Investment University

One of the commonest questions I get asked by hundreds of investors from across the world is: "How are we to make sense of Equity Investing? We get so much conflicting advice. Can Investing be simplified so that even lay Investors can do a decent job on their own?" 

Let us admit and accept this much. Last 12 months have been bizarre! Major world indices have scaled highs, seemingly unmindful of  " fundamental" factors.

We have had no period in the last 100 years in which our health has been at more risk while our wealth, in general, has been seemingly, less at risk. 

However, the introduction of Covid vaccines has increased the level of complacence on the health side, and a continual up- trend in global equity markets since last March has led to extreme complacence on the wealth side as well.

Investing has never been easier. College kids have been making 100% routinely. 

Is it indeed that simple?

While it is pretty simple in health terms to be safe (get vaccinated, wear a mask whenever out), financial complacence is a disease which is infinitely harder to prevent and almost impossible to cure. 

Let us take a stab at reducing complications and increasing awareness about risks relating to your wealth and what precautions you should take.

So, we give below The Definitive Primer on Safe Investing

Precaution 1: Asset Allocation will determine most of your returns, so practice it religiously

Asset allocation is not just the best thing. It’s the only thing. If you are just going to be a single asset (largely equity) player, then you are generally going to have a roller coaster ride in your net worth and obviously, in your mental well-being.

Asset allocation basically means your investment pie chart is strategically diversified across various available asset classes. 

There are many pieces of research which establish that correct and tactical asset allocation can determine as much as 90% of your overall eventual returns.

There are plenty of examples in support.

Here’s the data just to illustrate an example: post the 2000 tech crash, US equities halved. It was one of the worst  periods of wealth destruction in recent history. 

However, in that very same period, a number of other asset classes, including gold, oil and US treasuries, delivered significant positive returns.

Did you ever hear any financial advisor recommend that you should have a lower weightage to equities and higher weightage to gold and government debt? We know the answer already!

The general, perhaps, the only refrain you will constantly hear is: keep buying equities. And that's pretty much what passes for Investment advice.

Reality is: Across different periods of time in financial history, different asset classes have delivered vastly different returns, even in the very same period. 

For example, in the period 2003 to 2005, commodities delivered vastly better returns than US equities. 

Even in 2021, industrial commodities have outpaced global equities by a substantial margin.

In this very period, US bonds which had a stellar 2020, have been absolutely decimated this year with the sharp rise in bond yields.

The reason for this "equities are the only thing" advice, is simple: nobody in the business of fund management or financial advice makes much or any money by recommending investments in government securities, gold or even commodities. 

The maximum fees are for recommending equity. 

"All behaviour, good or bad, is always driven by incentives, and equities incentivise their salespeople far more than any other asset class. Even if equities don’t always deliver returns, and definitely not consistently": Alok Kumar, Fund Manager, First Global

Don’t ever forget this! 

“Remember XYZ stock I told you about 3 months ago? It is up 80% since!" Sounds like familiar party conversation…or something that you watch financial channels for?

If your end game is to have fun discussions at parties, this is fine. But if your purpose is to protect and multiply your wealth, or to optimise your portfolio, you are frankly approaching the problem from the wrong end!

Specific stock selection, which eats up most of your/ your adviser’s waking hours, contributes only 10 to 15% of stock market returns.

Moral of the story: if you are investing on your own,  it does not make sense to concentrate your resources and time on individual security or stock selection.

But all the talk you will hear from Portfolio Managers is how good they are picking stocks and great bottom-up winners.

The uncomfortable point is: bottom-up stock picking is a very, very difficult art and nobody in the history of investing has been able to do the successfully for decades. 

Yes, not even Warren Buffet. 

Just go and see his record in the past 15 or 20 years and you will see an investor who has missed practically every single multibagger that the US market has given in this period: Amazon, Netflix, Domino's, Google, Apple (he bought it well after it had become a household stock), Facebook, Microsoft, etc. 

