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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

My best investing decision

By Rohit Chauhan
In behavioral finance, General thoughts
September 23, 2023
4 Min read
M

I am most proud of an investing decision I made years back.

Let’s go the beginning.

I have been investing for last 20+ years. In the initial years, I was fumbling in the dark and trying figure it out. I had several failures and lost a decent portion of my tiny net worth. Over the years as I gained confidence, I started investing more of my net worth in stocks and moved out of mutual funds entirely by 2009. I launched the advisory in 2011 after investing my own money for 10 + years.

During the initial I did not invest a single penny of my mother’s money as I did not want to risk her hard-earned savings on my trial and error. However, by 2011, her savings were dwindling as inflation was eating into it. The interest on her savings were barely enough to cover her expenses and at that rate, she would have run out of money in the next 7-9 years.

Now you must be thinking – That’s what kids are for. I should be taking care of her to which I wholly agree. However, this line of thinking misses a key point – Independence and choice.

Fear of markets

Our parent’s generation is over cautious and conservative. They consider the stock market to be a risky place and media doesn’t help the cause. As a result, most of them invest mostly in fixed income. In doing so they take on a different risk – loss of purchasing power due to inflation.

This fear may not be rational, but you cannot blame them for it. In the 80s and 90s, the Indian stock market was poorly regulated with brokers often cheating their customers (it happened to me a few times). No wonder the earlier generation has been wary due to the speculative cycles and poor regulation of the past.

Instead of wishing the problem away, I tried my best to give psychological safety to my mother when I decided to invest for her

This is what I did in 2011.

  • Invested 50% of her net worth, same as my own/ advisory portfolio.
  • Reduced the withdrawal rate from her accounts to bare minimum and covered the balance.
  • Have not withdrawn anything from the portfolio and let compounding do its magic.
  • Promised to backstop her portfolio. I would cover any losses personally.

The last point was the key. It ensured that she would not lose money if I made poor decisions.

In the last 12 years, her equity portfolio is up 13X and is 80%+ of her net worth. The dividend income alone can cover her expenses.

There is a joy in having enough money of your own so that you don’t have to depend on your children. I continue to take care of her, but my mother knows that she doesn’t need it and she has a choice. She can ‘choose’ to spend her ‘own’ money as she sees fit. It’s a different point that she has limited needs and spends most of it on her kids and grandkids.

I cannot be prouder of this achievement. I can sense the satisfaction she has from knowing that she has enough to spend as she wishes and not depend on anyone.

If you have older parents, I suggest putting at least a small portfolio of their net worth in mutual funds (if you don’t invest directly). At a minimum, this money would act as an inflation hedge.

However, remember to manage their fears and caution about the stock market. Preferably, start small and earn their trust over time. Finally, be conservative and risk averse with their money.

Believe me, in 10 years you will be glad that you convinced them to do it.

Read on

Evolution of style and Stop losses

By Rohit Chauhan
In General thoughts
August 10, 2023
6 Min read
E

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.

Read on

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