How does one evaluate professional money managers ???

In this note , we attempt to distil and list certain traits that form the fabric of successful money managers . Understanding these traits , not only helps to evaluate professional money managers, it may also help you to stack up well as an individual investor.

 Countless studies have shown that the long-term investment success is a function of two critical factors : the right approach and the right traits (right person)  .

 The Right Approach:

 Think about investing as purchasing of companies rather than  trading of stocks ( buying a “piece of business” approach)

  • Ignore the market , other than to take advantage of its mistakes.
  • Buy a stock when it is on sale – as Graham says “ secret of sound investment is in three words – “Margin of Safety”.
  • Do not focus on predicting macro-economic factors
  • Shun consensus decision making , since investment committees are generally a route to mediocrity.

 The Right Traits:

 Sound understanding of economics of businesses : how industries work and companies compete.

  • Objective and Independent : neither take comfort in standing with the crowd nor derive pride from standing alone.
  • Rational and not driven by emotions . As often said – “Most of the activity that makes active portfolio management active is wasted ..(and is ) often triggered by ineffective psychological responses .

 Much of this may seem strikingly obvious , but vast majority of money is managed by companies that have neither the right approach nor the right traits , but are run by otherwise extraordinarily intelligent people . Then , as often said , most universal truths in life  are simple, but  are rarely practised.

 Happy Value Investing !!!

Perils of size …

Blessed are those that have the size and scale . Markets around the world  reward size. But in certain businesses size becomes winner’s curse  . Fund Management is one such business where size can be a limiting factor .

It is a well known fact that the year 2008 and 2011  were the  years that separated men from boys in this industry . But , it is not that well known that these were  also years that saw many princes becoming toads .  The performance results of many funds managed by top-notch private banks  ( read  princes) left much to be desired ( delivering under-performance).

Why is Smart Money , not that Smart!!! . The answer to this fascinating question can be equally revealing . One would expect the top-notch private banks and top-funds backed by army of  Research Analysts , most extensive business contacts , powerful brands and of course unlimited resources , to out-smart passive index funds as well as resource-starved niche / boutique portfolio management firms (practising boring and mundane value investment model) with a sleight-of-a-hand . But the reality couldn’t be more different with many top-rung private banks / funds struggling to beat the passive index funds , leave alone the nimble niche portfolio managers.

Detailed internal study  of the performance data for last  four  years of  Top-5 Mutual Funds , PMS schemes from HSBC, Kotak ,  Motilal  etc reinforces this view . Why does this happen . In the great majority of cases , this under-performance has nothing to do with  lack of  intellectual framework . It is more a product of (1)  powerful invisible force which Warren Buffett famously termed as  “Institutional Imperative “ whereby average is “safe” and the personal rewards for independent action are in no way commensurate with the general risk attached to such action (2) compelling need to look smart in the short-run (momentum driven approach) (3) dis-proportional focus on Macro and (4) large scale inhibiting personalized portfolio construction ( perils of scale ) .

Of course , there is other side to this coin . Niche portfolio firms , while have an advantage of not having to deal with institutional dynamics , it can have potential risk in the form of not having the right investment philosophy and sound research framework . For investors , if these risks can be assessed and validated , then the choice is easy . Then , the only challenge they need to overcome is the lure of size and brand !!!

Happy Value Investing !!!

Mysteries of Investor Behaviour !!!

Attempt to unravel the mysteries of investor behaviour can be a stimulating experience . Countless studies have been done on investor psychology , yet mysteries remain. A field known as “behavioural finance” has evolved over time to offer better understanding on how emotions and cognitive errors influence investors and on the decision making.

The most intriguing behaviour that still eludes “Behavioural Finance” experts is the one that comes in plenty at  times of market peaks and bottoms. In big Bull Markets , Investors remain blind to risks while they remain doubly blind to opportunities in big market declines . It is fascinating to observe that investors who were willing to bid any price at peaks are now unwilling to even give a second glance at prices that are 1/4th of their peaks.

