CategoryInvestment process

In the last post, I wrote about three stages of an investor – The Beginner, Novice and Expert.

In the initial years as you learn, you will find books and courses to guide you through this evolution. After 8-10 years of this journey, if you are still investing actively and more importantly learning, you won’t find a nicely packaged curriculum to progress further

In college our learning is structured and guided by others. As an early expert – someone who knows a lot, you are now on your own and that is disorienting.

It is tempting to read more books, hoping to learn but you realize that you have reached the point of diminishing returns. You look for gurus, but soon realize that they are no different, though some sound confident online. Often these gurus are performing no better than you and make similar mistakes

Finally, the handful of super-investors who can teach you something are not accessible.

You have to develop your own learning process. There are no pre-defined guidebooks to do that, but some approaches which I will share with you

Mistakes as your guide

One of the most powerful ways to learn at this stage is reflecting on your process and mistakes. Let me explain

Once you have learnt the basics and become proficient, it’s time to start documenting your process and decision making. Write down the thesis, valuation estimate, your entry criteria, position sizing and so on. Finally, when you exit the position, review what happened versus what you expected

Reflect on what went wrong, what you got right and what you missed. Go back to your process and refine it. You have to keep doing this to keep learning

Teach others

The other well known way to learn is to teach others. Write about it, make online videos or take classes for other investors

When you make your knowledge explicit, you teach others as much as you teach yourself. You find gaps in your knowledge and can fill those gaps

I accidentally stumbled into this through my blog and have been learning/teaching others for 20 years. My plan is to expand this further

Jump boundaries

I realized this aspect of learning in 2019 when I found gaps in my understanding of the market and was unable to explain some of my failures. As I reflected on these mistakes , I started studying other types of investing. This led me down a rabbit hole of swing and position trading, Momentum investing, Quantitative and Technical analysis and more

I am still a value investor at heart, but have incorporated the core principles of these approaches into my process

Keep an open mind

This is the key to your learning process. Do not think of yourself as an expert who knows it all. Always consider yourself as a beginner – in other words, keep your ego out. Be open to learning from other investors including ones who are much younger than you

I follow all types of investors as they bring fresh ideas and new approaches which sometimes don’t make sense to me. Whenever I am confused or find something is working but doesn’t make sense to me, my instinct is not to dismiss it but to dive deeper into it

That’s the reason I am obsessed with AI and other new technologies these days. I get energized when I find something new to learn and that gets me to the final point

To develop as an investor, you must love the process of learning and getting better at your craft each day.

We wrote the following note to our subscribers

We are in the middle of the earning season. I wanted to share what we are seeing and how we are thinking about the portfolio.

The overall results have been patchy with single digit topline and profit growth for several companies. There are sub-sectors which have shown better performance, some of which we hold in our portfolio

Private sector banks/NBFC : This segment has shown mid teens (15-20%) growth in topline and profits. As the rate cycle turns, it should help the NIM in case of banks which have a strong liability profile. We have two positions in this segment

PSU banks: Several PSU banks such as Union bank, PSB bank have shown decent results

Healthcare/Diagnostics space: Several companies in the diagnostics space have delivered good performance. These companies are 100% domestic and have no impact from Geopolitical issues. Our holding in this space has delivered good results

Jewelery: Companies in this space have posted high growth driven by gold prices. Kalyan jewelers had 37% growth in sales and profit. Titan company posted around 19% growth in sales. Also the continued rise in price could impact the demand for gold in time

Hotels: This segment continues to perform well with an increasing ARR driven by increasing demand supply gap. Demand continues to outpace supply.

Pharma/CDMO space: The long term trend of outsourcing research, development and manufacturing of NCE continues. This trend is similar to the IT services business which leverages the capability and cost arbitrage across countries. We hold a few positions in this space

Diversified without concentration

We cap the size of our positions at 5% and around 15% for any sector. This allows us to manage risk.

At the same time, we are also diversified across sectors. The upside is that some part of our portfolio is always doing well. The flip side is that some parts of the portfolio is also doing badly. That is the point of diversification

If your portfolio is doing too well at a point of time, then your diversification is too low. There is nothing good or bad about it – it’s a personal risk preference

As we have shared in the past, we prefer above average returns with below average risk. That means we will never have mind blowing results, but then we will also avoid stomach churning losses

For us investing is a 20+ year marathon. If we want to be around doing this in 2045, then its important to keep our blood pressure low and sleep well. An above average results for a very long time, will work wonders as our past record shows

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 1^st 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

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

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