Learnings from the Current Market Crash

Antifragility is a subject we have repeatedly written about in this community(here, here, here, here, here…). To recap, Taleb describes things / phenomenon in the world into three kinds - those that are harmed by randomness / disorder, those that remain unchanged by randomness / disorder and those that are strengthened by randomness / disorder.

Now, change is a fact of life, and given the complex nature of the world we live in it would be downright stupid to assume all change would be favorable changes. As can be observed in each of our own lives, life has certain key points of adversity.

And it is also a time tested observation that adversity tends to be the best teacher (that is, unless it is something really, really crippling like your death or brain damage). If you have the mindset geared the right way, it forces you to think of things that you can improve so that the next time a rhyming adversity comes, you are ready. We have mentioned how, without exception, all intelligent fanatics we have seen have become stronger through adversity - so much so that we come to the surprising conclusion if they had not faced the adversity, they would have been worse of.

In the spirit of learning from these exceptional entrepreneurs, whenever I face something really difficult in life, the first question I try to ask is “How can I come out of this stronger?”

One part of my life where I am facing adversity is my portfolio. The Indian stock market has been quite brutal over the past year or so. The correction in prices of many stocks have been upwards of 60%. Given this is just my third year of deploying capital it has been quite taxing mentally and emotionally. I also observed that certain positions which were down steeply worried me much, much more than others.

So I thought it best to write down and share certain observations / learning / (hopefully) principles to be followed that I have developed so far in this downturn.

Monetary, Time and Mental Capital:

When we deploy capital in businesses we like we part with some money to gain more (inflation adjusted) money later (duh!). Due to the tangible nature of money (tangible vs abstract bias) and since it is so easily measurable (physics envy) we tend to give disproportionate importance to this capital. In our focus on monetary capital we tend to forget the aspects of mental and time capital which I believe are more important.

Time capital is the amount of time you spend on any business in your portfolio - for the maintenance work that is required for your position. For example, a listed company which does reasonably regular concalls and well-written annual reports would not require much time capital as compared to a position (perhaps a nano or microcap) which requires meeting the management.

Mental capital is the amount of mental space the business occupies over a period of time. There is a linkage between time and mental capital for sure. For example, I observed that certain flavors of highly leveraged business going through stress tended to take disproportionate amount of my mental space. So did businesses where my (illusion of) understanding of the business model or something else was not clear. So did positions where my average purchase price was relatively cheap but not absolutely cheap (more on this below).

I thought about the above as I observed that certain positions which though formed, let’s say x% of the portfolio, tended to take 2x/3x% of my time and mental capital. This meant the other names were crowded out of my limited brain space and also meant I could not work with clarity on new businesses as my mind kept going back to such positions.

This led me to what I think is quite a strange conclusion - I want to own positions that I can almost forget (‘almost’ being the key word). What I mean by this is that you want to own those collection of assets in the portfolio, where the comfort is so much under common kinds of stress that it does not occupy your time / mind so much. The common kinds of stress to my mind are - lack of liquidity, lack of demand or supply shortage.

Don't be a fair-weather friend:

I love Marilyn Monroe. What a vision, what a feast for the eyes. (In interest of not creating avoidable adversity in my marriage I would like to swear here that my wife is a far, far more preferred vision to my eyes).

Coming back to Marilyn Monroe, I love this quote of hers,

" I make mistakes, I am out of control and at times hard to handle. But if you can’t handle me at my worst, then you sure as hell don’t deserve me at my best. "

Most of us intuitively weed out people from our life who we consider to be fair-weather friends. These people stay when times are good and disappear during the tough times. If we filter people out this way, should we ourselves not behave accordingly?

I observed that certain kinds of themes make me uncomfortable during the tough times. I realized that I would only be a fair-weather friend to such businesses. These include businesses under deep distress which required me to be a really, really good and quick Bayesian thinker (any change in fact which changes the situation needed quick action). I am a slow thinker and need time to assimilate information and change my mind. So I try and avoid such themes.

