Blog

An American university did an experiment where it gave a set of students a coffee mug. A few days later, the same coffee mug was offered for purchase to other students. The ones who had to buy it, valued it at around $3 on the average but the students who had the mug were not willing to sell it for less than $6-7. This is a classic example of the Endowment Effect or the Endowment Bias.

Other examples of the Endowment Effect include experiments which found that participants' hypothetical selling price for a ticket to a big sporting event was 14 times higher than their hypothetical buying price.

It has been found, in multiple experiments, that people's maximum willingness to pay to acquire an object is typically lower than the least amount they are willing to accept to give up that same object when they own it - even when there is no cause for attachment, or even if the item was only obtained minutes ago.

This attachment or the tendency to overvalue what you own only becomes stronger when you have inherited an object or owned it for a long time.

This, in short, is the Endowment Effect or bias: when you value something more simply because you own it. It has been observed time and time again. For example, you may have bought a bottle of wine for say Rs. 800 but if someone wants to purchase it, you won’t sell it for less than Rs. 1,100 or even more.

And like most things that are common across human beings, this is not a recent trait. Thousands of years ago, Aristotle wrote: "For most things are differently valued by those who have them and by those who wish to get them: what belongs to us, and what we give away, always seems very precious to us."

Too close to be objective

And the Endowment Effect makes an appearance pretty early in our life. A three-year-old will guard her favourite toy, even if you promise to replace it with a replica.

Neuroscience shows that when we look at objects owned by us, the parts of the brain dealing with our self light up. We closely identify with what we own, almost as if it is a part of us.

In traditional economic and finance theory, humans are supposed to be strictly rational creatures but in real life, a whole lot of studies have shown that our behaviour is anything but rational.

Behavioural economists and behavioural finance scholars explain such allegedly irrational behaviour as a result of some sort of cognitive bias that warps the individual's thinking. This is the second piece in my series on these Cognitive/ Investing biases. The first one looked at Why Human Beings are hardwired to make the wrong investment decisions.

In investing terms, the Endowment Effect means that once you hold an asset or investment, your evaluation of it is no longer objective or rational.

Let us say you are capable of analysing and valuing stocks. If it is a stock you do not own, you will be better able to make an objective assessment about it but if you own it, you will always feel that it has a higher value without being conscious of it.

If you didn’t hold that stock, you may have thought after your valuation exercise that a PE multiple of 18-20 times was justifiable but if you hold that stock, you may feel that the PE of 25 or 30 is also justified. You may continue to hold that stock even when it goes beyond your rational valuation threshold.

This bias can affect attitudes towards assets owned over a long period or even crop up immediately—as soon as the asset is acquired.

Why ‘hold’ exists?

Going back to the earlier examples, when we get attached to even mundane objects like coffee mugs or a bottle of wine, securities or other investments we hold are much closer to our hearts because firstly, they are more closely aligned with our well-being.

Secondly, investing in a stock or other asset means that you have analysed the options and made a conscious choice. Now you do not want to change your mind because you do not want to think that your earlier choice was incorrect. Hence, you are likely to be even more invested mentally (pun intended) in a stock that you own than in other daily-use objects.

That is why most people will keep defending the stocks that are in their portfolio and hold on to them for too long.

In fact, the Endowment Bias is the single reason why a “Hold” rating exists in the lexicon of market analysts.

Think about it, if a security is not worth buying today, why is it worth holding? The whole construct of having a “hold” rating is to hide from us the fact that we are being irrational by putting a covert premium on something precisely because we are already holding it.

Don't Kid Yourself! 

You may even kid yourself that you are holding on to this investment because you do not want to incur unnecessary transaction costs but the fact is often that investment may not make sense even if you net out the transaction cost involved.

Usually the transaction cost of a switch in investments is negligible compared to the potential loss of holding onto the wrong investment or the potential profit forgone for not making a switch to the right asset.

Other factors involved may be just a comfort factor with something familiar or a decision paralysis that leaves your portfolio unchanged for long periods because you want an irrational premium to sell something you hold.

The problem is such rationalisations can be detrimental to your financial health because of the failure to take the required action.

Since you now know that this is a bias, you need to guard yourself against it. The only real way to make a start is a zero-base portfolio approach. Do not think that how can I sell Hindustan Unilever shares bought by my parents or that I have made a ton of money on Reliance or Apple, so I should continue to hold them.

The cash test

Think that if my portfolio was liquidated and in cash today, how would I allocate it? What would I buy? Would it be the same assets? In the same proportion? The last is very relevant for your multi-baggers that may now be a disproportionate part of your portfolio.

So also for a large number of “riff-raff” securities that were hot once, you bought them and have seen them dwindle. If you had the cash today would you invest in them? In a very small number of cases the answer may be “Yes”.

In others, you are better off booking your losses, forgetting your history with the stock and investing in better quality assets and investments.

The Endowment Effect is very insidious and a very core part of our being, so the only way to overcome it is with a rigid set process of looking at your portfolio from scratch every quarter or at least annually—preferably with another independent set of eyes. That can be the beginning for optimising your portfolio.

(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

  • Socialise with us at :
  • Image result for facebook logo

...

