AuthorRohit Chauhan

Asking the right questions

A

The basis of white collar work is changing rapidly

In the early 2000, with the internet and google, the grunt work around finding information was removed. Value add for any type of work shifted to putting together this information in a valuable format

For investors, this meant that bulk of your effort shifted from finding information to synthesizing it to arrive at an investment decision. The front end of the workflow – Finding annual reports, data points which used to be manual was now available at the click of button.

In the same manner, for jobs like coding, we have repositories for a lot of the boiler plate code. A significant part of such jobs is now is in glueing these components together to achieve the desired outcome

Paradigm shift

The launch of LLMs in 2022 is changing the core of all white collar jobs again. The difference this time is that it is faster and moving up the value chain at the same time

I was initially curious about these new tools and started experimenting with them in early 2023, as I did with the internet and google in the past. For those who saw the early internet, these tools felt like the dial up connection of the late 90s – slow, clunky with limited usage

Google and broadband in the early 2000s made the internet what it is today – cheap, easy to use, ubiquitous. I am seeing the same transformation in the LLMs, but at 10X the speed

The early chatgpt was Realtime and good at answering questions for which the answers already exist on the internet (and thus part of its pre-training). With the launch of the O1 and now O3/O4 models, we have reasoning models which can ‘understand’ your questions, plan the tasks and decide which tools to use to best answer these questions

This is a paradigm shift on how computers work

All other software tools follow a fixed information flow via logic embedded by the developers and system designers. In contrast these tools operate more like us, than traditional systems. They are becoming autonomous agents

Burying head in the sand

There is a lot of chatter around the implications of these tools on the future of work. I will not get into which jobs will or will not get replaced. Time will tell

A few things are, however, clear based on the current state of these tools

  • The base models continue to improve rapidly based on new algorithms and more compute
  • We have new reasoning models which continue to improve based on reinforcement learning techniques
  • The cost of these tools continue to drop exponentially (almost 90% per year)

This means that the cost of performing routine tasks and synthesizing information is dropping rapidly. If the major part of your job is to use existing information and put it together in a different format, you face competition from these tools which can do a good enough job at 5% of the price (and dropping)

This does not mean we are doomed to irrelevance as the tools get better. However it does mean that we need to re-think what is our value add (to get paid well)

This is similar to waves of automations in the past – Farm and factory workers were not happy when machines replaced human labor. They fought this change tooth and nail. We will see the same happen with white collar work.

A lot of pushback is on the following lines

  • The work quality of these tools is poor (same as weavers complaining about the quality of hand-woven cloth versus the machines)
  • They are taking work away from hard working people
  • It is unfair

I am not denying the pain these tools will cause in the workforce, but burying our head in the sand is not going to change reality.

Change your workflow

I personally think we should all take these new tools seriously and start learning as much as we can on how to use them. The next step is to breakdown your own workflow into what can now be done more efficiently using these tools.

Let me take investing as an example

The job of portfolio managers/Investors/Research analyst shifted from finding information to synthesizing it in the last few years. There are screening tools, financial websites, charting tools available where we can get all the necessary information in a few minutes (which used to take hours and days in the past)

The main job for us was to put synthesize all this information and arrive at the final decision – should I buy the stock, how much of it and at what price ?

As an investor, we get paid for our decision, not for the effort we put it. If we can reach a high-quality decision in a few hours versus days then it’s even better. In such a case, these new tools are a great benefit to us. We need to drop the mindset from our school days: grade = amount of homework. In markets, it is always quality over quantity

In the past I would read up a lot of documents and think of questions to answer. I would then dig further for the answers, but generate new questions at the same time.  Invariably there would be a point of diminishing returns after which I would decide with 70-80% of the information

I am no longer constrained

My job as an investor is to read the necessary documents as a starting point and come up with a list of questions. I can feed these questions to one of the LLM tools and  get a detailed answer. I can dig into this output, push my understanding forward and generate a new set of questions

The result is that I can have a better understanding of the company and its industry in a much shorter period of time. What can be better than that?

I will dig deeper in my next post into how I have changed my workflow and incorporated these tools.

The most important change for all of us, including investors, is now to come up with high quality questions. We are getting to the point where our computers will generate better answers than most humans

The price of uncertainty

T

The Nifty is down 1% for the week and up 2% in the last 30 days. It is down 3.85% for the year.

