The Final Decision

Here's a jot down of my thinking process and organizing those thoughts, after I slept over my last two posts on clearing confusions and focusing ..and I'm happy to have emerged stronger from the turmoil and have a clearer vision now :)

Immediate Actions, in this order

(0) Set the eventual goal of investing, write it down, and make sure you don't flip-flop - most important is to stick to the process and plan and not get worried by noises and intermediate results, which are anyways temporary...

1. Trim down PEL to a maximum of 5% of portfolio. This translates to selling about 40% of existing held shares in this counter. Then move this investment into speculative category.

[DONE]

2. Exit ARBL and IL&FS completely.

[DONE]

3. Start (small) SIP in PPFAS LTV fund.

[ONGOING]

4. Decide about MCX - whether to continue holding it as a high risk speculative bet in portfolio, or put sin money rather into Index Options trading (more as a portfolio hedge or trading only in strongly trending markets with clear stop losses and deep in-the-money options). Well, I feel more comfortable "avoiding options" due to the huge mental stress cost associated with them, at least as of now, and in that respect, MCX is easier. I'll therefore keep Index Options as a hedging instrument only, that too after assessing the risk-reward given I've liquidated some amount of stocks already. let that be a separate action below, in the next actions category. For MCX, I'll very slowly accumulate the stock whenever it is a bargain - need to look at latest audited balance sheets for the same, and that's an action now.

5. Analyze whether CARE needs to be exited immediately, or we have more to analyze it in further details.

6. Analyze what to do about capital goods stocks (BHEL, CG, MAZDA)

Next Action is to create a study plan, that'd comprise of:

(0) Can mutual fund SIPs (regular and continuous) be good enough for average returns, slightly better than fixed income? Further, invest (new money) directly into stocks only if you find a really great bet after very conservative and thorough analysis? As Mr. Buffet says, 2-3 great picks an year are more than enough...

(0->1) Goals and deadlines are for pure science work, which is somewhat true in office and engineering products. Investing is more of an art and hence it's futile to set goals and timelines. Be clear about it and set a wider goal accordingly, which should be to live a happier life. Outcomes which are out of your control should not worry you so much in future.

(...) I also need to revise lessons from Bhagvad Gita as it'll help me stick to my philosophy and strategy, and not get deviated by noises.

1. Technical analysis for long term investments and portfolio hedging using index options?

2. Portfolio allocation between value oriented investments, speculative bets (can you rely on others for this? are you competent emotionally for fast moving market timing based decisions? cost of mental stress?) and other investing methods (quantitative value investing purely based on numbers like Ben Graham's or Magic formula based screening or Prof. Bakshi's statistical bargains...).

3. The following readings for value investing / behavioral control, as I also mentioned in last post:

- Letters from Mr. Warren Buffet
- Mr. Charlie Munger's work on mental models
- Howard Marks's memos to investors
- Security Analysis by father of Value Investing, Mr. Ben Graham

- Prof. Bakshi's blog

- Pat Dorsy and Phil Fisher

- A few books on behavioral finance and history of market manias and crashes

4. Finally, maintain a regular portfolio review schedule - say every fortnight, and you don't want to spend too much time on this every week.

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Here're the notes based on brainstorming and taking final decisions:

1. Base rate of success of value investing in the long term, and timing the market along with study of business fundamentals - on this topic, I find and believe that base rate of long term investing success is quite good if time horizon is 15 to 20 years, as evident from below summary of few reads:

This link shows how long has it taken for value oriented investments to recover in the past, and it is generally less than 5 years. Based on this "history", the decline that started in end of 2010 in Indian stocks (not the indices) should end by 2015 or earlier, and we should get good chances to exit investments in "not so great" businesses or not so great stocks in our portfolios at a decent if not great profit and re-balance portfolios sometime in 2016-2018. You need to stick blindly to buy and hold, but rather be vigilant of the business conditions and take decisions to sell stocks. Further, this study shows that base rate of success of a diversified portfolio with balanced allocation and held for over 20 years is quite high, and the key is NOT to time the market and staying invested. Finally, if you buy stocks very cheap, dividend yields tend to get higher and they more or less offset the cost of capital that's held in the investment. Hence, finding great value bargains with dividend yields approaching long term bond yields is an excellent opportunity to make great wealth.

The next question that relates to market timing is - What if I keep accumulating good quality stocks at good prices, but when it's time that I need money, we have a great depression? I'll just have one chance. On this, I read and found that:

This interview by Mr. Buffet tells us how staying invested in equities for long term generates superior returns - which is an increase in purchasing power of original invested money, post tax and costs, while ensuring sufficient safety of principal invested. Many other articles (like this) explain how timing the market is not so useful (yes there're exceptions, but probably the cost of stress and amount of time-investment is not so advantageous in terms of extra returns, even if they could be generated). Finally, we know the base rate of success of market timing is quite poor. We may still explore this subject of "Technical analysis for long term investments" in future as a part of study plan, but for now, we're incapable of performing this timing analysis on existing investment.

3. Whether to use PoE and quickly decide which stocks I can't hold for long enough, as an action from the last post. Not so sure, and rather the stock actions below are a better choice.

4. Stock actions (with the intention to minimize time resource allocation towards stock study, and re-allocate the same time more towards reading and learning):

  a. Trim investment in PEL, mainly since I don't understand it very well, and sidecar investment can't be top holding in a value oriented long term portfolio. Considering it can still be a good investment, I'll trim it down to about 5% of my portfolio, and hold it as a special situation (where the capable manager in Mr. Piramal can revive the enterprise and generate superior returns, but this still has a level of speculative element as an investment and hence not a pure value play, and rather a turnaround story which may not do so)

  b. Exit IL&FS and ARBL, as they'e anyways speculative bets not going to run away in a hurry and better would be to re-allocate these funds into mutual funds that I already hold (and they do have invested in these stocks). An action here (to get exposure to IL&FS indirectly) is to start a small SIP into PPFAS Long Term Value Mutual Fund, which may generate decent returns over long term (yes, there's a key man risk involved, and hence limiting exposure through a small SIP)

  c. To conclude on what to do about capital goods stocks, MAZDA, CG and BHEL, I think I'm little worried about their long term future - they may not turn out to be great investments, but I think they'll generate good returns. The question is - since this is the industry I understand the best (engineering stocks), and they're ones in deep losses (except MCX), should I continue to hold or exit in the hope of timing the market and buying them when signs of recovery in capital goods industry are better, and even re-consider better bets like L&T? I don't yet know, and need to think on this with focus...

  d. Rest of portfolio is MCX and CARE, of which I just moved MCX to speculative grade and hence I'll decide on that soon as a separate action, and CARE needs more analysis (if it's too hard to understand well) before any call can be taken. Regarding INFY and BHARTI (Bharti Airtel is probably a business more complex than I originally assumed, but since I understand it at a high level and believe that the worst is over for this sector and the business, I can afford to wait for some time to analyze this in deep, or move to the "out / too-hard" basket later on), I think I'll remain invested in these sound businesses - downside risk is quite limited in these, and I'll slowly perform more conservative analysis of these businesses and take a call accordingly, but no hurries to sell these two stocks right now.