wrong with your decision-making process in the first place.

Thus, you're doomed to repeat your mistakes over and over again

"Don't Confuse Brains with a Bull Market"

As this quote says, the step one for an attempt to side-step this bias is to know how much of your gains are due to the luck of being in a certain market at the right time. When profits pour in during a bull run, it is easy to congratulate yourself and your outstanding analytical skills.

This happens not just with lay investors but even professional fund managers who arguably have even greater incentives to do this in order to justify their fees.

Always remember that in both successes and failures there is a combination of skill and luck.

Your mind should not skew your thinking such so that you think that everything that does well was due to your skill and everything else, "Poor me! I could not have foreseen that. Bad luck".

In real life investing, both failures and successes have elements of skill and luck but in the investors mind the success is all skill and failure is all luck.

One other trick which helps reduce the impact of this bias is writing down your logic for why you are taking a certain investment decision so that later on whether it turns out well or not you can go back and check whether your logic was correct. This is important even if your decision turns out right. Even if you make money on an investment, your logic for taking the position may have been totally wrong and the 'right' outcome may've been only a lucky fluke.

If you do not write your logic down BEFORE you make this investment, you can rest assured that your mind will play tricks and tell you that you always knew what really happened, which is another cognitive bias altogether that I will deal with some other time.

Of course, when the outcome is not as per your liking/ estimates, go back and study your decision-making to see where the mistake or error was.

Another important thought: a positive outcome does not mean your decision was correct just as a negative outcome does not mean your decision was incorrect.

In investing your decisions are always made with many unknown factors and hence there is always an element of luck.

But that's a topic for another article altogether.

(A version of this article first appeared in Moneycontrol)

From the desk of 

Devina Mehra & Shankar Sharma

If you want any help at all in your wealth creation journey, in managing your Investments, just drop us a line via this link and we will be right by your side, super quick!

Or WhatsApp us on +91 88501 69753

Chat soon!

https://firstglobalsec.com

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As an investment professional, the question I face the most is some version of this: "What do you think of the market?" "Where do you think the market is headed?", "Will the market go up or down?"

And really the only answer to this is: "Which market are you talking about?" Because my reply depends on this.

Otherwise asking whether the market is going up or down is like asking whether a Giant Ferris Wheel is going up or down. The direction for you depends only on which passenger cab you are in.

Now think of the Investment Universe as this giant wheel with each asset class being represented by a cab. At any time, certain asset classes are going up and some others are going down. Put another way, there is always a simultaneous bull market somewhere in the world, even as there is a bear market elsewhere. The outcome for your investment portfolio depends on which passenger cab you are in.

Before we go further, let's first understand what's meant by an asset class. The textbook definition is: An Asset Class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations.

Historically, the three main asset classes were considered to be equities (stocks), fixed income (bonds, fixed deposits etc), and cash equivalent or money market instruments. Since then, many others have been included: for example, real estate, commodities, futures, options and other financial derivatives, cryptocurrencies etc. As you would notice these include both physical assets like real estate as well as financial instruments.

While these are broad categories, these can be further divided by geography and other characteristics. For example, equities in Japan or South Korea may behave very differently from the equities in the US. Similarly in Fixed Income, the categorization is not just by geographies but also by credit rating and issuers - like government bonds, Investment grade Bonds and Non-investment grade Bonds (also called High Yield Bonds).

Asset Allocation determines most of your returns

The first thing to remember is that 85 to 90% of your investment returns are determined by your asset allocation - that is is the mix of various asset categories in your investment portfolio. This is to say that your choice of whether you are in US Technology stocks or German Real Estate or Singapore bonds will determine more of your investment Returns rather than the specific choice of stocks and bonds.

This, in some ways, makes investment simpler as you do not have to look for the needle in the haystack in the form of the multibagger stock you can boast about -what you do need to do is to be in the right mix of investment categories or asset classes at the right time. 

What matters is that you/ your Investment Manager/ Advisor has the right skills to do this.

According to Venkatram Mandalapu, the CEO of NV Consultancy, "In a fast-paced market environment, some asset classes tend to outperform the other. To keep up, asset allocation is the answer to weathering any storm through the key concept of diversification."

A truly smart Fund Manager can create a Permanent Bull market in your portfolio. Which brings us back to the Giant Ferris Wheel. If you can hop off the cab (asset class) going down and get onto to one going up, your portfolio can be in a permanent uptrend.

