{"id":15,"date":"2019-12-21T09:35:53","date_gmt":"2019-12-21T09:35:53","guid":{"rendered":"http:\/\/cedcapital-in.preview-domain.com\/?p=15"},"modified":"2020-03-03T05:57:52","modified_gmt":"2020-03-03T05:57:52","slug":"behaviour-as-an-edge","status":"publish","type":"post","link":"https:\/\/cedcapital.in\/?p=15","title":{"rendered":"Behaviour As An Edge"},"content":{"rendered":"\r\n

\u201cWhat\u2019s\u00a0not<\/em>\u00a0going to change in next 10 years?\u201d<\/span><\/p>\r\n

\r\n\r\n<\/span><\/p>\r\n

-Jeff Bezos<\/span><\/p>\r\n

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Internet, securities regulations and entry of talented individuals have blunted the erstwhile investment edge offered by better information and better analyses.\u00a0Rational behaviour<\/em>\u00a0\u2013 buying below intrinsic value and selling above it irrespective of short term noise \u2013 still remains a sustainable source of investment edge. That\u2019s because\u00a0institutional compulsions<\/strong>\u00a0and\u00a0human emotions & biases<\/strong>\u00a0force participants to eschew this rationality and create mispricing. These two factors will not materially change in next 10 years.<\/span><\/p>\r\n

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Institutional Compulsion<\/strong>: Investment behaviour of fund managers at investment institutions is driven by minimising\u00a0career risk<\/em>. Their jobs, promotions and bonuses depend on increasing the assets under management (AUM) which in turn depends on matching or beating their benchmarks net of fees on quarterly basis. Often unconventional and\/ or concentrated stock picks cannot offer this guarantee. Therefore most of them construct \u2018index aware\u2019 portfolios \u2013 euphemism for mimicking benchmark indices. Many companies that are out of index donot find buyers and remain mispriced. Rising interest in Index Funds\/ETFs (passive funds that mimic benchmarks fully without any human discretion) will further aggravate this anomaly. Further, redemptions or regulations force fund managers to sell stocks irrespective of value. Recent SEBI reclassification drove lot of money out of mid and small caps to large caps irrespective of fundamental merit.<\/span><\/p>\r\n

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Human emotions & biases:<\/strong>\u00a0While good for hunting, gathering and surviving, evolution has ill prepared us to do well in investing. Fear and greed were mental shortcuts that helped our hunter forefathers survive. They ran when there were rustlings in the bushes (fear). And, they overate\/ stored whenever food was in excess (greed). These genes are passed on to us as their legacy. Price fall triggers the same fear. Risk aversion rises and future projections get grim. No price is too low. Conversely price rise engenders same greed. Risk taking rises and future projections get rosy. No price is too high. Behavioural Finance has demonstrated that we are not perfectly rational. We are susceptible to heuristics and cognitive biases.<\/span><\/p>\r\n

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Behaviour Edge:<\/strong>\u00a0Knowing above, following offers a sustainable investment edge:<\/span><\/p>\r\n

\r\n\r\n<\/span><\/p>\r\n

    \r\n
  1. Operating only in businesses that one honestly understands and having a sense of their intrinsic values.<\/span><\/li>\r\n
  2. Remaining humbly aware of multiple possibilities including our own folly and therefore buying with a margin of safety.<\/span><\/li>\r\n
  3. Understanding that (a) intrinsic values are less volatile than price, and (b) emotions revert to mean.<\/span><\/li>\r\n
  4. Raising money and\/ or investing only when prices make sense (is harder than seems) and willingness to hold cash when opportunities are thin. Our \u2018zero fee and profit share only\u2019 structure supports this behaviour.<\/span><\/li>\r\n
  5. Looking for opportunities in spaces where price discovery is still inefficient.<\/span><\/li>\r\n<\/ol>\r\n

    \r\n\r\n<\/span><\/p>\r\n

    Rational Money<\/strong>: A fund\u2019s behaviour is derived from its investors\u2019 behaviour. We may, thanks to above reasons, find bargain securities and buy. Prices however may continue to fall even after that despite fundamentals remaining intact. Interim NAV performance may look poor. If investors panic and withdraw on those times, the paper loss will be converted to actual loss and all our behavioural astuteness (1-5 above) will amount to nothing. A fund manager can be only as rational as the money she manages.<\/span><\/p>\r\n

    \r\n\r\n<\/span><\/p>\r\n

    Note: This piece was part of one of our half yearly letters sent to\u00a0our investors.<\/em><\/span><\/p>\r\n","protected":false},"excerpt":{"rendered":"

    \u201cWhat\u2019s\u00a0not\u00a0going to change in next 10 years?\u201d -Jeff Bezos Internet, securities regulations and entry of talented individuals have blunted the erstwhile investment edge offered by better information and better analyses.\u00a0Rational behaviour\u00a0\u2013 buying below intrinsic value and selling above it irrespective of short term noise \u2013 still remains a sustainable source of investment edge. That\u2019s because\u00a0institutional […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[1,2],"tags":[],"class_list":["post-15","post","type-post","status-publish","format-standard","hentry","category-investment-psychology","category-value-investing"],"jetpack_featured_media_url":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/cedcapital.in\/index.php?rest_route=\/wp\/v2\/posts\/15","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/cedcapital.in\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/cedcapital.in\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/cedcapital.in\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/cedcapital.in\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=15"}],"version-history":[{"count":4,"href":"https:\/\/cedcapital.in\/index.php?rest_route=\/wp\/v2\/posts\/15\/revisions"}],"predecessor-version":[{"id":199,"href":"https:\/\/cedcapital.in\/index.php?rest_route=\/wp\/v2\/posts\/15\/revisions\/199"}],"wp:attachment":[{"href":"https:\/\/cedcapital.in\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=15"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/cedcapital.in\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=15"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/cedcapital.in\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=15"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}