IIC 2020 : Taming Uncertainty by Ralph Hertwig

Moderated by : Madhu Veeraraghavan

Contributed by: Rajni Dhameja, CFA

The 10th India Investment conference hosted one session on Taming the Uncertainty by Ralph Hertwig. He is a director of the Centre of Adaptive Rationality at the Max Planck Institute for Human Development at Berlin.

 The contours of the session were designed around how the uncertainty is different from risk and how in real life we deal with uncertainty more often than not. The hypothesis was that considering the fact that people are not fully rational as assumed by financial models, can we invest more time and effort to understand how people take decisions and train the models accordingly. Hence it is an attempt to consider the approach of “moving from people to models as against the existing approach of models to people“.

Uncertainty is a human condition. It is a space where outcomes of a particular event are either not known or incompletely known hence the surprises can happen. For instance climate change in an uncertain situation rather than risky situation because full impact of climate change is unknown to a large extent. Following are few real life examples depicting uncertainty and the way people deal with it:

  1. Miracle of Hudson river in 2009, wherein plane was stuck above the water due to some issue in the engine. Between the choices of going back to the starting point and landing over the water, pilot made the less popular choice of landing over the water. In hindsight, pilot explained that for this decision pilot relied only on one piece of information i.e. direction of movement of windshield which indicated that if pilot attempts to land he will be able to do so.
  2. Decision making by cab drivers in the city of New York (approximately 6000 times in year) as to who they can let inside the cab so that they do not let any unwanted person inside the cab. Their decision making is based on simple heuristics of preference towards women over men, individuals over group, older people over younger ones etc.
  3. 80% of decision making by firefighters is in less than 1 minute

The above three completely different examples of uncertain situations point out to one common thing i.e. way of decision making in these situations. Decision maker’s reliance on simple heuristics rather than complex algorithms.

Let us understand the difference between risk and uncertainty:

Risk is perfect knowledge of possible outcomes of a space along with the associated probabilities of occurrence of those outcomes whereas, uncertainty is  where the all outcomes are either not known or incompletely known hence the surprises can happen.

In real life lot of situations are such which are uncertain in nature rather than being risky. Mervyn King, former governor of Bank of England once mentioned that : “If only banks were playing in a casino, then we probably could calculate approximate risk weights”.

Further, the outcomes can be known in the problems which are small world problems hence they are risky nature and can be solved with Bayesian principles. eg: outcome of a lottery ticket. But if you consider the uncertain situation like planning a picnic, it cannot be solved through Bayesian principle as the outcomes are unknown.

In real world people deal with uncertainty in a manner which is completely different than the rational way as defined in neo classical economic theory. The neo classical economic theory specifies the problem solving approach as defining the objective, understand the attributes of decision making, define the alternatives and associated probabilities and choose the outcomes. But, real life decision making is far from this in most of the situations. The real life problem solving is through bounded rationality as against the idealistic Olympian rationality of neo classical theory.

The moot point over here is, in certain situations which are uncertain in nature heuristics leads to better decision making than the decisions taken through fully rational methods.

A research program was conducted in simple heuristics to develop a framework which helps to improve the quality of decisions. The framework is as follows:

  • Adaptive toolbox: What are the heuristics available which people use
  • Ecological Rationality: It is important to understand, in which environment do heuristics succeed. The argument is not that heuristics are always better than the models or other way round. The argument is that there are certain situations where heuristics lead to better decision making than the models and figuring out those situations is the key. Heuristics can be applied where uncertainty is high, alternatives are many, data available is in smaller quantities and there are time pressures to take decision. For instance comparing the 14 models of asset allocation including Markowitz mean variance model and other variations of it with 1/ N diversification, 1/N was not necessarily the top most in terms of results but one among the top ones. For complex model to generate superior results, 500 years of stock data is required. This clearly states the trade off. Hence it is important to understand the ecological rationality.

There are alternative views which suggest that heuristics cannot be effective in          complex situations because complex situation need complex solutions for instance   catching the liar or game theory. One research was conducted to apply the heuristics        to a complex problem. Complexity was introduced in the game theory by increasing the proportion of fat tails i.e. uncertain outcome. The final result of this experiment was that the simple heuristics lead a better result than the complex algorithms. Hence, this indicates that heuristics can be useful to solve complex problems as well.

  • Boosting: How can the people’s competencies be fostered to improve decision making as against the popular idea that human beings are flawed decision makers and nothing can be done about it. The popular belief is that human beings are biased and lazy thinkers hence rely on heuristics. The boosting believes that by training people about the abstract concepts in simple heuristics manner can improve the decision making. eg: training the micro entrepreneurs on abstract skill of separating the household and business accounting. Instead of taking complex route, if u explain the home accounts and business accounts as two buckets and tag the expenditure in relevant bucket will help people understand the accounting in easier manner. A real life experiment in this area has shown significantly improved results.

 This brings us back to the idea which was introduced at the beginning of this write up as to “approach of moving from people to models as against the existing popular approach of models to people”.

Two important takeaways from Q&A are application of this principle to the financial world in terms of valuation and risk communication. In valuation it is important to consider that the landscape of projections is more of uncertain nature due to which we may not be aware about all the outcomes and hence factor in the black swan events.

In risk communication, if we adopt the communication style which is more heuristic in nature as against the current approach of using technical terms the investors might be in a better position to understand them.

List of books which were suggested to understand the decision making process of human mind :

  1. Predictably Irrational
  2. Irrational Exuberance
  3. Blind Spot
  4. Misbehaving
  5. The Biased Mind
  6. Human Error
  7. Why we make mistakes
  8. Thinking Fast and Slow
  9. Taming the uncertainty



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IIC 2020:“Portfolio for the Future, the new normal is here” by Virginie Maisonneuve, CFA

Moderated by: Mr Aditya Narain (Head of Equity Research at Edelweiss, India Equity Strategist)

Contributed by: Vikrant Warudkar, CFA

Among other eminent speakers and moderators at the flagship event of CFA India Society, Virginie Maissonneuve, CFA (member of the CFA Institute Future of Finance Council) spoke on“Portfolio for the Future, the new normal is here”. Virginie Maisonneuve (VM), had firstly invested in India in 1990’s, for one of the first foreign investment fund in India.

