BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “APPRECIATING THE ROLE OF LUCK”

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While we involve into any of the investment decisions then those decisions are having dependencies on the future. As we know that future is uncertain and it is difficult to predict it. In such uncertain investment environments, luck plays an important role and we have to recognize the role of luck in our investment journey.

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When we get some result or looking at the result then we must have to think the role of randomness in that generated result.

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Many outcomes are visible to us but we have to think those outcomes with different viewpoints. If someone has made a risky & uncertain investment and he gets a good outcome from it. We can say that such outcome happens due to luck not due to skill. But people take such outcome as their skill, not consider a role of luck.

For example, baller throw ball towards stump for capturing a wicket of the batsman and that becomes the wrong throw and ball has touch boundary line then it is not a skill of batsman but the role of luck.

Many times, people get the return on investment by just being in the right place at a right time. Not due to their skill.

If someone has invested his fund during the year 2013 with just making a portfolio with random stocks then also that person generated a good return. Doubled your Money in Last 3 Years? Skill or Luck?

In short term, we can able to generate a good return and many a time achieved an abnormal return by just being in the right place at a right time. But what about the long-term result? How we can say that luck always keeps on favoring us.

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Generally, during a boom period, the person who takes a higher risk get highest returns. But that is not the reason to consider them as the best investors. Very few people appreciate the role of randomness or luck in the life or in investment journey.

Mr. Taleb has mentioned the list of things which are generally mistaken by us.

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We should understand that when things going right, luck looks like a skill and people misinterpret lucky investors as skillful investors. Many a time, we get an extremely good reward by chance and we make a mistake to consider such result as our skill.

That means batsman hit ball for six and that ball also declared “No ball” and batsman get free hit and he again hit another six on a free hit.

In short run, we can win and make good returns by an occurrence of chances but in a long run, our wise decision provides us a good reward.

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When we realize that investment outcomes get an influenced by the randomness then we can able to focus on every event with the different perspective. Otherwise, we just thought that such outcomes happen due to our skills only.

We have made a list of assumption for the occurrence of events but we also should focus on the occurrence of other different events; which we may not have assumed. It might be possible that sometimes all other events have collectively more probability to occurred compared to the single event on which we have put the huge focus. Such ignorance becomes dangerous for our financial health.

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Investing something like a mixture of both skills as well as luck. Investing is not a pure luck like a snake and ladder game or not a purely skilled by the game of chase.

While we play chase then we require a skill to protect ourselves from moves of an opponent’s. We cannot able to win chase just by waiting for the favor of luck and mistake made by an opponent. We have to create a scene where opponent commits a mistake and we can able to win a game.

Whereas, there is not a requirement of a skill in throwing a dice while playing a snake and ladder game.

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But we generally consider our winning as our skill while we should recognize that we are winning a snake and ladder just due to a support of a luck. While we should reach towards 100, we should not forget that there is a snake on 99 number which can bring us towards number 7. And transform our success into failure due to highly dependencies luck. Similar happens to us while we play an investment game on the base of pure luck. We may win till number 98 and maybe that our fortune transforms into failure by destruction in our wealth. We climb many ladders, get many multifold return generator stocks but we forget that such occurrence is due to luck. If we do not have our skill involve in it, then our wealth get destroy. We should not forget that investment requires a luck but also it requires a skill. If we fully dependence on the luck then we should never forget a snake on number 99.

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “KNOWING WHAT YOU DON’T KNOW”

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When we concentrate on the small part of the things then we acquire more knowledge regarding particular aspects. We need to work harder and harder to develop our skills by which we can able to know more than another person. Enhancing knowledge will be work like an edge for us to knowing our positions better than others.

Also, we try to identify that where we currently stand, what’s our actual position so that we can prepare ourselves for the further development.

When we predict upcoming changes then we can able to earn money from participating in that changes. But if we have predicted something which is not going to change then it will be near to impossible to earn money. If things do not go to change then we cannot able to earn money by taking benefits of those changes.

It’s very difficult to forecast future and people generally forecast future with regard to what has happened in the past.

So that forecast can get right some of the time but it should be consistent in the getting right every time which can be very difficult.

