Tag Archives: Defensive

CYCLE POSITIONING – 14 – MASTERING THE MARKET CYCLE

Posted on by under Bibliophile: 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.

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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.

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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.

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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?

Posted on by under Bibliophile: Mastering The Market Cycle

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.

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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.

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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.

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

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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.

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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

Investment versus Speculation: Results to Be Expected by the Intelligent Investor

Posted on by under Bibliophile: The Intelligent Investor

From today, I am going to start a series on Book “The Intelligent Investor” under the Bibliophile category. Mr.Buffett has always mentioned that he keeps on reading this book every year. This book helps us with the developing an investment philosophy and also, help us to recognize ourselves as an investor or a speculator. I am grateful to the readers by which I am getting motivated to keep writing more and sharing more pearls of wisdom.

Mr.Graham has started the book with the definition of an investor which is very essential for us to understand to becoming a wise investor.

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Many of the people call themselves as an investor but they are not meeting criterion mentioned by Mr. Graham. If a person does not meet any of the criterion mentioned above then we need to consider him as a speculator rather consider as an investor. We have to check to introspect and need to check whether we are meeting above criterion or not. If not then we are doing speculation though we called ourselves as an investor. I have seen many of the people focuses on the adequate return but not meet up other two criteria, or they meet safety and return but not meet up with thorough analysis so that we need to consider those as a speculator, not an investor. People get more involves speculation because they get excitement into it and investing is a boring & lonely game. But over a longer period of time, excitement does not reward us. The stock market is not a place for getting excitement or thrill but it is a place where we need to stay calm, cool with a balance of emotion and balance of activities with hyper activities. When we do speculation, we get an immediate result but not happens the same with the investment. We can earn through making an investment in the long term only if we play this game with the rules.

People call themselves as an investor though they are just buying and selling shares at the stock exchange. They do meet the criteria of being an investor or not. Investor word commands a good reputation among the people so we feel the pride to call ourselves as an investor but rather to just get feeling, we need to work on logic and accept the reality. Though we perform a thorough analysis of investment opportunities or not, we consider ourselves as an investor but we need to understand that it is easy to call ourselves as an investor but it is difficult to act as an investor.

  • A thorough analysis of companies means we need to analyze the soundness of the company, long term survival of the business, pricing power with the company, etc.
  • Our major focus should be on capital protection. When we work on capital protection, we have already won half of the battle. I always emphasis on my philosophy which is “Return of Capital” is more important rather than “Return on Capital”.
  • We need to focus on adequate return rather than earning an extraordinary return. We run behind getting rich within a short period of time so that we desire to earn an extraordinary return.

People can do speculation also but many a time, speculation becomes dangerous –

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If we cannot stop ourselves from doing speculation then put some fund aside for making speculation and we never put the fund into the same account for making speculation and for making an investment. Also, we should not increase a fund to the speculation account just because the market has gone up or we have a good profit into it, but we should bring out the fund from it and transfer it to the investment account. 10% limit of our overall wealth is permissible for the speculative bets and we should not violate this rule. When our speculative account goes above 10% then those amounts need to shift to the investment account and if it goes below 10% then we should not transfer fund from investment account to speculative account.

Mr.Graham has advised to the defensive investors to keep their portfolio into the high-grade bond and into the common stocks. We should have a range of bond should be into the 25-75%, not less than 25%, and not more than 75%. Similar to the common stock also.

We need to make a selection of stocks and bond on the basis of inflation, interest rate, the future expected return from stocks, etc. Which can help us to earn above inflation return. As a defensive investor, we should make an investment to the company which has a good business with a strong track record of financial. We should avoid buying hot stocks which can be harmful to our wealth during the long term. Mr.Graham also has mentioned the concept of Systematic Investment Plan (SIP) for the defensive investors.

Mr.Graham has explained methods for aggressive investors such as 1) buying a security which is doing better than market average, and those not doing better which are candidate for short selling a security 2) Buying a companies which are expected to post a good earning or other favorable development expected 3) Buying a companies which have given a good earnings growth in the past and expected to deliver similar to the future or companies does not have a good past earning but expected to post a good earning to the future.

Here, uncertainty associated with the investment is human error and wrongly estimation of future or estimated future is already into the current market price. When we buy stocks on the basis of current year good result with the similar will happens to the next year then it is highly possible that other participants also think in the same manner.

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If we buy popular stocks on the street then we end up with the result what everyone else is expecting. We are not able to get above average return. We have other ways to make a return without taking a huge risk is a special situation such as a merger, demerger, buyback, liquidation, delisting, etc.

One of the bargains is given by Mr.Graham was Net of Current Asset (I.e. Working Capital) after adjusting all the liabilities. That means the stock price is well below working capital – all the liabilities. Here, we are not taking a plant and other fixed assets into consideration. Such issues consider as a bargain to its value.

One of the Indian air cooler company was available below the net of current asset

Company has a current asset of Rs.74.24 crore and total borrowing was Rs.29 crore so that the net of the current asset was Rs.46 crore, whereas Market Capitalization of the company was Rs.35 crore at the end of FY2009.

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Many of the investors do not take rest when odds are not in our favors. They keep on doing something though things are not into their favor. Such hyperactivity is also dangerous to the long term return of investors.

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We have seen that many strategies and stories for the stock is getting popularized over a period of time and also erased as time get passes. We always need to focus that stocks only will perform well or poorly in the long run when business behind that stocks will do well or poorly. So that we need to focus on the performance of the business rather than focus on the different kind of strategy to becoming wealthy in the long run.

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

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig

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

Posted on by under BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS

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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.

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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.

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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.

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

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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.

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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.

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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.

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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.

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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”.

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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.

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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.

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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.

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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.

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

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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.

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