The other extremely important thing is that getting the asset class right is a relatively simpler task than getting individual stock picks right.

For an individual investor doing self investing, asset allocation should be the very first skill that they should learn.

Precaution 2: You do not find multibaggers. Multibaggers find you. Take a Portfolio approach to investing 

If we got a thousand dollars for each time that we were asked: how does one identify multibaggers, we would have at least $100 million in extra pocket money!

Most investors believe taking individual stock advice, or ‘tips’, from aggressive brokers, advisors, and horror of horrors, from Twitter, and then implementing them on their own is the way to making big money. 

Wrong. This is a one-way ticket to financial ruin. 

The reality is that all the big stock winners that we know of could not have been identified in the beginning. As we always say, "Making 100% in a stock is skill. Making 1000% is luck."

Individual stock picking is a game in which we are carried away by the stories of people who became very rich on a certain stock. But that kind of story is extremely dangerous because it highlights something called survivorship bias.

Survivorship bias basically means that we look at the survivor of a certain kind of investing style and we find one guy or two guys who made serious wealth doing it in that particular manner while ignoring the fact that probably 99.99% of the people went bust doing exactly the same thing!

If you randomly pick 1000 investors and they randomly pick a certain number of stocks, you are guaranteed to find one or two investors who  become very rich. This is nothing but a simple probabilistic outcome but one that hides the fact that the vast majority will not become rich and will probably end up becoming reasonably poor.

The correct approach is to take a portfolio approach to determine your equity selection. 

The way to find these multibaggers is to carefully select at least 25 reasonable stocks, divided into various buckets of risk and potential return.

Assuming you have done some basic risk management and diversification such that you are not exposed to the vagaries of just one or two industries, at the end of a certain finite period of time, for example 1 or two years, you will find around 10 or 20% of your investments have become good winners while the majority will be  delivering market returns. Anything between 10 to 30% may also be losers.

Approach this exactly like you would approach a cricket team selection.

Eliminate your bottom performers and fill those spaces with the next crop of companies you come up with.

Again, after a certain period of time, you will find that the same/ near same initial list of stocks has continued to perform very well. 

Those are going to be your multibaggers and it is at that point that you can increase your allocation to them slightly more than where they started out from.

Those are going to be Sachin Tendulkars or Diego Maradonas, of your portfolio.

You will get to them by a systematic selection process and not by a brain wave.

"In short, finding Multibaggers is like looking for a needle in a haystack. 

Instead, look for several needles in several haystacks, and you are guaranteed to find your Multibaggers": Devina Mehra, Chief Investment Officer, First Global 

Precaution 3: Human thinking is inherently biased. Biases come in our way of making rational decisions

"All humans suffer from deep-rooted biases which influence how we think and make decisions. Biases deflect us from the path of objectivity and lead in directions which are sub-optimal": Achin Agarwal, Head of Quantitative Research, First Global 

There’s an extremely long list of biases that humans are known to suffer from: 

Storification Bias: Humans rely on stories more than data

Recency Bias: Recent events are far more easily remembered and unduly influence our decisions rather than events that happened further back in time

Herd Mentality: If everyone is saying the same thing, it must be right! Not really

Each one of these biases can be tracked down to an evolutionary reason. For example, in hunter-gatherer tribes, chances of survival were higher if one moved around in groups rather than alone. Hence, herd mentality became a way of life and of survival.

Unfortunately, the traits that helped us survive the threats of the physical environment are the same traits that lead us to financial suicide.

Not even the best minds of the world are able to eliminate biases from their thinking. Nobel laureate Daniel Kahneman, who is known for his seminal work on human biases, says he is incapable of overcoming his biases!

Any investor would do well to ask their financial advisor how do they avoid falling prey to these biases, and safeguard their portfolios against these portfolio-destroying human biases.

Precaution 4: Chew on the Risk Management pill daily

If there is one God in investing, it is Risk Management. 