The presentation carried theme of importance of the ESG factor in portfolios and about climate change, the evolving new normal. It shed light on enough facts and figures, supporting the hypothesis that ‘the climate change is a long-term trend in which companies and governments are evolving’. The presentation discussed purpose of asset management, Disrupters or Shapers having tipping points, and culmination of these disrupting trends shaping decisions of investment managers in portfolio construction. At the start of the presentation, VM urges audience to appreciate the importance of climate change. She also argues that in future, investment management industry have to give options with ESG factors to its clients.

She started the presentation with basic of the Asset Management Industry (AM), where clients seek assistance to achieve their financial goals given the risk. Ethic, trust, sustainability and clarity are additional factors clients seek.Inability of AM to produce alpha at large has paved the way for ETFs, which are now gaining traction in India as well. ETFs are set to cause disruption in the AM ecosystem. Other disrupters mentioned were asset management fees, rate of return (lower for longer), regulation, mass customisation, and ‘Shapers’.VM defines ‘Shapers’ as long term trends having tipping points.

A Tipping points is the critical point in an evolving situation that leads to a new and irreversible development. It is the point at which a series of small changes or incidents becomes significant enough to cause a larger, more important change.Tipping points are difficult to notice or identify since the underline changes are small and gradual. For example, the emergence of China as economical prowess over the decades.The most important tipping point we are facing today is gradual rise in the temperature of atmosphere on the Earth. After industrialisation, the rise in temperature has resulted in the climate change, impacting us significantly. For investors, it warrants inclusion of ESG factors in portfolio construction.

The disruptor’s list also entails technological advances like Artificial Intelligence and Robo Banking. For the coming decades combination of the ‘Shapers’ like Demographics, Climate Change, Technology and share of EM’s in world will continue to shape the world economy. Value creation will come from sustainability and riding the disruption. Asia can remain the centre of the world for coming decades. The growth in the past decades was more based on carbon emission, which is not sustainable, underpinning the need for new growth models. There is consensus among population at large about importance of ESG, and Asia becoming a centre of influence. But positive impact of AM on society has been denied.

Demographics, Technology and the Ultimate Resources

  • Demographics:

On demographics, the statistics presented are insightful. In spite of a decrease in fertility rate, population of the world is expected to increase, especially of India, China, Pakistan and US. Sub Saharan population to double in 2030 and in future may face migration due to heat. Japan and Europe are facing shrinking population. India is poised to reap demographic dividend.  Longevity and ageing will add salt to injuries as pension gap is increasing. India maybecome the highest populated country in 2050. Large numbers of millennial are in China and India. They are tech savvy and respond towards wellness and environment. They question the transparency of media and politicians. The generation Z (born after 2000), referrer of Gig economy, will set the new long term trends.  In India, millennial believe in saving and insurance. But they like to take the financial decisions independently. They do believe in sharing economy. Female millennial have strong ambitions. However, millennial have reached their peak of consumption cycle.

  • On technology VM has coined an equation:

Brave New World (BNW) = Artificial Intelligence (AI) + Human Intelligence (HI) + Emotional Intelligence (EI) 

Higher computing power (Moore’ Law) along with lower Cost of storage has buttressed growth of AI and ML. This has assisted humans to think faster and smarter. Though AI and ML inbuilt technologies have penetrated other industries, Portfolio Management is yet to see the disruption, barring trading with algorithms. Other technologies and their blends for example pattern-recognition, biometrics and neuroscience are proved to be disruptive. Homo Sapience (2.0) needs to adapt themselves to changing sources of alpha by learning soft skills including EI.  New era Portfolio Managers need ‘T’ shaped skills which includes soft skills like EI. Board and executive constitutions need a paradigm shift to address the changing environment. It calls for more representation of women, especially in the investment industry.

  • The Ultimate Resources

Climate change, the disrupter,was theme of the presentation. As the ultimate resource is the planet and there is no planet ‘B’, we must save this. The Commitments from the governments are shallow and everybody cannot pay equally for the problem. For instance, China and India are larger producers of greenhouse gases; however they have no equal resources to pay for the same.

Person of the year Greta Thunberg says “We can’t just continue living as if there was no tomorrow, because there is a tomorrow”. The next generation has alleged us for stealing their future.

VM explains that climate change is a significant variation in average weather conditions over decades. Rise in temperature causes the change in weather pattern, floods, draughts fire and extinction of corals. Since ice age, sea level has increased by 106 meters, due to the rise in temperature by 5 degree Celsius. Rate of warming of the ocean has doubled since 1993.

Major assets which are at risk includes infrastructures under water (communication cables) ($500 Billion) and coastal shelters. Further, as temperature increases productivity decreases. Heat waves may affect GDP as much as 25% in one day. If, ice at Arctic melts down, not only it will raise the see levels but also release tons of GHG beneath it. Then the process of heating the planet will accelerate. There will be problems of food, shelters, and some part of the worlds may become uninhabitable. Power grids may fail. There are no meaningful actions initiated, but grass route level some steps are being taken. Companies which are not taking actions against the climate change will be punished by the stakeholders or the climate.

India being the second largest coal producer, importer and consumer after China, it needs to shift its electricity generation to nuclear or renewable.A target has been set to shift 40% of present power generation by 2030. Cattles and farming activities are also responsible for emission of CO2 in India.

The ambitious goal of zero emission is still a pipe dream as there is no action from the largest five emitters of Carbon Dioxide. The priority between shareholders v/s stakeholders needs to be decided by adopting the longer-term views.

In the Global economy it warrants for ESG and a sustainable business model with TCFD, financial inclusion and innovation. Collaboration is required to tame Geopolitical tension arising out of the economic fragmentation.

What asset managers need to do to align with the changing reality?

Portfolio management shall reorient themselves for ESG factor, green finance, rigorous measurement and regulation. Alpha generation may happen on the building blocks of ESG.

