AuthorRohit Chauhan

Here we go again

By Rohit Chauhan
In General thoughts
1 month ago
3 Min read
H

A recent post to our subscribers on the current market situation. Hope you find it useful

We have experienced 13 drops of more than 10% in the last 14 years of our advisory. A few have been more than 20% and the one in 2020 was 30%+

If you have been in the equity market for a long time, this is not a surprise. Even a cursory study of market history, shows the same. Yet, a lot of people get shocked by such drops.

The recent drop is being explained with a new set of reasons whereas just a few months back, India was being touted as a miracle economy. If you really need a reason, how about this? – The markets fell as it often has in the past and will do so from time to time in the future

A study of the past

I recently did a talk about past cycles of manias and booms & busts. You can watch the recording here. Some of the key lessons are

  • Manias and crashes are driven by human nature. They will always be there as long as people are trading in the markets
  • There is a plausible, kernel of truth which gets stretched to excess
  • No one can predict when/where a bubble will start and when it will end
  • Media always acts as a cheer leader of Bubbles (Story/Attention Bias)

As part of this study, we also reviewed the past 25 years of the Indian market. We have incorporated the learnings in a new process, where we review the market on a monthly basis to gauge its trend, breadth and sectors which are doing well and ones that are slowing down

As a result of this review and rising valuations, we started exiting some positions and are now at 25% cash levels

Did I foresee that the market would drop? No amount of market analysis can help you forecast the future. What we did realize was that some companies in our portfolio were stretched and so we started pulling back. We also exited positions where the performance was poor and the stock was weakening

In a nutshell, we raised our cash level as the risk reward ratio in our portfolio dropped

So what about the cash?

The next set of questions, we invariably get after every drop, is when we plan to invest the cash. For starters, we are not swing traders who are trying to catch the swing low to make a 20% gain on the next bounce

Our focus is to buy stocks with a 2-3 yr window and a 10% drop is not enough. Several stocks have dropped from a PE of 100 to 70. That is not cheap

We are constantly searching for new ideas and that process continues independent of the market condition. A bear market turns up more ideas for consideration, but we are not in a hurry. We have slept well and made reasonable returns inspite of holding high cash from time to time. We will continue in the same manner

Read on

The psychology of stoploss

By Rohit Chauhan
In Advisory letter
4 months ago
4 Min read
T

I wrote this to our subscribers recently. Hope you find it useful

Why be cautious

It is easy to swing for the fences. If we had been fully invested and had higher allocation to some positions, our returns would be higher. However, I have been a proponent of the principle – The number one goal of investing is survival.

This does not mean we won’t lose money at the position or portfolio level from time to time. Our goal is to have losses from which we can recover financially and psychologically. Most investors underestimate damage to the psyche after a huge drawdown. All high return strategies appear great in hindsight, but usually have 50%+ draw downs in them. It is easy to see such drawdowns on paper and completely different to experience it.

I am certain that less than 1% of investors can tolerate a 50%+ drawdown and continue to invest in the same manner as before. Most throw in the towel, never to return to the markets. There is no point in following an approach you cannot stick with, especially when the going gets tough

The psychology of stoploss

This is another change we introduced in the last few years to manage risk. I never used a stop loss for 20 years and found the idea contrary to buy and hold. If you plan to hold a position for the long term and it drops in price, then it surely is cheaper, and one should add more?

We have done that in the past, before we got hit by a few failures in 2018 and 2020

As I mulled over this issue, I realized that buy & hold works only as a special case – my analysis is correct and there is no change in the underlying thesis. In these failures, I got the analysis wrong, or the thesis changed. Holding onto such positions is financial suicide

We review a host of fundamental and technical factors to arrive at a stop loss number, which also depends on the type of setup. A long term buy and hold position has a much wider stop loss compared to a momentum stock

More than the number though, a stop loss acts as a line in the sand. It allows us to exit the position and look at it at a later point without any baggage.

The most important benefit for us is psychological. It has allowed me to be more aggressive with new ideas as I know that our downside is capped. In absence of a stop loss, the downside risk would have me worried, and we would often miss the idea. In other words, the idea of stop loss has been mentally liberating

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 may hold 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
Read on

Winning the battle, losing the war

By Rohit Chauhan
In Investment process
6 months ago
3 Min read
W

I have tweaked my approach in the last few years. An outcome is higher number of transactions and re-entering the same position even though it did not work the first time. This is not about being proven right, but buying a stock if the probabilities are favorable, even if it did not work the first time

This gives an impression of flip flopping to my subscribers. I wrote the following note in response to that.

Winning the battle, losing the war

I have been fixated on the success of each position for a long time. This is a very common mindset among all investors. Although, everyone knows that it’s the portfolio returns that count, we get hung up on each holding

My guess is that some of this comes from our schooling, where we were graded on each question and the final score was a total of individual marks. It does not work that way in life and Investing

For example, if you hold 10 stocks in your portfolio and one stock goes up 10X and the rest drop by 50% before you liquidate your entire portfolio, you have made 45% on your portfolio

Is this hypothetical? Not in the venture capital world where one position can go up 100X and the rest can go to 0. Public market portfolios behave in the same manner.

