Monday, October 14, 2013

Fool's Wisdom # 1 -Its how much that matters !!!

Whenever a novice investor suffers financial losses in markets pat comes the advice from relatively seasoned players “Consider it as tution fees for your learning”. After having paid (and continuing to pay) enormous amounts of such tution fees on numerous occasions we are beginning an attempt at collating some learnings through posts thus appropriately labeled “Fool’s Wisdom”.

Over time we hope to share our philosophy and general thoughts on investing through this series.

We hasten to add that this mere act of posting should not mean that we have discovered some holy grail of investing and are now any less novice in our actions. Also, these are and should be merely construed as OUR colour blind view of the ‘right’ way. Like clothes, you are the best judge of whether our brand of investing may be the right fit for your temperament. Infact, as time passes, our own bodies may change shape and thus clothes that used to fit perfectly well earlier, might not fit anymore and need to be discarded. Our thoughts are similarly liable to be discarded to make way for fresh (or old) approaches which we ourselves find more suitable.High conviction is not amongst our strengths and we think we are better off without it (as of now J).

To quote Parcher, the imaginary boss of Dr. Nash from the movie ‘A Beautiful Mind’-
Conviction, it turns out, is the luxury of those on the sidelines.

It’s not only ‘WHAT’ but also ‘How Much’

Let us start with a story...

Without fail four friends, let us call them Niren, Abhinav, X & Y, make it a point to meet annually every new year day for a ‘stock idea forum’. The goal of this meeting is unambiguous. Hoping to learn from ‘the wisdom of the crowd’, they aim to discuss threadbare and identify 2-3 ideas which they could each add to their individual portfolios with a 3-5 years investment horizon.

In January 2010, for reasons best known to them, this group narrowed down on two ideas viz ITC and Suzlon. They all decided to add these stocks to their respective portfolios. Three years later when they met again in January 2013, other than the customary discussion on fresh ideas, they also got down to reflecting on the performance of their individual portfolios. Soon, it became evident that each had a different perspective. X was thrilled with the positive contribution these meetings had made to his overall wealth. On the contrary, Y seemed distraught. He seemed to think that the picks made by the group had been nothing short of disastrous and he was seriously reconsidering if he wanted to come back next year. Niren and Abhinav were largely indifferent.

This was a big surprise!! Had not these friends had the same stocks in their portfolios ?? How come then each had a different view on the returns of the stock picks??

The answer thankfully was not too difficult to find. We share below the secret they unraveled J

Portfolio allocation to idea
Portfolio Impact
10% ITC, 1% Suzlon
+ 11.5%
1% ITC, 10% Suzlon
1% ITC, 1% Suzlon
+ 0.4%
5% ITC, 5% Suzlon
+ 2.1%
ITC went up 122% in the 3 years while Suzlon fell 80%

It now dawned upon them!! All these years while they had been vigorously debating stock ideas, they had conveniently forgotten to close the discussion with the most important follow up question. What should be the allocation!! While they were mature enough to acknowledge that both, positive outcomes like ITC and accidents like Suzlon are inevitable in the life and times of any investor, they realized that the position sizing decision can make a good decision look bad and vice versa.

In fact sizing of the position probably has a larger role in overall wealth creation as compared to the idea itself.

The discussions inevitably led to the sharing of past experiences (The I had told you so syndrome). Niren remembered how he had identified Zydus Wellness early but allocated only 1% to it thereby barely moving the needle, while Abhinav had been none the wiser after his large allocation experience in SKS Micro. While Y was understandably silent J, X pointed out the fact that while there is a plethora of advice coming daily on how to go about the what to buy or avoid decision, there seemed insufficient debate on how to go about the all important position sizing decision.

They solemnly promised never to break up without debating ‘HOW MUCH’. Without this it was all really a colossal waste of time!! 

We will follow up soon with OUR thoughts on "How Much".

Till then ..Best of Manufactured Luck !!


  1. Manufactured luck capital allocation is indeed most important part in the game. There is no scientific basis for the same (some research points that portfolio of 100 stocks across various industry is best suited for diversification) while some famous investor like to be best 5-6 stocks with different allocation based on own conviction level. Also in many thoughts it is proposed that for creating good wealth we have to take less number of bet when odds are in our favor and give big bets. Intuitively for Indian market considering RJ investments small to mid cap stocks with upto 20-25 number is best suited for the purpose (considering chances of more black swan even due to weak implementation of rules and regulations and deterrent for promoters against frauds). Ultimately it boils down to own objective and capital available at hand and how high probability he feels for success.

    1. Thanks Niraj for sharing your thoughts. We agree entirely that there is no 'scientific' basis for the allocation decision. But that is true for the stock selection decision as well. What is a good idea for one, may not be for the other and various styles exist. We hope to share our thoughts on an allocation framework in future posts..