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On selling

O

There are three ways we can sell or scale out a position

  1. Sell early or in other words sell into strength
  2. Sell late or in other words sell into weakness
  3. Sell at the absolute top

The first two options are known only in hindsight and the third option is a desire of many investors, but should never be the goal of a sensible investor. I know of no system where someone can sell at the top on a consistent basis (consistent being the key word)

All forms of investing and trading try to achieve an above average return on a consistent basis. So lets remove option c and focus on the other two options.

We have to pick our poison – Either sell early and leave some money on the table or sell late and see some of the paper gains evaporate. We use a mix of the two to minimize regret

For example, we sold some of Polycab, Apl apollo etc into strength in 2022 and 2023 and the balance was sold after we hit the peak and the stock started sliding. In these two cases, we sold some early based on position sizing and the rest once we hit the stoploss or due to some issue. In both cases, we achieved a decent return on the total position.

Both the stocks rose after we trimmed the positions in 2022/23 and polycab even doubled from our initial sale. For the portion we held on, we made a decent return but sold below the peak price

In effect, we had regrets after each transaction and that is the key point. No matter, what decision we make, we will have regrets. Sometimes the result of the action will be visible in months and sometimes after years (such as Balaji amines which went up 20X+ after we sold)

We are not trying to achieve perfection in any investment decision. We are trying to do a reasonable job and minimize (not eliminate regret).

This means that our transaction timing will be reasonable but never perfect, though we are making constant effort to improve the quality of these decisions


Disclaimer

  • This report is published by RC Capital Management – SEBI Registered Investment Advisor (INA000004088).
  • This report is for educational purposes only and should not be construed as an Investment Advice.
  • RC Capital Management may have recommended the above stocks to our clients in the past. However, this is not a recommendation to buy / hold / sell the stock at the time of publishing this report.
  • The securities quoted are for illustration purpose only and are not recommendatory
  • RC Capital Management does not hold any position in any of the companies mentioned in the report at the time of publishing the same. Its partners may hold a position in this company in their individual capacity at the time of publishing.
  • Neither RC Capital Management nor its partners have received any compensation from any company mentioned in this report for the preparation of this report.
  • There is no conflict of interest for RC Capital Management / it’s partners due to publishing this report.

Bankruptcy risk analysis

B

It was the later part of March 2020 and I was really worried about the tail risks to our portfolio. I started getting worried about Covid in late feb/early march and wrote the following posts on it

Battening down the hatches

Tailrisks

And the key post in the series: Economic sudden stop in which I wrote the following

What is an economic sudden stop – It is when most economics activities for a location come to a sudden stop due to a financial or natural disaster. In most cases such sudden stops are local such as due to a flood or an earthquake.

Global sudden stops are extremely rare and have happened only during the great depression in 1930s and 2008. Even during wars, we do not have such a situation.

The current crises has the potential of an economic sudden stop (and may have started). I have been thinking of this risk (which I have been referred to as a Tail risk). Over the weekend, I drew the following crude picture to illustrate my hypothesis (please excuse my drawing)

In view of this risk, I decided to analyze all my positions for bankruptcy risk. I wanted to assess how long the companies in my portfolio would survive, if there was complete stoppage of business (revenue = 0)

I am attaching the analysis below. Please note all companies in the note are for educational purpose only. Also we don’t hold these stocks now.

Bankruptchy risk analysis

Real estate cycles

R

I am sharing an edited note, we published to subscribers recently. A few points to keep in mind as you read this note.

  • I have a terrible track record in forecasting business cycles.
  • I got the real estate cycle wrong the last time when we added to the sector in early 2017.

That said, I am stubbornly persistent. Even if I got it wrong the first time, it does not mean I will not try again.


I wanted to start the update for this quarter with some broad comments for the sector and how it is influencing our decisions for this basket. I am looking at the real estate basket versus individual companies, in the same manner as financial services/banks.

The real estate sector is a longer duration cyclical sector like infra in comparison to the financial sector. The real estate cycle is around 8-10 years from peak to peak versus 2-3 years for financials. Again, this is not an empirically proved number, just an observation.