Most of our alpha have come from a handful of positions

If this is the reality, it leads to a few logical actions

  1. We should not chase a high hit rate. A less than 50% success rate is fine as long as we manage the downside risk. Portfolio management is not an entrance exam
  2. The key is to get a few positions right and make the most of it. If that means, re-entering the same positions several times, so be it. Did it matter we lost 20% on Neuland labs before making 150% on it. The other downside of this approach is higher number of transactions
  3. We will appear to flip flop and regularly change our mind. We will hold our position only if the company gives us reasons to do so. Each position has to earn its place

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 may hold 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
Read on

Brain damage Stocks

By Rohit Chauhan
In General thoughts
7 months ago
3 Min read
B

There are some stocks which have a high risk reward equation for investors, but the equation does not work for the investment manager

Let me explain –  There are some stocks a fund manager can buy and even if he loses money, his investors will not be upset. Think of HDFC bank or Reliance industries

And then there are stocks which if you lose money, you will be questioned (to put it mildly). There have been such positions in our portfolio in the past. The prime example was Shemaroo. I still have some of those emails with me as a reminder

We try to ignore the noise and act as rationally as possible. That said, I am human and experience the same emotions. We are far tolerant of such positions in our own portfolio compared to what we recommend for all of you. Neuland labs was not entirely in that bucket, but had elements to it when we re-initiated the position

To begin with, we lost money on it in our first try. We were cautious in restarting the position and did not want to impact the portfolio if it failed again.

High returns are not free

There are some positions which have worked very well in our personal portfolio, but we will not add to the model portfolio. These are small cap, turnaround companies which have a higher risk reward ratio. Also if things go wrong, exit is not easy.

There is no free lunch in the stock market. We are not going to find a 20% compounder with 25% ROC valued at 10 times earnings. There was a time when such stocks were available and I was lucky to invest in some, but those days are long gone

We some time buy these higher risk/reward, ugly looking stocks for our personal account, but the downside for the model portfolio is too high.

We are thinking of how we can develop a different product for such stocks for investors who are tolerant of much higher risk. We will keep you posted as we get ready for the launch

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 may hold 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
Read on

Financial planning is 80% Psychology

By Rohit Chauhan
In behavioral finance, General thoughts
7 months ago
5 Min read
F

First a disclaimer: We don’t provide financial planning services, so this is not a sales pitch

I recently met with my extended family and went through a financial planning exercise for some of them. It was a learning experience for all involved

The no.1 element of such exercise is behavioral, or psychology of the individuals involved. An advisor who misses this point and focuses on numbers alone will never be effective. This is like a doctor who prescribes a medicine but does not understand the motivation and fears of the patient. Patient compliance is low in such cases

I focused on the psychology and life situation of each individual and tailored my advice accordingly. I also tried to simplify as much as possible so that it would be easy for them to follow my advice. I used a 3 bucket analogy for savings and investing

Bucket 1: Liquid assets for emergency expenses

Bucket 2: Savings for children’s education (medium term)

Bucket 3: Savings for a long term goal – Retirement

Let me share three case studies and hopefully you can see some value in them even if your personal circumstance may not fit it

  1. Young single mom

A single mom and sole earning member of the family. She is making a reasonable income and is saving a small portion of her income. Most of the savings are in cash or fixed deposits due to lack of knowledge.

I explained the three bucket approach to investing. As she has enough asset in cash/FD, we decided to move some of this capital to broadly diversified mutual funds. The idea was to get started with a small amount initially and then add via SIP over time (to reduce the timing risk)

I took time to re-assure them that her financial situation was fine, and she was doing a good job of saving. She had to focus on creating long term assets to fund her children’s education and her retirement.

  1. Married couple with young children

Typical married middle class couple with home loan and other expenses. They are making reasonable income and saving some portion of it. Most savings are in cash or FD earning low rates of return

I followed the same three bucket approach to investing. The recommendation was the same as the prior case, but as they are making a good salary, we decided to move faster into mutual funds compared to the single mom

Also, they could fund some of their children’s education through regular earnings and could focus on saving for their own retirement. Finally, any bonus or windfall was to be used to pay down debt after ensuring that there was enough in the emergency fund

  1. Married couple with children and volatile income

Very similar to the second case, but the income is very volatile due to business instead of salary income. My template for financial planning was the same as the previous cases but I have asked them to build a 12 month cash reserve.