Some of the people stick to always bullish or always bearish view and keep that view for a longer period. So that sometimes they get right with their forecast. It does not mean that their forecast will be right all the time. If you toss coin 100 times then there are a half of the possibilities to get the head of the coin. We cannot say such outcomes as a consistent outcome.

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We have to check that how many forecasters have predicted meltdown of subprime crisis or again boom was driven due to huge domestic liquidity currently.

Forecasters are called as “I know” school of investors. They are more confident about the future and the things will work out as per their assumptions.

“I don’t know” group of people can able to guard themselves while they have to deal with the future at the macro level.

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We never want to invest for the future which is largely unknowable and on the other hand, we need to face unforeseen future without forecasting the future.

The biggest problems arise when we forget the difference between probability and outcomes. We cannot surely know the occurrence of future events but we can know the probability of the occurrence of the events. When we forget the difference between probability and outcomes then we start predicting future events with surety.

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Investors who ignored such limitations then they make mistakes in their portfolio and also incurred huge losses. Events do not always occur as per our assumptions and we have to be ready for it.

When we do not know the future then we act in a different manner such as we diversify, hedge to the position, taking less leverage, focus on today’s value over a future growth, etc. On the other hand, while we feel that we know the future or future event will occur as per our assumption then we start taking more risk, taking more leverage, play on making an assumption of bright future. If we know the future then we play an aggressive game. We not take a diversification and take a huge leverage.

When we know that there will be no obstacle comes to our way while we are driving then speed, carelessness will increase. And on the other hand, when we know that our way is clear but any obstacle can come on the road anytime then we drive the vehicle more carefully with a speed which we can able to control. Similarly with the investment, when we believe that future is knowable then we behave for investment in a different way and when we believe that future is unknowable then also we behave for investment in a different way.

As the road is clear while we are driving but anytime any vehicle can come to that road and we can able to meet an accident if we do not have a control over our driving. Similarly, if we do not have a control over our investment then any unforeseen event can destroy our wealth. We need to wear a helmet while driving for controlling risk and also take proactive steps while making an investment for guard ourselves against unforeseen accident.

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “PATIENT OPPORTUNISM”

01 PO

We bought an investment in a panic and sell it at the boom. Such an opportunities, we get during the market cycle. But sometimes being inactive and wait for the opportunity works better in an investment.

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We bought an investment in a panic and sell it at the boom. Such an opportunities, we get during the market cycle. But sometimes being inactive and wait for the opportunity works better in an investment. We should not be going for chasing an investment rather we should wait for investment opportunities to come to us. When we are chasing an investment then it might happen that we might not get an opportunity at a bargain. We only get bargain where the seller is motivated to sell and such opportunities provide us a bargain.

Every time a great bargain will not be available, cycle – pendulum not at an extreme where we can go against it. Many a time, Market situations are balanced and fairly priced. In that case, we have to make an investment decision from what is available to us.

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In cricket, we do not try to hit each and every ball. We try to identify proper pitch to hit and till that opportunities, we just need to wait for a proper pitch or just keeps on rotating strikes.

Same with the investment, we should always wait for the proper pitch which is in our competence area and then needs to hit on it.

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In investing, the penalty is the loss of our capital. And if we try to eliminate such possibilities of getting penalized then, of course, we only remain with the rewarding investment opportunities. But many a time, we also need to miss some winning opportunities for getting our perfect pitch. And that can be bearable compared to the penalty of losing our capital. Staying on the pitch is more important compared to sitting at the stadium and seeing dreams of playing well for winning the match.

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We should wait for the profit-making opportunities with the control on risk. If we lost our focus on protecting our capital then huge waiting period and higher returns also might not be able to provide us above average returns.

Many a time, we get lucrative profit-making opportunities but for getting those opportunities, we need to take a higher risk and sometimes, we do not even know that we are taking a higher risk.

Generally, people shift towards higher risk investments while they do not get desire returns from the safer investments.

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Before the credit crisis occurs, people tend to take borrowing at a cheaper cost and make an investment into the high return opportunities with the belief of low risk.

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When prices are keeps on going higher and higher than, we cannot refuse to have a lower returns with the higher risk. Mr.Howard Marks mentioned few aspects while lower returns environments exist.

