Incentive Caused Bias and the Indian Politicians

Charlie Munger refers to incentive caused bias as one of the most potent of all biases that mankind is afflicted with. And we see it everywhere around us, all the time. I was thinking of this when I saw one leading mutual fund manager mention on his facebook account on the ills of the RBI not cutting rates quick enough to boost growth. He was peeved that RBI was more concerned about taming inflation than looking at industrial growth. Here, I thought, is a classical case of incentive caused bias. A fund manager, would obviously love industry to grow, so the stock market performs better and he gets a better bonus.


The non-stock-investing common people (I read somewhere that in India about 5% people invest in equities, so that leaves the the majority in this category) want higher bank deposit rates. People with home loans want their home loan rates to go down. People with cars want petrol prices to go down and those with diesel cars want diesel prices to remain where they are.


The politicians are also trapped within their own set of incentive caused biases, primary among them is winning the next election. Financial and economic propriety is irrelevant when it comes up against such a strong bias. So, who gives a damn about the fiscal deficit or the trade deficit! Most people in India wouldn't even know what these terms mean or what impact they have on their lives.


Every subsidy that the government doles out has a set of people who have very strong incentives in continuing with them, so it becomes very difficult to break the setup. As the French have shown us recently, no one likes austerity for the long-term greater good. The hell with good economics as long as we can live well now. That has been the downfall of all (atleast nearly all) great civilizations before ours. It will be interesting to see, if it is the same for us!


The only solution to this is to align long term interests of the nation to those of the elected politicians. For example, factors like reduction in absolute poverty levels (the threshold is immaterial - whether its Rs 28 per day or Rs 40 per day it does not really matter, as long as it is fixed and their is a steady decline in number  of people below it), increase in education levels at all levels (not only primary, but also secondary, college, professional and technical), healthcare availability, access to clean potable water, access to roads, availability of 24x7 electricity and other such critical parameters. If the politicians cannot deliver, then all the MPs will be debarred from contesting elections for the next 10 years. Then we shall see real progress as the ministers and all the opposition MPs will have incentives in ensuring that the country makes actual progress!


P.S. I know this will never happen and we will continue to perform pathetically in the future, just as we did in the past! But, no harm in dreaming, is there!

GuruSpeak: Charlie Munger speaks to Becky Quick of CNBC

Charlie Munger speaks to Becky Quick of CNBC.

There's Always Something To Do - (Peter Cundill) written by Christopher Risso-Gill: Part II

In Part I, I covered some of the excerpts from the life and investment approach of Peter Cundill. Here are some more.



Typical starting point for investigating stocks for investing in Cundill Value Fund:-

• Share price less than book value. Preferably, it will be less than net working capital less long term debt.
• The price must be less than half of the former high and preferably at or near its all time low.
• PE must be less than 10 or inverse of the long term bond rate, whichever is less.
• Company must be profitable. Preferably it would have increased its earnings for the past 5 years and there would be no losses in that period.
• Company must be paying dividends. Preferably, the dividends should be increasing and have been paid for some time.
• Long term debt and bank debt (including off-balance sheet financing) must be judiciously employed. There must be room to expand the debt position if required.

Once the analysis is complete and you have reached the firm conviction that an investment is right you should not try to be too clever about the purchase price. If you have to take a loss - don't dither. Learn the lessons and then forget about it..


Firstly, very few people really do their homework properly, so now I check for myself. Secondly, if you have the confidence in your own work, you have to take the initiative without waiting around for someone else to take the first plunge.


The timing difficulty in selling does not lie in not knowing when the trading discount to intrinsic value has been eliminated, but in judging by how much it is likely to be surpassed. The ultimate skill in this business is in knowing when to make the judgment call to let profits run.


Selling "formula" used in the initial years of the Cundill Value Fund:-
the fund would automatically sell half of any given position when it has doubled, in effect thereby down the cost of the remainder to zero with the fund manager then left with the discretion as to when to sell the balance.


The most important attribute for success in value investing is patience, patience and more patience. The majority of investors do not possess this characteristic. 

There's Always Something To Do - (Peter Cundill) written by Christopher Risso-Gill: Part I

I am currently reading There's Always Something To Do written by Christopher Risso-Gill. It is written on the life and value investment approach of the famous Peter Cundill, the founder of the Cundill Value Fund. Peter Cundill derived his approach from Graham & Dodd and included learnings from his informal mentor, Sir John Templeton and was one of the few extremely successful international investors.


What I am really loving about this book is that its taken from the copious journals maintained by Peter Cundill, so provides a first hand account of the thought process that an investor goes through. Typically, all other books by fund managers are written post-facto and are guilty, to some extent atleast, of hindsight bias. Here, the I could feel the dilemma that Cundill goes through at various points in his investing journey which I can related to very closely.


Here are some excerpts from the book:-

What I am beginning to perceive is that investors tend to follow trends and fashion rather than taking the trouble to look for value. This must offer opportunity for the professional investment manager, as a result of the short term mispricing of securities.