I also observed that I am uncomfortable with leveraged financial services businesses where the loan book has increased tremendously in a short period of time. It makes things hard to assess.

I do invest in cyclicals for sure but avoid cycles which are violent and quick to turn.

One hack I am trying to develop to avoid this is to empathize with myself :-). I try and imagine how I feel if the price is down 30%. Will I be excited to buy more or will I panic? While that question is quite hard to answer, I still think it a very useful way to think.

Birds of a feather should *not* flock together:

Similar kinds of people tend to hang out together. This can be commonly seen where, let's say in college or workplace, people who speak the same language tend to hang out together.

But this is not a good idea for the portfolio. In a conversation with my mentor, he said something really important - Risks in the portfolio should not overlap. For example, you may have a huge confidence in the long-term potential of the Indian consumer. But perhaps it might be intelligent to have export businesses as well in your portfolio. It might help to also have businesses which have offices / plants across the world.

You might love the idea of leveraged (operating or financial, particularly) businesses which can generate huge returns when things turn. But it might be intelligent to also balance it with un-leveraged business.

You might love asset intensive business models which provide important / irreplaceable products to customers. But maybe, one should balance it with capital light businesses as well.

You might love nanocaps, but perhaps you should own large businesses which have survived for decades as well.

The whole idea in investing is to make money, but to make money you have to first survive. And to survive, you have to ensure there is no particular flavor of fragility / risk present across your portfolio.

Bhav Bhagwan Che: This is a Gujarati phrase which means “Price is God”. I had to go through a painful crash to learn this most basic of lessons. A low price can cover for a multitude of mistakes that one makes in investing.

Here, my major observation in my behavior was that due to a combination of optimism coupled with FOMO (Fear of Missing Out) I used to deploy capital urgently and quickly build my entire position at a price that seemed relatively cheap. And that really, really hurts. It is probably how a bad hangover feels like - but in this case you do not recover as quickly.

Now I look for absolute cheapness of the business and deliberately wait before taking a buy call to the extent possible. If I feel the urge to buy a stock really badly, I would try to force myself to slow down. I am thinking of scratching my itch to buy something by buying a book now.

No personal leverage please:

The last couple of years in India have been really, really interesting. If one pauses and observes, a number of business houses (Essar, Essel, Anil Ambani Group, Bhushan, Wadhawan, Rana Kapoor) have either become extinct, or are in deep trouble. The overarching pattern across all these cases of business extinction / survival threat is leverage combined with bad luck.

Leverage magnifies business returns but increases risk of extinction. As Prof Bakshi demonstrates in this wonderful talk, a leveraged business can seem really intelligent for a long time till suddenly, it is not. Yes Bank was the darling of many investors and generated profits for, I think more than 40 or 50 straight quarters before organic manure hit the ceiling.

And while I want to make money, I want to survive more. So while I will invest in leveraged businesses (and cap its allocation in the portfolio) I will absolutely not want to lever myself.

As Charlie Munger says, “The first rule of compounding is to never interrupt it unnecessarily.”


We would love to hear your learning from the current downturn in the market.


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If you enjoyed this post, you might enjoy the other articles below.

Constraints Provide Clear Direction

The David versus Goliath Battle of Marico and Hindustan Lever

Vikram Somany - Strength in the Depth of Despair

The Story of MyPillow


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Very interesting post, Rohith! Great articulation and analogies as usual. As you know, I also have had similar experience in the market over past 2 years. Your post got me thinking. While I agree with most of your learnings, I am also trying to grapple with some contrasting ideas.

On Mental and time capital: Won’t the worst ideas (relatively speaking) occupy substantially more bandwidth? Is it possible to avoid them? Theoretically yes, but in practice?

On being fair weather friend: Isn’t investing by nature being a fair weather friend? (Btw this is our common mentor friend’s idea.) Wouldn’t we like to enter just before the business (and also share price) momentum is picking up and leave before the party is over?

