Friday 24 April 2020

Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week.

The interconnectedness of financial systems
Many people did not realise how interconnected the financial system was. For instance, brokers in the equity market, who rely on customers buying and selling, did not realise how much of this trading business was driven by leveraged investors in the debt market. The brokers were always good at creating noise, but now it is very quiet on the trading side. But we do know that the City never stays the same for very long. History suggests that finance will always go through cycles. My model suggests we tend to overweight recent events, and tend to play down the longer-term, historical context.

Specific curiosity is what makes the difference
Curiosity predicts creativity when it is deployed within narrow parameters, to solve a particular problem or puzzle – or, as scholars term it, specific curiosity. Creativity scholars usually focus on the curiosity that freely flits from subject to subject, tracing novel trajectories as it goes. Specific curiosity is more discomfiting, resembling an itch to resolve a highly localised point of uncertainty or challenge.
This form of curiosity can be harnessed for creative purposes through a technique known as idea linking. When people are high on specific curiosity, they don’t just generate whatever ideas come to their mind randomly. Rather, they would have an initial idea and their next idea would be built upon the initial idea without abandoning it.
The idea that stepping outside your comfort zone is a good way to liberate the creative juices provided the context is sufficiently forgiving

Do less to achieve more
To “do less” is to slow down. Focus on one activity at a time. Do less total activities. Be willing to pass through occasional interludes of full non-productivity. To “do better” is to direct your focused energy toward quality activities, when possible. Finally, to “know why” is to get at the very core of the deep life mindset. Working backwards from your values to determine your activities creates a lifestyle dramatically more meaningful than working forward from whatever seems appealing in the moment. It’s the difference between resilience and anxiety; satisfaction and distraction.
The deep life is not an ambitious one-shot goal, like completing a marathon, that you work hard at until you one day obtain it all at once. It’s a state of being with which you become increasingly comfortable. A process that starts with your mind.

Role of luck in our lives
An interview worth reading on the role of luck in our lives.
The whole process of constructing life narratives is biased in ways that almost guarantee that people won’t recognize the role of chance events adequately. So, you’ve been successful, you’ve been at it 30 years. It’s true that you’ve worked hard all that time, you got up early, you put in a lot of effort, those memories are all very plentiful and available in your memory bank. You’ve solved lots of difficult problems. You remember examples of those, too. You know the formidable opponents that you’ve vanquished along the way. How can you forget them?  So, if somebody says, “Why did you succeed?” those things are going to get top billing in your story.
Maybe there was a teacher who helped steer you through trouble in the 11th grade. You don’t remember that. Maybe you got a promotion early on when one of your colleagues who were slightly better qualified had to turn it down because he had to stay and take care of an ailing parent. You don’t remember that either. Then there’s all this work on the asymmetry of memory.
You’re running into the wind, you’re keenly aware of it every second. You turn the corner and the wind is at your back. That’s good. You like that. But then two minutes into the return course you’ve forgotten completely about the fact that you’ve got something helping you along. Because a headwind is something that you have to work actively to overcome, you almost can’t fail to notice it. But a tailwind helps you along; it’s out of your field of vision mostly. You don’t think about it because you don’t have to think about it.

The best appreciation is when your competitors applaud
Over 20 years of watching different businesses -- incumbents like Blockbuster and Walmart and all these companies -- I’ve never seen such a good execution of the incumbent learning the new way and mastering it.
Netflix CEO Reed Hastings is a big fan of Disney+. 
Disney announced its flagship subscription video service, Disney+, has gained more than 50 million subscribers in just six months since the service debuted in November. Hastings called the rapid accumulation of subscribers “stunning.” Disney+ costs $6.99 per month and is the home for Disney’s large archive of movies, including Marvel, Pixar, and Star Wars films, along with other original content.
“To see both the execution and the numbers line up, my hat’s off to them,” Hastings said. “Great execution, clarity around brand and focus really makes a difference.”

Friday 10 April 2020

Weekend Reading

Reading across disciplines is one of the best ways to improve our investment acumen. Here is a summary of some of the best articles I read this week.