Read More
  • Share Via :
  • Facebook Icon
  • Twitter Icon
  • WhatsApp Icon

Enquire Now

Without getting into a long preamble, we invite you to take a look at the data below, which clearly shows you the returns of the various Mutual Funds and PMS Providers, but most importantly they show you where the returns are coming from: Higher Risk or Higher Skill.

Stories can take us only upto a point and fund managers are great storytellers as we all know.

But ultimately it is only data and data alone that matters when it comes to money.

The data below shows clearly that we, at FG, are delivering not just far ‘ahead of market’ returns, but also that these returns are coming with far lower risk, as compared to the market and the major peer group.

A] Comparison of First Global-Indian Super 50 PMS Scheme with various Multicap PMS schemes on various Performance parameters (Small Caps are just 10% of our allocation)

Sr No.

Multicap PMS Scheme

Apr'21

CYTD
(Jan-Apr'21)

Total Return
(%)

(Mar'20-Apr'21)

CAGR since
IS50 Inception (%)

(Mar'20-Apr'21)

Risk/ Volatility
(%)

Risk Adj Return
(CAGR/Volatility)

(x)

Gain To Pain Ratio

(x)

1

FG’s India Super 50

9.00%

22.50%

72.10%

59.30%

20.70%

2.86

4.02

2

Stallion Asset Core Fund

2.20%

9.40%

49.80%

41.40%

28.30%

1.46

1.78

3

White Oak India Pioneers Equity

1.80%

9.20%

40.30%

33.70%

28.50%

1.18

1.49

4

Girik Capital

5.60%

12.00%

34.50%

28.90%

22.80%

1.27

1.43

5

IIFL Multicap Advantage

2.30%

5.70%

34.00%

28.50%

21.20%

1.35

1.76

6

ASK IEP

1.30%

7.70%

27.90%

23.50%

31.70%

0.74

0.92

7

ASK Growth

2.60%

10.50%

27.50%

23.10%

30.40%

0.76

0.97

8

Marcellus Consistent Compounders

-0.10%

-2.30%

26.10%

22.00%

23.60%

0.93

1.06

9

IIFL Multicap

1.90%

5.70%

26.00%

21.90%

35.30%

0.62

0.94

10

Axis Brand Equity

-1.10%

3.00%

25.00%

21.10%

28.30%

0.74

0.91

11

Motilal Oswal BOP

-2.40%

1.80%

23.40%

19.70%

28.80%

0.68

0.89

12

Motilal Oswal NTDOP

-0.90%

6.80%

22.60%

19.10%

30.00%

0.64

0.88

13

Moneylife Mass Prime

5.00%

6.10%

19.40%

16.40%

30.10%

0.55

0.83

14

ASK India Select

1.90%

3.80%

18.80%

15.90%

29.40%

0.54

0.7

15

Alchemy Select Stock

4.70%

12.40%

16.50%

14.00%

34.40%

0.41

0.69

16

Axis core and satellite

-1.40%

2.60%

16.20%

13.80%

27.60%

0.5

0.64

17

Alchemy High Growth

0.30%

2.60%

4.60%

4.00%

31.60%

0.13

0.31

 

Nifty 500

0.50%

7.60%

35.50%

29. 8%

30.70%

0.97

1.29

 

Nifty 50

-0.40%

6.20%

32.60%

27.30%

30.00%

0.91

1.19

B] Comparison of First Global-Indian Super 50 PMS Scheme with various top Multicap Mutual Funds on various Performance parameters

 

Sr No.

Multi Cap Equity Mutual Funds

Apr'21

CYTD
(Jan-Apr'21)

Total Return
(%)

(Mar'20-Apr'21)

CAGR since
IS50 Inception (%)

(Mar'20-Apr'21)

Risk/ Volatility
(%)

Risk Adj Return
(CAGR/Volatility)

(x)

Gain To Pain Ratio

(x)

1

FG’s India Super 50

9.00%

22.50%

72.10%

59.30%

20.70%

2.86

4.02

2

Nippon India Multi Cap Fund

0.00%

15.30%

22.50%

19.00%

38.70%

0.49

0.71

3

ICICI Prudential Multicap Fund

0.50%

10.20%

31.00%

26.00%

32.70%

0.79

1.07

4

Axis Capital Builder Fund

0.60%

5.70%

27.50%

23.20%

29.50%

0.79

0.96

5

Invesco India Multicap Fund

1.50%

10.10%

30.10%

25.30%

32.10%

0.79

1.15

6

Baroda Multicap Fund

2.10%

11.00%

36.90%

30.90%

28.20%

1.1

1.38

7

Nippon India India Opportunities Fund

0.40%

11.20%

25.20%

21.30%

38.40%

0.55

0.76

8

Principal Multi Cap Growth Fund

0.40%

9.30%

29.90%

25.10%

29.80%

0.84

1.16

9

Sundaram Equity Fund

0.70%

10.50%

31.00%

26.10%

31.10%

0.84

1.2

 

What do these ratios signify? 