What you must avoid at all cost is SCCARs

"A Single Country Single Currency Single Asset exposure can SCAAR you forever," says Shankar Sharma, Vice Chairperson, First Global.

What is meant by this? Most of us, when we think of investments, think of investing only in our home countries and that too in a single asset class - usually equities.

Therefore if you are from India you might think of investing only in Indian equities. We all have this bias due to sheer familiarity if nothing else -but this can be very dangerous to your financial health because there can be long periods of time when a single market is not performing or is in a bear phase.

What you need is tactical and dynamic asset allocation because of this reason.

There is nothing called a Bull Market or a Bear Market 

There is always a bull market and there is always a bear market coexisting at any point in time - depending on which geographies or asset classes you are looking at.

What this means is that certain categories of investments will be in a bear market while at exactly the same time, some other categories will be in a bull market!

A trip down history will make this clearer.

Let's go back nearly a quarter of a century to the Asian crisis of the late nineties. This hit South Asia hard from Taiwan, South Korea and Hong Kong to Thailand, Malaysia and Indonesia. Suddenly the gleaming Asian Tigers had a comeuppance, with both the stock market as well as the currencies crashing.

In dollar terms all these markets were down 50 to 90% within a year. This was a disaster few saw coming as the 90s were go-go years for these economies and many other developing economies wanted to emulate their success. This brought home very starkly the dangers of being exposed to a single market, even if it is a high growth one.

However, the real story is that even as these Asian markets were in a tailspin, European equity markets were up over 25% in that same year and US Treasuries were up 20%.

That is a pattern we will see repeated time and time again as a crash or a bear market in one Geography or asset class is accompanied at the same time by other markets or assets going up.

Most of us remember the 2000 tech crash well, when after the first Dot com and tech boom, there was a major crash not just in the Nasdaq but across the US markets. US equity markets halved between March 2000 to October 2002. Even as this was happening gold was up 14% and both oil and US treasuries had good Returns.

A corollary to this is that no market is in a permanent bull phase. For example, nowadays many investors think that you cannot go wrong buying the US Stock market and particularly the Nasdaq. However there have been long periods of time when the Nasdaq ie US Technology has not been in a good asset class to be in.

For example, over the entire period between 2003 and 2007, the returns from US equities were very very tepid. Even from the post crash lows they went up only over 61% over this period and did not even take out their 2000 highs. In fact, NASDAQ did not reach its 2000 high right upto 2015!

Over the same time span, the Emerging Markets went up several times. The Emerging Market Index was itself up three and half Times. Brazil was up 10 times. Markets like India were up six to seven times. Oil tripled. Gold and commodities were up 130-150%. As always bull and bear markets co-existed.

In the last 10 years prior to 2020: Emerging markets were in a bear market while US markets were in a bull market. Despite, both being Equities!

Overall, Equities were in a bull market while commodities were in a bear market.

Till a few quarters ago when the commodity cycle began to turn. Oil and then metals began to turn towards prices that had not been seen for 10-15 years. More recently, food and other Agri commodities are racing towards their highs of a decade ago.

The point that is that there are simultaneous Bull Markets and Bear Markets.

They coexist. All the time.

It only takes deep understanding of markets, to understand this. And exploit it.

Smart, proactive Asset, geographical & Sector Allocation, coupled with tight, tactical Risk Management can indeed create a permanent bull market for your wealth.

"To remain in a permanent bull market Asset allocation and Percentage (%) allocation plays a very important role. One of the assets will always have its run in any given point of time," says Charudutta Joshi, Board Member Greenback Capital Limited.

Do ask: is your investment manager or wealth advisor capable of understanding, and then exploiting these simultaneous, bull markets and bear markets?

Or are they just a one-trick, Equity-bull-market pony?

A Fund manager who defines their investment Universe very very narrowly normally saying something like 'I invest only in my circle of competence'. What it really means that they invest within their comfort zone. That type of investment strategy or philosophy becomes a trap for you as an investor because that fund manager will do well when their type of securities are in a bull phase but when markets change as they invariably will, your portfolio can underperform for years together.

It is something like the fable of looking for your keys where there is light rather than where you are likely to find them.  So fund managers that confine themselves to a narrow area are unlikely to be able to find you the keys to riches.

As Luis Freire CIO & Managing Partner of BTA Wealth Management puts it, "Diversification ensures that by not 'putting all your eggs in one basket,' you will not be creating an unwanted risk to your capital. Diversifying your investment portfolio is important because it keeps any part of your investment assets from being too heavily weighted toward one company or sector."

