It is always a great pleasure to listen to Sankaran Naren, one of India’s most admired and well-known fund managers, and the chief investment officer (CIO) of ICICI Prudential AMC.
He recently spoke at the Tamil Nadu Investor Association sharing some of his best wisdom from his 3-decade career in the Indian markets as an investor, broker, and fund manager. He’s perhaps best known for his contrarian style of investing which has helped him create immense wealth for investors. Here are some of the best insights from his recent speech.
Investing is not arithmetic
I must start by saying that investing is not arithmetic everyone thinks that in investing you won’t make mistakes but in investing mistakes keep happening and the challenge in investing is you have to make few mistakes and get many things right
Even the legendary Warren Buffett made a few mistakes for example he talks about his mistakes in Dixon shoes and Tesco and IBM and in Precision Shaft Etc
It is impossible in investing not to make mistakes and the day all of you come to the conclusion that you will never make a mistake I think it is going to be very difficult.
- One of the key lessons that I have learned over the 34 years of being in the markets is that mistakes are part of investing but you should make fewer mistakes and get many things right.
Every time you make a mistake you have to go through an introspection exercise and realize what you learned from that mistake so that you don’t repeat it again.
Many people don’t realize this but the easiest job in investing is buying.
When I started my career in 1989, 89-90 was such an easy period to buy stocks. All you need to do is to look at the annual report, look at the business, look at the valuations, and think what will this company do over a period of time and it becomes very very easy to buy. All the investment literature is also focused on buying so actually buying is the easiest part of investing.
For example in the cycle that started in 2020, there have been a lot of advantages for investors and I worry about it that many of them started their investing career in 2020 at a very very good time they bought shares cheap the timing was fantastic the stocks were very very cheap and you could buy them cheap and you made very very good money but that is not the difficult part.
The difficult part comes now. In 1989-90, I didn’t realize it but in 1994-95, in the bull market of 94-95 I realized it was very very difficult I did not know many things at that point in time when you are in a big bull market like 94 95 like we are in a bull market in 2023 you have to recognize that you are very very different situation from 2020 and therefore you can make many mistakes
Asset Allocation:
The most important lesson that I learned from 94-95 is asset allocation.
What happened is that in 1994-95 you could not have an allocation to equity as much as what you had in 1990 when the market was very cheap in 94 95 you had to have an allocation to equity which was lower but that was not to be.
Take a time like today:
Is there anyone investing in debt? the answer is no.
Is there anyone investing in any cautious product at this point of time through the mutual fund industry? the answer is no.
Is the derivative exposure and open interest in stock options and stock futures? The answer is yes
So what people are doing is what is called reverse asset allocation which means that when the markets are high people are not cautious This was the mistake that many investors made in 1994 and the single biggest lesson that one learned from 94 to 98 was that asset allocation was very important.
What is Asset allocation?
Asset allocation is taking out money from an asset class that has done extremely well and pushing it to an asset class that has done very badly.
If we go back into history, in 1998, Debt used to give 16% interest rates so it was very logical you had to invest in debt at that point in time. In 2002, Debt used to give 4% interest rates so it is very logical that you are to move from debt to equity in 2002.
What is it you need to do from an asset allocation perspective today?
Look at the 10-year return of the small-cap index - it is 20% CAGR. What is a 10-year return of the mid-cap index? it is 22% CAGR. so what is the simple thing that you have to do? You have to take out money from small and midcap and move it to something safer at this point in time that’s what asset allocation tells you to do.
What does the mutual fund floor show at this point in time? exactly the opposite - what we call reverse asset allocation.
Why does this happen? because somehow behavioral Finance always forces you into reverse asset allocation.
It’s very important that people practice asset allocation. is it rocket science? the answer is certainly not. there is no rocket science involved in it.
What is Cycles?
As Howard Mark says it’s a pendulum that can sometimes have extremes on both positive and negative and sometimes you can be in the middle.
How to determine where you are in the cycle is Art and you can get it wrong so the factors that you make use of certainly are:
- how much institutional ownership is there in the sector?
- how’s the valuation of the sector on various parameters compared to the Past?
- what kind of sentiment is there in IPO Market in that sector?
- and what is the general margins profile in that sector?
It is important for investors to close their eyes 15 minutes a week and think about where they are in the cycle and what are they doing with their investments in the cycle, if they do that I think there is a huge amount of learning you will get.
What you do in asset allocation should always be a function of where you are in the cycle
When the cycle is extremely exuberant, you have to be careful and when the cycle is extremely pessimistic you have to be very very aggressive and that is the biggest learning that I got from Howard marks over the years.
Structural Investing:
If you look at a country like India you could have taken a call on something like private sector banking or retailing or many sectors like that or it services and you could have held it for 20 years and made huge money and if you had bought it right at the beginning of the cycle and then stayed on for 20 years the kind of returns that India has given in many of these sectors has been stupendous frankly it doesn’t require any rocket science to know that private sector banking was going to grow or retailing was going to grow or even Telecom was going to grow but it required patience and the right company to back on and uh it requires some amount of stock picking skills.
I believe structural investing is something that is very very enjoyable for most people. for example, globally people who got things like Apple Google Amazon, and Tesla right have had such a fantastic experience investing because it was the best kind of structural investing that you could have ever done in investing at any point in time in the world
Reading Pulak Prasad’s books, Howard Mark’s memos, and Hearing from Warren Buffett in Delhi 10 years ago, there was one thing that came out very very clearly from all these things which is that the market sometimes goes to extremes and when it goes to extremes you have to act and this number of times it goes to extremes is very very rare it goes maybe once in five years once in 10 years in fact in that meeting Warren Buffett said it normally comes once a decade and 5 times in 50 years and that’s when you have to act in a very very big way.