Let us break it down for you in the most simplest of language:

(For those interested, the formulae used for all the calculations are given at the end of the blog)

1.  Volatility or Risk: The Volatility or Risk of a portfolio of stocks is a measure of how wildly the total value of all the stocks in that portfolio varies. A portfolio's volatility is calculated by calculating the standard deviation of the entire portfolio's returns.

 As is clear from the table above, the Volatility of our portfolio is very low compared to our peers as well as when compared with the markets.

The volatility of our returns is the lowest in the whole market. It is one third below the market volatility and as the next calculation shows it is even lower as a proportion of returns we have generated.

2.  The Risk Adjusted Return (RAR) compares the portfolio’s return versus the standard deviation of returns. It is calculated by dividing the Annualized returns by the Annualized Volatility.

It captures the amount of returns for each unit of risk.

For First Global this ratio is 2.86 as against 0.9 for the market.

More to the point there is no other PMS or Mutual Fund that has reached the value of 2.5, 2 or even 1.5 clearly showing that not only have we got the highest returns in the market for our investors, these returns have come at very very low volatility and risk. The returns per unit of risk are double of the next best player and nearly three times the value for the market.

3.  Gain to Pain ratio: This is one of the best measures of return and risk profile of any fund.

The formula to calculate this ratio is: Total Returns ÷ Absolute value of negative returns.

So, the numerator is the sum of all monthly returns, positive and negative through the year. The denominator is the absolute value of the negative returns, for the months when the returns were negative.

We illustrate this through a simple example

 

Jan

Feb

Mar

Apr

May

June

July

Aug

Sep

Oct

Nov

Dec

Returns (%)

5%

-3%

-3%

4%

5%

6%

7%

8%

10%

10%

-5%

6%

 

The sum of all Monthly Returns is 50.0

The absolute value of all return deficits (-3.0, -3.0, -5.00) is -11.00

The Fund's Gain to Pain Ratio is 50.0/11.0= 4.54

Our Gain to Pain ratio at over 4 is way ahead of other PMSes and funds, none of which are at 4, 3 or even 2. The market's gain to pain is a measly 1.3

This our returns have come with minimal pain or minimal drawdowns.

The reason for First Global's performance with higher returns and lower risk on all measures are not because of some great magic!

It is because of using some of the most advanced investment analysis technologies known to man, and building an investment tech stack, our FG ExoTech, that reduces the role of luck and increases the role of skill dramatically.

Do you want your fund managers to be relying on their luck or on genuine skill? We think the answer is clear.

The above data shows you where the skill is.

We look forward to being partners in your wealth creation journey.

Ratio Calculation Details

Sample Variance Calculation

Let us consider the Monthly returns of a PMS fund over a 1 year period.

 

Jan

Feb

Mar

Apr

May

June

July

Aug

Sep

Oct

Nov

Dec

Returns (%)

5%

3%

3%

4%

5%

6%

7%

8%

10%

10%

5%

6%

% Deviation = Return -Mean

-1.0%

-3.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

4.0%

4.0%

-1.0%

0.0%

Squares of Deviation

1%

9%

9%

4%

1%

0%

1%

4%

16%

16%

1%

0%

Mean=Total Returns/12=72/12=6%

Variance=Total of the Squares of Deviation of all months/12=62/12=5.17

Monthly Standard Deviation=Square root of Variance =2.27

Annualized Std. Deviation=2.27*Square Root of 12="2.27*3.46=7.86%

Hence, Annualised Volatility=Annualised" Std Deviation=7.86%

Sample calculation of Risk Adjusted Returns (RAR)

RAR formula = Return on Portfolio ÷ Standard deviation

For example if the return is 12% with 10% standard deviation, then RAR = 12÷10 = 1.2

From the desk of 

Devina Mehra & Shankar Sharma

Enquire Now

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

  • Socialise with us at :
  • Image result for facebook logo

...

Read More
  • Share Via :
  • Facebook Icon
  • Twitter Icon
  • WhatsApp Icon

Bitcoin has undoubtedly laid the foundation for the rapid development of Blockchain technology as we know it today.

It all started soon after the financial crisis of 2008 when on October 31, the now-famous whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System” was shared on a cryptography forum by Satoshi Nakamoto, as an answer to the shortcomings of the traditional, fractional financial system that had led to the crisis.

That was the start of not just a new asset class but also the beginning of a mystery or enigma because Satoshi Nakamoto is a pseudonym and the person or persons behind it have not been identified even 12+ years later.

A few days after the White Paper, Nakamoto registered the project on SourceForge, the open-source code platform, and on January 3, 2009 the first-ever Bitcoin block, named the genesis block, was mined, awarding Satoshi the first 50 Bitcoins of the 21 million that will ever be created. 

In that block, Nakamoto put the message: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”, a headline of London Times that day, which has been interpreted as both a timestamp and a critique of the traditional financial system. 

Regardless of who Satoshi Nakamoto really is, on January 12, 2009, he made the first-ever Bitcoin transaction, sending 10 BTC to developer Hal Finney, who was actually one of the candidates to be Satoshi. 

To try and understand why Satoshi Nakamoto chose a pseudonym and not their real name, it is a good idea to recall the basic idea behind Bitcoin. 

The first sentence of Bitcoin’s whitepaper reads as follows: “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” This opening statement makes it abundantly clear that the basic idea behind the network is decentralization.