If you were out on holiday from 1st jan, did not check the news and looked at your portfolio today, you would not know about the daily chaos. The problem is investors check the news by the hour and that has caused a lot of volatility in the markets

This volatility is great if you are a day trader or high frequency quant. It’s a problem if your horizon is a few months to a year. As your horizon starts lengthening, this day-to-day volatility becomes less of an issue

The first step is to decide your investing horizon and act accordingly

The eventual outcome of this tariff war will have differing impact on each company, but that will be known in years. It’s futile for an investor to analyze the impact in real time when the main actors in the drama keep changing their stance by the hour

FOMO of a sharp recovery

In 2020, we took a slow and steady approach. We justified this approach as follows

How does one invest under such extreme uncertainty? One option is to assume that there will be a quick recovery and go all in. The other extreme is to wait till it is all clear and then deploy the capital. In the first approach one is making a bet on a specific scenario which may not occur, leading to sub-par results. In the second case, we may end up with sub-par returns too because prices will adjust once the uncertainty goes away.

If we assume that 50% of the investors bet on rapid recovery and the other 50% bet on the whole thing dragging on, the first group turned out to be right

You are now hearing from such investors who went all-in, in the month of March/April.

As the market recovered sharply from April 2020, we slowly deployed the cash with the following thinking

Under the circumstances, my approach is that of ‘regret minimization’. That’s a fancy way of saying that I will do something in middle, so that I can avoid FOMO (fear of missing out) if the first scenario occurs, but at the same time have enough dry powder available in case the economic recovery takes longer

We had a weaker 2020, but made up for it in the subsequent years. The reason for this hedged approach is because I think Survival is the ultimate prize

I don’t want to be a hero with our subscribers or on social media by calling the bottom and going all in. Our goal is to invest in a measured fashion and make decent returns over the long term

Pricing the imagined risks

I am not advocating burying head in the sand and waiting for all uncertainty to clear up. As investors, we think the future is clear sometimes and cloudy at others.

This is just a mirage. The future is always cloudy

When investors think the future is clear, they bid up the price of stocks. At that time, it makes sense to remind yourself that the future is unknown and reduce your risk by selling down the overpriced stocks

Conversely when investors get frightened and over discount uncertainty, we should become active in the market. The key word is over-discounting the risk

At such times, stock prices reflect real and imagined risks. This is the time to take your hard earned money and deploy it in the market. Your emotions will scream at you to get out as the market keeps proving you wrong in the near term

I am not waiting for the uncertainty to clear (it never does), but the market to ‘price’ in the uncertainty in specific stocks of interest

Actions in the Fog of war – Redux

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The following note was published to all our clients today


We have feelings of Déjà vu. To know why, read these two updates from March 2020

Actions in the Fog of war

And

How do i execute ?

The first post was written deep into the Covid crisis. I used the term ‘Actions in the fog of war’ as a metaphor for decision making under extreme uncertainty. This term is used by generals who make major decisions with uncertain and conflicting information in the middle of a war

We are a literally in a war, except its an economic war on a global scale. It started last week when the US announced tariffs on all countries around the globe. There is a lot of analysis and commentary on it and I will not rehash or analyze it.

I personally think it will do us no good as this is a very fluid situation and who knows how all of this plays out. This could get resolved soon with each side declaring victory, spiral into something worse or we keep muddling through this chaos for the next few years. No one can put any probabilities against each scenario for now. Its too early to tell

Not burying head in the sand

We are however not advocating burying our head in the sand. As we shared at the start of the year, we decided to pull back and went into cash as part of the risk management process.

As the market zigzagged over the last few months, we have rejigged our portfolio a bit and added some positions. In other words, we have not been in a hurry and will take our time.

That said, we laid out a few action items in our posts in 2020, which remain true today. Let me share the same with minor edits

  • Please ensure that you have at least 6-9 months of cash or FDs so that you can take care of your expenses if there is a loss of income. This will help you remain rational and avoid panic selling to meet expenses.
  • It is going to emotionally tough and gut wrenching to remain invested. Your mind and emotions will scream at you to get out. It will be a torture to put money into the market and lose 20-30% in a matter of weeks
  • We maintain a list of 200+ companies which we track from time to time. The buy candidates will be from this list. We are in no hurry to rush in.
  • It is a given that we will get the timing wrong. we will either buy too early or too late. I hope you have already realized that and are fine with it

On the question on how to execute, we laid out the following points which remain true today

  • Please review your asset allocation (yourself or with your financial advisor) and plan how much you are willing to allocate to equities. This allocation is based on individual situation and there is no fixed percentage. That said, one should not exceed this allocation.
  • Once you know the amount you can allocate, one of the options is to invest it as per the model portfolio. If that is the case, the amount per position is based on the position size in the model portfolio (multiply position size % with the amount you want to invest)
  • If the current price is below the buy price , you can add that position to your portfolio.
  • I would suggest going for a staggered approach. Start with 25% of the final size and keep adding to it over the next few weeks/months (as long as it is below the buy price). You won’t get the absolute bottom for each position, but should get a decent average price

There is no assurance that things will work out equally well, but history shows that equities offer the best long term returns when there is a lot of uncertainty.