Get back the lost art of reflection
A focus on information processing, reaction, and execution — while it may feel productive — causes the quality of our thoughts to suffer.
In reflective thought, a person examines underlying assumptions, core beliefs, and knowledge, while drawing connections between apparently disparate pieces of information. 
Time is a precondition for slow thinking. To develop a routine, time for reflection should be a regularly scheduled and a protected event. A list of divergent questions can be a very useful tool for elevating oneself above tactical considerations.

The Chinese have been focused on creating their own narratives
For decades, Beijing’s approach to shaping its image has been defensive, reactive and largely aimed at a domestic audience. The most visible manifestation of these efforts was the literal disappearance of content inside China: foreign magazines with pages ripped out, or the BBC news flickering to black when it aired stories on sensitive issues such as Tibet, Taiwan or the Tiananmen killings of 1989. Beijing’s crude tools were domestic censorship, official complaints to news organisations’ headquarters and expelling correspondents from China.
But over the past decade or so, China has rolled out a more sophisticated and assertive strategy, which is increasingly aimed at international audiences. China is trying to reshape the global information environment with massive infusions of money – funding paid-for advertorials, sponsored journalistic coverage and heavily massaged positive messages from boosters. While within China the press is increasingly tightly controlled, abroad Beijing has sought to exploit the vulnerabilities of the free press to its advantage.
In its simplest form, this involves paying for Chinese propaganda supplements to appear in dozens of respected international publications such as the Washington Post. Meanwhile, in the US, lobbyists paid by Chinese-backed institutions are cultivating vocal supporters known as “third-party spokespeople” to deliver Beijing’s message, and working to sway popular perceptions of Chinese rule in Tibet. China is also wooing journalists from around the world with all-expenses-paid tours and, perhaps most ambitiously of all, free graduate degrees in communication, training scores of foreign reporters each year to “tell China’s story well”.

Re-ordering of supply chains are starting
Japan has earmarked US$2.2 billion of its record economic stimulus package to help its manufacturers shift production out of China, as the coronavirus disrupts supply chains between the major trading partners.
The extra budget, compiled to try to offset the devastating effects of the pandemic, includes 220 billion yen (US$2 billion) for companies shifting production back to Japan and 23.5 billion yen for those seeking to move production to other countries, according to details of the plan posted online.
The move coincides with what should have been a celebration of friendlier ties between the two countries.

A primer on electric cars
Electric vehicles or EVs may just be the single largest disruption to hit the car industry in its 133-year history. No, the world may not be moving as fast as initially expected towards e-mobility, and there still are massive hurdles to overcome. But as Victor Hugo said, “nothing can stop an idea whose time has come.” 

A slightly detailed look into the next in battery technology
Despite over two centuries of close study since the first battery was invented in 1799, scientists still don’t fully understand many of the fundamentals of what exactly happens inside batteries. What we do know is that there are, essentially, three problems to solve in order for batteries to truly transform our lives yet again: power, energy, and safety.

Monday 6 April 2020

Using Stop Loss in Investing

Should you have a stop loss if you are an investor? That is the question I have have been trying to answer for myself. I have been dabbling with various quant systems and obviously stop losses is a part of the thought process in any trading system.

Stop loss is a simple yet extremely powerful concept. It can protect you from major catastrophes that can completely erode your portfolio to protect a large part of gains made (when used as protective stops). It is part of the "money management" or "allocation" strategy followed in trading systems.

Money management is perhaps one of the most important things that I learnt while studying quant systems. And I find that not knowing it was stupid. Every investor MUST know about money management and adapt it to their own investing style. More on money management later.

There are only 2 types of stocks - trending and mean-reverting. 

Trending stocks are those that follow a trend (it keeps going up or down over time - since we are usually all long-only investors I will talk about price rise trends). The rising price trend is usually but not necessarily improving fundamentals like earnings. Examples are many like Pidilite, Asian Paints, HDFC Bank etc.

Mean reverting stocks are those where the prices keep oscillating about a mean position (which also tends to slant upwards but at a much lower slope). Practically, most stocks belong to this category. 

Stop loss should be used differently for the 2 types of stock. 