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There is no easy way to cope up with such situations. One major mistake people make is reaching for the returns and forgetting the risk. Always seeing dreams for making a century in every match and forget the risk of losing a wicket before hitting a century.

When there is a low return environment then we need an exceptional skill, high risk bearing capabilities and huge luck for generating higher returns.

The major opportunities for buying an investment comes where the holder of an asset are forced to sell it. Such situations create a bargain opportunities for us. When baller is frustrated and then only there will be a chance of occurring a mistake by him and that creates an opportunity for a batsman to hit six. But for hitting a six, we need to protect our wicket and need to stay on the pitch. We get a good opportunity to make a good score when baller is frustrated and throwing lousy balls; not when he is sharply bowling and chance to lose our wicket is higher. Or batsman is frustrated and want to make score then he will lose his wicket. Similarly with the investment; we do not get good investment returns while we are frustrated and want to make an investment or all our friends are earning & we have missed out opportunities. We get good investment returns while all are negative or frustrated and we have the capability to capture the opportunity.

08 PO

Sometimes question raised in our mind that seller can be well informed and rational also then why he sell something at the bargain price?

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When forced sellers come to sell their assets then market requires a liquidity to buy assets at a bargain price. So that the person who is waiting for an opportunity those only can capture such opportunities.

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “FINDING BARGAINS”

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In all the previous articles of the series, I discussed buying a cheaper assets / Investment. But buying cheap does not mean that we should go and buy anything which seems cheaper.

We need to prepare a list of investment ideas which are matches with our criteria, matches with our risk tolerance capabilities and exclude which are not matching with our criteria. There are not each and every idea which are compatible with our risk appetite, we need to work on the ideas which fall under our circle of competence. We get many ideas which can be good but not compatible with our criterion then we need to stay away from it.

Before eating a food, we need to know which kind of food we really like to eat. We do not like each and every food so as similar to it, we need to prepare a list of ideas which match with our criterion.

If we are managing the fund of others, then not only our risk appetite but also risk appetite of clients, we need to focus.

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The second step is to select an investment idea from the prepared list; which is suitable for the potential returns and risk ratio, value for the money scenario.

After getting the list of the foods which we like then we need to work on the place from where we get a food with requiring quality, where we get food as per our spending, etc. we generally do not prefer to visit the place where food is not available as per our taste and preference.

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If we pay high valuation for the any of the assets then it is logical that our potential returns will be kept on reducing and might be chances of occurrence of loss starts increasing. We made an investment for generating returns and enhancing returns.

We buy food for fulfilling our hunger not for exhibiting of our food dish with expensive food. We sometimes eat expensive food, not on a daily basis. As not only expensive foods can able to fulfill our hunger similar to that not only good and quality investment can able to provide us returns.

We need to focus on the bargain through which we can able to generate a potentially higher returns with minimizing risk.

Sugar IT

As I quoted an example of a good fundamental IT & Pharma company with cheap sugar company.

We can see that if we have bought the comparatively lower fundamentally good stock at a cheap price than this stock has generated a higher return compared to the good fundamental stocks in last 5 years.

Good food means we get a satisfaction & fulfill our hunger from eating that food, and that never matter how much expensive or cheap it is.

In general buying good assets mean, the assets provide us high potential returns relative to lower risk and also has a low price relative to the value of an asset.

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Mr. Howard Marks mentioned that while popularity is high towards stocks and people hates bonds, also many institutions shifting from bond to stocks; such situations provide a bargain for the bonds.

When the time change and people seek for more safety relative to the price appreciation then they start recognizing the potential of bonds.

Generally, people start recognizing the potential of the assets while the price of an assets starts appreciating. But people who have identified assets earlier, those can produce above-average returns.

When the restaurant is crowded then only people recognize the popularity of a restaurant. We make a decision by seeing how much-crowded restaurant is. If no one at a restaurant then we generally not prefers to visit by assuming that particular restaurant provides a low-quality food. Similarly with stocks, when everyone is buying particular stocks then we also run for buying those stocks with assuming high quality with high return. We do not check anything and follow the crowd.

We should try to make an investment into the underpriced assets rather than fairly priced. Fairly priced assets just provide fair returns with risk involvement. So that we should focus on underpriced assets with risk involvement for generating above-average returns.