Portfolio risks and (a little bit of) personal leverage:
“A few major opportunities clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving diagnosis involving multiple variables. An then all that is required is a willingness to bet heavily when the odds are extremely favourable, using resources available as a result of prudence and patience in the past.” - Charlie Munger.
Of course, ‘bet heavily’ is subjective, however does it not mean allocating disproportionately which would imply concentration of risk? After all you have to get rich only once and then not make big mistakes. But what should one do till that point? Not at all disagreeing that the risk will anyway be low because margin of safety will come from multiple sources, and price being one of them, in such opportunities.

Additionally, I would love to hear your and other experienced member’s thoughts on: Should we let some of the (probable) mistakes, benefit us in a bull market first? In other words, how do we make sure that we do not move from being risk averse to loss averse. We may be right for the wrong reasons but it might help us in becoming rich or should I say financially free. Remaining rich is another matter though.

PS: These are some contradicting thoughts I am still wondering about and have not made conclusions yet.

Thank you for the post!

Cheers
Manan

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Thanks Manan! You should write more…

I enjoyed your thoughts. Here are some of my thoughts in response…

On time and mental capital: I agree with you that it is probably quite difficult to practically apply avoiding them.
But at times, you observe a huge difference between how you thought about a business before you invested versus how you think about it after you invested - it could be months or weeks. And at times it is consistency bias that is holding you there.
Also, even if you cannot avoid them entirely, I think the concept is more apt to existing portfolio investments. You can see dramatic savings in time and mental capital once you remove or reduce the exposure of existing investments that are taking a lot of bandwidth.
Reframing the situation has helped me bring clarity. Instead of obsessing about the problem affecting the company itself, these questions helped me:
How long do I think the problems will continue? In my investing time frame of 5 years has the range of returns I can expect with the new information changed? How much has it changed as opposed to what my expectation was in the past?

I can remember at least 4 cases where the exit or reduction in position of existing holding has greatly improved the thinking space.

On fair weather friendliness:: I agree with you there. In that context, when investors (who do not necessarily have a buy and hold strategy) have a 5 year horizon, there is a probably a dissonance with the promoter who has a horizon that is a multiple of that.
But as our friend says, the context in which the idea is applied matters.
As you say we want to buy at distress valuation and sell at overvaluation ideally. In that context, I think not all situations at compelling valuations are emotionally acceptable to all investors. Again, this is based on personal experience but I observed in certain cases the volatility in share prices do not affect as much but in others they do.

Investing is a field where we get paid for handling discomfort. So the idea here is to figure out the discomfort that one is comfortable with, if that makes sense.

On Munger, Portfolio risks and leverage:
I read somewhere that the Munger wealth is concentrated in three places : Berkshire, Costco and Li Lu investments. Berkshire is a group of dozens of wonderful operating assets, Costco is a tremendous franchise and Li Lu’s is also a collection of stock participations (I think).
So while superficially, the number of positions are few, the positions themselves are a collection of enduring assets.
In Munger’s statement, to my mind the word ‘major’ and ‘using resources available as a result of prudence in the past’ are key.
He looks at big ideas using his formidable worldview, mental models and character.

The question I ask myself is, can I honestly follow his approach like he does at my stage of intelligence, experience and character?
Then there is what he doesn’t know and what he doesn’t know he doesn’t know and how that can affect his companies. I am sure they are really different than the answer to those same questions to me. And also he invests in large businesses like the above, so they might not be as important for him as it is for me.
Given his focus on only holding on to large high quality companies forever, can I really apply his framework of position sizing to my all cap portfolio which has a different flavor ?

However if existing positions become a large part of the portfolio due to the business performing, and if there is still runway, that is a different thing. I am talking about position sizing when you build positions in the portfolio.