If you have bought a trending stock, a stop loss is a must. It helps in preventing massive losses in case your thesis is wrong or there is a major market correction. It also prevents in locking in gains by the use of a trailing stop loss. (A trailing stop loss is one where you keep raising the stop price as the price of the stock keeps going up). If you have bought a trending stock at 100, and it falls to 80, the trend is possibly broken and you need to reevaluate your thesis and hence get out of the position. Exactly, the same situation with a trailing stop. It gets hit when the trend reverses.

On the other hand, if you have bought a mean-reversion stock, where you are expecting a change in fortune, then a stop loss initially is a STUPID idea. This is precisely why Warren Buffett or any other value investor do not use stop losses. Value investing, by definition, is a mean-reversion strategy, where you are expecting the price of the stock to revert back to its mean "value". In a mean-reverting stock, let's say you have bought it at 100 and expect it to revert to its intrinsic value of 150 in some time period. Now if the price falls to 80, ideally your philosophy should drive you to buy more at the lower price since you are now getting a better bargain and potentially more profits when the stock does mean revert.

How to set stops?

There are many ways stops can be put. Unfortunately, there is no correct way. Different people use different methods based on their trading style, capital at risk, investment horizon etc. Some basic strategies are:
1) Using a fixed percentage stop loss (say 10% or 20% from buy price)
2) Based on technical chart patterns (support levels, breakout levels, gaps etc)
3) Based on statistical indicators (Fibonacci levels, moving averages, ATR etc)
4) Volatility based
5) PE based (exit at x PE)
6) Growth level based (if earnings growth falls below x% for 2 quarters in a row)
7) So on and so forth...

Stop levels need to be in line with your capital and time horizon. If you keep a 5% stop loss and your a long term investor, you will get stopped out 99% of the time. You need to understand the volatility of the particular stock and make sure you do not get stopped out under normal market gyrations. However, if you are a day trader and are trying to make 1% return from the stock, even a 1% stop loss may be way too high.

Portfolio level stop loss vs individual stock stop loss

The next problem is whether to have an individual stop loss for a stock or a stop at the portfolio level. Again, like in nearly everything in life, the answer is "it depends". Individual stop loss, in my opinion, should be more liberal, if you are a long term investor. Something like 30-40% or even 50%. But if you combine it with a market level stop loss, then it could get triggered at a lower combined level. 
For example, say you have bought a stock at 100 and you have a 30% stop loss on it. You expect the stock to double in the next 4-5 years. When you bought it, the Nifty was at 11,000. Now, the markets start tanking and Nifty falls to 8800, which is a 20% loss on the index. Now, if you have a complex stop loss which takes both individual stock price and the index price, then you could actually be stopped out of the position even without the individual stock not having lost 30%.

Single or Graded Stops

You can use either single stop loss to get out of your entire position or graded stop loss to get out gradually. Example: Sell 50% at a 20% stop, and then 10% every 5% fall.  

Does a stop loss reduce drawdowns or lock-in losses? What is the impact on profits?

This is the most crucial question that very few people actually ask. I have been dabbling with this for a while now. **Stop loss in my studies, nearly always, reduces returns.** Obviously, there are many assumptions that have gone in the data studying primary amongst which is that you are not a very poor stock picker and you make reasonable profits when the markets are doing well. If you are not sure if you are a good stock picker, then use a stop. It is like a helmet. It will save your life if you crash.
However, if you are a good stock picker and have a good track record, 9 / 10 times your stop will get hit and the stock will recover ground post that. Only in very very rare cases like a DHFL or a Yes Bank would it protect you immensely. But then again, if you were a good stock picker you would have gotten out of those even without a stop loss. 

Is a stop loss strategy a behavioural strategy more than a money management strategy?
A stop loss is mostly a behavioural strategy. It is also a strategy for those who do not know the stocks they are buying so in a way it is ignorance insurance. It protects you from the unknown and from making stupid catastrophic mistakes. 

BOTTOM LINE: Since the world is dynamic and you can never know everything about everything, having an exit strategy is important for all your investments.  Stop losses are part of that exit strategy.

Friday 3 April 2020

Annual Performance Review - Intelsense Model Portfolio

We completed 1 year as an advisory on 31-Mar-2020. What a year it has been. Something we are unlikely to forget in our lifetimes. I am sitting at home as part of the unprecedented countrywide lockdown and writing this note.