If Satoshi had chosen to reveal their real identity, they would have become the central element in a decentralized system. So, in order not to hurt the concept of decentralization--Satoshi probably chose to remain out of the spotlight. 

Multiple attempts by various online communities to decipher the true identity have been made over the years. Various linguistic and behavioral studies were carried out, which led some people to believe that Satoshi resided in the United Kingdom as suggested by their impeccable written English or the fact that they occasionally used typically British phrases. Other people analyzed the posting patterns to suggest they must be living in Eastern or Central time zones. 

Other researchers suggested that Satoshi simply could not be just one person: their level of expertise in multiple fields including cryptography, computer science, economics, and psychology--and the ability to communicate it all fluidly--could support the hypothesis that Satoshi is a moniker for a collection of people. 

The top two candidates discussed in the past have been Hal Finney and Nick Szabo. Hal, who died in August 2014, was an early Bitcoin user and received the first Bitcoin transaction from Bitcoin's creator Satoshi. Nick Szabo is a blockchain pioneer and founder of “Bit Gold”, which was one of the earliest attempts at creating a decentralized digital currency in 1998. However, Nick has denied that he is Satoshi.

Many hypotheses and rumors have been floated on this. The most famous one being about Elon Musk who denied being the inventor of Bitcoin. 

Craig Wright, a claimant, has also been disregarded as the founder of Bitcoin by the cryptocurrency community, in spite of his claims.

According to Jerry Brito, director of the cryptocurrency research group Coin Center, the real Nakamoto ought to possess one key that's associated with Bitcoin's so-called Genesis Block, the beginning of the public ledger of Bitcoin transactions called the Blockchain.

For now, none of the self-declared inventors have conclusively been able to prove that they are the masterminds behind Bitcoin. So there is still no consensus on who Satoshi Nakamoto is. 

And, while the true identity of Satoshi Nakamoto may never be clarified, it probably doesn’t matter. Or does it?

(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

  • Socialise with us at :
  • Image result for facebook logo

...

Read More
  • Share Via :
  • Facebook Icon
  • Twitter Icon
  • WhatsApp Icon

The style of investing that has attracted maximum derision in the last decade, it is value investing.

The aftermath of the 2008 crisis in which Central Banks flooded economies and markets with liquidity, effectively crushed the risk-free rate down to levels unseen before.

The effect it had on growth equities was astonishing: the FAANG trade was born roughly one year after the GFC, and did not look back till the end of 2020.

Most investors did not quite understand then, the implications of the effect that a lowering of discount rates has on equities: even a modest lowering of 20% in discount rates can magnify future returns massively. And here we had a lowering of rates by 50% and more!

What essentially happened after the 2008 crisis was that even moderate expected growth became magnified in present value terms simply because of a lowering of discount rates. This, in turn, inflated valuation multiples.

But things have changed a bit lately, due to the hardening of yields, pretty much across the world. This raises discount rates with which to value equities, and this has implications for all sectors.

Does this mean a return of value investing as high flying tech stocks suffer valuations compression because of the higher discount rates that should now get embedded into making valuation forecasts?

It stands to reason that rising discount rates should result in the value space becoming more interesting.

But how exactly should one define value?

The conventional methods are: Low Price-to-Earnings, Low Price-to-Book, high Free Cash Flow Yield, low EV/EBITDA ratios, etc. Their efficacy can be debated but that is not the point of this article.

 Is there another lens through which we can define value? We think there is.

 How about looking at value in "real” terms, i.e., adjusted for inflation?

We looked at broad sectors globally and compared their real returns with their own past, and also relative to the broader market. We find some interesting patterns here, and we get some insights into what Assets might be considered “value".
 

Rrelative to the broad S&P Global 1200 Index, sectors such as Energy, Financials, Industrials and REITs are trading in the bottom quintile/deciles of their 25-year percentile return ranges, while the recent high momentum sectors like Information Technology and Consumer Discretionary are within striking distance of their highest levels ever against the broader index since 1995! 

When almost all new-economy sectors have delivered strong returns over 10 - 15 years, Energy and Financials have delivered flat or negative real returns in the past 15 years.

In fact, REITs, Financials, Materials and Energy have remained at the lower end even when real returns are sorted by 10 and 15 year timeframes.

Additionally within the S&P 500, the weightage of these sectors is currently at their lowest level in decades and almost 2 to 5 percentage points below the average weightage over the same timeframe.

Meanwhile, sectors like Technology and Consumer Discretionary have the highest ever allocations in the index (4 to 5 percentage points higher than their long run average).

Just to highlight an interesting data point, the sector exposure of S&P 500 to Technology as of April 2021 is almost 6 percentage points greater than in the year 2000 and just 2 percentage points below its peak in 1999.

The above statistics looked at sectors from a relative value lens, but even on an absolute basis the sectors highlighted above look intriguing.

For example, when the broader markets are already climbing to all-time-highs, sectors like Energy (-38%), REITs (-6%) and Financials (-2%), are still trading significantly below their peaks of the past two decades in real terms (in nominal terms as well, in most cases). 

