To all subscribers,

I have been emailed variations on this question – What, when and how much should I buy based on the model portfolio?

Before I share my thoughts, let me share a few pre-conditions

• Please ensure that you have around 6-12 months of cash or equivalents (like FDs) to take care of your expenses. This would ensure that you can handle any loss or reduction in income.
• Do not and I repeat, DO NOT invest any capital which you need in the next 2-3 years.
• Do not use any form of debt to invest in the market. A lot of crazy stuff can happen, and we have seen the impact of debt in the form of margin calls in the recent past where individuals were forced out of their positions.
• There will be volatility in the near term. Be prepared to see wild swings in portfolio.

Both me and kedar have arranged our personal affairs in the above manner. We maintain enough liquidity and avoid debt, so that we can remain rational inspite of extreme swings in the market. We have never used even a single rupee of debt to invest in the market. There is enough risk in equities and we don’t want to amplify it more.

Onto the question of how to execute

• Please review your asset allocation (yourself or with your financial advisor) and invest an amount which matches with 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 exceed this allocation.
• Once you know the amount you can allocate based on the previous points, 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)
• I have shared the buy price which can be used as reference to make a buy decision. If the current price is below the buy price (which it is in most cases), then 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
• In terms of adding positions, go from the top to bottom. The bottom most positions have the highest risk, but also the highest upside (should they work out)
• Be ready for wild swings in the price

It is natural to feel confused and concerned about losing money under the current circumstances. The best course of action in such a situation is to slow down your decision making. It is important first to survive and then thrive/ take advantage of the uncertainty.

I wrote this note over the weekend to my subscribers. This is a hypothesis based on how events have played out across countries. Things could get better, but the probability of that happening in the near term keeps reducing by the day. We are seeing the first order and maybe the second order impact of the Pandemic.

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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.

On rare occasions we get economic sudden stops at country level due to economic reasons – think of Asian currency crises in 1997.

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).

Key points

• Due to the exponential nature of the spread of this infection, most countries have under-reacted in the beginning.
• Once the numbers cross the threshold, a country has an Oh shit ! moment. US and Europe had it last week. I don’t think India has had it yet.
• Once we cross this moment, we enter the panic phase quickly where all economic activity slows down dramatically as the country stops travel, and all kinds of social and business events which involve more than a handful of people (update : US has banned all events for > 50 people)
• We will not see a gradual slowdown of economic activity. It will drop off the cliff.
• As you can see from the picture, economic activity will resume (slowly) as the situation normalizes. As of today, we cannot predict when it will happen as it depends on both the domestic and International situation.
• This is a major event and will permanently change the behavior of Individuals and Countries. Its too early to predict what will happen

Action plan

• The focus should be on making through this event – both health-wise (both self and family) and financially
• As I shared earlier, I will not try to rush into the market based on valuations alone. Depending on how things play out, the financials and even viability of a lot of business will change