  • Environment– Climate, Resources, Pollution, Waste, Food etc.
  • Social – Human Capital, Stakeholders, Slavery, Child Labours, Human Rights, Working Conditions etc.
  • Governance – Corporate Behaviour, Transparency, Alignment, Board Diversity and Structure, Taxes and Long-Term Strategy etc.

The managers shall dwell more on the integration of portfolios. More negative screen for ESG factors are required than ever before. Corporate engagement and shareholders actions require more attention. A collaborative approach is paramount of all. The alternative of public-private partnership is required to avoid externalities. Bottom (20%) of ESG stocks have experience larger drawdown (3 times) as compared to top (20%) stocks.

One should look for opportunities in shifting world where there is sustainability in the growth with key themes of security, more with less, sharing on demand, and entertainment / leisure.

  • Security– infrastructure, food, water, health, and predictability
  • More with less-productivity enhancement (in energy, industry and technology), learning and adaptability, and materials
  • Sharing on demand– transportation, consumer
  • Entertainment / leisure– virtual, local v/s global

Future portfolios need to adapt to the uncertainties and volatilities generated by the disruptions created by the ‘Shapers’. Over long term, timing the ‘Tipping Point’ is more of art than science, and hence opportunities for alpha generation can be from asset allocation. New skills would be required as the new normal will change. The ESG remains the king.

During Q&A session VM expressed her conviction of for ESG-ETF becoming massive success over next five years, as cost of ETF is coming down. While considering ESG factors, those needs to be taken as average instead of isolated E, S or G. For example, while consuming coal for power generation affecting environment, social issues of workers in coal mines also needs to be taken in to account. Though there is high cost associated with complying for ESG factors especially for mid and small cap companies and large corporates are pushing back the agenda, investors have to think from perspective of having the Tipping Point at a short distance and start investing in sustainable companies. There are huge opportunities in entire space and also PE and VC. Investors will not want to invest in companies which are not going to survive. Companies with more innovative ways for sustainability need to be screened. To avoid abuse of ESG as marketing tool, United Nation Principles for Responsible Investment agreement need to be considered by the firms, which would require reporting. The companies who are not ESG compliant can face difficulties hence there will be a huge demand for ESG compliant investments.A path for adoption of ESG needs to be adopted and scaled up as ‘Tipping’ is long-term and not going to happen tomorrow. Countries like India should use data (structured and unstructured) and AI to use ESG framework more effectively.

VM has suggested two books to the audience to acquire ‘T’ shaped skills

  • Mindset by Carol Dweck
  • The Uninhabitable Earth by David Wallace-well


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Session on “All about Cycles and Cyclicals” by Mr. Jiten Parmar

Contributed By: Udai Cheema

Jiten Parmar

When it comes to investing in cyclicals, a handful of names come to mind for having successfully practised the art and one such name is Jiten Parmar. So, when an opportunity to hear him speak on cyclical investing presented itself on 14th December 2019 at Holiday Inn, New Delhi, you bet I was there. The conferences held by CFA Society India are slowly becoming the industry benchmark for their rich content and this one was no different.

With this post, the goal is to summarise this insightful presentation made by Jiten and deliver the essence of his talk in the most effective way.

Here are some of the highlights from his talk;

  • Whatever has been learnt, has been learnt through trying, making mistakes, reflecting upon them and trying not to repeat them. This journey over the years has been intellectually enriching and financially fruitful.
  • Investing is an amalgamation of multiple disciplines such as psychology, history, sociology, politics, science and not just finance. Understanding your behaviour and the market’s (other participants) behaviour is crucial for success in investing. Politics has a strong bearing on our markets especially in highly regulated sectors like sugar etc. so if we don’t understand the policies of the government in these sectors it’s difficult to invest in them. For example, some recent policy changes regarding ethanol production by companies in the sugar sector has made the industry less cyclical than what it empirically has been. With housing for all as one of the primary agenda for the current government and subsequent implementation of RERA, it was clear back in 2015 itself that the real estate prices will stay in check for the foreseeable future. This way one needs to read into the Government’s actions and try to think of the 2nd and 3rd order effects that they might have for a sector in the short/long term.
  • Different people have different temperaments, so it’s critical to ‘Know yourself‘. Some are good traders, some are good investors, some don’t fancy cyclical investing that much whereas some are all about cyclicals, so it’s quite individualistic and one has to find an answer to that within. Cyclical investing can be quite a lonely place at times because usually, no-one is interested in your stock when you discover it and there is no set timeline as to when the winds will start blowing in your favour, if at all they do. These can be testing times and not everybody can handle it, just like the stresses associated with day trading are not everyone’s cup of tea. It’s your conviction and mental strength that comes to your rescue in times like these.
  • There is much more cyclicality in the world than we think. Cyclicality is all around us and not just restricted to a few commodity-based sectors. Markets are cyclical, the economy is cyclical, returns are cyclical. Infact, most things in life are cyclical, it’s just that the degrees vary.
  • Cyclicality can be divided into three categories based on their degree;
  1. Deep Cyclicality – Commodity businesses such as steel, cement, etc. are good examples.
  2. Moderate Cyclicality – Eg. cars, financial services.
  3. Low Cyclicality – Eg. FMCG sector.
  • One needs to look at two cycles, the business cycle and the other is the market cycle. So even if the business isn’t cyclical, it will be affected by the market cyclicality. So understanding these two cycles can make a lot of difference in the returns one ends up making in the markets. He shared a great quote by Howard Marks;

Rule No. 1 : Most things will prove to be cyclical

Rule No. 2 : Some of the greatest opportunities for gain and loss come when other people forget Rule One.