Therefore, the question to ask is: how good is your investment manager at the business of managing risk while continuing to generate Returns.

Allow me to give you some examples from our own experience.

In India, in the month of February last year, we saw plenty of dangers looming up because of the virus.

As a result, we immediately took protective action through our Tactical Insurance for Portfolio Protection Strategy: TIPP Tech, which uses derivatives only for the purpose of hedging. And by buying Government treasuries.

Our TIPP Tech saved our clients from a lot of damage in India as well as in the Global Stock Market.

From that point onward, i.e., March-end, we remained fully invested, riding the entire Bull market.

However, from the month of October, we started to buy a matrix of put options, via TIPP, again which was hedging at different points in time, different elements of our portfolio.

Therefore, we kept capturing the upside that the markets gave us without running the risk of big losses.

On the Global side where there are far better Risk Management and investment options available, it is so easily possible to diversify beautifully, across the world, into several uncorrelated asset classes, and individual stock Positions, that one can escape big meltdowns: just the massive range of choices available: 13,000 stocks, 100s of Fixed Income and REITs, dozens of commodities (previous metals, industrial, strategic like Rare Earth), all, when combined together into a perfect portfolio symphony, can capture most of available upside, without endangering portfolio safety.

And one can hedge each security, as well as a basket, too!

Just imagine the flexibility on offer globally!

See how we did it in 2020

We moved away from our large American Technology stocks positioning around August last year and we increased our positions in Emerging markets and commodities.

As a result, we have had a very decent run even from the time that the NASDAQ became wobbly, with a flat-lining of major stocks like Amazon, Netflix, Facebook, Microsoft in the second half of 2020.

At about the same time, significant opportunities arose in commodities and thereafter in carefully chosen REITs. Of late, we have once again lightened up on commodities.

Further, our portfolios have been extremely well-balanced, with our overlay of TIPP Tech.

 Therefore we kept capturing most of the upside that was on offer across the world, without running the risk of suffering massive losses, should the market have fallen.

Therefore the way we do things at FG, whether in our India PMS or Global PMS and Global Fund, is completely different from the rest: we are extremely vigilant at all points in time and we keep adding layers of protection of risk management, on an on-going basis.

We always keep scanning the environment for durable shifts in trajectories of asset classes, sectors, countries.

Then, by tactically hedging our portfolios, through a combination of TIPP Tech and Tightened Stop losses, we almost ensure that even if there is a massive crash, we don't suffer massive losses as other PMS and Funds routinely do. (Some losses can and will happen, of course. We are concerned only about big losses)

This creates sustainable portfolio returns, even if it means foregoing some extra upside, once in a while.

Nobody minds that!

What should be your takeaway?

Simple: You just need to choose your Investment Manager or Wealth Advisor wisely and then leave the Tactical aspects like asset classes and sectoral allocation, the Risk Management, to that carefully chosen Investment Manager.

And then only you can enjoy the full benefits that the market offers.

The best Fund Management & PMS Services companies should be able to deliver this tactical Risk Management, that smoothens out your portfolio returns, by prevention of massive losses, thereby creating a near-permanent bull market in your portfolio.

If they can't ensure this, they don't deserve your wealth.

The key learning for you is that if your choice of investment manager is right, you have solved your entire problem completely with regard to the management of your money/ funds: if your investment manager has the capabilities to navigate good markets and bad markets, that's all the analysis & work you need to do.

For example, if this so-called liquidity-driven market collapses, is your Investment Manager or Wealth advisor already aware of this risk and have they done adequate, proactive Risk Management and sectoral diversification?

Investing Heaven is possible: one can participate in all the Bull markets that are happening in India and globally while not running the risk of massive capital loss: that is what this business of investment  & portfolio management skill is.

So stop worrying about navigating markets. Stop worrying about whether markets are too high.

Because that's what our job, as Investment Managers, is.

And that's what we do the best in this business.

And to end, this is how one can create a Permanent Bull Market: Smart proactive allocation, and risk management.

That's what Smart Money Managers or Fund Managers do.

We look forward to building steady and safe wealth for you.

(A version of this article first appeared in Khaleej Times)

From the desk of 

Devina Mehra & Shankar Sharma

If you want any help at all in your wealth creation journey, in managing your Investments, just drop us a line via this link and we will be right by your side, super quick!

Or WhatsApp us on +91 88501 69753

Chat soon!

https://firstglobalsec.com

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