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Bargain only available while perception is worse compared to the reality towards the asset. If everyone feels good and want to own that assets, then that asset will not be available at a bargain more.

When everyone cannot able to see the potential of the asset then we need to check the reason for unloved of the asset. Unloved assets can be available at the bargain if people hate it more than it should be.

If nobody is loved to the asset then nobody holding it So that demand for the asset will increase when people can able to see the potential of the asset. If our assumption has proven wrong and nobody is holding an asset or people unloved an asset then we might get limited downside or get the least loss from our investment.

When nobody to go for visiting a particular restaurant then we get foods at cheap cost with the proper quality for maintaining its customer.

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

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “Combating Negative Influences”

In this article, I am going to discuss regarding the psychological factors which affect our decisions negatively.

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Market many times provide us an opportunities to earn superior performance through inefficiencies, mispricing, misperception, mistakes of other people.

But the question is why such opportunities come? What makes us different from other people? Why mistakes do occurs?

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We need to analyze data and reach the conclusion. In investing errors occurs not due to analytical factors but errors mainly come from psychological factors.

Let’s look at the few psychological elements which affecting the investment decisions.

First emotion is GREED – Desire for money.

Most of us are making an investment for making more money. If we don’t care about the making more money than we are not going to make an investment.
And also there is nothing wrong with trying to make money. The market and economy run because of our desire to make money. But we should remain careful with a transformation of desire towards greed.

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Real estate

Real estate sector in India in the year 2007-08 creates a bubble and huge jump in the optimism by everyone. Such situation resulted under the sharp fall in the value of the sector.

Deepak parekh

Due to an impact of greed, people hope that their strategies help them to produce higher returns without taking higher risk for forever. And due to this hope, many times people hold highly priced securities with expectations of more appreciation can be possible. Many times such expectations went wrong and prove that expectations were unrealistic and people have ignored the risk.

Opposite of Greed is FEAR. As similar to the greed, excess fear is also harmful to the investors. Excess of fear stops us from taking a constructive decision while actually, we require taking such decisions. Due to fear, many a time we cannot able to make a good investment and also lose the opportunity.

The third factor is PEOPLE’S TENDENCY TO DISMISS LOGIC.
Generally, it happens that people stop using logical thinking and they start doing work with an irrational mindset. Many a time, we are not ready to accept logical reasoning for the situations and work as per unrealistic scenario. We do not apply what we have learned in the past but get easily deviate from those learning.

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When market or a particular strategy starts generating higher returns for a while, then we started believing that it will continuously generate such returns without an involvement of risk.

Howard Marks called such situations as “Silver bullet”, the Holy Grail.

But is it really same strategy keeps on generating higher returns without risk?

CNI05

As Warren Buffett mentioned, when prices started rising then it affects to the reasoning power of the people. It led to mania and situations of mania results towards the bubble.

The fourth factor is THE TENDENCY TO CONFORM TO THE VIEW OF THE HERD RATHER THAN RESIST.

Many a time, we started Believing to the crowd and starts to take an action as per the crowd behavior. Though behavior of the crowd is harmful and dangerous to us.

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The fifth factor is ENVY. Envy comes into the picture when we are comparing ourselves with others. And envy works as a negative force which affects our decisions.

When we see that our investment is growing then we remain happy. But the time we start comparing our investment returns with investment returns of others then we become sad. Now, envy starts showing its color and we make decisions which we may not take or which may be harmful to the financial health.

It is very difficult to see the higher growth of other compared to our growth.

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The sixth factor is EGO. Ego gets satisfaction while we generated higher returns compared to others. And we are keeps on evaluating our return in the short term. While we should focus on the longer horizon returns rather than keeps on tracking returns in the short term and also try to get out of the trap of ego. Ego can be harmful to the financial health. We keep on demonstrates that how much we know much compared to others rather than focusing on how much we know and how much we do not know.

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The seventh factor is the CAPITULATION. It means investors give up towards the situations while economic and psychological pressure becomes irresistible.

Many a time, overpriced assets become more overpriced, and underpriced assets become more and cheaper. This scenario affects to the psychology of investors and repetitions of such situations inspired investors to give up towards the situations and make investment decisions without using logical reasoning.

