LIMITS ON COPING – 15 – MASTERING THE MARKET CYCLE

We have seen superior results with superior insights. But for getting these skills, we also need to know the limitations and how difficult it is to acquire them.

If we are going to identify what will be going to happen tomorrow or the day after tomorrow or next week, next month then we are not going to get success in identifying cycle. Identifying cycle is never easy, it requires a greater effort to capture a cycle in a better way which provides us with an advantage.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

CYCLE POSITIONING – 14 – MASTERING THE MARKET CYCLE

It is always important to be defensive and aggressive over a different period of time. We cannot be defensive for every time or aggressive all the time. The most important is when we should become defensive and when we should become aggressive, it matters a lot. If we become defensive at the bottom of the cycle and aggressive at the top of the cycle then it will be dangerous for our wealth.

We require aggressiveness, timing and skills for achieving success. Aggressiveness at the right time creates a fortune.

For getting success, we have to focus on key elements mentioned by Mr Marks.

• Risk in our portfolio in the cycle, which assets we are holding in the portfolio and among those which are overweight or underweight.
• Aggressiveness such as holding second-grade assets, leverage, macro dependent investment, putting more capital at risk. Defensive investment such as holding cash than securities, safer assets, avoid leverage. Selection from above both depends on where we stand at the cycle and what can be a future market development.
• The skill requires to make a balanced decision. Luck required when randomness has more effects on the events. Skills help us to make a decision in the portfolio but luck can fail our right decision or proven to succeed in our wrong decision in the short run. Skills win the battle in the long run.

When we found that we are positioned in the cycle where pessimism at lowest, the economy has better development, etc. and we have become aggressive towards portfolio positioning then it will reward us with greater profits while the market does well as per our assumption. And also incur losses if the market does not work as per our assumption.

Being right is not into the control of anyone due to the involvement of randomness and luck factors.

When we found that the economy started being optimistic, the psychology of investors started optimistic, good news started flowing then we need to cut position in our portfolio which we feel overpriced. This effort helps us to reduce risk when slowdown or recession occurs. But this decision requires a skill set otherwise we will underperform the market at whole.

We always have to keep in mind that when the market is low in the cycle then the probability of losses is low and the probability of making profits is higher. Reversely, when the market is high in the cycle then the probability of incurring losses is higher and the probability of making profits is lower. We cannot predict the outcome but we can take advantage of the cycle by making an assumption of it.

After identifying the market cycle, we need to make a selection of the assets. If the price of the asset is lower compared to its intrinsic value then it will do better than other assets. And if the price of the assets is higher compared to its intrinsic value then it will not do much better than other assets. We also should focus that whether the intrinsic value of the assets has scope for further growth or not.

Theoretically, it quoted that the market is efficient and all the information is available with everyone so that no one can make profits from it. But reality shows something different. It shows that few people can think differently from the crowd and get above average than all. This is called second-level thinking where we need to think wise and differently from the crowd. Those who use second-level thinking they can do above average than consensus. This is key to assets selection.

Winners have a tendency to fall less than the market and during the rising market, they meet the market. And those who do not have a skill, they fall more than the market and does not have a higher return when market raises.

Aggressive investors with superior insights, fall slightly more than market in falling time but raise more than market in good time. Whereas defensive investors with superior insights, outperform in the worst time and underperformed the market in good time. We need to keep a balance between both. The person who can make a balance between both aggressive and defensive with superior insights, that investors outperform the market at the worst time as well as in the good time also.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Checklist about market cycle – 13 -MASTERING THE MARKET CYCLE

We cannot predict the future and cannot see the future so that can we prepare for the future? How can we be positioning our investments? Answers to these questions lie in the understanding of the cycle and at where we stand at the current cycle.

It’s not always what we buy that matters but at what price we are buying that matters a lot.

These checklists help us to an understanding regarding cycle and where we stand at the cycle. That understanding helps us with what we should do and what can be the portfolio positioning. These checklists also help us to remove some mistakes such as buying little when risk is low so that capital allocation decision also can be improved. The capital allocation also one of the key elements to becoming a successful investor.

We all see the everyday events which were covered by the media but we also need to put effort to understand that what it is going to indicate to us. These efforts help a lot to us. I got saved in recent market turmoil due to understanding of the cycle which I have practised after reading “The Most Important Things”.

