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The price of uncertainty

By Rohit Chauhan
In Investment process
1 month ago
4 Min read
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

Read on

Actions in the Fog of war – Redux

By Rohit Chauhan
In Advisory letter, Risk management
1 month ago
4 Min read
A

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.

Read on

Agency and Fun

By Rohit Chauhan
In General thoughts
2 months ago
2 Min read
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

Read on

The wrong questions

By Rohit Chauhan
In General thoughts
3 months ago
3 Min read
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

Read on

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