Prevention is always better than cure. You have heard this many times. This applies equally to wealth as it does to your health. 

Strong risk management is that preventive measure that can ensure that you never need to go into a financial hospital. 

Avoiding big losses is about the closest to golden advice you can ever get. 

Charles Ellis wrote a while ago, that Investing is a Loser's Game. What that means is that in investing whoever loses the least, wins.

To illustrate, if your $100 becomes $65 in a market fall, you need a 50-60 per cent rise in the market to just come back to $100! That’s usually a 1-3 year journey.

However, if you were able to limit your losses and fell to just $90, with a 50% rise, you would be up to $135 instead of just breaking even! Big difference.

As human beings, we are not wired to making decisions that recognise pain or crystalise losses. We are happier taking pills to mask pain. 

Recognising and booking a loss becomes an ego game: "How could we be so wrong?" 

Unfortunately, this approach can bring a permanent end to your investing career. And some of the most misleading advice that you hear is to keep averaging on the way down. This approach is marketed by selectively cherry-picking data. 

In reality, it is always better to ruthlessly accept a loss and look for better places to deploy the remaining capital. 

Precaution 5: Take periodical insurance against catastrophic Portfolio loss

We buy all kinds of insurance: life insurance, health insurance, insurance for our cars, offices, etc. But why is it that we don’t often hear about insurance for one of the most important assets that needs protection: our life’s hard-earned savings, our financial assets?

You wouldn’t think of not owning health insurance. Why does the same not apply for portfolio insurance?

And just like with any other type of insurance, when it comes to portfolio insurance, there’s an entire spread of alternatives to choose from. What are the types of assets that we want to insure? What is the extent of coverage? 

Through rigorous analysis, these questions can be answered to ensure enough protection, simultaneously minimizing the cost of the insurance premium.

A small cost outlay can protect the portfolio during difficult times and gives you unmeasurable peace of mind, knowing that your portfolio is not slave to the whims and fancies of the markets.

That is worth every single penny spent!

Nobody will be complaining if the portfolio anyway does well and the insurance premium that we paid goes to waste. We don’t wish to fall sick just because we bought health insurance!

"Portfolio Insurance is something that you must always think of: specially when investing becomes so easy that the shoeshine kids are doing it.": Kavita Thomas, Head of Research, First Global 

Precaution 6: If you want to avoid SCCARS, diversify globally

SCCARS stands for Single Country, Single Currency, Single Asset Risks. These can leave one’s portfolio “SCCARd” forever!

A mere glance at country-wise performance data for the last few years is eye-popping.

Brazil, which was the best-performing market in 2016 (+69%), was among the worst performing countries in 2020 (-20%)

The best performer in 2020 was – surprise, surprise: Vietnam (+81%). Which was among the worst performers in 2018 (-19%) and 2019 (-3%).

Greece was the best performing market in 2019 (+46%) and was also among the top in 2017 (+41%), but it was at the bottom of the pack in 2015 (-31%) and 2018 (-27%).

Similarly, Russia was among the best performers in 2016 (+53%) and 2019 (+45%) but among the lowest in 2017 (-1%) and 2020 (-10%).

In the 10 year period 2011-2020, US equities returned a brilliant 11.5% CAGR, whereas Emerging Markets equities returned a meagre 2.5% CAGR in the exact same period.

The point is that polarization of returns is not an aberration, rather the rule. The best performers of today can end up being the worst performers of tomorrow.

And even within the same asset class, one part of the world can be in a bull market while another part of the world is in a bear market.

If you are not diversifying your investments across the world, the market is going to extract a very heavy price at some point. Japanese investors experienced this in the 1990s, in some other parts of Asia in the late 1990s, and European and EM investors in last 10 years. 

Global leadership keeps changing from year to year and there is very little persistence in trends.

These simple precautions are your mask, vaccine, social distancing and work from home, rolled into one.

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

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!