Let's think in simple English: Oil today, is the same price as its price in 2005! Copper is at the same price as in 2011 while Aluminum is trading at 2006 price levels.

This means that in real terms, they are lower by at least anything between 20- 40% than their prices of decades ago!

Therefore, this is another way to define value - sectors and asset classes that have "cheapened" dramatically over a decade and more, in real terms.

This list of “Value" is pretty clear: Industrial Commodities. Financials. And from a purely dividend yield perspective, REITs.

These three broad classes represent the deepest value that exists in markets today and they also therefore represent the areas of maximum potential return in an era of rising yields and potentially higher inflation.

Financials

While there are significant disruptions that this sector is undergoing, reality is that even after 13 years of the great financial crisis, the Financials indices have struggled to get past their levels of a decade and a half back, thereby making them extremely cheap in real terms.

Commodities

If one thinks about it, there is hardly anything that we can buy today which was cheaper 10 years back.

Unless of course you're talking industrial commodities!

Even leaving aside crude oil for the moment, hard commodities such as industrial metals, are still trading well below their levels of 10 or even 15 years ago!

The Industrial Metals index itself is down 25% in real terms and 12% in nominal terms over the last 10 years. Many individual metals have fallen even more.

 

 

Do physical goods with a related cost of mining/ extraction and refining selling at prices lower than they did 15 years ago, fit the definition of value? Certainly there is a case for thinking so.

What’s also noticeable right now is that, as of April 2021, supporting the energy market, industrial metals and agricultural commodities in general is also the rising backwardation or roll yield. Over 12 months that process -- known as positive carry -- currently returns 6-7% in oil, 1% in copper, 18% in Corn & 16% in Soybeans, offering a healthy return even before any further price increases. With yields from many of the more conventional asset classes depressed, this is something to be noted.

 

Real Estate Investment Trusts (REITs)

Then there are REITs, arguably one of the most underappreciated sectors/asset classes. 

Let's look at where they are today: They are trading at a significant discount to their all-time highs and also relative to the market.

Even more important, they still provide dividend yields of 4-8% in USD terms - at today's interest rates!  Very “cheap" especially for that class of REITs that have not missed their dividend even during the Pandemic turmoil. 

In a world of decadall- low interest rates, REITs sure look like value bets based on these metrics.

By altering the lens through which we value “Value”, as we have done above, one can begin to see several asset classes, sectors which are trading at an inflation-adjusted prices much lower than the previous 15 or 20 years'. 

Real Estate Investment Trusts, on the other hand, are deep value because of the huge dividend yields that they are paying.

In our worldview, the above are the best "true" value trades available in the world right now which hold potential to beat other sectors and asset classes through the lessening of their long term "cheapness".

(A version of this article first appeared in Business Standard)

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

  • Socialise with us at :
  • Image result for facebook logo

...

Read More
  • Share Via :
  • Facebook Icon
  • Twitter Icon
  • WhatsApp Icon

The History of Bitcoin

On January 12, 2009, the pseudonymous Satoshi Nakamoto made the first-ever Bitcoin (BTC) transaction, sending 10 BTC to developer Hal Finney and just like that a new asset, or rather a new asset class was born!

Never mind that the 'value' of the asset was still minuscule. The first-ever BTC/USD rate was $1 = 1309.03 BTC, or inversely, 1 BTC was worth just $0.00076, or a mere 0.076 cents on October 2009! A few months later, on February 6, 2010, the first-ever Bitcoin exchange was established. 

Going back a bit further, triggered by the 2008 financial crisis, Nakamoto mined the first-ever Bitcoin block, named the genesis block, on January 3, 2009 awarding Satoshi the first 50 Bitcoins of the 21 million that will ever be created. To put this in perspective, about 18.6 million Bitcoins have already been created, leaving only 2.4 million or so to be mined.

In May 2010, a developer and early adopter, Laszlo, offered 10,000 BTC for two large pizzas, in bitcointalk.org. Someone took him up on that offer. With a cost of around $25 dollars, these pizzas set the first “real-life” value for BTC at $0.0025 dollars. This was a significant milestone in Bitcoin’s history and has since been celebrated in the ecosystem as “Bitcoin Pizza Day”.

On February 9, 2011, Bitcoin reached parity with the dollar on Mt. Gox (a Bitcoin exchange that dominated the market until February 2014). On June 2nd, it reached $10, then by June 8, it climbed to its highest price yet of $31.91, only to plummet again to $10 four days later, on June 12. This movement would become known as “The Great Bubble of 2011”, and it wouldn’t be the last parabolic movement in Bitcoin prices. 

In April 2013, Bitcoin price surpassed $100 for the first time and the market cap broke the $1 billion dollars threshold. Bitcoin reached $266, before crashing again to around $100, after another exchange hack.

That's when governments began to notice Bitcoin and tried to figure out how to categorize, regulate, or even control, this new digital currency. 

In October 2013, the FBI managed to shut down the infamous dark web site Silk Road and seize its assets. This cast a shadow on Bitcoin as the coin of criminals and money laundering. 

