When a self proclaimed writer/ investor claims ‘Investment is the ultimate liberal art’, a title such as this is bound to raise eyebrows- has she crossed over to the dark side? Over time I have been made to accept that adamant adherence to a school of thought in investment will not consistently deliver results in the Indian stock markets. We, the participants in the Indian markets, are faced with a choice- should we rigidly abide by a philosophy or should we be nimble and therefore humble while facing Mr. Market?
Fundamentals and momentum, both constitute a market
The price of equity is a function of two sets of factors- fundamentals and momentum. We have a tendency to overweigh the importance of the first while completely deriding the thought of the latter by terming it something that only ‘traders’ engage in. In our weighting of the importance of these factors we demonstrate a faulty understanding of the markets. The markets are a collective of human beings interacting with one another. Our actions therefore are not carried out in a vacuum. In an active marketplace, we are playing against the other market participants.
“Warfare is fluid…changes continuously just as water will adapt its form on land. He who can change tactics in relation to his enemy will succeed.”
-Sun Tzu, Art of War.
In adopting a defined investment framework- be it value investing, or momentum investing or the many manifestations of those broad categories, what we assume is the predicability of the move made by the ‘enemy’, Mr. Market (a collective of plethora of differently programmed grey cells). Our embraced strategy would work only if everyone else out there is practicing something contrary to it. Arriving upon a single conjecture as to how a network of human beings interplay with one another all the time, would be the finest example of foolhardy behavior to say the least.
Belief in hope, disbelief in traditional ‘value investing’
Proponents of the value investing school of thought are quick to point out the outperformance of the strategy vs. the index in the last ‘x’ decades in the US. Yet one of their own breed, accepts the flaw in such thinking.
“I was too rigid at times. We would focus too much on metrics like price/earnings and price/book ratios, and didn’t pay enough attention to the total picture. We didn’t have the imagination of what could happen over five or 10 years…”
-Mark Mobius, Franklin Templeton, Exit Interview.
In an emerging market like India, a colossal failure on our part would be to lose conviction in the ability of human endeavour, in hope.
Ego does not defeat the tape
This rigidity stems from and re-inflates our ego, which gets us at loggerheads with the market. Deriving amour propre from our closely held investment beliefs leads us to develop emotional attachment to our investments. We allow ourselves to believe in a false notion of control over the occurrences in the market and rationalise every move by the tape against our logic. We hold on to our investments so dearly in order to be proven right that we forget the purpose of investing- wealth creation.
A trade made in the endeavour of being proven correct on one’s philosophy, renders us blind to the signals given out by the market. We lose the one edge that all successful investors must maintain- response to stimuli. The response need not always result in an action, but must always result in introspection.
Rigor in process not in beliefs
Constant questioning and the resultant nimbleness in the market, is a sign of humility not a lack of discipline. A rigid investment philosophy should not be confused with disciplined investing. The former is merely a culmination of all our biases as an investor.
The regimentation should be exhibited in our processes and checks as an investor, in the thoroughness of our research endeavours but never in typecasting ourselves as a member of an investor clan. I do not argue against having a checklist in place prior to investing, I am arguing against our biases making their way on to that list.
In my first stint as an analyst for a ‘macro hedge fund’, I had the privilege of sitting next to the Director of Technical Analysis of the firm. He had a printout in all capital bold letters stuck to his screen, “IN PRICE THERE IS TRUTH”. I have learnt to appreciate this statement now.
(Note: This piece too is a result of a discussion with a friend of mine who asked me the very question that is now the title of this article).
April 10, 2018 at 7:27 am
Its quite worthily and thoughtful the article. An eye opener for the invester and prompt him/her for thorough analysis prior to invest for long term and larger the gains. God Bless You!
June 29, 2018 at 5:37 pm
When you say ‘response to stimuli’ do you suggest a common response or one which is subjective? If it’s subjective then what you are suggesting by it is to actively assess situations(based on the investor’s models) rather than sit and watch? Or to keep on changing the finer implementations of one’s models while keeping a constant core?
July 2, 2018 at 10:14 am
In investing a common response can never be possible. The point I was attempting to make here is that when we become so adamant that our thesis be proved right we miss the other signals (not necessary that all trigger an action but certainly all of them should trigger some amount of thinking).
I should ideally have rigidity in process which means that without doing a certain amount of work, I would ideally never take a call. But models or frameworks should aid agility in understanding different industries, points of time in the business cycles- need not be a fixed set every single time. The constant core should be process and not the knowledge itself in my opinion.