I want to quote my learning from the most important things here to explain this concept with a few additions.

The earlier scene in the year 2017-18

The current scenario in the year 2019-20

We need to focus on the current scenario what it is indicating to us, not to worry about the future. If the current scenario tells us to stay away and we are into the third phase of the bull market then we need to adjust our portfolio accordingly. And if the current scenario suggests the third phase of the bear market then we need to adjust our portfolio positioning accordingly. We cannot track each and every information flowing around the world but we need to understand which of them are important and help us to reach the conclusion.

When market and psychology of the investors flying then do not care for the valuations. People argue that old valuation techniques do not work in the current period. Another argument is that we should look at the business, not stock so that valuation does not matter. But what happens to this logic when bear take a charge?

Old technique again starts taking place. Higher P/E looks as an unhygienic for the health of the portfolio and low P/E tempted to the investors.

We can see that during the bull period even non-qualitative companies also traded at the multiple of quality companies.

There are qualitative and quantitative two phenomena which we can study to understand where we stand in the cycle. We always need to ask the question to ourselves how the assets priced and how the investors around us behave? That means the quantitative part refers to the valuation of the assets. And qualitative part refers to the behaviour of investors around us & understand it.

Example – one of the E-Commerce company of India

When the market is booming, the psychology of investors is positive, economy growing, people are eager to make an investment then low-quality securities also getting issued by providing a better rating.

We have to be contrarian, have to learn to go against the wind prevailing in the market.

When market falling, people tend to stay away from it. They argue that keep away from catching a falling knife. But when dust gets settled and we realize that the final bottom has made, a bargain will also be gone.

There is no way to know when and at what price exact bottom has made. We come to know about the bottom only after it has made.

We should avoid buying with leverage money because when pendulum moves towards extreme pessimism then we cannot able to know where it will stop and we get a margin call, due to the leverage. We get a disastrous outcome of such an act.

John Maynard Keynes is reputed to have said: “The market can remain irrational longer than you can remain solvent.”

When the economy is in a troublesome period and investors psychology also negative then only, we get a good asset at a bargain price.

We have a two-risk scenario – one is a risk of losing money and the other one is a risk of missing out an opportunity. Investors have to make a balance between the risk. When market moving higher in the cycle, we have to focus more on the risk of losing money and when market-moving lower in the cycle, we have to focus on the risk of losing the opportunity. When there is a high chance of losing money then we have to play defensively and when there is a chance of missing out an opportunity then we need to play aggressively.

The cycle is going to happen and how we respond to it is the key matter. Successful investors are those who have survived under the different market cycle and that cycle makes them more thoughtful.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

INNOVATOR, IMITATOR, AND THE IDIOT — 12 – THE MARKET CYCLE

As an investor, we have to deal with the prices of assets and evaluate where currently its standing and what can be in the future. Prices of assets are getting affected by fundamental and psychology.

Psychology of the people does not remain the same forever. It will change for any of the reasons for millions of reasons.

Rising prices of the assets make investors’ psychology in the optimistic area and falling prices of the assets make investors’ psychology in the pessimistic area. The reason and result for the occurrence of the cycle do not remain the same with all the cycle but it is sure to a repetition of a cycle. Performance numbers are already recorded and sometimes, we require skill to understand it thoroughly. This is a past and we are not able to predict the future. It is essential to roughly think about the future to protect our investment. Second-level thinking also help us to understand the psychology of the market participants and act according to our conclusions.

There are few factors which influence and force cycle to occur.

Confirmation bias where investors seek for a piece of information or events which supports the thesis or not.

The tendency toward non-linear utility where we value a money loss is far greater than money made.

The gullibility is which influence the investors to swallow tales at good times which have the potential to gain at a good time and the excessive scepticism that makes them reject all possibility of gains in bad times.

Risk tolerance and risk aversion which investor ask for risk premium for the incremental risk.

Herd behaviour indicates to act with keep in mind that what the other people are doing.

One of the highly influential bias is to see other people making money with the idea which we have rejected initially. We do not resist such situations and left with the buying those assets which resulted in a boost to the asset bubble. Also, we generally do not select an unpopular idea and prefer to go with the herd.

All such biases lastly transform into the greed for more, envy of the money others is making, and fear of loss.