  • Within sectors and stocks, one has to comprehend ‘business cycle’ as well as ‘market cycle’ and they might not coincide. So investors need to make adjustments accordingly. ‘Best price’ may come before ‘best results’ and ‘worst price’ may come before ‘worst results’. The exit is absolutely crucial in cyclicals, better early than late as things can change very quickly depending on the demand and supply situation which makes any sort of earnings predictions extremely difficult.
  • It is true that one can’t time the market but one doesn’t have to get the timing exactly right. Even if the investor can get the direction of the cycle right and be ‘approximately’ right, it’s good enough. We don’t have to get in at the ‘bottom’, nor do we have to get out at the ‘top’. Exiting a bit early and leaving something on the table is a good strategy to follow in case of cyclicals.
  • Gave the example of a leading FMCG company that increased revenues from 10000cr to 19000cr between 2001 to 2011. Profits from 1600cr went to 2300cr but the stock gave zero returns during the period but the same company from 2011-2019 grew its revenues to 37000cr and profits to 6000cr and during this period the stock went up by 900%. The company is currently operating at all-time high EBITDA margins and they can’t keep rising forever. Similarly, a leading IT company has multiplied profits 37 times since 2000, but the stock price is yet to see the price once achieved in the year 2000. So, getting in at the wrong time can be dangerous for any type of company, be it quality, low cyclical and definitely for the companies in a deeply cyclical sector.
  • Refutes the argument of ‘quality at any price’. A company growing revenues at 10% YoY should not be trading at multiples of 80-90.
  • A big question that investors need to ask themselves while investing in cyclical is,

What do we expect/want from the investment?

Most of the time people think that it’s going to be a joyful ride to wealth, not realizing that they are also prone to speed bumps and accidents. More so when we try to piggyback on someone else’s research and conviction or try to be too adventures and start performing dangerous stunts with our money. It’s better to take help than to lose money.

  • There is a difference between perception and reality when it comes to success. Most people think that it’s a straight road to glory but in reality, it’s a much more convoluted path with multiple traps that can lead to failure. Every investor no matter how successful suffers from self-doubt at times and this is where the mental strength of the investor gets tested.
Source: flippedlearning.org


  • Shared an original quote with the audience to explain a critical aspect of cyclical/commodity investing;

Cyclical/Commodity plays are like going to a pub. Enter during happy hours and leave at midnight when the party is in full swing. Even if you stay late, be near the door, or you might end up paying the bill for others too.

On the contrary, people enter during the rush hours and try to stay until the end. That’s where the chances of getting trapped are the highest. Instead, if you leave something on the table still there will be handsome returns for you in such cyclical plays.

  • One needs to keep in mind that cyclical businesses can give phenomenal returns in the years of the business upcycle but they can give equally phenomenal draw-downs when the business cycle takes a downturn. So, getting the business cycle right is crucial for success. As a general rule of cyclical investing, the sector leaders give less upside in upcycle and less downside in downcycle.
  • First of all the investor needs to understand the commodity price cycle to identify the peaks and troughs which are underlying for the booms and busts in the stock price of these commodity-based companies.


  • Investing in cyclicals requires the investor to be a contrarian and follow the counter-intuitive/inverted approach. That’s because listed below are a few things that you are required to do while investing in a deep cyclical/commodity-based business;
  1. Buy when ratios are bad – EBITDA margins, ROE’s are down. The company might be in a loss.
  2. Sell when these show sharp uptick and the company becomes highly profitable.
  3. Buy, let’s say when PE is 60 (or negative) and sell when it is 6.
  4. Buy when the sector is completely neglected and sell when it is hot.
  5. Buy when no one is covering the stock and sell when many buy reports come.

So, a contrarian approach is required and you are basically betting on reversion to the mean. Simply put, one needs to buy when the stock is down n out and the sector is written off and sell when it’s the talk of the town with increased coverage.

  • The evaluation parameters include;
  1. Triggers show up. Identify the sector/commodity behind the triggers.
  2. Study the past cycles.
  3. Study production data, supply/demand.
  4. Check for capacity utilization.
  5. Check for Capex (when many companies announce, great signal to relook/exit).
  6. Check the margins.
  7. Check Price to Book (current, historical during upcycle and downcycles).
  8. Check replacement costs. P/B and replacement cost are good parameters in the case of deep cyclicals.
  9. Check for insider buying/selling.
  10. Check if the company has cash/manageable debt.
  11. Don’t look at PE ratio.
  12. Start initial buying at the highest pessimism levels.
  13. As cycle starts turning, add.
  • Some examples of triggers include;
  1. Sugar: 2 years of monsoon failure in India and failed Brazil crop in 2015.
  2. Paper: Largest producer BILT plants closing down.
  3. Fertilizers: A good monsoon after 2 failed years.
  4. Polyfilms: Increasing delta between RM and finished product.
  5. Chemicals: China measures for pollution control and closing of many units, ADD (anti-dumping duty)
  6. Metals/mining: Chinese plants started closing down due to pollution. For Steel – MSP, Infra focus.
  7. Cement: Government focus on infra, supply not coming as per estimated demand leading to higher capacity utilization.


  • It so happens that in a prolonged downturn, a lot of companies tend to perish due to unsustainable losses especially the ones that don’t possess adequate balance sheet strength to survive. Hence, before making an investment in a deeply cyclical business, the investor must make sure that the company has the financial strength to see through the adversity. If it fails to hold up in an extreme downturn then you run the risk of permanent loss of capital. Another way to mitigate this risk is to follow a basket approach i.e buy a couple of stocks from the same sector to form a basket of stocks, in case one of the companies doesn’t survive, the portfolio will be less affected compared to a single stock portfolio.


  • Exit strategies;
  1. Try to get out before the best earnings. Peak prices come before peak earnings.
  2. Always understand that there is “extra-ordinary” earnings in upcycle. Don’t commit the folly of assuming these as normalized earnings and look at it with a PE lens.
  3. One can employ a strategy like getting in at 0.2-0.3 of P/B or replacement cost and getting out at 1-1.2 of these.
  4. Try to estimate normal EBITDA margins by averaging them over downcycles and upcycles. Accordingly, calibrate your entry and exit strategies.
  5. Never repent if price still goes up after you sell, as long as you have good returns.
  • Rules to follow;
  1. Always make positional plays. These are not long term buy and hold kind of stocks and the maximum holding period is usually not more than 2-3 years.
  2. Patience is required. Be ready to hold until the story plays out.
  3. Adhere to strict portfolio allocation. Avoid going beyond 25% of the portfolio in a single deep cyclical sector. One can cut down the allocation to bring it down to 25% if it exceeds, that way you also get to take some of the profits home.
  4. Do not change the narrative, just to hold onto the sector/stock. For example, the change in the narrative of sugar-based companies to now ethanol-based businesses might have reduced the cyclicality in the sector but it doesn’t take it away. The base product that is sugar is still an Agro-commodity which is highly regulated and policy-driven. Another such change of narratives played out in graphite electrode stocks, people simply converted what was a whiplash cycle into a structural story and it did not end well for those who entered at the top or did not sell in time. Generally, the cycles that rise too fast don’t last very long.

