Value Investing

Value Investing

Self Awareness

Drawing lessons from this piece by Samuel Lee of MorningStar, I put together this grim doodle to keep reminding me of the importance of awareness of our ignorance. The solution obviously lies in either reducing our self ignorance or seeking external help. In the context of investing and speculation, reduction of self ignorance usually means learning by reading more and learning by application. If one has little time for that, then turning over the game (fully/partly) to a qualified investment advisor is the best option.

Awareness of Investor

Progress Through ReGrESS

Middle men have always blocked new ideas and won reconciliatory middle ground in India. The inclusion of ETFs in the Rajiv Gandhi Equity Savings Scheme (RGESS) is one such example. While the matter of the difference of opinion between the Finance Ministry and the Securities and Exchange Board of India (SEBI) is interesting, the development is noteworthy since it could benefit us retail rats quite a lot.

 The thing is that equity remains shunned as an asset class by an overwhelming majority of small investors in 5% – 7% growing emerging India. Whatever little money does get invested goes into managed funds finds its way into the Mutual Fund coffers. ETFs offer a long term, cost efficient vehicle for parking money and are quite cheaper as compared to Mutual Funds. So if the retail rats don’t get it, why shouldn’t the Government play pied piper and lead them to the bourses. It certainly helps that the current Finance Minister (Chidambaram) is more taken to the merits of equity as compared to his predecessor. A part of him may even secretly look at the market levels as a barometer for his success.

 It’s also a great idea to pool in slivers of equity from profitable PSUs, bundle them into an ETF and offer it to investors. That way you don’t have to do an IPO/FPO for each constituent PSU and give some semblance of portfolio stability to the investment. How much this appeals to local financial institutions is the key question. It is institutional demand that really gave the initial impetus to ETFs in the US. The other factor is the capacity and standing of the sponsor has always been key during ETF issuances since a strong, well spread out sponsor will bring it the much need liquidity without which ETFs generally fail.

 I will be exhorting whoever I can and whoever is bothered to listen to max up their contributions in RGESS. While direct investing in equity is always better when we are taking about holding it through a full business cycle, ETFs could be better for people who do not have enough financial savvy as it takes the guesswork out of the process. Here are some useful links to additional material on the topic:

Seven Habits of Highly Ineffective Investors

Inverting the perspective sometimes yields interesting insights. Here’s my attempt at an inverted mashup of Stephen Covey’s widely popular work. Stephen Covey died on 16July 2012.

Lack of Independence or Self-Mastery

Habit 1

Being ReactiveEquity investing is never risky. The risk does not come from the trade but from the trader. Reactive traders are influenced by the noise around them – hot tips, consensus, crowd behaviour, market gloom etc. All losses that are experienced by investors fall into three categories – direct control, indirect control or no control. Almost all the losses of highly ineffective investors fall in the direct control area. The boring but effective investors usually have control on their losses or experience losses due to events totally out of their control (9/11, Lehman Collapse, etc.)

Habit 2

Begin With No End In MindThe ineffective investors’ Covey urges them to visualise their funeral. What would their obituary read? Here lies an ineffective investor: he was a wayward arrow and never knew where he was headed (until his last journey!). Ineffective investors do not have a personal trading mission statement. Neither do they have personal trading heuristics or models and typically tend to get along with the flow. They don’t write down what their closing position should be before entering the trade.

Habit 3

Don’t Put First Things FirstIneffective investors do not prioritize and plan their tasks based on importance. They have no independent will and are generally incapable of thinking for themselves. If they read a research report or a stock story, they rush into buying or selling without spending enough time on self discovery and understanding ‘why’ they trade.

No Inter-dependence

Habit 4

Don’t Think Win-WinIt is not at all important for an ineffective investor to have a plan B and a pre-determined response to what one needs to do if the investment thesis does not work according to plan. A win-win thinker hedges his bets, uses stop losses and balances his portfolio wisely. Why bother with all this if your aim is to be as ineffective as possible? “What dork expects to win on a heads and win on a tails as well? Is it really possible?”, is something which a highly ineffective investor would like to know.

Habit 5

Seek First to be Understood, then UnderstandBragging rights are reserved for ineffective investors. There is a certain male bravado amongst this set. They unnecessarily keep staring at the screens and fantasise and want to talk about their exploits to anyone who would care to listen. The clinically precise and hermit-like reclusive effective investors tend to focus their energy in listening to what the market is telling them

Habit 6

No SynergyIneffective investors do not tap into the power of the network; they do not read extensively and they do not develop their lattice network of various mental models that are required for one to be effective in analysing investment options. Why waste time in reading books, investment blogs and other data reports when all one wants to be is ineffective at investing?

No Self-Renewal

Habit 7

Forget To Sharpen The SawSelf-rejuvenation and self-renewal are only meant for people who want to be effective. These losers seek a balance in their life, are not obsessed with the markets and are perfectly fine checking their portfolio values once a day (it at all). Ineffective investors are blunt instruments are would be the ones who’d typically lose sleep over their positions and want to keep tabs and follow the market even when they are on a vacation. Ineffective investors do not plan, practice and re-test their models.