A bull market where prices of assets risen, rising or will raise and bear market where prices of assets fallen, falling or will going to fall.

But there are three-phase of the bull market –

In the first phase, growth and better improvement are invisible to most of the investors. Because it does not have a huge price appreciation, also occurs after the crash, wipeout of the prices has affected the psychology of investors.

In the last phase, prices of assets have risen, improvements are visible & started a long back. This improves the mood of the market and investors where they are ready to pay any price for the assets.

It is obvious that those who buy assets in the first phase, those got assets are at bargain prices and the probability of making money is huge. Whereas those who buy assets are at last phase then assets are available at costlier prices so that probability of losses are higher.

 “What the wise man does in the beginning, the fool does in the end.”

Warren Buffett has said much the same thing even more concisely: “First the innovator, then the imitator, then the idiot.”

As we have seen three phases of a bull market, there is also a three phases bear market.

We have to see the problem behind the scene. Because an excess of good things always invites trouble. And an excess of pessimism gives birth to the new era of optimism. We need to focus on each little thing happening into the surrounding which helps us to recognize problem or opportunity earlier than others.

People always get pain when they see others are making money so that they fear continuing of trend and they will miss out on an opportunity. Thus, they also join the trend. Such influence affects the investors who have rightly enter at the first phase and by affecting the psychology, they again enter the last phase where they involve doing the wrong things. The most brilliant person also can fall under such psychological influences.

We also have to understand that the bubble is not always where the market raises and also not bust where the market falls.

If the company is good in quality then also it has taken around six years to reach the same price but if assets are not good quality then it gets disappear after the bubble get burst.

No assets are good enough that it will never be going to become overvalued. Price does not matter and borrowing money to make an investment are a sign of building a bubble. I have met a few of the people who take a loan on credit card, use credit period to trade in the market. Such is a sign of the bubble. This was an incident of late 2017 and starting of 2018.

We can see that good news, maximum availability of the credit, maximum optimism in psychology, maximum prices, minimum potential returns, etc. All come at the same time, which is a signal for the identification of the bubble.

Reversed to the top, the bottom has an inability to get credits, falling in the asset’s prices, maximum pessimism, bad news flows, minimum risk.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

03 – THE REGULARITY OF CYCLES – Mastering The Market Cycle

The world is full of randomness and people behave differently at different times so that it is difficult to predict the exact future. If we study the science and mathematics cycles then those have predictable sets of rules and moves in a regular way. But economics, companies, and participants are relying on the psychological influences so that they do not behave in a regular way. When emotions have an involvement then things become more difficult to predict.

So that Greed and Fear of the investors remain regular in every cycle. This affects the prices of the assets.

As per the Cambridge dictionary, the definition of cycle “a group of events that happen in a particular order, one following the other, and are often repeated.”

We can see that many factors affect the occurrence of the events and that makes it difficult to predict the exact for the future. Current global scenario, we have an ample number of factors that can affect the cycle such as crude, the decision of the USA, domestic economic conditions, etc.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Mastering The Market Cycle – 01 – WHY STUDY CYCLES?

After the completion of the Bibliophile series on the book “The Intelligent Investors” by Mr. Benjamin Graham; I am hereby starting a series on the book “Mastering Market Cycle” by Mr. Howard Marks. I have already completed bibliophile series on his first book – “The Most Important Things”. He is one of the investors to whom I admire and learn about the cycle and always get to protect my wealth while nobody thinks about it.

As the cycle getting change, our odds also start getting change. It is mainly depending on our position to the cycle at where we stand to the cycle. If we are standing in a favorable position then we can increase our bets and reap the benefits of the cycle. Similarly, in unfavorable situations, we can protect ourselves from unfavorable changes in the cycle. If we are standing at unfavorable situations then we can adjust our position.

If we have the same information as others have and we analyze as similar to them then we cannot outperform the mass. Consistently outperform the mass is already a difficult task to perform.

Mr. Buffett has mentioned regarding the desirable piece of information – it has to be important, and it has to be knowable. Macro definitely affects the market so knowing it helps. But for consistently outperforming through knowing macro is difficult.

When we are constructing the portfolio then we generally look at the difference between price and value. Also, we bought the company which has the highest value I. E. Company available at a discount to its value.