First the performance.

Model Portfolio
Nifty 500

The report and some thoughts are available here.

Stay indoors. Stay safe.

Thursday 2 April 2020

Weekend Reading

I am tired of Coronavirus related topics. So, completely avoiding them.

Forecasting and the stories we tell ourselves
Ample research shows that most experts do not make great forecasts. This might appear to be a problem if you are in the business of making predictions. But it turns out that the ability to explain what happened after the fact, often in a way that flatters your faulty prediction, is an incredibly effective coping mechanism. Barbara Mellers, a professor of psychology at the University of Pennsylvania, says, “We find prediction really hard, but we find explanation fairly easy.” We tell stories to ourselves and others to paper over our poor predictions.

The story of Hidesign
For a long time, Dilip Kapur thought international affairs was his calling. He moved from Pondicherry (now Puducherry), to the US to do a PhD in international affairs. But life had other things in store for him. While doing a part-time job at a leather factory, Dilip fell in love with leather. After completing his studies and returning to Puducherry, Dilip started making leather bags as a hobby. His time at the factory taught him all he needed to know about making leather bags. Dilip started sourcing leather from Chennai and started making hand-crafted leather bags in Auroville.
By 1988, Hidesign had ventured into garments, with leather jackets and long pants. The UK market couldn’t get enough of Dilip’s leather bags. Hidesign was soon present across 700 stores in London.
Dilip’s company now clocks Rs 170 crore gross annual revenue and has 1,400 employees. It has evolved from a leather goods maker into a lifestyle brand with presence in exclusive stores, airport stores, shop-in-shops, multi-brand outlets, and ecommerce platforms. It claims presence in 102 exclusive brand outlets and 112 large format departmental stores. Hidesign’s product portfolio comprises ladies’ bags, men’s bags, wallets, belts, shoes, sunglasses, luggage, and jackets. The ladies’ bags and men’s bags are its top sellers.

Reading fiction is more important than nonfiction
When it comes to reading, we may be assuming that reading for knowledge is the best reason to pick up a book. Research, however, suggests that reading fiction may provide far more important benefits than nonfiction. For example, reading fiction predicts increased social acuity and a sharper ability to comprehend other people’s motivations. Reading nonfiction might certainly be valuable for collecting knowledge, it does little to develop EQ, a far more elusive goal.
One reason fiction works so well in the workplace is that characters, plots, and settings in foreign locales help anchor difficult discussions. The narrative allows participants to work through sensitive and nuanced issues in an open and honest manner. Also, research suggests that reading literary fiction is an effective way to enhance the brain’s ability to keep an open mind while processing information, a necessary skill for effective decision-making.
Research on reading shows literature study to be one of the best methods for building empathy critical thinking, and creativity.

Industry matters more than the business
What if Federer played badminton? He would face Lin Dan, the champion in that sport. Each man may be the best ever in his respective game, and both are extremely marketable, with competitive instincts and personal charm. But Dan doesn’t make anywhere near what Federer does—and he never will. That’s because Dan has an “industry” disadvantage. A Top 10 tennis player makes 10 to 20 times what a Top 10 player in any other racket sport earns.
Likewise, a company’s choice of industry matters a great deal—more than many realize. When we tracked the economic profit of the world’s 2,393 largest companies over 10 years, we found that about 50% of a firm’s performance compared to the broader corporate universe is driven by what’s happening in its industry, highlighting that “where to play” is perhaps the most critical choice in strategy. Your industry trend is the single biggest factor shaping your odds of outperformance.

How meditation changes the brain
MRI scans show that after an eight-week course of mindfulness practice, the brain’s “fight or flight” center, the amygdala, appears to shrink. This primal region of the brain, associated with fear and emotion, is involved in the initiation of the body’s response to stress.
As the amygdala shrinks, the pre-frontal cortex – associated with higher order brain functions such as awareness, concentration and decision-making – becomes thicker.
The “functional connectivity” between these regions – i.e. how often they are activated together – also changes. The connection between the amygdala and the rest of the brain gets weaker, while the connections between areas associated with attention and concentration get stronger.