Once again Bitcoin saw a huge price surge, going from a little over $100 in October to breaking the $1000 barrier in November. But a ban from China and the bankruptcy of Mt. Gox, both in a span of a couple of months, drove the price down again, and Bitcoin didn't reach that psychological barrier again until January 2017. 

2017 was definitely a very interesting year for Bitcoin and the ecosystem in general. There were innovations like Multi-million Initial Coin Offerings (ICOs), forked coins etc. 

And of course, the bull run brought a lot of buzz around “the new digital currency”. The cryptocurrency rallied from around the $1,000 mark to almost $19,000 by December 2017.

In 2017, Bitcoin also gained more legitimacy among lawmakers and legacy financial companies. For example, Japan passed a law to accept Bitcoin as a legal payment method, and Russia had announced that it will legalize the use of cryptocurrencies such as Bitcoin. However, by 2018, regulations also started creeping up. In January 2018, South Korea brought in a regulation that requires all bitcoin traders to reveal their identity, thus putting a ban on anonymous trading of Bitcoins.

Come March 2020, Bitcoin was no exception to the “dash for cash” considering it tanked more than 50% at the height of the COVID-19 crisis to $4,800. However, the rebound has been as fierce, it hit an all-time high of $64,000 on 14th April 2021. The recent top came in coincidentally on the exact same day that we witnessed a bumper listing of Coinbase (COIN) on NASDAQ at an eye-popping valuation of $100 billion.

Meanwhile, acceptance of this novel cryptocurrency kept accelerating. In October 2020, PayPal launched a new service enabling users to buy, hold and sell cryptocurrency. And in March 2021, Elon Musk tweeted, “You can now buy a Tesla with Bitcoin.” Of course, there have been many somersaults on that since.

How Bitcoin Works

Imagine a pearl lying on the sidewalk. I find that pearl and give it to you - you now have one pearl and I have zero. Now let's look closely at what happened, I put my pearl in your hand, we both know it was real, we experienced it. 

Did we need a third person to confirm that this transfer occurred? No. So what does this mean? Well, the pearl is now yours, I can't give you another pearl because I gave you my only one. I am officially “pearl-less” and you are currently in full control of that pearl. You can give it to a friend and they can give it to someone else and so on or you could just leave it on the sidewalk. The choice is yours. That's how an in-person exchange works. 

Now, let's say I have one “digital pearl” and I give it to you. The problem? How would you know that I didn't duplicate the digital pearl before sending it to you? How would you know I didn't send the same pearl to my friend on Instagram? You wouldn't know. Only I would. Now you can see that this digital exchange has some significant flaws, sending digital pearls is not the same as sending physical pearls. This problem has a name, it's called the “Double Spending” problem. 

Just like a physical ledger, where you record all transactions, we need a digital ledger for the above online transfer or transaction and have someone in charge of it. However, that brings up another issue - what if the person in charge of the ledger, wanted to create some more digital pearls? Well, they could. No one's stopping them from adding/ bringing more pearls into existence - thus adding to the supply and reducing its value.

Then there is a second issue.  When I first gave you my pearl, it was just you and me. Imagine that the person in charge has to verify the ledger every time there is an exchange. That's not very efficient, is it? Here’s where Bitcoin comes up with a nifty solution - a “peer-to-peer” network.

What if we gave this ledger to everybody? Instead of a single ledger living on a third party's computer, everyone involved would have a copy of all the transactions that have ever happened.

These digital pearls transactions are recorded on everyone's ledger, thus, you can't cheat. I can't send you digital pearls I don't have since that wouldn't sync up with everyone in the system. It would be a tough system to beat especially if you need to change hundreds of thousands of other ledgers. As the system gets bigger, it also gets harder to hack or take control of. 

Plus, it's decentralized, so no one can decide to give themselves more digital pearls. The rules of the system were defined at the beginning and the code and rules are open source. 

You could participate in this network, update the ledger and make sure it all checks out (“mining bitcoin”). In fact, that's the only way to create more digital pearls in the system.  For your trouble, you could get some digital pearls as a reward. This system exists, and is called the “Bitcoin Protocol”.  All those digital pearls are the Bitcoins within the system. 

The rules define the total supply of Bitcoin, subject to a total maximum of 21 million as mentioned earlier. When I make an exchange I can certify that the Bitcoin left my possession and is now entirely yours because it's a public ledger, I didn't need a third party to make sure I didn't cheat. We can now deal with 1,000 Bitcoins or 1 million Bitcoins or even a tiny fraction of a Bitcoin. I can send it with a click of a button, even if I was in Dubai and you were in Denmark or Denver. 

Bitcoin vs Gold: Is It Safe?

Bitcoin is largely being touted as “digital gold” or as a store of value. However, gold itself, to become what it is now, to be in all these bank vaults around the world; survived the end of gold coinage, the rise of paper money, the end of the gold standard and so on. It fended off many challenges to become what it is today. 

So it is only natural to expect that we will witness volatility in this novel asset class/ payment system. Here, the idea of antifragility could be applicable i.e. the more it survives, the more reputable it becomes.

On a comparison with gold, this is what Vineet Arora, Managing Director BTA Wealth Management has to say “Bitcoin is to Millennials what Gold was to a Generation ago. It's liquid, mobile, hedges against inflation and gives growth. All attributes that we grew up associating with gold, the current generation associates with Bitcoin. Whether we like it or like to dislike it, it’s here to stay.

