Portfolio Management

When you're hunting for elephants, don't get distracted with rabbits.

This may be one of the most important topics for a fund manager.
I have read a lot in a short span of 2.5 years; after all, it's only when I stand on the shoulders of giants that I can see far.

I have noted that value investing is a tricky business, not because it's difficult - hell, it's easy to find a few bargains - but conviction, patience, gumption and controlling one's behaviour is mighty difficult.

Seth Klarman, Bruce Berkowitz, WB, Prem Watsa, RJ, JM Eveillard, Howard Marks, Leucadia and Markel guys, Mohnish Pabrai have been the main contributors towards who I am becoming.
And they dont talk much about diversification, rather, they talk about focus.
A focus on moats and the price you pay.

And then they say, dont invest in too many companies.
Because you definitely cant believe that you will make as much money on your 20th best idea as you will on your best or 2nd best idea.
I never understood a portfolio with more than 30 companies - Peter Lynch spoke often about his 1000+ companies, and I was baffled. How can this make sense?

Good, quality companies are hard to come by, and the essence of diversification lies in the ability to sell a company that is well-priced and buy another which is poorly priced.
May be it also keeps your brain more active.
And then, you run the risk of not putting enough money into a Berkshire Hathaway in the 1970s for example.

My concern is:
What if I find a company trading at 3x earnings/ cash flow/ whatever floats your boat - and I invest a princely 2% of my portfolio in it?
And what if I invest in another company at 8x, another 2%?
And what if the prospects of the cheaper company are better because of its odd moat?


The chief risk with over-sizing is highlighted by Mohnish Pabrai and his investment in Delta Financial. A 100 year storm tore down the business, and his investment went to zero.
But his concentrated quality portfolio still allowed him to keep compounding thence.


Finding a mispriced security is based on maths and knowledge and experience.
Structuring and controlling your portfolio can be based only on a checklist and what one is comfortable with - hence, art.

Pabrai, marketing, relationships and today

Longevity is more important that a short lived, sudden success.

Am currently watching Pabrai talking about Marketing and human relationships. One would think that someone in the stock market shouldn't care too much about the seemingly thoretical subject of marketing.
But, everything adds up.
For example, I can well imagine why Bajaj Auto will succeed where Hero will become mediocre.

Also talks a lot about cloning in businesses. It's fantastic to copy; somehow kids in India are more than happy to do so, but as grown-ups, they find it demeaning. 

In other news, there is a sudden bout of euphoria in the Indian markets because Narendra Modi will be India's next Prime Minister. Let's see what he does.
Meanwhile, I refuse to buy things based on prospects and at a price above my understanding.

There is a beautiful Seth Klarman quote.

“…conservatism may cause investors to refrain from making some investments that in hindsight would have been successful, but it will also prevent some sizable losses that would ensue from adopting less conservative business valuations.”

I think I am currently there right now. 

Price Actions

It's odd that one feels better with a paper gain than with a paper loss.
Particularly, when the underlying companies have similar performance, and potential prospects.

No wonder Buffett once said at an interview with the FCIC "... price action alone starts dominating people's minds."
Those words stuck with me, and now I see the gravity of the statement.

The potential of a value trap, the gnawing feeling of envy, and the doubt about an investment decision, all, after a period of time, are influenced by an asset price.

It is then that one has to sit back and question whether the mistake is in one's decision or in the markets'.

Mr. Market is there only to guide you, not to influence you.

I read this, and I spoke about this, but it is only in the face of exuberance that one questions one's judgements.

So many value investors

It's fun to see so many value investors out there who tend to focus on a company's moat and its growth potential. I find it odd that the word 'moat' has become so prevalent now, it seems that many companies have a moat.

People forget that a moat has to be wide, with crocodiles and Arnold Schwarzenegger in it (and Justin Bieber).

Anyway, I write today to emphasize the need for a margin of safety if one wants to be called a value investor. A margin of safety dictates that in the face of a downturn, the business is capable of withstanding the slowdown/ shock and then, able to realise its potential value.

In good times, investors forget about the margin of safety and conveniently account for that in terms of the growth of the company; said company shall grow, and in face of growing cash flows, my investment becomes safer.

It's easy to see the global potential for air coolers vis-a-vis air conditioners, but air cooler manufacturers may not be able to hold on to pricing pressures.
Consumer good manufacturers will compete with each other in a growing pie of the African and Asian and Latam continents, but only the best will be victorious.