The Indian real estate sector went through a longer down cycle this time due to some additional events namely Demonetization in 2016, Credit down cycle in 2018 and then covid in 2020. At the same time, demand for real estate is usually steady over the long term. There are sub cycles of extra demand from investors, but over the long run demand is tied to household formation, migration, and replacement of old stock.

We had an overinvestment phase from 2003-2010 which peaked around 2011. Since then, we have had a bear market for 11 years during which the excess inventory was absorbed. I had originally estimated that the cycle would turn in 2017 but got the timing wrong (by only 6 years!)

We are seeing an upcycle now. Keep in mind that this cycle will not be a linear one. We could have intermediate downcycles within this secular uptrend. This trend is now visible across the sector as follows.

  1. All real estate companies are now reporting high double digit pre-sales. This will translate to higher reported sales in the next 2-3 years.
  2. There is a trend towards higher priced housing. Increasing pre-capita income level is driving this trend.
  3. Regulatory and other changes mean that the organized sector is capturing incremental demand. This means industry consolidation, better pricing, and higher ROC in the long run.

My gut feel (Which can be wrong) is that we are in the initial phase of this cycle, and it can continue for 3 years or more. At the same time, there will be periodic corrections as we go along.

Our investment in this sector is based on the above thesis. We are spreading our bets so that we can benefit from the tailwinds without being 100% right at the company level. We may swap positions based on the relative performance of the companies in the sector

Managing risk without timing the market

M

We posted the following to our subscribers recently. Thought of sharing it with a wider audience


There was a question from one of the subscribers to which we responded via email. we wanted to share the communication with all of you. We have slightly edited the conversation and added to it

Question:  

I am fully invested into the model portfolio stocks currently, will I get any panic alert to liquidate portfolio and raise cash and wait for a dip again. Is that how your investing style works or I stay put and be invested at all times. Asking this as, most stocks are trading at all time highs. Is it possible to buy cheap and sell high!?

Our response

We think the underlying question is about timing the market and if we cannot time it, then what will be our course of action? Will we sell in panic to raise cash or just stay put and live through the rollercoaster ride

For starters, we cannot predict the stock market and so can no one else. We have spent 25 years looking at all kinds of systems and approaches and there is none which can predict the market. Some approaches can alert you to the possibility, but there is no fool proof system. If one exists, it is unlikely the practioner will ever share it.

The second part of the question is about a sudden crash and panic selling in response to it. The only scenario where everything just collapses and requires us to liquidate the full portfolio is if a major global catastrophe occurs. Unfortunately, no one can predict or prepare for it.

We have never seen a market where everything collapses suddenly. The worst case was covid which took close to a month to play out.

So how should we navigate this risk if we cannot predict.

We have a defined process to manage risk at the portfolio level and at the risk of repetition, let’s go over it again.

  1. Being diversified: We have 20+ positions in our portfolio with no position exceeding 7% and sector allocation capped below 15%. A collapse in a stock or a sector will hurt us, but not wipe us out
  2. Avoid leverage in the portfolio including F&O: No one can force us to sell
  3. Have sufficient cash: This is not part of our advisory, but 101 of personal finance which all of you should practice. Have proper equity allocation based on your age, and risk tolerance and enough cash to cover personal expenses for 6 months
  4. Stop loss on all positions: This acts as a circuit breaker at the stock and portfolio level. If the stop loss is hit for a stock due to company, sector or market related reason we will exit from a risk management standpoint. We will cap our losses and look for reasons at a later point. These stop losses are reviewed monthly and in advance so that we don’t have to make decisions in the heat of the moment

Our approach is to buy and hold each position till either of these conditions are met.

  • Stock becomes extremely overvalued, and we decide to cut position size to manage risk.
  • Company level issues occur and causes me to lose confidence.
  • Stop loss gets hit for obvious or unknown reasons.
  • A better idea comes along.

In summary we have a process laid out to manage risk level in the portfolio via diversification, position size and finally stop loss so that we don’t have to predict what will happen. As we cannot predict, our only option is to react to what is happening and if a dire situation occurs, we will do what needs to be done

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