On leverage: This is probably very personal. For me, if I have leverage I would not sleep well. The time and mental capital would go haywire and I would not be the best fiduciary for the capital I manage.
The wish is for x to become 100x, but I am worried about what if the x becomes x/2. It is more difficult for the x/2 to become 100x.
And so I would rather focus on increasing surviving probability and expose the portfolio to bets with hugely asymmetric payoffs without leverage.


On the last part, I do not have an answer yet. Perhaps if mistakes are benefiting us, the first wish is I have the intellectual honesty to acknowledge that it is dumb luck.

On risk averse vs loss averse… That is a valid question… I do not know or have any thoughts for now…

3 Likes

Well I don’t know if I agree with this statement :smile:

As I was reading your post I couldn’t help but think of a passage from a letter I read from one of my favorite investors, Josh Tarasoff:

A truly self-sustaining portfolio—one that requires nothing of the portfolio manager—is an unconventional goal, which may not even be achievable. After all, great companies sometimes falter, stable industries eventually change, and prized investment theses can come to disappoint. Even Warren Buffett has had his blunders and misfortunes. The mighty Coca-Cola is facing the headwind of growing health consciousness, and GEICO’s venerable franchise could be significantly impaired by autonomous driving. Yet, Greenlea Lane resolutely seeks investments that we can hold (for all intents and purposes) forever.

Does it make sense to have aims so high they border on the unrealistic? I think it does. I think that aiming high can be an antidote to the uncertainty of the world and the fallibility of human beings. If we aim high enough on business quality and compounding runway, and if we raise the bar over time, then perhaps we can achieve something worthwhile even while falling short of our hopes. The goals we set could be more important than how close we get to them. Framed in this way, having lofty goals is an eminently practical approach. I think Greenlea Lane’s current portfolio is a good start, and we will use every setback (they will come) as an opportunity to aim higher.

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@iancassel… I did think you would have something to say to the nanocap comment :slight_smile:

And thank you for sharing that snippet from Josh’s letter… It is very nicely articulated…

Hopefully you would be able to share more nuggets in the future…

1 Like

I believe there is something to re-learn from Buffett’s 2 big takeaways from the Intelligent Investor.

  1. Mr. Market is manic depressive. Currently, it is depressive in a big segment of the Indian stock market. Interestingly, it is also manic in a few highly priced companies, which are therefore called ‘quality’ companies.
  2. As a shareholder, you own a part of the business.

When the tide goes out -
a) We get to see companies and management and people for what they truly are.
b) We get to see ourselves for what we truly are.

The rhymes of the market comfort me; we have new bad guys, we have new superheroes, we have a new blame game - but this happens every time. The characters and screenplays keep changing.

I like what Ian said and quoted; discomfort is a big part of being an investor.
And as Munger has said; if you cant see a 50%+ drawdown in your company’s price, you shouldn’t be part of this business in its current (long term value investing) form.

An old value investor from India once said and I paraphrase:
“Every 7-8 years, a new crop of investors gets washed away by the market, and a few survive. Your goal is to make it through the fear mongering and doomsday scenarios. And then 7-8 years later, it will happen again, and you will be surprised again.”

The rules for me:
Build a margin of safety into your price and analysis.
Beware of the pendulum of Mr. Market.
Surprises are called surprises for a reason.
Diversification is good.
A 3 stock portfolio is ok for gods like Munger, but not for mortals like us.
Management will always know how to spin stories, and will also know how to seem nice and humble and shareholder friendly.
If you lost money on a well analysed company - something was wrong with your analysis, and we need the humility to accept that.
Don’t get swayed by stories.
The market will agree with you if your analysis and reasoning are right; if it doesnt agree with you, you are the patsy.

It’s simple but not easy.
I guess we just have to work harder :slight_smile:

2 Likes

Thanks for sharing that Tirath.

I never really thought about it till recently when a friend pointed out that in most cases when Buffett talks about the tide he is talking about liquidity.