The safety aspect depends on an investor’s definition of “safe”. Let’s consider two simple ways of assessing this: price volatility and maximum drawdown (the maximum decline from a high peak to a pullback low).  

If we look at volatility, Bitcoin (BTC) is more than 5 times as volatile as Gold and 10 times as volatile as the US Dollar (DXY). Meanwhile, the maximum drawdown of BTC is a whopping 83%, compared to 20% and 14% for Gold and the US Dollar respectively. Another empirical evidence of BTC’s notorious risk profile can be encapsulated by looking at the maximum one-day loss registered - 27%! (12th March 2020). Doesn't look like a store of value, does it?

Another possible risk is the complete loss of principal. By storing your Bitcoins on an exchange wallet (“hot wallet” or “online wallet”), you are taking on counterparty risk (hack, default, etc). A “cold wallet” comes in handy here. A cold wallet is a wallet that is not connected to the internet and therefore stands a far lesser risk of being compromised.

So, does this mean, Bitcoin should not be a part of your investment portfolio? "I wouldn’t dismiss it just yet," says Harsh Shivlani of First Global, "Rather than assess it only on a standalone basis, it is important to look at any investment as part of a portfolio to assess whether it adds any value, in terms of risk-adjusted return, to your original portfolio."

On this front, BTC comes out much better than expected. We will deal with the issue of what happens when you add Bitcoin to a portfolio in a forthcoming piece. 

The Future? A World Operating On Digital Currencies?

The primary goal of any form of currency is to be a reliable and convenient source of payment. For this to happen, you would expect the value of the currency to be fairly stable over time and the infrastructure surrounding it to have the ability to process sizable transactions relatively quickly.

Currently, Bitcoin can’t come even close to competing with legacy payment systems. With a capacity of just 7 transactions per second and confirmation times of 10 minutes on average, it’s far behind Visa’s maximum capacity of 65,000 transactions per second and its nearly instant payments. 

Furthermore, because only so many transactions can fit in a block when the network is congested, fees skyrocket, in a bidding war between users to get their transaction in the next block. However, there are certain upgrades in line that could solve all these problems, such as the “Lightning Network”. 

According to a survey by the Bank for International Settlements, one in 10 central banks expect to issue their own digital currencies within the next three years. 

The views on cryptocurrencies remain quite diverse.

"While CBDCs may replace currency, in the near term I still find it hard to accept Bitcoin or any altcoins as a store of value and a medium of exchange. Blockchain as a technology however does seem to be poised for a great future", says Prashant Mehta, Chief Investment Officer KEF Holdings Ltd

On the other hand, Devvrat Moondhra, Director Duro steel AG and Blockchain Investor says, "Bitcoin is like religion. Initially there are few believers and many non believers (atheists), but eventually there are more and more believers, following which there is mass adoption. We are still early in the adoption cycle, there will be volatility but in the long run Bitcoin will become a store of value like gold is. The best part is unlike gold there is finite amount of bitcoin that can be mined”

The Elephant in the Room: The Ecological Costs 

Bitcoin transaction confirmation depend on a “proof-of-work” mechanism. The mechanism requires miners to solve computationally expensive and complex cryptographic puzzles. Miners receive compensation in the form of digital currency for the same. However, this exercise requires significant energy consumption.

Currently, Bitcoin alone accounts for 0.62% of the world’s total electricity consumption i.e. if Bitcoin were a country, it would rank 27th in annual electricity consumption! The ecological burden of Bitcoins is real and huge.

On average 39% of proof-of-work mining is powered by renewable energy, primarily hydroelectric energy. China is the biggest player here. However, considerable commercial energy continues to be used.

We will be dealing with more aspects of investing in Bitcoin and other Cryptocurrencies in our forthcoming pieces.

(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

  • Socialise with us at :
  • Image result for facebook logo

...

Read More
  • Share Via :
  • Facebook Icon
  • Twitter Icon
  • WhatsApp Icon

Over a period of time, a certain School of Investing has dominated all investment thought.

And that is the Warren Buffett School of Investing.

What exactly is that school of investing about?

That school of investing in essence comes down to this:

Buy a small group of high quality branded consumer companies which have supposed pricing power (the ability to raise prices without affecting demand much) and therefore 'predictable' cashflows - companies which have strong "moats", that is, companies whose business fortresses are protected by strong fortifications so that competition cannot enter their kingdoms.

This story has been told over 35 years by none other than Buffett himself. And it has been told and sold beautifully by him. 

It has pervaded investment thinking deeply, so deep that it is considered heretical to even question any part of it, let alone question it in its entirety.

About the only person who has managed to get away by questioning Buffett, has been the legendary Chicago Business School professor, Nobel Laureate Eugene Fama. When asked about Buffett, he has always shaken his head, saying "Ah, that man Buffett..."

Fama's view has been that Buffett is a purely statistical phenomenon, an outlier, and nothing more than that.