How Many Eggs In Your Basket?

“Don’t put all your eggs in one basket”. That’s what Cervantes made the  rotund Sancho Panza say in his book Don Quixote. The view expressed across the Atlantic, however, was quite different. Mark Twain told us to put all eggs in one basket and to watch that basket very carefully. Wise wits and financial advisors take Cervantes’ cue and tell us to scatter our assets and attention. The saying undoubtedly originated from the simple observation that if you put all your eggs in one basket and if you were to drop that basket, then you’d lose all your precious eggs. If I were a CFA or a wealth advisor I’d have egg on my face if I said that I believed that Mark Twain was right, but since I am not, I am going to exactly do that in this post! It’s important to understand the context in which it’s good to diversify and where it is not. This is the context I am referring to: make a pie chart of your wealth and ensure that you always have 3 – 4 wel diversified slices in it. Within the particular slice of the pie that indicates your equity exposure, you shouldn’t have too many further sub divisions. Many people interpret the eggs in one basket to mean that they need to own multiple stocks and multiple mutual funds!

According to me, it’s obviously important to have a little diversification and redundancy but generally small investors take this to the extreme. They play with woefully small stakes. So even if they bag multi-baggers it hardly grows their personal wealth. Even if you get a 3x return what’s the point if all that you have running on it is a measly 10,000/-? If I have to talk co-variances and correlations, the multi-basket approach only works if the baskets are independent. Which means that it is obviously a great idea to spread your wealth across (mostly non-correlated) asset classes like gold (not too much please!), real estate (uncorrelated really?), stocks, equity mutual funds, fixed income (PPF, bonds, debt MFs) etc. Fixed income may be interesting over a 2 – 3 year horizon if the local interest rates move down. If you noticed, I did not mention insurance since I do not consider that asset class as an investment, sorry.

But it’s a horrible idea to spread your investments across > 15 stocks (just to pick a number, my Kelly Formula post notwithstanding). Why? Because its impossible for a small investor with a daily job to digest all those bits and bytes of information that get generated in the financial marketplace everyday. You can’t monitor multiple baskets beyond a point. By spreading your capital across multiple stocks you are certainly setting yourself up for cleaning the mess that’s soon to appear on your floor. Be careful with those egg shells when you walk, you may bleed (in more ways than one).

If I have lost you or you remain skeptical, then let me try some other way. Let’s try to visualise as to why you may want to keep all your eggs in one basket:

  • You have only one egg [well. you shouldnt be in the markets. Line up to buy Super Lotto.]
  • You have only one arm [I do. I am not ambidextrous – juggling work and finances and home and hobbies is challenging on me. Quality suffers. So I have only one arm to give for monitoring my trades]
  • You need all your eggs [which means dropping one basket with all eggs will cause you similar grief as dropping some baskets]
  • It’s a trash basket [all your eggs are already broken or rotten – i.e. hopeless loss making holdings. I’d strongly urge you sell off all your shares (if they are really broken or rotten) and A) start fresh and B) start reading this post from the top!]
  • You eggactly know what you have [i.e. you’ve focused on a few ideas but really thought very deeply & are honest to admit to yourself what you don’t know]
  • Last time you spread your eggs across baskets you dropped a few of them [This is true in my case and the following paragraph talks about that]

A past colleague and good friend drilled this message into me. Since then (this was nearly 3 years ago) I have consciously tried to reduce the number of positions I have at any given point in time in a bid to improve my performance. I have been resonably able to limit my holdings to a few, and I can now stand up in front of the mirror and talk about the basis for each of my speculation – when bought, how many shares bought, why bought, when will I fold, maximum loss threshold etc. It was impossible to do this when I had > 15 stocks in my portfolio.

The challenge here? As your portfolio size increases having just 5 – 6 stock positions at any given point in time means your stakes go really high. If you cannot make the mental shift to think in % terms and remain rooted to absolute rupee amounts, then this focus will be impossible to achieve. You will either end up being under-invested in equity (since it’s too much work) or have loads of positions to monitor.

Finally, inspired as I am by Mark Twain, let me invent a quote: “Never own more stocks than there are colours in a rainbow!” Am I an egghead or what? 🙂

Why Long Term Financial Planning Sucks

Long term planning lulls one to believe that the future is under control. Many of us meet fast talking financial salesmen (women?) and feel smug when we buy some investment cum insurance policy or unit linked insurance plans etc. Even a house or the index for that matter bought for the purposes of holding on to 10+ years makes us feel confident that we have secured our future. A book that I really like doesn’t think so. Its called The Zurich Axioms (by Max Gunther) and I like picking it up and reading a small chapter or two on and off, repeatedly. The fable of the ant and the grasshopper is turned on its head in the book:

The dour and practical ant works all summer long in anticipation of the winter ahead,while the planless grasshopper just sits around singing in the sun. In the end, of course, the poor grasshopper has to come around, hat in hand, to beg for food, while the ant has the satisfaction of saying, “Ha, ha, I told you so.”