I think intelligent forecasting (company revenues, earnings, etc.) should not seek to predict what will happen in the future. its purpose ought to be to illuminate the road, to point out obstacles and potential pitfalls and so assist management to tailor events and to bend them in a desired direction. 

I believe that there is probably one opportunity in every man's life which demands his knowledge, his guts, his self-esteem and his judgment. If he seizes it with both hands and it is successful, he joins the first rank, if not he remains a mortal with feet of clay.

Some insights near the beginning of his career:

• Management's ability to predict earnings is universally poor

• It is the strategic modelling behind the portfolio that matters most.

• One needs to develop a sense of spaced maturities in a common stock portfolio in a way that is comparable to a bond portfolio.

• In a macro sense it may be more useful to spend time analysing industries instead of national or international economies.

I will follow up on more excerpts as I continue reading. So, stay tuned.

Guru Speak: Tenets for Value Investing by James Montier

I am just beginning to read James Montier's extremely acclaimed book Value Investing: Tools and Techniques for Intelligent Investment, so thought would share some of his thoughts that I had read in 2010. Important to note that how he has adapted his views on investing after 2008.


Tenet I : Value, Value, Value - Value investing is the only safety first approach I have come across.By puttig the margin of safety concept at the heart of the process, the value approach minimizes the risk of overpaying for the hope of growth.


Tenet II : Be Contrarion - Sir John Templeton once said that "It is impossible to produce superior performance unless you do something different from the majority".


Tenet III : Be Patient - Patience is integral to value approach on many levels, for waiting for the fat pitch, to dealing with the value manager's curse of being too early.


Tenet IV : Be Unconstrained - While pigeon-holing and labelling are fashionable, I am far from convinced that they aid investment. Surely, I should be free to exploit value opportunities wherever they may occur.


Tenet V : Don't Forecast - We have to find a better way of investing than relying upon our seriously flawed ability to soothsay.


Tenet VI : Cycles Matter - As Howard Marks puts it, we can't predict but we can prepare. An awareness of the economic, credit and sentiment cycles can help with investment.


Tenet VII : History Matters - The four most dangerous words in investing are "This time its different". A knowledge of history and context can help avoid blunders of the past.


Tenet VIII : Be Skeptical - One of my heroes said "Blind faith in anything will get you killed". Learning to question what you are told and developing critical thinking skills are vital to long-term success and survival.


Tenet IX : Be top-down and bottom-up - One of the key lessons from the last year (2008) is that both top-down and bottom-up viewpoints matter. Neither has a monopoly on insight.

Guru Speak: Lessons from Bruce Berkowitz

Here is a list (highlights are from me) from Bruce Berkowitz, a very prominent value investor and owner of Fairholme Capital and judged as the best fund manager of the decade in 2010 by Morningstar.

• You always have to have cash, especially when no one else has it. 
• No free lunch- it’s not free, or it’s not lunch.
• You can’t change people! You can change yourself, but not others.
• You only see reality under extreme stress- you want to get to know someone, you need to see them under extreme stress.
• Volatility is not risk!
• Always assume you will have bad luck.
• Few variables to win. Once you have to think about more than 3 variables, your odds of winning are low.
• If you have to use more than 6th grade math, you’re in trouble.

Dark clouds on the economic horizon

Let me make a confession. The last few years I have not read a single pre-budget article nor watched any pre-budget shows on TV. I have shied away from these as I have seen that the budget has been hyped up by the TRP/ratings hungry media into something which it is not. So, inevitably the budget disappoints and after a couple of days people forget about it completely.

This time looking at the macro economic scenario after the budget, I see two dark clouds on the horizon. The first is the huge market borrowing planned by the central government to the tune of 5.8 lakh crore. The second is the rupee depreciation.

The net impact of the huge government borrowing would mean that the interest rate is unlikely to come down in the near term. Even if it does, it will not be more than 0.5% to maximum of 1.0%. It will also make corporate borrowing more difficult and may push more and more companies towards ECB (external commercial borrowing). Both of this is likely to be a major dampener for corporate earnings growth.

FII net inflows into India in 2012 has been $7.16 billion as per SEBI. To put that in perspective, the FII net outflow in 2011 was $358 million. However, in the euphoria of such large doses of FII liquidity, an important point is being missed. The fact is that even with this huge inflow, the rupee has not appreciated at all. In fact, it continues to hover around the Rs 50 mark with respect to the US dollar. This means if the FII inflows weaken, the rupee can take another dive towards the 55-57 to the dollar mark.

Macro economic forecasting is a fool's endeavour and I engage only to amuse myself :-) Sometimes, though it can give some insights into the headwinds and tailwinds of the economy. At this time, I am a little bit more skeptical than six months back on the immediate economic future. I think I will have to relook at those stocks which have high FCCB/ECB borrowings and maybe shed some weight there. Good buying opportunities may be there in export oriented companies.