So, does it not look at the quality of the company?

Yes, it is right that for successful investing, we need to identify the company which understates the value proposition. Higher the upside, we can take a position accordingly. But if we adjust our position as per the upcoming market storm then it can be more profitable and can add further value to our investment journey. This estimation of the upcoming market situation helps us with the decision making to remain aggressive or to be defensive in our portfolio. We only make an aggressive /defensive decision when we know the investment environment and where we stand in a cycle. When we get investment opportunity at cheaper, discounts to value then we should be aggressive and when getting expensive, then we should be defensive.

Similar we can do for the midcap and small-cap universe. And prepare ourselves from an upcoming cyclone.

We all talk about the risk but what actually risk mean? It can be loss of capital, academic says the risk is volatility in the price of assets. So, Mr. Marks has explained the types of risks in a good manner.

Opportunity loss, this is a missing out a potential gain, our investment has underperformed compared to what we missed and things do not happen the way we want it.

Risk means the occurrence of more things than we have predicted. If we know what is going to happen then there will be no uncertainty or not any risk. And if things are certain then we also get certain returns such as bank deposits. We cannot surely know the outcome of the events but we can assume the probability of the occurrence of the events. We assume the probability of the events that does not mean that we know the occurrence of the events. Anyone event can occur out of the many events. When we do not know the occurrence of the events, then we do not have an edge and we have to stay depended on luck. When we have the knowledge of the occurrence of the events then we have an edge and winning probability will increase with lower down losing probability.

Superior investors are attentive to cycles and they capture the cycle for reaping profits.

When a cycle is in our favor, we can earn good profits by taking benefits of it and visa Versa, when the cycle does not favorable to us then we can protect ourselves for loss of capital.

When cycle at extreme of Greed then we have to protect ourselves from capital loss. There will be a higher chance of incurring losses rather than earning profits.

If we look at the P/E of Midcap and Small Cap index during the year 2017-18 then on the closing basis it was 37.22x and 86.19x respectively and high P/E of both during the same period was ~47x and ~114x respectively. At such valuation, we are not ready to buy a few growing large caps but having a huge hope of getting a return at such high valuation and transformation of small-cap as a future large cap. So that such a scenario is for protecting capital rather than chasing high returns. I had parked ~73% of my portfolio in the liquid fund during the same period which has helped me to survive in such cyclone. We need to focus on the cycle, pendulum where it is moving and where we stand in the cycle.

When in a similar cycle economy, corporate profits and prospects remain the same but pessimism among the participants provides an excellent opportunity to make an investment, increase our position to be more aggressive. And when the economy, corporate profits, and prospects remain the same but having a huge optimism among the participants then we should adjust our position as a defensive investor.

When our position in the cycle changes, our odds also get change and if we do not change our investment accordingly then we miss the opportunity to enhance return or protect capital.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

One of the books which have influenced me and my investment journey is “The Most Important Thing by Howard Marks”. This book teaches us the most important thing which we need to develop for becoming a wise investor.

“The Most Important Thing” has many concepts which can help us to our investment journey. I have posted articles on the book. Now, I have compiled different articles into the one file for the ease of reading.

For, All in One Article click – BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “ADDING VALUE”

If our target is to achieve returns similar to the market returns with the similar risk & reward scenario then it’s not a difficult task. We just need to buy an index fund. But if we want to add a value to our targeted returns, different risk & reward scenario then we require a superior investment skill, superior insights which we have seen in second level thinking.

For the understanding, what actually mean for skillful investors to add value, we need to understand Beta – portfolio’s relative sensitivity to market movements. And Alpha – ability to generate performance unrelated to the movement of the market (I.e. personal skills).

While we are active investors then we have a number of options available to us.

1) We can decide that whether to build aggressive or defensive portfolio compared to the index, such characteristics of the portfolio is for temporary situations or for permanent. If we build an aggressive portfolio then it will increase a systematic risk of the portfolio that is beta.

2) We can make a decision to get deviate from the index. We may buy few index stocks and exclude others or add stocks which are not the part of the index. As such portfolio gets diverted from the index so that return of portfolio also get deviate from the index. But in a long-term, the return of investors with superior insights will cover index return and can able to add value in terms of risk-reward scenario.