Agency and Fun

A

I came across this word recently and resonated with me. On reading about it, I realized that I have always admired this behavior and strived for it. So what is agency?

As per google,

In a person, “agency” refers to the capacity to act independently, make free choices, and exert power to shape one’s own life and experiences. It’s about having control and influence over one’s actions and the outcomes they produce

In India, we call this jugaad

As I look back on my own life and those around me who have done well, I find almost all have had high agency – a drive to improve their life

In my generation, India had started opening up and we experienced the first technology revolution – Internet. A lot of young people in the late 90s joined IT services companies (making switches from other careers), some started online businesses, some moved to the US and some like me started a blog on investing on a whim

I enjoyed reading and investing. Pre-internet it meant getting annual reports from brokers and reading the newspaper. There were no Indian blogs (only US based such as the Motley fool bulletin boards). When I found this new medium, I started writing my own thoughts for no particular reason

Today its called content marketing, but then it felt like writing to myself with no one reading it

One thing led to another – I eventually started an advisory with my friend – Kedar which we have been running for 12 years. I still get surprised to hear from people that they have followed me for years and were reading what I was writing. I never realized that this would happen

The new revolution

We now have another shift in the making – Artificial intelligence. I am equally excited about it. As in the late 90s I get the same tingly Spidey sense of something exciting.

How will it evolve and where will it lead us?

I don’t know, but as I did earlier, I am learning about it and playing with it

I am sure it will be an exciting and fun journey as it happened with the internet. I keep saying to anyone willing to listen to do the same but be less timid

The wrong questions

T

We wrote the following to our subscribers


When and at what level will the market bottom?

what should be the cash level in the portfolio to ride out the bear market?

These are wrong questions to ask. Let me explain –

I wrote about preparing for a downturn in my prior note. We have developed a process based on the study of the past bear markets and our failures. The key point is that we ignored some risks in the past which hurt us when the market cycle turned.

We have identified the following risks and managed them as they intensified towards the second half of 2024

  1. Valuation risk: We exited/trimmed several positions in tranches as stocks went from under-valued to fairly and then overvalued. We did not exit these positions in one shot as we wanted to take advantage of the momentum
  2. Position size risk: There are positions we want to hold through the cycle. However, this poses the risk of opportunity loss if the size is too large. We trimmed some of these positions so that we can hold the balance with less stress
  3. Sector concentration: we reduced positions if they were based on the same theme and sector. When a sector goes out of favor, it can impact the stock for a long time
  4. Poor performance: In some cases, the performance of the company was weakening and we exited as the risk reward was no longer attractive

One additional element this time was to review the indices and breadth to gauge the market cycle. As the cycle weakened in Q4, we actively reduced our risk.

In summary, we were focused on managing risk and not predicting what will happen to the market.

Half the battle

We are now at 45%+ cash level which is the highest ever and it is NOT burning a hole in our pocket. This cash level is an outcome of the process

It is easy to feel smug at this point. However, this is only half the battle. Equally important is to re-enter the market and not get locked into a bearish outlook.

We will not depend on market forecast or expert views for it. We have looked at this phase of the market too in the past cycles and have a process of initiating or raising our positions. Some of you have asked how long will it take?

We don’t know. That can only be known if you can predict the market (We can’t)

Graded entry and exit

We had a gradual exit out of several positions to reduce the aggregate risk as the market weakened.  We will re-enter in a gradual manner too driven by our buy process

The buy process for a stock will be based on its fundamentals and risk reward equation. It does not require for us to forecast when and at what level the market will bottom. Fixating on the market level is a waste of time. We are focused on refining and executing our process of finding and entering new positions

This time around, the cash level will also be a result of executing this process

Preparing for a downturn

P

We published this note to all our subscribers today


I have been doing a detailed analysis of the past bear markets of 2008, 2016, 2018, 2020 and 2022. I looked at the indices, individual stocks and our past holdings during this period. It has allowed to me understand context of the market and mistakes I made during these periods.