The surplus capital will move into diversified mutual funds for funding their kid’s education and their own retirement

Some observations from the exercise

The online / Twitter world is completely disconnected from the reality of 90%+ people in the outside world. On Fintwit, a lot of people are jumping around talking of their multi-bagger picks and beating the market

The rest of the world is busy with making a living and saving the best they can. There is a high level of ignorance in terms of financial planning and investment options such as mutual funds. A lot of people are good in terms of savings (though this is reducing), but have no idea on how to invest

As a result, they are invested in low yielding assets. These people also face the risk of mis selling by unscrupulous people. Frustrated with low returns, these people are sold high risk products which does not suit their financial situation or goals.

If like me, you are proficient in financial planning, I think its our moral duty to advise such people – provided they are open to listening. A lot of people will ignore your advice, but a few will listen and that is enough.

If you can help someone secure their financial future, then you have done a big service to them.

Selecting a few mutual funds

I provided a few names to my relatives which I cannot share for obvious regulatory reasons. My criteria for selecting these funds was very simple.

  • Ignore all high risk funds such as Quant, thematic, sector etc. Their returns may be good, but they are not suitable for the people I was advising
  • Select a broadly diversified flexicap fund
  • Short list funds with above average 5 – 10 years of returns
  • Recommend two or three funds. There is no need to go beyond that

The key is to get started and not split hairs on which fund has given the highest return. As I mentioned earlier, the online world is fixated on alpha, whereas in the real world just getting started and making more than an FD will make all the difference

Read on

On selling

By Rohit Chauhan
In Investment process, Portfolio management
9 months ago
3 Min read
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.
Read on

Bankruptcy risk analysis

By Rohit Chauhan
In General thoughts
11 months ago
2 Min read
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

Read on

Real estate cycles

By Rohit Chauhan
In Industry analysis
December 10, 2023
3 Min read
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

Read on

Managing risk without timing the market

By Rohit Chauhan
In Investment process
December 1, 2023
4 Min read
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

Read on

Beating the market is not supposed to be easy

By Rohit Chauhan
In General thoughts
November 16, 2023
4 Min read
B

“It’s not supposed to be easy. Anyone who finds it easy is stupid.” – Charlie munger

Investing is very easy when you are investing in a bull market. If you are ‘unlucky’ to begin investing in a bull market, you start dreaming of being the next Rakesh Jhunjhunwala or Warren Buffett

I used the word unlucky on purpose because every new investor who starts investing in such  periods gets a rude awakening in the next bear market

Bull market stories

A common theme during such periods are stories we hear from people who are striking it rich at such times

US covid Tech boom

“Buy quality at any price”

“Chor bane mor”

Secular growth of financial services

Perpetual growth in Infrastructure

The last one was in fashion in 2006-07 when a lot of current investors were not around

What happens at such times is that investors fit a story to the price action and think of it as a law of physics. These stories gain prominence as more investors get sucked into it. Eventually the trend runs its course and a lot of investors are left holding the bag when it eventually turns

Beating the market appears deceptively easy

Can you think of any activity in life which pays well, is competitive in nature and easy all time ? Is it easy to be a doctor, architect, actor, chef ?

Investing seems to be the only field where a lot of people get fooled into thinking that its easy. The reasons are not complex to understand

  • For starters this is a probabilistic field with returns accruing in spurts. A 15% CAGR over 10 years is not spread evenly over this period. Its more like +25%, +10%, -15%, + 18% and so on. Anyone who invests during a bull market thinks of it as normal and tends to extrapolate it
  • During such bull run making money appears to be easy. Just buy whatever is in fashion and it works. No need for any kind of risk management
  • Its easy to trade and getting easier by the day. Open an account in a few days and start trading in F&O. A thousand rupees is enough to get started. There are no qualifications or gate keepers to stop you

Performance over the cycle

Anyone can be a bull market genius. The true measure of performance is over multiple cycles which include several bear markets

Most investors get washed out after a bear market, never to return back. The few who stick around, dig deeper and learn the craft of investing. Even so, this does not assure you of above average performance

The reason for it is that the basis of out-performance changes over time. What worked in early 2000 does not work now. As I look back on my old posts up until 2013/14, it was easy to buy good quality small and midcap companies at cheap prices to make multi-bagger returns. That game is over now

In the same manner, quality at any price worked in the 2015-18 period, or loss making tech companies were the go to place in 2020. A lot of investors tend to stick with the old theme even when the paradigm has shifted

Beware of the snake oil salesmen

If you want to do well over the long run, you have to overcome your natural biases which trip most investors. One has to un-learn and relearn every 3-5 years as the paradigm shifts. If you miss one, then be prepared to live through a period of under performance till you adapt to the new one

That’s the reason why a lot of successful long term investors have said: Trading or active investing is a tough way to make easy money

I can vouch for that. I have worked in the corporate world and invested actively at the same time. I can tell you that making a living from the stock market is much more difficult than a full time job.

So anytime someone tries to tell you that beating the market is easy over the long run, keep these points in mind

  • They are trying to sell you something which is not worth buying
  • They are lying on purpose
  • They are incompetent and a bull market wonder
Read on

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