Equity selection and Group think

Tough post. Not too many people should read this, especially if you are NOT a direct equity investor.

Did your parents ever tell you that what others thought was not so important? Well my parents never did but they NEVER did anything because somebody else did it. So that was good behaviour.

When I entered the brokerage business in 1987 I was part of what can now be called ‘Absolute Return Investing’ – a common sense based approach. No client/customer ever (ever, ever) asked ‘how much did the other customer get’ or ‘how much did all your customers get on an average’ or ‘did you beat the benchmark’ or ‘how many brokers broke the benchmark’. Frankly, they all believed that what others got was their business. All of the clients (I toyed between Most and all to begin this sentence) believed that if their equities performed well, they had done well. They did not care about what markets did, asset allocation, etc. So saving them Income tax, interest on home mortgage, reducing their risk – was all a part of my job. Trading equities was incidental.

When I quit in 2000 I quit because I did not want to be in a people intensive, technology intensive business with just my own money. And as a person averse to borrowing (never work with others money), taking money from Angels, Vee Cees, etc. was NOT an option. One huge advantage was I escaped the ‘Relative Return Investing’ disease. The pressure to conform in the investment management industry is HUGE. As the name implies, these investors are measured relative to the crowd. One wrong step in one QUARTER and they may look different. And worse they are answerable to a bunch of people. This is yuck investing. Congratulations Naren, PJ, Anand, Ramdeo – but investing under the glare of so many people is a skill that i could never, ever have developed. Its not me.

For most fund managers being different is alien. Even on the upside it takes a very long time for the market to accept that ‘such a strategy is good’. Take Naren for example – a classic case of sticking to his guns in this market. Take Sameer Arora – he is lucky that he is not running a fund – remember he runs a long-short fund and such funds are not allowed in India. If a manager outperforms too much his board of Trustees and the AMC board will keep hounding him about some transgressions. If he were to under perform he would lose AUM and the whole world will tell him how ‘he should have sold Infosys while keeping TCS’. Absolute returns? My foot. See what the neighbor did, preferably, daily not just monthly or Quarterly. Yuck again.

From what I’ve seen over the years, to raise a lot of assets under management (AUM) in the investment management industry (which by the way is more important than managing it well), the key is looking a little better, but not too much better. Of course you cannot look too bad for too long! Of course this also comes from the fact that the people selling your funds are bank employees who like ‘predictability’ in an equity fund. So they are happy selling (mis-selling?) a balanced fund which will SURELY give them 1% p.m. return for the rest of their lives.

This whole movement happend because of the ‘Institutional Consultant’ who is given a ‘what to tell the client today’ in the morning and for him predictability is important. So the mandate is ‘do not outperform too much, but please stay above the average line’. Then this guy goes and pumps in money into funds who are ‘above average’ in performance based on an amazingly stupid star rating system. If consultants allocate assets to asset managers on the basis of ‘do not surprise me’ will he ever buy an Equitas by selling Reliance or Infosys ( examples please, not suggestions)? Or will he short LnT because the capital allocation is a joke? No. He needs to have Reliance, Infosys, LnT. Nobody will accuse him of missing Equitas or a Mindtree, but he will be lynched if he was underweight Reliance AND Reliance were to go up.

Of course internationally it is even worse. Institutional consultants allocate lots of money and are hired by pension funds etc, to decide which managers to use for their plans. The consultants’ assets under management and their allocations are huge and are getting bigger in markets where alpha is shrinking! Of course their aum has got bigger over time, increasing the desire by asset managers to be selected. So managers want to look more and more like ‘slightly better than average, but not too different’.

I am so happy that I do not do fund management as a profession or a business. Selecting good fund managers and sticking to them is much easier, and if I expect alpha to shrink further…just saying ‘go index it’.

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