You entered them as a commodity play, so treat them as a commodity play & exit them as a commodity play. Don’t change the narrative!

  •  Be prepared for failures. Cut when you realize it. Always keep your initial buy small so that if there has been a mistake and you have to cut your losses, the portfolio doesn’t get materially affect. Instead, try to build up the positions as the conviction grows and triggers start to appear.


  • Some observations;
  1. There are different strategies in investing and each has its merit. Choose the one that works for you. We don’t need to copy anybody, rather we should try to understand ourselves and see what suits our temperament.
  2. Successful investor trait – remove bias, rigidity. Try your hand at various styles of investing and see if it’s for you or not. Be and stay a learner.
  3. When good times come, make them count. One can use a trailing ”profit protection” i.e once you have realized that it’s time to exit from a stock (be it a cyclical or an overvalued quality company) but you know that it’s in fancy and you wish to ride the maximum upside, put a mental trailing stop-loss in place. For example, once your desired exit price is reached, simply put a 10-15% trailing stop-loss and exit at once if it hits otherwise keep riding the trend.
  4. Many investors keep watching the index, watch your stocks instead.
  5. Good stock at a bad price may underperform bad stock at a good price.
  6. Investing is more of an art than science.
  7. Temperament is the most important quality of a good investor.
  • Some case studies with financials taken from screener.in;

1. A Graphite electrode company in which the OPM jumped from 16% in 2016 to 71% in 2019 and during the same period, net profit went from 4cr to 3026cr. The PE was 150 at the price of 150 Rs which came down to 5 when the price hit 4500. The best time to invest was when the PE was 150 rather than when it became 5. The best results for the company came a year later in 2019 but the stock price had already corrected significantly by then. So, the price peaked way before the best results. That’s why one needs to think counter-intuitively when it comes to cyclical investing.

2. A Paper company that had operating profits of -39cr in 2012 and OPM of -17% which transformed into an operating profit of 71cr and OPM of 22% in the year 2017. During the same period, the stock price went up from Rs 10 to 280. As it’s a cyclical stock, the operational metrics, as well as the stock prices, have cooled down ever since with the stock trading at Rs 75 in the more recent times.

3. A Polyfilm company delivered a net profit of 1056cr in 2011 from a net profit of 94cr the previous year, subsequently in March 2014 the company ended the year with a loss of 7cr. That’s how the cyclical whipsaws tend to work. The stock price went from 90Rs to 475 Rs within a year’s time. The margins went all the way down to 3% in 2014 from the peak margins of 36% in 2011.

4. A highly profitable metal mining company consistently had OPM above 40% YoY but due to certain factors the year 2016 saw the OPM drop to 11%. Considering the average OPMs for the company were way higher in the past, this appeared to be an anomaly of sorts and anomaly it was as the margins recovered back to >40% in the next two years. The stock price went from Rs 90 in 2016 to Rs 265 in 2018. Considering it’s a PSU, the risk-adjusted return from the investment was quite good considering the time frame.

  • Some helpful sources of information;
  1. http://www.platts.com
  2. http://www.steelmint.com
  3. http://www.lme.com
  4. http://www.mcxindia.com
  5. http://www.zauba.com
  6. http://www.mining.com
  7. http://www.steel.gov.in
  8. http://www.businessinsider.com
  9. http://www.google.com

With this post, my goal was to summarise this insightful presentation made by Jiten and deliver the essence of his talk in the most effective way. He has been kind enough to share the slides of his PowerPoint presentation from the event. Link to the slides can be found [Here]

The article was originally published at : https://www.investorsingh.com/all-about-cycles-and-cyclicals-with-jiten-parmar-a-cfa-society-india-event/



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IIC 2020: The Long and Short of Bad Credit..and Bad Credit Analysis by Joel Litman (President and CEO, Valens Research)

Moderated by: Satish Betadpur, CFA (Managing Director, Head of Investments, State Street Global Advisors)

Contributed by: Vivek Rathi, CFA

Joel Litman started his session with a gracious photo of outstanding investors of last century. May be one of the few photos where we can see Warren Buffet, Benjamin Graham, Charlie Munger, Tom Knapp, ED Andersen, Walter Schloss  (WJS parner)  William Raune (Raune Cuniff, Sequoia fund),etc. together. The underlying philosophy was to show the amazing investment record of these market masters.  Most of these legends have consistently generated high Alpha over long period of time. Warren Buffet have generated over 12% Alpha for over 40 years, Charlie Munger had generated consistent alpha ranging around 15% before joining Warren Buffet. He continues with highlighting the contribution of Prof. Benjamin Graham in the field of Valuation and Analysis. In fact, the origins of CFA certification are also traced to Prof. Graham’s efforts to formalise certification for security analysis way back in 1940’s (though CFA program finally took off in 1963). Finally, he stresses on the importance debit/credit in Analysis and valuation, these terms appears more than 400 times in Prof. Benjamin Graham’s Books (Security Analysis and Intelligent Investor).

As popularly said, history does not repeats its rhymes and it is amply clear in financial markets. He describes how global crisis of 2008 were similar to crisis of 1908. He goes on to explain the effect of interest rates on credit cycle. He further explains that the rising interest rates are not same as high interest rates. High interest rates are a problem but rising rates may not be bad. Finally, he completes by showing how high interest rates may lead to credit crisis which in turn would drive collapse in equity market. The pattern was same for most of the crisis over last decade. Almost all of them were preceded by squeeze in availability of credit (Panic of 1907, The great depression of 1929, The Roosevelt recession of 1937-38, Dot com bubble of 2000, The global crisis of 2008, etc.)