I am listing a few learnings from this study. This should give you a context of our actions in the recent months during which our cash levels rose from 6% to 33% now

The current market reminds me most of the 2007/early 2008 and 2017/early 2018 period. It does not mean that we will have a financial crisis later this year. Please keep in mind that it is about similarities with these periods, but you cannot use it to forecast the market

A few learnings

No one can predict the market but often there are signs of froth, and it makes sense to become cautious. One can guess ‘what’ may happen, even if you cannot figure out when it will happen

  • Valuation extremes: In the past, when valuations hit the extremes, it took months for the excesses to be wrung out of the system. Valuations are now at their 10+ year high in the small cap/mid cap space. Promoters have been launching IPO/QIP etc to raise capital when it is cheap
  • Deep corrections: Theme stocks of the current cycle, no matter how good the prospects, get hit the most and can easily drop 50% or more. Other stocks will not be spared as indices drop 10-30% from peak to trough
  • Nowhere to hide: During deep corrections, there is no place to hide, and all stocks will be impacted. The key is to remain invested in those companies with a robust business model and good growth prospects for the next 2-3 years

Mistakes from the past

We made the following mistakes which I am trying to avoid now

  • We were concentrated in a few sectors/ stocks in the previous downcycle. When these stocks were hit, our portfolio had a big impact
  • We kept buying or held on to stocks which were in continuous down trend. A lot of these companies did not recover for another 2-3 years
  • Heavy losses made us risk averse and we were not prepared enough when the market turned

Some recent actions

  1. Reduce valuation risk – We have reduced or eliminated positions where the valuation was much higher than the median. This was to reduce the valuation risk in the portfolio
  2. Reduce concentration risk – We have reduced the size of some positions which are fairly valued. This was done to reduce the concentration risk
  3. Exit weak sectors – We have exited some stocks where the stock and the sector seem to be topping off and growth is slowing such as the FMCG space

Go forward plan

We have not started a new position for some time.  As we have shared in the past, we will not invest to show activity from our side and justify our fees. We will act only when the risk reward is favorable

Just because the market is down 10% does not mean that it’s a good time to buy. If you expect steady stream of ideas, you will be disappointed as markets don’t work that way. There are times to be active and then times to just wait and prepare

We continue to monitor all our positions and will not hesitate to exit or reduce some of them if the risk reward is not great. Just because a stock is already down, or a turnaround is around the corner is not the right way to make decision.

Experience in prior bear market has taught us that hope is a bad strategy. Take your hits, clean the slate and conserve your financial and mental capital. We will be ready whenever the market turns

Learning and feeling dumb

L

I started my career in Marketing and switched to IT (consulting). The pay was 2X and the stress was half of that. I had also come to the realization that I did not enjoy sales/marketing. Reading and learning was the thing I loved, and IT provided a great opportunity for that. Investing was the other area where I could the same and earn at the same time

I joined one of the Large IT services companies and was deployed on an ERP project. I had no clue about the technology. I tackled the problem the same way I had handled it as an investor

I went online, downloaded the implementation guides, manuals, notes – whatever I could find and started reading them. At first, they made no sense. However, by the third reading (cover to cover), I started getting a hang of it

The next step was to get into the software and practice. I became good at it within a year.

On the next project, I had some juniors working with me who were in the same place, I was a year back. To my surprise, when I asked them to read all the material, cover to cover, they balked at it. Till the end of the project, they kept reaching out to me for help and just coasted along

Most people avoid lifelong learning

At the end of this episode and a few years later, I realized a couple of things

  • These colleagues did reasonably well in other companies and moved into managerial roles. It just showed that learning was not key in moving up the ladder and most companies did not care for it.
  • There is a perverse system where a lot of IT service companies do not reward for deep expertise. As a result, they end up with a layer of management who have outdated technology skills. It is not their loss though as they tend to fire such resources when they get bloated
  • Curiosity and drive to learn is not as common as I thought. Most of the people I know would rather coast along without pushing themselves

Why people avoid learning

Initially I was puzzled why people avoided learning when it was fun, and you were better off in the end

I realized that the process of learning makes you feel stupid. I recently went through this phase when I was learning technical analysis and poker a few years back. Even now, I get the same feeling on a regular basis. This is not a question of intelligence. No one likes to feel dumb and as a result people avoid learning new things

This will be a major hurdle in the future for a lot of people as new AI based technologies go mainstream. I have gone down that rabbit hole in the last 2 years and can see massive changes on the horizon.

Unfortunately, a lot of people will complain and find reasons to avoid the discomfort of learning. I am lucky that I am comfortable with feeling lost and stupid most of the time. I have 25 years of practice in it

Here we go again

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

The psychology of stoploss

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

Winning the battle, losing the war

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

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