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When few or all the factors combined then it affects to the investor’s decision making and that affects the market. This resulted in the mistakes and those can be expensive for our financial health.

Psychology in IPO is funny. When our friend is applying to IPO and we asked for the business then he doesn’t know about the business. But he is applying for getting good returns. And he continuously getting higher returns and such higher returns earned by our friend attracts us to make an investment into the IPO. And such situations keep on repeating & more people get involved into the IPOs.

IPOs

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “AWARENESS OF THE PENDULUM”

In the previous article, we have seen that everything moves in a cycle. And if we cannot able to understand the cycle, then we must pay for it. In this article, I am going to discuss on moments of the pendulum and how we can take benefits of its moments.

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We have seen pendulum and its moments. Generally, pendulums do not always remain to the extremes, majority time pendulum stays near to its main point. And whenever pendulum moves towards its extreme then again it will come back towards either extreme. The force of the swing of the pendulum itself responsible for its reversal.

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Generally, our behavior towards the situation is responsible for the swing of the pendulum towards extremes and also responsible for coming back towards its mean point. Investors see the situation with either greed or fear and reach to the conclusion. When people are greedy, they become more optimistic toward the situation and they want to pay any premium for getting that situation favorable. Vice-versa, when people feel fear, then they are not ready to buy the stock at the cheapest value.

Excess greed creates risk taking behavior and excess fear creates a risk aversion among the people.

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As there are two major risks in investing – 1) Risk of losing our capital and, 2) Risk of losing opportunities. But when pendulum moves towards the extreme end, then one of the above risks will dominate our investment decisions.

When pendulum at extreme bullish situation then

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And when the pendulum nears to the extreme bearish situation then

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When things happen in a good manner, then people become more greedy and confident about the situations which bring optimism towards the particular situations. People forget the involvement of risk and ready to pay anything for getting the assets. Vice-versa when things not happening in a good manner, then people are more fearful towards the situations and realize the inherent risk. Such situations bring bargains for the assets.

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Sugar prices

Sugar stocks

We can able to see that when prices of sugar were low, people not ready to make an investment in the sector, etc. at such situations provide us a bargain opportunities and when things start getting well, we can able to make a good return. Vice-versa when everyone knows about the story, then that story is there in the price. We cannot able to make an abnormal return or chances are high to lose of our capital.

Wise people recognize the bargain first, then others will follow them and run behind the assets for buying it at any premium price.

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We have seen three phases of the bull market. As similar to it, the bear market also has three phases.

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When everyone fears with the negative news, events and they start thinking that such worst situations remain forever. Major bottom occurs over such situations. When everyone forgets that tide can again come in and such situations provide us a bargain opportunity. Vice-versa when everyone thinks that good time never going to end and they can generate higher returns easily, people forget that tide can go out then major top gets formed.

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Those people who understand swing of the pendulum then they have protected their capital as well as made the huge return during the year 2009 and year 2014.

When everyone fears from the situations and think such worst remain forever. When such situations arise then the person who analyses and conclude that things can go better he can generate a better return with lower risk. Vice-versa when everyone thinks that things remain better forever than that is a period of painful losses.

The pendulum never continues to swing towards an extreme, it will be reversed from extreme. Extreme swing of the pendulum is itself responsible for the swing towards the opposite direction of the pendulum.

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

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “BEING ATTENTIVE TO CYCLES”

In this article, I am going to discuss on cycles and reasons for the occurrence of the cycle. For becoming a successful investor, we need to understand cyclicity of the market, earnings, business, etc., then only we can able to protect ourselves from the destruction of our wealth as well as we can able to grow our wealth.

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We as a human also born, grow up and die. These cycles keep on continue. And like that company also came into existence, grow up and once it will close or might get some revolution.

(Click here for human life cycle – https://www.youtube.com/watch?v=SdprpVCIhu0)

Cyl 02

As like our life, Economy, businesses, products, earnings of businesses, etc. also rise and fall. It also moves in a cycle. Many a time people forget that everything moves in a cycle and that situation provides us an opportunity for protecting and creating a wealth. We should always keep in mind that nothing in the world keeps on rising in a straightway. It will rise to an extreme level and falls to an extreme level.