Let me explain what that phenomenon would look like: if you get 1 million people to play the stock market, using any method that they want, there is a certainty that a very small number of these original 1 million people, will get fabulously wealthy through the stock market. That is nothing but a simple probabilistic outcome. 

Probability theory dictates that when a large number of people play a game, a very small number of people will emerge as the statistical outliers, or the winners.

It is these statistical outliers that are then played up in the popular imagination to be representative of the merits of the game which draws the next 1 million into it.

The story then repeats with a handful of fresh millionaires getting born out of the second 1 million players.

According to Fama, Buffett represents that "handful" of people out of the millions, who become fabulously wealthy through the stock market.

Therefore if only a very small percentage of people become truly wealthy through the stock market, what is indeed this game of investing?

Is it a game of luck as the statistical probabilities above show, or is it a game of skill?

This is a question we pose ourselves every day as fund managers, and it has some very interesting aspects to it.

We bought Amazon in 2001 at the depths of its crisis. The price then was around $15. 

The stock is now around $3,000 and we sold the last of our holdings in the last few months.

Was this fabulous, 300- bagger trade, a trade of luck or a trade of skill?

Let us analyze the rationale for the investment first. We turned bullish on Amazon for two major reasons back then.

Reason number one: the company had turned free cash positive in that period after bleeding cash for its entire history. 

The second reason was equally important: uniform negative opinion on Amazon on Wall Street. Lehman Brothers' lead credit analyst, Ravi Suria, had downgraded Amazon bonds stating that they were going to default.

Mary Meeker, the High priestess of Internet 1.0, then with Morgan Stanley, wrote a piece on Amazon, titled "Throwing in the towel on Amazon".

Business Week had a cover around the same time, with the title "Can Amazon survive?"

A great trade was born. And the rest is history.

But back to the question: was it luck or skill? 

In hindsight when we look back, out of the total gains of around $2980 on the stock, we would attribute around $50 to skill. 

By this what we mean is: it was fairly easy to predict a doubling or even tripling if not quadrupling of the stock from the depths of despair, because when a debt laden company given up for dead, turns around by positive cash generation, it is almost a certainty that the stock which has been crushed, will rally massively.

History is replete with several such examples of beaten down stocks which when they get even a glimmer of hope, stage magnificent rallies.

So the journey from 15 to 60 can be attributed to skill.

But the remainder of the journey from $60 to $3,000?

Come on, that is pure luck! Nobody in their right mind could have predicted that the Amazon stock would be $3,000 and the company would one of the most valuable companies in the world. Not even Jeff Bezos could have done that.

Therefore if one were to dissect the element of luck and skill in this Investment, one can see that 98% of the profits made came from luck and only 2% came from skill!

The other way to look at this whole debate of luck and skill is to dissect the returns of any fund manager over a period of time.

If the returns are concentrated in a handful of stocks, while most of the stocks have not contributed much or have actually detracted from the overall returns, one can safely say that this fund manager or investor's returns are largely a product of luck and less a product of skill, because when Returns come from a tiny handful of somebody's holdings, that is nothing more than a very generous dose of luck at work.

That investor or fund manager can be called the "Survivor". In other words, he is the guy who has won the lottery as opposed to the millions who are destined to lose money in the lotteries.

As Charlie Munger candidly admits, "If you take out Berkshire's tiny set of companies that have delivered most of our returns, we are left with very mediocre returns on the majority of the portfolio." 

It is hard for a major fund manager to be as honest as this.

Without saying it in so many words, what this amounts to is that Buffett, and a few others, are the "lucky" survivors of a game in which the majority will lose. 

All because the way the majority plays the game is all wrong.

A game of skill by necessity, means that you are hitting at least an average of 55 to 60% winners in your portfolio. 

Almost every storied Investor, runs a strike rate of anything between 1% to 10%! Yes, that's it.

A US study of 20,000 venture Capital deals over several years revealed that only 0.5% of the deals, ended up being 50 baggers! Now if that is not luck at play, then what is?!

For us to call investing a game of skill, we must by necessity, establish that any fund manager or investor's returns are coming from a minimum of 55% of their holdings instead of the usual hit rates of 1 to 10%.

Remember, 50/50 is a given outcome of a series of coin tosses of a fair coin. 

This analysis leads to some very interesting conclusions on how most mutual fund managers as well as other money managers and individual investors, will randomly have periods of great runs, when they seemingly have a Midas touch, a "hot hand". 

And this period of pure luck is marketed, masqueraded, as skill.

It is like consistency in cricket: a batsman who gets to an average of 50 by making 0s in 4 innings, a 250 in the 5th,  will be largely a product largely of luck or randomness, while a player who gets 50 each in 5 innings, will be called a player with skill. 

Always analyze this aspect of any fund manager or investors' return profile and you will understand what is at work in terms of driving their returns.

(A version of this article first appeared in Outlook Business)

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

  • Socialise with us at :
  • Image result for facebook logo

...

Read More
  • Share Via :
  • Facebook Icon
  • Twitter Icon
  • WhatsApp Icon
load more
Categories
Accolades from Global Media

First Global's research and ideas have been covered in major US, European and Asian publications like

Subscribe to our fun and informative newsletter

Contact us, to increase your Wealth

Follow our buzzing social media handles