In real life, however, it is more often the ant who gets himself fumigated or has his nest torn up by a bulldozer. That’s what comes of having roots, and roots come partly from long-range plans. The grasshopper, lighter on his feet, just hops out of the way.

You may have visibility for probably a week ahead (unless black swans fly over your head). If you are really gifted, maybe you can portend the events to come a month ahead. What about six months? Or a year? The visibility dims considerably, but you’d still beable to reasonably predict where you will be in your personal and professional life a year or two ahead. I can bet that you can’t predict where the markets will be a year or two ahead with the same level of confidence. Even on personal/professional matters, a period of five years  itself starts getting quite blurred to predict into, especially if you are a relatively young person who has just started his career and family. If you older, then yes, maybe you can see five years ahead. But then long term financial planning is done by young ‘uns, right? And wait, we just got to five years! What about ten years? Twenty years?

You just can’t see through the fog of time. Remember that – you just can’t see through the fog of time.

The advise: don’t try to make really long range plans or let others make them for you. Instead, be light on your feet, like the grasshopper. React to events as they unfold around you, all in the present. When you see opportunities, go for them. If you see some danger coming your way, just hop away and come back when the trouble has rolled over.

The only long term plan you need, as far as your wealth and finances is concerned, is to have a sincere intention to get rich. The ‘how’ will differ from person to person – do try to discover it, but do so in the now and operation in today’s moment with a less of a “buy and forget it” kind of an attitude. It may work for Peter Lynch or Warren Buffet – that strategy may really suck in your case.

REC Tax Free Bonds

 I just applied for 1L worth of tax free bonds from the Rural Electrification Corp (REC) whose IPO opened today. This appears to be the last opportunity this year to buy tax free bonds and the application window is open till 12Mar (very small really). Unless you have pigged up heavily on fixed income, this issue should warrant more than a cursory glance by you. Here are the salient points from the prospectus (click here):

  • Ratings: “CRISIL AAA/Stable”, “CARE AAA” , “FITCH AAA(ind)” and “[ICRA]AAA”. So from that perspective looks to carry a low credit risk
  • No one’s underwriting the issue. No one wanted to or did the AAA ratings make REC say no to middlemen?
  • Usual 3 categories but NRIs absent from the scope. Sad. This is apparently to ensure that the allotment etc gets done within this FY and some folks say that involving our foreign bhais will slow down things. In any case the previous issues by NHAI, HUDCO etc took more than a month to get listed.
  • Interest of 8.13% for 10 yr and 8.32% for 15 yr bond for Category III (retail rats). 750 crores (25%) of the issue is reserved for Category III which means if more than 75,000 individual applications come in at cut-off, then the allocation game of dice will play out. Allotment will be made on a first come first served basis. In case it gets oversubscribed (which I assume it should) then if your application reached the bankers one day prior to the date when oversubscription occurred, you’d get the FCFS treatment else you’d get proportionate to your application amount. So it pays to apply early. The recent NHAI tax free issue was oversubscribed by 2.5 times.
  • The NHAI tax free bond, while it took its sweet time to list, jumped up immediately when it listed on 7/8 of Feb’12. It went up some 2 – 3% during listing time – which means that tax-free bonds are best bought during their IPOs and not from the secondary markets.
  • The 09.15 G-Sec maturing on 2024 (12 years to go) is trading at yield spreads of 8.27% – 8.28%. (
  • Interest will be payable yearly on 1Jul. Would’ve been nice for Category III to get a cumulative interest option. Even then, 10 yr bank deposits offer less than 10% today and when you bake in the tax benefit (if you are in the highest tax bracket, these bonds give you a return of ~11.5% or so.
  • While you can apply in lots of 5 bonds (fv 1000/- each) you can sell one bond at a time, if you wish. Given heavy institutional interest for the 10 year paper, liquidity and therefore demand is likely to be high on that and therefore price of the bond on the secondary market (will list & trade on BSE) should be higher. If RBI does start dunking down interest rates towards the latter part of the year, then the price will canter up more. But capital gains tax will apply.  

It was good that IRFC’s (which is the financing arm of Indian Railways) budgeting went a bit awry (their plan size for FY11/12 was cut by 16%) and they could not use up their quota of tax-free bonds. That slack got transferred to REC instead of the Government allowing railways to roll over its unutilized portion to next FY. The Government had allowed INR 30,000 crores to be raised by infra sector PSUs during the current FY via the tax free bonds route. Assuming an interest payout of 8% this translates to a servicing cost of 2,400 crores. Assuming a low tax rate of 20%, this translates to INR 480 crores of income forgone by the Government which means a margin give up of 1.6%. But I guess that’s small change if you get INR 300 bn of capital in a year to fund infra building…

This is surely a good thing – I hope that the FM announces an even higher quota for the next FY.

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