Sanjay Bakshi recently wrote about the beauty of quality companies and how some of them have managed to deliver returns to shareholders even if shares were purchased at seemingly high valuations in the past. But very simply, people are focusing on the winners and not the losers. One could pick a potential good quality company today, and buy it at a good price, only to see it becoming Dexter Shoes, facing regulatory issues, or management issues.

Good quality companies are difficult to determine, and even when one finds such a company, what price allows for a margin of safety? Does a Bajaj Auto at 16-19x and 40-50% payout qualify as a good company with an adequate margin of safety? I think so - it's one of those rare beautiful companies. But does that make it a good investment today?

A rising tide lifts all boats. It is time for caution and hold on to that life vest.
Am afraid of Canada, China and Japan.

Mistakes

It's important to chronicle one's mistakes; it's humbling, humiliating and growth inducing.

People prefer talking about their winners, but it's the losers that one ought to worry about.

Luckily, position sizing helps with understanding the actual performance in a portfolio.

I bought Zylog Systems around the beginning of 2013. 

Of course, I have my original investment note citing a pure behavioural and Graham play.

There's a press release by the company saying nothing unusual is happening, and it is business as usual. This was when the share price was falling drastically, lower circuit after lower circuit.

" On the other hand the Promoters of the company have been buying and increasing their stake in the Company"

- Press Release.

I saw the balance sheet and said:

" Unless there is a fraud, I make money. " - this was at a share price of 73.

I did some background check on US visa applications, linkedin profiles, the canadian subsidiary (does it actually exist) and it did.

And then, there was some sort of a fraud; haven't been able to decipher what really happened. 

But, something wrong with receivables and the promoters used company money to buy shares in their own names.

So, there we go.

My hurry to invest and my disregard for potential fraudulent activity, caused me a few % points.

Lesson:

• Take it slow.
• Understand the downside
• Make sure you believe in the management
• Graham net-nets are quite a waste of time
• Spend more time on finding quality companies
• Understand the mistakes of others.

Mistakes of others:

• Dexter Shoes
• MTNL
• Cort Furniture
• Delta Financial
• US Air
• Berkshire Hathaway (original)
• General RE
• Renuka Sugar
• Bajaj Hindustan
• Suzlon

Lessons from Mistakes:

• Understand debt and debt covenants/ restrictions
• Understand industry changes
• Regulations have a tendency to kill companies
• Un-understandable liabilities are a pain to work with
• Can this business be seriously challenged?

I wrote this post after much deliberation, and based on the 2007 Berkshire letter where Buffett writes about his mistakes in "The good, the bad and the gruesome".

Portfolio

Writing after a long time on this blog.
Have learnt quite a few things, but the most recent thing is interesting.

Was going to increase a position size in one of my companies, and then read Confessions of a Value investor - Sanjay Bakshi, and something else by him where he says that some investors have the ability to increase their concentrations, but there is no need to.

• Just because that company is available, doesnt mean that you keep buying into it.
• There are many things that can go wrong with it even at this price of 3-4 PE; electric motors, oil prices, supply chain block
• Focus attention elsewhere
• Can always find another company in due time. 
• Am getting too greedy

Currently capping my cost-based investment in any security at 10%

1987

I believe that Classics are called Classics because they are. I read WB's 1987 letter to BRK's shareholders today.

• Mr. Market can act crazy, so it's important to wait for the right opportunities
• The best businesses are those which don't have to change themselves too much over a multi-year time frame
• It's better to be prepared with a loaded gun while hunting rare elephants - liquidity more important than opportunity cost
• He wasted his time (while at the partnership) by hunting for mediocre or bad businesses at cheap prices. His preference has become excellent businesses managed by good managers
• They are not macroeconomic analysts, or technical analysts or security analysts - they are business analysts. If they don't understand it, they won't go ahead
• There is no need to churn a portfolio based on a target price being reached. As long as a well bought business (marketable securities) is run well by good managers and is making a satisfactory return on equity, is churning out good quality earnings and is not overvalued - there is no need to sell out. Example: In 1987, GEICO, Cap Cities and the Washington Post Co. had a cost price of USD 560 Mn and a Market Value of USD 2 Bn. The Earnings were approx USD 100 Mn which is a 5% yield on market value of holdings; but I believe that his philosophy was that as long as things dont get wildly overpriced, the holding wont be sold