If we are managing our portfolio actively then we require having a second level thinking skill. If we do not have such superior insights then it is advisable to go with a passive investment. We need to shift a portfolio from aggressive or defensive as per the surrounding situation and need to avoid a frequent trades with the belief of generating a higher returns.

Different active investors hold different portfolios, some of those portfolios perform better than others portfolio, and some of the portfolios perform well during some particular time period. In a longer-term, active investors with superior insights can able to generate an above average risk-adjusted return. Combination of all different active portfolio reflects market behavior but in fact, all of those portfolios having different features.

Aggressive investor’s portfolio can able to generate a higher returns compared index in a good time and lose more compared to the market in a bad time. This volatility is measured by beta.

If the Investors who generate higher returns with risky portfolio compared to other investors who generate average returns with low-risk portfolio then always we need to put more emphasis on the risk-adjusted return. But we cannot quantify each and every risk involves the portfolio. So that we need to accept that investment skills having an existence though everyone does not possess it.

If we don’t have any investment skill then we can able to achieve index return by making an investment in the index fund. Some of the investor’s portfolio fluctuates more compared to benchmark and few of the investor’s portfolio moves near to benchmark returns and few others can able to control risk and fall less. We get a different result at the different market scenario but our core focus should be on controlling risk and able to generate a risk-adjusted return.

In bad years, defensive investor’s lossless and in good years, aggressive investors make more money. So can we say that they are adding value? We cannot able to say anything about the value added by just seeing to the one-year performance of any investor. We can able to see the value added in a long term only.

Mr.Buffett, Mr.Howard Marks have mentioned that they like to increase average in good years and fall less in bad years. This provides them an advantage to adding value over a longer period of time. Protecting ourselves against the worst period is essential compared to the beat into the good period.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “AVOIDING PITFALLS”

We have seen in all article series of “The Most Important Thing” that Mr. Howard Marks is always keeping focusing on the avoiding losses. If we can able to avoid losses then our investment success will come to us.

When we are going to focus on the risk and avoidance of risk then there is a chance of under-performance of our investment portfolio during the bull phase of the market. But also we can able to get protected from the worst situations coming into the future. We can able to get survived into the market for a longer period of time.

For avoiding losses, we need to avoid the pitfalls which invite the losses. And sources of pitfalls can be analytical/intellectual or psychological/emotional.

Looking at the analytical/intellectual error – such error occurs while we collect too less information, uses wrong analytical methods, wrong approach, computational error, etc. Such errors wrongly direct the result and tend us to make a wrong decision.

One type of analytical error which is called by Mr. Howard Marks is “Failure of imagination”. This error means we cannot able to imagine or little in imagine full range of outcomes or not understanding consequences of occurrence of the extreme events.

“Failure of imagination” is the inability to understand the different range of outcomes in advance. In investing, we need to be dealing with the future and many a time, we try to assume that future will be similar to the recent past.

Most of the time future looks like the past so assuming it does not harmful to us. But what happens while future will not repeat the scenario as similar as happens in the past, either we have to lose huge money or no money made by us.

Events might occur or might not occur or it take times to occur compared to what we have assumed.

While we largely depend on the certain outcomes to happen in our investment then not occurrence of those events can kill our investment. So that we should always try to focus that if certain events do not occur then also we should not lose our huge money. We should focus on controlling our risk.

During sub-prime crisis also things do not work as it should work which resulted in a global meltdown. During sub-prime also investors believe that risky situations do not go to happens and securities are backed by assets based mortgage which encourages the risky behavior of investors. Majority of the investors did not expect that value of backed assets also can befall.

We should make an investment which can protect us against deflation and hyperinflation situations. We should not always a stick to the cash, treasury or gold to avoid pitfalls. But as a when requires, we should shift from defensive to offensive and offensive to defensive.

It is important to avoid pitfalls but there must be a limit which differs from each and every investor.

Psychological factors are most interesting sources of investment error. These factors tend to extremely high or low prices of an asset, sometimes very irrational. (My Article on Psychological errors – BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “COMBATING NEGATIVE INFLUENCES”)

One of the psychological factors is GREED. Excess of greed tends to be higher security prices. We want to make a more money and for that, we keep on buying an asset though it’s price trading at a higher range. We believe that assets will keep on appreciating into the future.

