Evolution of style and Stop losses

I published the following note to all subscribers. Please read the disclaimer at the end of the note

The following holdings positively impacted the portfolio performance

• Apar Industries
• Bector Foods
• CERA sanitaryware
• Polycab limited

Conversely, these holdings had a negative impact:

• Aarti industries
• Quess Corp
• Puravankara

Style drift and new approaches

In my 2022 year end note,  I spoke about some changes in my approach and using stop loss to manage the risk.

These changes are by design and have not been done lightly. I have always resisted chasing performance based on the latest fad of the day. However, my failures with a few positions such as PEL, Edelweiss and Shemaroo made me question the process and look for my blind spots.

When these positions declined, I dug deep into the financials and thought a lot on it, but could not find a clear way to answer the question – do we sell or hold? The numbers looked good and so we held. It turned out that the market had already anticipated the collapse in the earnings.

That has led me to a 3+ year journey of understanding technical analysis, momentum, factors in investing and so on. As I have studied these other areas, I have adapted my value approach to fit the changing market structure.

10-15 years back, markets were slow in responding to earnings miss and business cycles. These things have changed considerably now. Markets react much faster now – mainly due to higher competition and automated algorithms. In effect the time horizon of markets is shifting.

I have now blended momentum and Technicals to my value style. The core focus on value and long-term value creation remains, however, momentum sometimes acts as a booster and Technicals are more like a trip wire to alert us

Purity of style

I have practiced value investing for 20+ years now. I used to wear it as a badge of honor and made it a part of my identity as an investor. Even my blog is titled valueinvestorindia.com

It is time to go beyond that.

I am not talking about switching from a long term buy and hold to swing trading. However, being religious about my approach is not the way forward. I have belatedly realized that other approaches to investing have their own strengths & weakness and adapting some of these strengths to our style strengthens it.

For example: Risk management is a strong point of successful traders and blind spot for buy & hold value investors like me, who believe in holding a stock forever irrespective of losses.

In a similar manner, momentum/quant investors have simplicity of approach in their favor. Their approach can be boiled down to a few bullet points and easily automated. Value investors like me have layers and layers of complexity. I have used this mindset to strip away the non-essentials.

For example: Over the short-term valuation and management quality are important but not critical. Overweighing this information, which does not add to returns, means we have missed out on good ideas with a 1–2-year time horizon

Stop loss and zone of action

I spoke about having stop loss for each position in my last update. I review the stop loss regularly but will not share it with anyone. The reason for it is simple – I want to retain the flexibility to change my mind.

There is nothing special about the stop loss. It is based on a blend of fundamentals and technical factors including max loss or downside. In case of long-term holding, the stop loss is wider than a trade as that is a position we wish to hold longer.

As long as the price is above the stop loss and I am comfortable with the long-term fundamentals of the company, I will not react.

We cannot react every time the stock drops or rises a few % points. On the other hand, we don’t want to ignore a 20%+ drop, which we have done in the past. A few % change matters for a swing trader but is noise for us. However, a 20%+ drop means that there is something occurring at the company or sector level and a lot of investors including traders are exiting the stock.

At such points, we need to react and make a decision. Are we ok with holding the stock for an extended period and bearing a much larger loss or should we exit and live to fight another day. On this count my thinking has changed. I would rather take a hit to my ego and come back to the position another time.

Evolution

I rarely talk about the macro conditions. It’s not that macro is not important, but there is already enough noise and drama around it

For example – The fed or RBI decision on interest rates is the same for all financial service companies. What’s the point of talking about it? A good financial institution will figure out a way to work around it. HDFC bank has performed well over 30 years even as PSU banks have faltered. Surely it is not because of the interest rates.

I want to focus on what matters for a company and how it can do well in the long run. In the same manner, I want to do the same for us when writing to all of you.

My investment approach and framework will have a lot more impact on our relative returns than the macro. If the world has a major event, such as COVID, all investors including us will be impacted. Our approach will however decide the level of impact.

I spoke extensively about the evolution of my investment approach in this podcast. You can review it if you are interested.

A long-term partnership

We repeat this every time in the portfolio review and will do so again (more for the benefit of the new subscribers)

• We do not have timing skills and cannot prevent short-term quotation losses in the market.
• Our approach is to analyze and hold a company for the long term (2-3 years). As a result, our goal is to earn above average returns in the long run and try to avoid losses during the same period.
• Despite our best efforts, we will make stupid decisions and lose money from time to time. We feel the same pain as we invest our own money in the same stocks.

We will treat all of you in the same manner as we would want to be treated if our roles were reversed. This means that we will be transparent and honest about our actions even when we have made a mistake.

Disclaimer – Stocks mentioned in the above note are for information / illustration purposes only. This is not a Buy / Sell recommendation.