Do you have the capability to act in that very very big way when the market is at an extreme? that is a challenge for all investors.
If you decide you’re going to act in a very very big way each day, then you’re not going to make money.
In my opinion, such opportunities come rarely so if you go to my 34-year period, 2002 was one 2008 was one March 2020 was one.
“If you want to be a good long-term investor you can’t be full-time you have to be part-time”
This comes as a very controversial point but my view is if you want to be a good long-term investor you can’t be full-time you have to be part-time.
In fact, I was studying what are the positives of what Warren Buffett and Charlie Munger did they don’t only invest for a living they invest and then they also run businesses
In these 30 years, what I’ve seen is that it is not logical for people to be full-time in investing when you’re full-time in investing the biggest challenge that happens is you don’t give the time needed for returns to come from stocks.
For example, if I bought a power stock four years back and it took four years for the returns to come would I be patient for those four years if I was full-time in investing that is a challenge
I believe very strongly that investors being part-time gives them a huge opportunity so if you are able to be an architect or a chartered accountant or a mutual fund distributor or if you are able to do any other work, I think it’s much better to be a part-time investor for example as a CIO I am involved in so many things I have to learn about for example New Age companies I have to be involved in training many of my younger colleagues on how to approach fund management how to approach equity research how to involve myself in many things so while I am a full-time investment professional I’m not every minute bothered about what has happened to my portfolio because finally I’m investing for the long term and it’s something which I’ve seen over a period of time and that too
My 10 years in stock broking taught me that all the people who are part-time investors actually had a much bigger headway over all the people who actually had a situation where they thought of investing as a full-time profession.
Even in India, you’ve seen people who have been phenomenal investors, one of them is running a phenomenal retailing company, another person started an airline, and another person has set up a beautiful University so I strongly believe investing is a fantastic part-time profession.
I believe it is very important for investors actually not to be over-focused on only investing because investing is not a business that gives you monthly income it is not a business where you can be sure you can make money every month.
There are a few people like Renaissance Simons who managed it but other than that most people can’t manage this whole concept of trying to make money every month they have to make money over a period of time.
That is the reason why I believe it is very important for investors to do a second activity along with investing to actually have the thrill of investing. this is something I’ve realized over the years and found it very difficult to convey to a lot of people that you can be a teacher you can be a professor and you can do many many other jobs along with investing and that will be far more rewarding from an investment professional point of view.
Using Market cap at extremes:
Whether it is in 1999 in Tech in 2007 in infra in 2015 in Pharma in 2021 in Fang, Using market caps at extremes has shown huge ability to deliver alpha.
I believe these extremes in the market cap can be used to actually deliver huge Alpha by comparing market caps
It is not that the market cap that is high needs to go down it is the market cap that is high needs to be sold or switched into the market cap that is low. For example, it is not that the large-cap Indian companies did badly it is the PSUs outperformed the large-cap Indian Companies.
This model should not be used on a daily basis it should be used in extremes and when the extreme comes it is useful to actually act in a very big way.
Seth Klarman’s famous quote “the entire concept of value investing is contrarianism with using a calculator.”
The whole calculator part is forgotten very frequently for example in many of the NBFCs and some of the private Banks the calculator told us not to invest and it turned out to be a correct decision
On the other hand in one of the telecom companies we went wrong on the calculator because we went wrong on a court case and that resulted in a loss because while we did value investing we missed the court case properly.
In another case, we looked at a Tea Plantation company and said this company has 15000 acres of land but we forgot that that company in their balance sheet had taken out lot of money and given it to another company in the form of loans and advances so the key is What said clarman mentioned which is that at heart if you want to succeed in value investing you have to be contrarian but you have to go right on the calculator part of it also and if you don’t go right on the calculator part of it you are not going to win in contrarianism and that is the challenge of value investing that sometimes people think value investing is just buying something cheap if you did something cheap you would have bought junk infrastructure stocks in 2007 you would have bought the wrong NBFCs in 2017-18 that won’t work you have to do contrarianism with a calculator for you to succeed in investing at this point of time and at all points of time this is the model which works.
Why is contrarianism useful?
As you succeed and manage more and more money, it is very easy to manage to buy and sell if you are a contrarian.
For example: if you wanted to sell small caps or PSUs now, it’s easy.
The drawback of following only one style of investing:
If you follow only one style it becomes a problem so all the people who are just quality got into trouble in 2020 to 23 although they had a beautiful 2017 to 2020. there are people who say I’ll be only small cap but they had such a bad experience between 2006 and 2013.
Contrarianism does not say that you should be only smallcap or quality or growth or value or midcap or large cap, it hunts for where there is intrinsic value upside.
The right time to measure your performance:
There is a time to measure your performance today if you are a small-cap investor or a Chinese fund manager, today is not the time to measure performance. you cannot measure performance when markets are either too high or too low that’s the wrong time to measure performance. you have to measure performance when you are in the middle and not when markets are at extremes.
Summing up investing:
The whole investing game which is very very rewarding financially is actually common sense.
How to practice common sense, in the long run, is the biggest challenge for all investors particularly for people like us when we are managing other people’s money it is even more tougher because we are answerable to other people.
When you’re managing your own money it is very important to remember that finally investing is common sense. was it common sense to know that in March 2020 Market was cheaper the answer is certainly Market was cheaper it was so easy to know was it common sense to know that in December 2007 Market was very costly answer is it was very simple in December 2008 Market was very cheap was it common sense the answer is yes is it common sense to know that small and mid-cap is very overvalued compared to lunch cap the answer is simple it is common sense
In the long run, markets will be rational, markets will show common sense, and in the 34 years that I have been investing, markets have been sensible.
Markets will give you superb opportunities if you are rational in an irrational market and somehow wait through it and succeed in managing to be rational in an irrational market.