NMDC

The margin of the company increases when the price of the iron ore increases and margin fall with the fall in the price of the iron ore. We must have to understand the cycle for protecting our wealth.

The main reason for the cyclical behavior of the economy is human involvement. Human nature is not mechanical but humans are emotional and inconsistent. Many a time Humans take the decision based on their feelings, emotions which itself cyclical in nature.

When we feel good, we remain optimistic about the situations and reverse when we feel bad then remain pessimistic about the situations. Our psychological involvement pushes cycle to the extreme points and after that extreme point, cycle corrects itself to the reverse direction and then again come to the mean value.

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If we see carefully, then we can able to understand that more worst loan given at a good time rather at the bad time. Because people forget the cyclical nature of the economy, industries, businesses, etc. also the credit available at cheaper rate. And additionally, people break discipline. They start to borrow extensively which will be resulted into the burst of the credit cycle.

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Credit cycle –

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When we are happy then we might get happier for some period and then our mood turns to the sad and vice-versa. Our mood also keeps on fluctuating and that turns out to be our happiness or sadness. Sometimes we become extremely happy or sad, but that situation does not remain similar for forever. It will change, it will get normalized.

So, if the cycle is in a good phase, then it might be remaining more good for the period and then correct for the bad phase and vice-versa. It will not remain good or bad for forever. It will come to the mean value at some point in time.

The cycle only stops occurring while people take all decisions by being unemotional and rational. But it is not always happening and such human decisions which will be resulted in the cyclical behavior of the market /economy. And this is only the major reason for keeps on occurring cycles.

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B Cyl 01

High profit into the business attracts the competition. This competition will turn high-profit margin into the low-profit margin. And business will fall into the problem. Many players get close and get out of the business. Consolidation of among the players will happen and few players survived in the business. Those survived players will again be getting a good amount of business and the again cycle starts moving. No business keeps on growing for forever with the same pace of growth.

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The growth of Indian IT is falling compared to initial days. Also, players among the industry and startup are rising rapidly.

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We always need to keep in mind that everything moves in a cycle and when we forget it, we will be at the risk of losing our capital.

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

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “CONTROLLING RISK”

In the last article, we have talked about the identifying risk and recognizing risk. Now, in the current article, we discuss regarding controlling the risk. Generally, in the market, we put much emphasis on the higher absolute return instead of superior risk-adjusted return. But the great investors are those who focus on the risk and generate moderate returns with low risk or high return with moderate risk.

Generating higher returns with the higher risk for a long time is rare in the market. The risk of losing money arises when our investment meets adverse situations and Loss does not occur till the negative events occur. We should always focus on controlling the risk because we do not know that when the negative situation arises and we met losses.

When we bought the home, we check that the home is constructed in a way which can be protected by earthquake or not. The similarly, we should focus on our investment. We should focus on the situations where the occurrence of such negative situations can destroy our wealth. And work as an earthquake in our financial position.

It can be possible that an earthquake will never happen in life long, but we bought the home which can be protected with an earthquake. Similarly, it may be possible that adverse situations will not arise during our investment time, but we should focus on raising of adverse situations and how we can able to protect our wealth from such situations.

The risk is not always easily visible. If our surrounding environment is positive, then we start thinking that negative situation may not arise due to the influence of that positive environment. But in fact, the risk is always present in the good environment also. And anytime good environment can easily turn out to the bad environment. Such transformation does not come to us with the prior intimation. We must have to be ready properly with such considerations before making investment decisions. Even controlling risk is becoming essential into the good environment because nobody is talking about risk and in a bad environment, risk takes care of itself because everyone fearing of risk.

Generating superior return compared to benchmark with the similar risk nature is a good performance. But, a good value addition is while we generate a return which is like the benchmark return with the lowest risk and with proper controlling of the risk. Such scenario is even better.

 

When the environment is positive, everyone rides the wave and we cannot able to say which one is better. (Good article – Doubled your Money in Last 3 Years ? Skill or Luck ?)

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So that we should always focus on the controlling risk, whether it will rise or not. Because we cannot able to really predict the occurrence of the risk.

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Careful investors always know that they cannot able to know the future so that they try to focus on controlling risk and try to factor the risk of loss of capital while they make any investment decisions.