He further talks on evolution of accounting, for example, the cash flow statement went through 7000 amendments before getting accepted in late 1880’s. At that point he highlights the loop holes in GAAP and IFRS accounting. According to him, the GAAP reported earnings do not give the correct picture, the earnings are distorted. He cites the opening remark of Warren Buffet in 2018 and 2019 Berkshire Hathaway Annual Shareholders meeting to substantiate his point on GAAP reported earnings. In 2019, Warren Buffet said “GAAP Rules..I’ve warned you about the distortions. The bottom line figures..totally capricious. It’s really a shame”. For example, on valuations using EBITDA, he quotes Warren Buffet, who believes it may not be a good measure to value a company (as depreciation is real expense, omitting it in valuation will not give correct picture). Similar observations were made by Charlie Munger and Seth A. Klarman. He cites distortion in Amazon.com GAAP reported earnings to support the above points on GAAP.

 The analysis of the aforementioned distortion by UAFRS (Uniform Accounting, Uniform Financials and Uniform Analytics) council has helped identify over 130 potentially material inconsistencies in GAAP/IFRS accounting. This ambiguity would be resolved with adoption UAFRS. Finally, he confirms, one can’t be great investor by relying on GAAP/IFRS reported earning’s nor by relying on Credit rating agencies.

On markets, according to him, S&P has potential upside of 30% from current level. Though, these projections may change if there is change of government in United States.


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IIC 2020: Unexpected places to understand risk, by Allison Schrager

Moderated by: Sunil Singhania, CFA, Founder – Abakkus Asset Manager LLP

Contributed by: Siddharth Gupta, CFA

The 10th India Investment Conference opened with a session by Allison Schrager, titled “Unexpected places to understand risk”. Allison Schrager is an Economist and Journalist, writing for Quartz, and author of “An Economist Walks into a Brothel”. The session was moderated by Mr. Sunil Singhania, CFA, founder of Abakkus Asset Manager LLP.

Allison’s talk was stimulating, and gave a differentiated look at Risks faced and the ways they’re mitigated by people outside the financial world. Freakonomics for finance would be an appropriate analogy of Allison’s talk, with seemingly unrelated examples from the real world revealing wisdom pertinent for finance professionals.

Allison highlighted issues faced in retirement finance due to lower ‘risk-free’ rates, which is akin to paying a lot for low risk, and how that is pushing portfolios towards riskier assets in order to generate portfolio returns.

For the first unexpected place to understand risk, Allison spoke of the case of brothels. While the business isn’t legal in most states in the USA, Nevada is one of the states where it is legal, albeit with heavy regulation. The setup she first visited in Nevada had each worker negotiating the rate with each customer individually. The brothel in fact gave special negotiation training to its workers, which Allison attended. There were some interesting takeaways, such as the average brothel worker charging $1000 per hour, vs the national average of $300, with one of the top employees making a million dollars last year!

The key takeaway, was that 50% of the earnings went to the brothel administration, for carrying out a licensed, regulated set-up. Allison highlighted how the workers were willing to pay up such a high share, despite having the option of running their own unregulated set-up, purely because the set-up was regulated and was considered safer. Customers also preferred the organised set-up, as it minimised risks and hassles for them, despite having to pay ~3x the National average amount charged. These financial trade-off decisions were being made by customers and brothel workers every day, prioritising risk minimisation over high cost, and this was akin to the current environment of lower risk free rates.

For the next example, Allison moved into the world of celebrity photographers, the Paparazzi. One of the key characteristics of this market was the fat tail upside, with photographers having to get lucky to get a photograph that could bag big bucks. The average photographs tend to be commoditized, paying very low dollars per photo. To eliminate this  idiosyncratic risk, the market started seeing alliances of photographers, with an understanding to share incomes, tips, strategies, etc. However, these alliances / partnerships were often unstable, as they weren’t enforceable by law. Nonetheless, this market-driven mechanism to bring down idiosyncratic risk couldn’t save them from the systemic risk being faced by the industry in the wake of the Global Financial Crisis (GFC). Post-GFC, the agencies through which photographers sold photos to magazines, witnessed consolidation. This consolidation changed the market structure, where instead of selling photos individually, agencies started having subscription contracts with magazines and glossies, and this reduced payouts for photographers in general. This was aggravated by the rise of social media applications, which saw celebrities engaging with their audience directly, and in turn, taking away potential earnings from photographers.

For the last example, Allison turned to the world of surfboarding, and had two takeaways. She recounted an interview with a surfer who almost lost his life. When the surfer fell off a wave and was pushed into the insides of the sea, he had two choices: to stay in the calm insides and wait it out, holding on to his breath (surfers are trained for it), or to try pushing up and risk being pushed down again by another wave. He instinctively swam up, but was unfortunately pushed down. Fortunately though, a jet ski nearby saw this, and rescued him. On further interrogation with other surfers, Allison discovered the following fact: Waves travel in sets of 5, and it’s convention to not surf the first two of a set, precisely to help in cases where the surfer loses control and is pushed down. In this case however, the surfer took on the first wave. On asking the surfer why, his response was interesting: the previous sets had less stronger 4th and 5th waves, where he couldn’t surf properly, and he was getting restless as the day was nearing an end. This made him take the riskier decision of going for the first wave of a set. Allison highlighted that it’s similar to how lower risk free rates are pushing portfolios towards riskier terrain.

What piqued her interest in the world of surfing, however, was the use of jet skis. Initially introduced as insurance, where a common jet ski was used to save surfers from drowning, it’s use was fast changing. Surfers started taking on greater risks, pushing towards more difficult waves, with the knowledge that jet skis were around (in fact even using them to be pushed onto the higher waves). This was akin to financial derivatives, which were introduced as a hedging mechanism, but are used in today’s world to make leveraged bets. The person who introduced these jet skis to the surfing arena, was in fact proud of how jet skis have improved overall safety levels, and brought on more avenues to the sport. Allison highlighted that just as how financial innovation such as derivatives often get blamed for creating instability, they are behind a lot of success of financial markets as a whole, and achievement of objectives such as poverty alleviation, economic growth, etc.