The second psychological error can be an error of not noticing. Sometimes we have a plan to steadily invest in the stock market. And we ignore the undisciplined buying by others has created a boom.

The third error can be not consistent with doing a wrong thing but failing to do a right thing. Average investors just being a fortunate enough by avoiding pitfalls. While superior investors avoid it and also take an advantage of it.

Our psychology resists us from accepting novel rationale and keep believing that “It’s different this time.”

The way pendulum swings, people forget to be skeptical every time rather believe that things keep on doing well.

The combination of Greed and optimism lead us towards the adoption of strategies which provides a higher returns without taking a higher risk. Pay higher prices for the securities with the hope of still left with an appreciation.

Just knowing about the pitfalls provide helps to us to some extent but the implementation of it leads towards success.

We should always learn the lesson and remember it throughout our journey. Mr. Howard Marks pointed out eleven lessons such as –

We should always be focusing on the things surrounding us. Excess supply of investment funds will lead to the situation called – “too much money chasing too few ideas”. Such situations can be dangerous for our financial health and we need to be careful during such situations.

When people become careless, investors not worried or skeptical about events, everyone becoming more bullish, increasing leverage. But we have to always keep in mind that such scenario will be going to reverse, it will never remain forever of the same magnitude.

It is near to impossible to avoid downfall but we can able to reduce our pain.

When we loss less than others then it provides a benefit to us such as we can able to maintain equanimity with others, able to avoid a psychological pressure and can able to generate higher profit by buying at a lower price.

Surviving during the declines provides us an opportunity to buying an asset at the low price. But for achieving success through this formula, we need to avoid pitfalls.

The way errors can appear to us is infinite but some of them are quoted by Mr. Howard Marks. Such as data or calculation error in the analytical process, ignoring the full range of outcomes or probability of occurrence of events, psychological factors (I.e. greed, fear, envy, ego, etc.), extreme risk-taking or risk avoidance behavior, etc. The second level thinkers can able to understand errors and also can able to detect over or underpriced assets. They can take a proper benefit of it and also take benefits of errors from others.

Errors are moves around us, sometimes assets prices reach a higher level or reach the lower level, sometimes such extreme scenario happens with entire market, sometimes to individual securities. Sometimes an error occurs while we do something and sometimes doing nothing leads to an error. So that error is around us and without any errors, there will be no occurrence of any events.

All above-discussed points don’t indicate rules for avoiding pitfalls but it provides us an awareness, flexibility, adaptability, and mindset to take the cue from our surrounding environment. There are times where few of our acts resulted in errors.

And sometimes reverse to such acts.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “INVESTING DEFENSIVELY”

Whenever someone asks us for an investment advice, then our first step must be an understanding his attitude towards the risk and return. We need to ask a question to him that what his choice – making money or avoiding losses is.

We cannot able to do both the things simultaneously in each and every situation.

If we provide an advice or we make an own investment without knowing attitude towards risk and return then we will not able to provide a proper solution. This is as similar as an asking for a cure from a doctor without disclosing our diseases to him. Investing is a full of bad bounces, uncertainty and random events which challenge us every time. So that such uncertainty requires knowing our risk-reward attitude for long-term survival into the market.

While we hit fewer losers then our probability to win the game is much higher. We need to choose how to play the game of investment – Offensive or Defensive.

We just need to do is to protect our wealth by not picking wrong opportunities. In investing, only avoiding losers is in our control, not everything else. We do not know what will happen in the future, our best investment can be turnout as the worst investment. But we have to be ready for it. We have to focus on missing wrong shots so that can protect game if our best turnouts as a worst.

If we look at the sports, many a time we need to protect our wicket rather play aggressively to make scores. Staying on a pitch provide us an opportunity for making a score while we get a good hitting opportunity. Investing also having many points which are similar to the game either positive or negative. As in cricket, Dhoni, Sachin, Rahul Dravid, Virat all having a different style to play a game. Some play defensive, some play aggressive and some make the balance of it. We cannot able to judge any players by looking towards his one match. Successful players perform well over a longer period of time with consistency.

Sometimes even a good players overestimate short-term success and forget to focus on the consistency of performance over a longer period of time.