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We start avoiding focusing on risk as the environment is going positive. Initially, we might put weight on risk, but many times that risk might not get triggered. So that we start avoiding it and started believing that there is a no risk into the environment. Such risk will not occur and we saved from the negative situation.

As we have seen in Russian Roulette with 100 chances, we may save for 99 times, but the 1 time can kill us. Or if we are lucky we can be saved all the 100 times. It doesn’t mean that there is no risk or risk may not arise in the future.

Example – THE EVENTUAL CONSEQUENCES OF RISK SEEKING OR RISK BLIND BEHAVIOR

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We constructed belief in our mind from our past experiences. If we have seen the positive environment, then we have made belief that negative situations never come. We should always keep in mind that occasionally extreme situations can arise and that can be out of our all belief.

In the year 2007, also welcome structured products, huge capital inflows, etc.

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We should not run from the risk but should manage risk intelligently. We should take the risk, but at the appropriate time and most importantly at an appropriate price.

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When we walk on a road with keeping our eyes closed and we do not meet an accident, then it’s not our talent, it’s a pure luck which plays out. We are a real blind if we consider such situation as our own skill. And such risky situations do not stay rewarding for a long period and we must walk on the road with keeping our eyes open.

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “RECOGNIZING RISK”

We have seen the process for the identification of risk in the previous article of the same series. In the current issue, I am going to discuss regarding recognizing of the risk.

For the successful investing, we must have to focus on the generating return with having a proper control on risk. And for the controlling risk, we require to identifying and recognizing the risk.

The risk is always being at a much higher where we are too much optimistic towards the particular scenario and also paying a much higher price for the buying particular asset. But we should focus on When odds turn out against us than how we can able to protect ourselves or get out of such scenario with least damage. So, for the protecting ourselves, we need to avoid paying too high prices and also keep ourselves away from the extreme level of optimistic sentiment.

Click for Video — Auction scene

We always forget the real worth of the assets in the bull phase and start chasing that asset class. Such behavior is dangerous for the health of our wealth. This increases the risk while we are purchasing assets more than its worth.

The market always works in a pendulum and people generally forget the nature of the pendulum. The pendulum always moves towards the both extreme directions.

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Whenever pendulum moves towards the bullish extreme, many of us forget that such situations will not stay forever. Many of us forget about the risk which involves during the bull phase. And start taking higher risk for generating higher returns; which invites further huge amount of risk. At bullish sentiment, people generally buy assets at the highest valuations multiple and that invites the risk to the particular asset class. This scenario has a very high chance of getting damage to our wealth compared to generating a higher return.

Reverse to such scenario, whenever the pendulum moves towards extreme bearish phase, then generally people start recognizing the risk and start avoiding to invest in the particular asset class; which take out the risk from that particular asset class. Such scenario is the appropriate time for capturing the opportunities because in such scenario we have very less chance to lose.

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Many a time due to bullish sentiment, we think that the risk is very low, we start taking more risky situations, also start taking leverage and from that time risk starts taking its shape. Our behavior towards particular asset class invites risk.

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Risk will be only low if we as an investor behave in a careful and wise manner. We cannot eliminate the risk, but we can able to control its effect. We have to analyze risk in every scenario. Risk always has its presence, though we are having a bullish sentiment. And according to me, the risk is much higher while having a bullish sentiment.

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At the extreme bullish sentiment, we forget to worry, fear of loss and instead of it, we think about to miss the opportunity. We think that all others will earn the money and we remain without earning money. We start taking much leverage and believe that we are living in a low-risk world.

Click for Video — Bull phase in auction

We have seen in the above video that the person who doesn’t want to purchase a horse for the Rs.5 lakh; same person bought the horse for the Rs.5 lakh due to the influence of the increasing value of the bid for the horse. The person doesn’t want to lose the horse and cannot see others to take that horse.

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

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “UNDERSTANDING RISK”

For making any investment decisions, we have to be dealt with the future, which is uncertain in nature. So, that when there is an uncertainty, then there is an involvement of risk and we cannot escape from the risk. We must have to focus on asserting risk while making any investment decisions.

When we focus on the return of the particular instrument, then we have concentrated our focus on half of the movie and rest half will get completed with asserting risk in that particular investment.