After her chat, she was probed with some very interesting questions by Mr. Sunil Singhania, around the examples cited in her presentation and more.

Some key takeaways from the QnA session:

  • There’s often too high a focus on the fat upper tail, even when the probabilities are very low.
  • Clear and honest communication with clients is important, and it’s essential that the client understands the risks involved in the investment operations.
  • Risk is just an estimate / probability distribution of what could happen, but uncertainty is where you have no clue of what could happen. To understand risk, one needs to model it and take effective hedges. The only insurance against uncertainty is Liquidity.


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IIC 2020:”Key Economic Challenges of our Times” by Nouriel Roubini

Moderated by: Ridham Desai, MD, Morgan Stanley

Contributed by: Jainendra Shandilya, CFA, CAIA

The last session of the 10th India Investment Conference, drew huge crowd to listen to the keynote speaker of the event. Nouriel Roubini, renowned economist, author and global strategists, spoke on “Key Economic Challenges of Our Times”. Roubini outlined four scenarios for the current states of the global economy and went on to elaborate each of these four situations. The global economy, as it stands today, can have the four possible paths:

  1. Return to expansion (3.4% growth globally)
  2. Continuation of current slowdown (3.0%)
  3. Further slowdown (2.8%)
  4. Global Recession (growth <2.5%)

During 2017 the global growth was above trend and the world economy grew to 3.8% wherein most of the global economies were growing in a synchronized fashion. In 2018, the global economy was still positive but it started showing signs of slowdown as the growth descended from 3.8% to 3.4%. Firms were worried about future and they stopped spending on capital expenditures. As a result, in the 4th quarter of 2018, the US broad market was down by about 20 percent. This was a case of synchronized slowdown.

Dwelling on scenario 1, i.e. the situation of moderate expansion of 3.4%, Roubini cited various reasons for the same: the phase I deal between USA and China, recovery of capex, Brexit is now certain and going to be soft and possible massive easing of monetary policy. Scenario 4 of global recession is much less likely with a caveat of Iran & US going to war and that may change the whole situation. Scenario 2 of continuation of slowdown (growth of around 3%) is much more likely according to Roubini.

In November 2015, a delegation of USA and European countries went to Beijing and they heard the Chinese Premier Xi Xinping quoting ‘Thucydides Trap’ – Coined by Harvard professor Graham Allison to capture the idea that the rivalry between an established power and a rising one often ends in war[1]. According to Xi, every time a power rose, someone else challenged it and the transition was very painful. For China, fortunately, there has not been much opposition. This situation was pre-Donald Trump election. The situation, however, turned out to be very different after Trump came to power. What we are witnessing in today’s world between China and USA is decoupling from globalization. The 5G argument of USA for not allowing China will lead to balkanisation of global economy. Going forward, with the advent of internet of things (IOT), every gizmo that we will be using will be having chip that will be connected to internet. That particular machine may be of Chinese origin and even if it is powered by technology coming from elsewhere, the Chinese company may still get to know the relevant information about the supply chain. Hence, there is no way for the world to go back from here.

The third scenario of further slowdown is also possible as PMI, ISM & other activities are showing. It might take a quarter or two before the economy bottoms out. The USA is doing okay as shown by the growth of S&P and given that the unemployment is low. However, India is witnessing sharp slowdown. If Bernie Sanders or Elizabeth Warren is nominated, we can see 10% correction in US market from here. Two aspects of the US Economy one should worry – one is this is late expansion of economic cycle for the past ten years and there is huge build-up of corporate debt financed by shadow banks and there are exotic CLOs and leveraged loans, high yield and junk bonds issued by corporations. The valuation of US market is frothy as the CAPE stands at 30 at this moment and this is three standard deviation over the historical trend. The growth rate of EPS is slowing sharply. The 30% rise in US market was driven by increase in P/E and not by increase in EPS. China is going to slow marginally. Latin America is seeing riots in many parts and so is the condition of the middle east. Argentina may default on its debt obligations. Russia is not growing much and India is also not doing well. The Eurozone saw growth of 1% last year, however, this year too it is not going to be any better. The largest economy of the Europe, Germany, escaped recession last year. Italy has a fractured government and the Europe will need structural reforms. The EU is drifting below China & the USA in terms of technology. The good news is the EU is not breaking up as was feared sometimes back and there is no hard Brexit. There are four ‘d’s that is responsible for global slowdown, and, they are

  • Deglobalization
  • Demographics
  • Debt deflation
  • Disruption
  • Democratic backlash

Aging is key problem in Emerging Markets especially in China and Russia. India will need 1 million jobs per month. Some individuals are fighting against the autocratic regime in different parts of the world.

The market is under-pricing the US-Iran conflict. There are four scenarios of this conflict:

  • Full scale war between US and Iran: This is unlikely
  • Direct military exchange: possible
  • Escalation of tension-short of military exchange: This is very much possible.
  • Return to status quo after short term: This is what market is pricing but it may not turn out to be the case.

What are the implications for macro policies under the four scenarios?

  1. Fed, ECB and other major CBS on hold; current set of fiscal policies
  2. Fed cut rates 25-50bps to 1%; ECB goes to -0.60% and BoJ to -0.20%; slightly higher fiscal stimulus in Eurozone and Japan but none in US given gridlock in election year
  3. Fed cut rates below 1%; ECB goes to -0.70% and does enhanced forward guidance and greater QE on private and public assets; BoJ goes to -0.30% and buys more ETFs and other public and private assets. Greater fiscal stimulus in Eurozone, UK, Japan and minor G10; Some fiscal stimulus in US.
  4. Fed goes to 0%, forward guidance and QE; other G10 go to variants of monetization of fiscal deficits. Large fiscal stimulus in all G10, more so in countries with greater fiscal space.

