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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