As all players cannot be a Sachin, Dhoni, Dravid. As similarly, all investors cannot be a Warren Buffett, Charlie Munger, Howard Marks, etc. We just need to focus on our game in our comfort zone.

We are not able to know what will the result of the game we played, any uncertainty can affect it. We cannot only focus on one single investment ideas, we need to work on a selective group of ideas.

Negative side – If we keep on playing an aggressive investment game then we might not able to stick for the longest period of time in the game. Many uncertain events work as bounces for us.

Many a time, short-term investment success can become a reason to ignore the durable and consistent track record of investors. And few get attracted towards shine without checking its durability.

When opponents try to keep on throwing bounces then referee blows the whistle to give warning sign to opponents but in investing, there is no one who blows the whistle, we cannot able to get protected. Also in sports, we get notifications for the change of turn from our to opponents. But in investing, there is no notifications are available to us. We have to decide ourselves for changing the game from offensive to defensive.

We need to focus on the outperform into the bad time rather focus on outperforming into the good & best time. In good time, everyone can able to generate a good return but skill comes when we can able to outperform into the bad time. Doubled your Money in Last 3 Years? Skill or Luck?

Every player can able to play well against a weak team but a good player who can able to play well against strong opponents.

We should focus on either making more score or stay on the pitch for a longer period of time. We cannot say that only one way is the right way and we just need to select it. Selection of way can be based on our experience, learning, market environments in which we operate, etc.

We require a different kind of mindset for doing a right thing and avoiding doing the wrong thing.

Defense is focused on avoiding bad outcomes. It can help us to generate a higher returns but more through avoiding bad outcomes, through missing bounces, through managing risk.

If we bought an asset at Rs.100 and it falls to Rs.50; it falls by 50% but for reaching to Rs.100, that asset has to rise by 100% to just reach break-even.

When we play offensive and if it works then it will add additional returns to our investment. BUT if not works then it creates a damage to our investment and to our wealth.

Defensive game help us to stay in the game during a tough time also, it helps us to survive for a longer period of time.

Majority of a time, financial markets works in an average manner but it shows one abnormal day which has reason to destroy our financial health. We need to prepare for that worst day. We just can prepare for the worst day but cannot predict how worst it can be or when that worst day will come. But it’s sure that worst day will come.

It is hard to say in investing that whether our investment becomes successful or not and it works in the future as we have expected, economy /industries / Companies moves in a certain way and we prove to be right every time. We need to take care of the unforeseen future events which can go against us and can meltdown us. Warren Buffett has given concept which can protect us from such unforeseen events that called “Margin of Safety”.

When we buy Rs.100 worth of an investment for Rs.90 then we have a chance to gain. But when we buy that same thing at Rs.70 then we have very less chance of loss and if odds will be in our favor then we can able to make a good return. So that buying cheaper provide us a “Margin of Safety” when our assumptions go wrong.

In the over-optimistic scenario, people buy Rs.100 worth of investment avenue for more than its worth (I.e. Rs.150, Rs.160) and then find a greater fool who will buy at the higher price from him.

When we need an above-fixed returns then we need to go for more uncertainty but how to balance the defensive game with the inclusion of offense is the key area to focus. We cannot get higher returns with the exclusion of offensive game. We cannot able to win the match by just keep on making a single run. We need to hit 4 & 6 but with also focus on not losing a wicket.

Our first focus is to play a defensive game for staying on the pitch and then the inclusion of offense to the game for generating higher returns. Such approach provides us a consistency for a longer period of time.

If we take out a history of investment managers, investors then we will come to know that very few get survival for the longer period of time. Not due to their inability to make a 4 & 6 but to lose wickets in many matches. Many investors come and performed well in a good time but worst time make them disappears.

The managers who do not get survived for a longer period, the majority of them have built up their portfolio on based of favorable scenario and with the hope of likelihood of outcomes without keeping a room for the occurrence of an error.

Aggressive investors require competitive technical skills with fortitude, patient mindset, and capital. The investment might have potential to work well in a long-term but above quality provides a support to stay in a game for a long term.

We should focus on controlling risk, avoiding losses rather than try to focus on gaining again and again.

Simply defensive investing means being scared while making an investment decision. Worrying about losses, bad luck, worrying about something we don’t know, bounces etc.

Read for more detail: The Most Important Thing Illuminated by Howard Marks