Temperament cannot be bought or taught

I wrote this note to all of my subscribers. Hope you will find it useful too

Let me state this again – My approach is to buy good quality companies at a reasonable price. There is nothing magical or new about this. Every other value investor professes to do this and I am no different. There is no secret sauceand I make it a point to share my thought process and analysis as much as feasible.

I have practiced a value based philosophy for the last 15+ years and it has served me well. I have no plans of changing a sound and logical approach for something else in the future. As long as I continue to do follow it rationally and with discipline, I think the long term results will be good even with occasional spells of under-performance.

One the first comments I get from a new subscriber after joining is this – I had a look at the model portfolio and I cannot buy more than 2-3 positions for now. I have a stock response for that – please be patient and give it some time. I have usually seen that most new subscribers are able match the model portfolio over a span of 2-3 years as some stocks drop below the buy level and new positions are added.

If you look at the price action of our 17 odd positions for the last two years – you will find that at least 14 hit the buy point and even went lower for a few days or more. So in effect, it’s quite possible to be 80% matched to the model portfolio for those who joined the subscription in the middle of 2014. I do not have the statistics of how many have done that, but my point is that over a 1-2 year time frame, one will get enough opportunities to buy and build your portfolio. One needs to have the patience to do that and not get swayed by short term events.

We started the model portfolio in Jan 2011. We have had several actual and imagined events such as Grexit (did not happen), Chinese hard landing (cannot say if that has occurred), Brexit (did happen), oil crash (occurred in 2014) and mismanagement of the Indian economy by the previous government.

Now someone could counter this logic by pointing the risk of 2008/09 collapse when mid and small caps crashed by 60%. What if one of these events had snowballed into a similar crisis?

–           For starters, one cannot invest based on the low probability, high impact macro events. One can diversify against black swan risks at an individual company level, but not at the country level. To give an extreme and silly example – how will you protect yourself from the risk of an asteroid crashing into a major city in India and causing a major economic crisis? Can one really diversify against such an extreme risk?
–           My second argument is that one needs to invest based on the higher probability risks (such as inflation) and insure against the low probability, but extreme ones. In other words, invest to beat inflation or secure your retirement and buy life/ health insurance to hedge the other extreme kind of risks. Finally there are some kind of risks, where one can only hope and pray that they don’t occur and we can do nothing about it.

If a 10-15% drop in the portfolio is going to scare you (as it may have in Feb of this year) and cause you to lose sleep, then equities are not for you. I can share my analysis and thought process, but cannot fix your temperament. You will have to bring a steady and calm mind of your own to the table.

Looking for trends
Some of you may have noticed that the model portfolio generally does not have a specific theme or view. One will often hear from investors that they have positioned their portfolio to benefit from better monsoon or revival in capex or some such factor.

One needs to keep in mind that a good monsoon or lower inflation is not a long term trend, but only specific events which play out for a small period of time. A long term trend would be something like demand for housing/ housing loans which leads to a growth of 2-3X of the average GDP growth rate.

Why am I discussing this point now? I think there is a lot of value in identifying such trends early and investing based on it, provided one does not overpay for it. As a result, I have now started looking at some of the current ideas from a trend point of view. We will however not know if the trend was real or a mirage, till a few years pass.
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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.