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

At the height of the epidemic, I shared my thought process on the next steps

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 but only because prices will adjust once all the uncertainty goes away.

We paid a price for being conservative. We lagged the indices in 2020 at a time when others rode the surge in small caps and achieved stellar returns

I wrote the following at the end of 2020

At that point of time the future was uncertain and anyone making a specific bet was ‘assuming’ a specific scenario. 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 investors who went all-in, in the month of March/April. It could have easily gone the other way and in that scenario, the second group would be highlighting the merits of being cautious, whereas the first group would be silent.

I personally avoid taking a specific view of how the future will unfold. The risk of doing so is high, if you get it wrong. If you are managing money for others (like me), then the risk is asymmetrical. If you get it right, you can tout your performance. If not, then your investors bear the brunt

I continue to stand by my conservative approach, though I should have reacted faster when all central banks pumped in a huge amount of liquidity into the system. By the time, I could appreciate the dynamics, it was too late

I have been following this drama closely and by mid of 2021, felt it was getting crazy. Valuations of profitless growth companies in the US went through the roof, Crypto was all rage and then we had the NFTs.

Some of these innovations could change the future, but why would I pay for a promise? If you are a buy & hold buyer (as many claim), then you should be paying a price which doesn’t discount the future. On the contrary at height of the mania, buyers were paying for the most optimistic future

The last one year has reminded me of the 2000-2001 dotcom mania. I had just started investing and resisted the mania for a long time, but finally succumbed to it in early 2000 when the bubble peaked. I promptly lost 80%+ of my meagre investments in the next few months

The advantage of experience is that if you can avoid repeating the same mistake. I have stayed away from all this madness and just watched it with amusement. You can see all the updates on my twitter feed @rohitchauhan

When the tide goes out

I created a presentation last year but did not upload it then for some reason. Interest rates have been on a 40 year downward trend and were close to 0% (and even negative). The investing world has gotten so used to this zero cost capital, that even a slight increase would be devastating to most assets

Although I could not forecast inflation and other macro issues, it was clear than any normalization or even reduction in the liquidity was going to be a problem for the market

We know what has happened since then – Inflation has surged due to war, supply shortage of commodities and all kind of supply chain issue

The net result is that interest rates are rising and have some distance to go. All central banks, including RBI have to raise interest rates and reduce liquidity to control inflation

Flip the script

So what’s my point in all this ? We all know what is happening.

If a cut in rates and increase in liquidity, resulted in a V shaped recovery, then the reverse should cause an extended downturn?

I think a lot of the correction has happened. However that does not mean markets cannot shoot on the downside. Long term investors often ignore the implications of liquidity

The net result is that the tailwinds of the last 2-3 years are now headwinds. If this turns out to be true, then there is no central bank to bail out investors this time around in the near term

Hunker down

My thinking is colored by my experience after the dotcom bust. As liquidity was pulled back, it took the markets years to normalize and start growing again. The current events are not the end of the world. At the same time, we should not expect that market will turn suddenly and resume their upwards trend

We are holding 20% cash as I write this note. My plan is keep looking for new opportunities (as always) and start with small positions. As these companies execute, we will scale into the position over time

Even as we invest and reshuffle our portfolio, we should expect losses in the near term. No amount of conservatism can save us from that. I have harping about diversification and asset allocation for last 2 years as I felt that a lot of the recent rise has been due to liquidity conditions around the globe

We can expect volatility and a tough slog for some time. The key is to manage the risk and focus on building a diversified portfolio