Under the four scenarios, as enumerated above, the implications for asset markets will be as under:

  1. Modes risk-on and reflation. US and global equities have single digit returns. Long rates in US, Germany and Japan go modestly higher (by 20bps or so). Credit spreads remain low for HY and HG. Dollar and safe haven currencies weaken modestly.
  2. Modest risk-off with 10% US and global equities correction. Long rates retest the lows of 2019. Credit spreads modestly widen. Safe haven currency modestly appreciate. Gold may go 5% higher.
  3. Correction turns into a bear market (20% down on global equities). Long rates go below 2019 lows. Credit spreads widen sharply for HY. Safe haven currencies appreciate by more than 5%. Gold will be 10% higher.
  4. 30% plus fall in US and global equities. US long rates below 1%. Japanese bond yields more negative than 2019 lows but spread widening for Italy and other risky DM bond markets. Sharp widening in HY and HY and EM spreads. Gold prices increase by more than 10%. Safe haven currencies will appreciate sharply, especially USD, Yen and Swiss Franc.

Replying to a question, moderated by Ridham Desai, Managing Director, Morgan Stanley, on how he views India, Roubini highlighted couple of remarks. There are problems at fiscal fronts, rural India, bad debts of corporates, infrastructure bottlenecks, labour market reforms. The good thing that happened is there is bankruptcy law now in India.

Responding to question on US-China cold war, how it would affect India, Roubini remarked that on technology and software front India has done well but not as successfully as China did in terms of low value-added manufacturing.

Whether Trump’s policy is good for china? He opined that Trump may damage China in the short term. In the medium term, however, China will not be stoppable. Many other democrats would be more harmful for China than Trump is.

On a question on his views on cryptocurrency, he explained that it is a total misnomer. There are functions of a currency and Bitcoin fails on all these counts: medium of exchange, measure of value, scalability issues and store of value. He further elaborated that nothing is being priced in bitcoin; there is so much volatility in its price; hence, it will never be a true currency. His preferred asset class would be: underweight US & global equity, overweight in fixed income and utility sector and gold. He would like to keep some cash until things turn out to be better. US Dollar and US Treasury look safer at the moment. Gold may continue to shine due to central bank’s policy; he sees an upside of 5 percent from the current level. ECB is doing policy easing; Japan is also doing QE. In terms of technology spending, China is more advanced than the USA; there are no 5G in USA and China can’t be contained. Chinese economy is government driven. The US growth has come from acquisitions from private firms.


[1] Financial Times, London: https://www.ft.com/content/0e4ddcf4-fc78-11e8-aebf-99e208d3e521

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IIC2020: ‘Global Trends and Disruptions for financial institutions of tomorrow’ – A session by Sir Howard Davies

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Moderated by Navneet Munot, CFA

Contributed by: Ritika Mankar, CFA (*)

In case you missed this insightful session held as a part of 10th India Investment Conference (IIC) organised by CFA Society India in Mumbai, scroll below for Ritika Mankar’s notes from the session.

Can the current recovery give way to a recession?
– Even as the world economy has maintained an average growth rate of 3.8% for a decade; he was of the view that despite this, a recession can be largely ruled out.
– What is likely to follow is a period of moderately lower growth and not drastically lower growth.
– It is easiest for a bank to make money when the yield curve is upward sloping since you can borrow short and lend long.  Despite the prospects of low GDP growth (and not no GDP growth), developed country banks now have a problem at hand since the yield curve in no longer upward sloping.
– Hence it is no surprise that most banks in Europe today are trading at a P/BV of close to 0.5x and in some cases even lower!

So what could be the reasons behind this situation?
– Potential reason#1: Whilst traditionally central banks (CBs) would only intervene at the shorter end of the yield curve, now CBs are operating all over the place!
– Potential reason#2: Has the demand for low risk assets begun to exceed the supply?
– Potential reason#3: Low productivity is acting as a disincentive for investments?
– Potential reason#4: Investment intensity has declined globally – since Apps are way cheaper to build than say a bridge!
– Potential reason#5: Over-regulation of the banking sector?

Regulation of traditional Banks in the developed world is rapidly increasing!
– The re-regulation of traditional financial firms since the crisis has been dramatic.
– Higher capital ratios for banks and tighter solvency rules for insurers. And there is still pressure for more capital and tighter consumer protection rules.
– Does this increased regulatory burden risk making conventional financial institutions uncompetitive? The low valuations of banks, especially in Europe, suggest that many investors think so.
– The said expert worries that the more you squeeze the formal financial sector through tighter regulation, lending will migrate to shadow banking where the risk management systems are significantly poorer than that for traditional banks.

Threats to traditional Banks given the rise and rise of Fintech.
– Trust in traditional banks in the developed world has been sinking dramatically. 40 yrs ago 92% users trusted their bank managers, today it is down to 20%.
– Fin tech in this context, promises to offer parts of banking services at significantly lower cost since the risk capital requirements here are significantly lower than that of banks.
– Big tech now training its vision on entering the financial services space. Unlike small fin tech; Google, Apple, Facebook and Amazon have huge financial resources and millions of customers already which can give traditional banks some serious competition.
– Also fin tech as well as big tech is significantly more agile and offer more innovation than traditional banks.

…and the Opportunity for traditional Banks
– Whilst tech is under-regulated today, regulatory frontiers are slowly and surely growing.
– Anti-money laundering and data security pose challenges for rapidly growing big-tech firms.
– Customer acquisition is undeniably a challenge especially when it comes to attracting the deposits business.
– Users of fin tech still rely on it is as a secondary financial service, a traditional bank is still the primary financial service relied upon.


So ‘Can Fintech get customers before Banks get innovation?’ If you know the answer to this question then you know who wins the race, traditional banks or fintech!

Comments regarding India
– India is severely under-banked and under-served but has unusually high access to telecom and data. This should make for a fertile ground for fintech!
– State ownership of banks has to and must decline. The private sector can be incentivised to do justice to welfare objectives, but the multiple costs PSBs are best avoided.

(*) Ritika Mankar, CFA is a Director on the CFA Society India Board and a Director at Ambit Capital



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