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Traditionally, we all have learned, that in making a higher return, we need to take an incremental risk.

But we think logically about the same that if we get a higher return for the taking of incremental risk than there should not be a risk. We get rewarded by the returns for taking a higher risk.

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Traditional risk/return graph has communicated the positive relationship between risk and return but ignored uncertainty involved for making such returns. Additionally, traditional risk/return graph has shown a risk as similar to volatility, but not focused on the danger which is involved in the investment.

Many a times volatility cannot be an as riskier as compared to other dangerous events for our investment.

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So, that risk is not a volatility in the price of stocks, but the real risk is the permanent loss of our capital. And we must have to be worried about the permanent loss of capital rather than volatility. We must have to focus on the understanding of the risk which could have the probability of erosion of our capital.

Many a times risk is not only limited to, permanent loss of capital or to volatility, some kind of risk are objective and personal in nature; such as-

1) Falling short of one’s goal

Many investors have a different need, goals and not meeting those by investment results can be the risk for the particular person.

If someone just requires meeting the routine expenses, then getting a fixed return from fixed return instrument might not be at risk for the person, but if someone who wanted to build capital for investment then such a lower return can be a risk for that particular person.

2) Underperformance

Such kind of risk is related to the investment manager. If the investment manager cannot able to generate higher returns compare to index than the investment manager might lose his clients.

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3) Career risk

This is an extreme form of underperformance risk. Continuous underperformance can have resulted in the risk to the career.

4) Unconventionality

This risk is connected with a being different while making an investment idea. If unconventional idea got wrong, then there might be a risk to the career.

We buy metals, sugar stocks, etc. (at the worst time of the cycle). Instead of buying pharma, IT, Banking which is a darling of the industry. And if our stock picks up doesn’t work, then we have to face trouble and extreme risk of loss of career.

5) Illiquidity

This risk arises when investors need a money for some urgency and unable to break his investment.

Let me take an example of the cricket match for understanding a risk.

The main risk in the cricket match is to losing the match, series, etc. as similar to losing our capital in investment. If all the players play a poor game, then definitely team will lose the match and similar to an investment; if all our investment resulted in poor returns or more risk oriented than we might lose our capital or lose real value of capital.

As we have seen in Indian cricket history that Mr. Sachin Tendulkar, Mr. Rahul Dravid has played very well and created the record, they don’t always come to the ground for making a century or creating a huge score but always played well for protecting their wickets. Their focus on protecting their wicket helps them to play well for the longer period of time. And on against to them, many other players came to Indian cricket history and gone also; cannot able to stay for a longer period of time. They just have focused on making a score and sometimes due to the luck they can able to make good score but not always.

If players do not able to play well on a continues basis, then they will have lost the opportunity of staying with the cricket team (Career Risk). Also, we have seen that Mr. Mahendra Singh Dhoni has taken a many unconventional decision for the team during the match. Many of his decisions got success and many not. When he filled with his unconventional decisions, he has to face the anger of the people. This is as similar to our unconventional investment decisions and has to face anger from our clients if we filed into the unconventional decisions.

It is not necessary that we only can be incurred a loss by buying weak fundamental stocks. If we bought the comparatively lower fundamental company at a very lower price than that investment turns out to be a successful investment.

Sugar IT

We can see that if we have bought the comparatively lower fundamentally good stock at a cheap price than this stock has generated a higher return compared to the good fundamental stocks in last 5 years.

Also, not good macro environmental promises of safety. Because too positive news brings up prices at too high and any small adverse development can be enough for damages to our wealth.

People generally tend to associate with the things that are doing well. And that investment might be able to fulfill expectations for a while and thereafter small negative event can damage much higher. Such scenario having an involvement of higher risk.

So, that value investors believe in achieving higher returns from lower risk. We have to be ready with underperformance risk while we are buying bargains and market is in a heated bull phase. We need to accept it rather than incurring losses.

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Investment is dealing with the future and the future is highly uncertain. And it’s impossible to know anything about the future.

Risk means more things can happen compared to what happened in the past. Understanding of risk requires a second level thinking and it’s not an easy task. The risk of losing money is observed by one that’s similar is not observed by another one.

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