What explains this rather irrational behaviour . It goes back to two basic human emotions – greed and fear . It is not so much about  lack of awareness of either risk ( in Bull Markets) or opportunities ( in Bear Markets) that is driving this behaviour . If so , what blinds us in these extremes. It is rather our mis-guided confidence ( of course coupled with greed and fear) . We , as humans , overestimate our ability to out-smart the crowd in exit and entry .  At the peak of Bull Market , it manifests in the form of false confidence that when the music stops , you can , not only stop dancing , but also can rush to the exit comfortably. But people forget the hangover and gate-crashing effect . This is what happens when everyone in the crowd thinks that he can out-smart the other (bigger fool theory !!). Preciously the same illusion blinds us , but in reverse , at the bottom of the market .

The problem gets further compounded because of  the presence of false and misleading sharp corrections in Bull Markets and strong rallies in Bear Markets.

So , why is this strong dose of philosophy  being dispensed ? . Being aware of this neural limitations can help in executing one’s investment objectives rationally . Needless to say , it also helps in capitalizing undervalued market opportunities at cloudy times like this without worrying about quotational  / notional short-term  losses , but  keeping an eye on long-term wealth building !!! .

Times are exciting for Value Investors !!!

Magical Middle !!!

Date 29th  Oct 2012

Bigger is not better

It has been a mysterious slump for many of the yesteryear stars in the market . Crown jewels have been losing their luster while lesser known mortals have been gaining prominence . This divergence has been the starkest in the  last year , to say the least.

Barring few in the large cap space , the journey has been tumultuous for most . For many stalwarts , behind their glittering facades , the underlying stock performance has been less reassuring and more ominous . The list is long  , but the  prominent ones being Reliance Ind ,Bharti , Infosys , Wipro , R-Com and so on . All of these have delivered negative returns over last year in a market that has delivered over +8% returns ( data as on 26th Oct ‘12) . On the same breadth , many of the small and midcaps have delivered stunning returns . The list is endless on this  count with some notable ones being  Amara Raja Batteries, NIIT Tech , Mindtree , JK Lakshmi Cement etc.

What does this trend portray at deeper levels . One , the well-entrenched myth that the blue chip stocks are safe has been shattered with some family silvers rusting woefully on the corner . Second , law of size probably is catching up on many  bell-weathers , besides regulatory hurdles and macro challenges . Take the case of Reliance Industries .  Story has lost steam with pressure on refining and petrochemicals margin ( accentuated by surplus  capacity in both globally) taking a further toll on the earnings story that is already under threat by declining Oil and Gas production . Neither , the medium term prospects  inspire confidence .

The undercurrent in other cases is equally alarming . While Infosys is haunted by law of size and company specific issues ( management issues) , Bharti  Airtel suffers from regulatory challenges ( spectrum refarming , one time spectrum fee etc) , slowing growth and mounting debt ( piled up on acquisitions) . Wipro is another notable one struggling to regain its lost glory .

In contrast , mid sized companies seems to be in their sweet spot with size playing to   their advantage in a lackluster macro . Mid cap IT exemplifies this more starkly than any other  sector . Surprising  the  market on the  upside , companies like  Infotech  Enterprises , Hexaware , KPIT ,NIIT Tech etc have out-performed consistently over last few quarters . Stunning volume and earnings growth delivered by mid-cap IT companies is not an isolated phenomenon .  Mighty middle is a growing trend in other sectors as well . Many examples come to mind .  Few prominent ones are  Symphony , Finolex Cables , Innoventive Inds , Heritage Food , Sundaram Finance and PVR etc.

When it comes to investments , this middle path has added magic .  Conventional wisdom says that mid & small cap space is risky ( as it is prone to extreme swings) and should be avoided . But , astute investors know this is a myth. Extreme volatility , in many occasions , throw mouth-watering opportunities in terms of distressed valuations in an otherwise fundamentally sound stories . Such stories , when backed up by solid research and purchased at distressed valuations can deliver very high long-term returns , though short-term returns ( notional) could be bumpy . To paraphrase Warren Buffett , “I would prefer a bumpy high return than a smooth low one”.

As market emerges from the shadows of the biggies , middle ground is becoming the new breeding ground for many potential winners . ‘ Middle is mighty‘ is not a passing fad , but a growing trend that will catapult stock specific ( bottom up ) investments to mainstay in the coming times !!!.  Needless  to say , it will be music to ears for staunch value investors !!.

Happy Value Investing !!!