Saturday 17 October 2015

Envy: Most lethal of all sins in Investing - Part I

We, as investors, have read a lot about the impact of emotions such as greed and fear on our investment returns. However, there are many such emotions, which, though escapes the limelight, but play an equally important role in success or failure of our investment decisions. In fact, I feel that we may be well prepared psychologically to deal with emotions such as greed and fear because they are extensively discussed by many veteran investors and market participants consistently as key emotional aspects that can have large impact on investment decision. Thus, after a lot of practice and paying tuition fees, we do eventually find a reasonably prudent way to deal with these emotions. However, we completely ignore other human emotions such as envy, that subconsciously play a big role in our decision making process, but are less talked about in the context of investing. Here is what Charlie Munger has to say about it.

"I have heard Warren say a half a dozen times, ‘It’s not greed that drives the world, but envy.’ And you go through the psychology survey courses, and you go to the index: envy, jealousy, in a 1,000-page book — it’s blank! There’s some blind spots in academia, but it’s an enormously powerful thing"

So, it seems that the literature, leave alone investing, even psychology literature has underplayed the role of a very powerful emotion called Envy. What I have learnt through my own experiences is that envy manifests itself in various investment situations leading us to make imprudent decisions at times which can result into permanent loss of capital. In this two part article, I am putting up situations where, I have felt, envy dictating the decision making process subconsciously even without me being aware of it. I have also put in some thoughts based on how I try to handle the influence of "envy". Here are the four such situations
  1. You have given a miss to an investment idea after thorough research based on your reservations while your friend has made an investment and it has turned a multibagger for him
  2. Some stocks/sectors grabs fancy of the market continue to run unabated while one's portfolio or stocks remain range bound at most!
  3. You stay in cash- due to over valued market- and market keeps making new highs
  4. You do not subscribe to IPO while others make quick and hefty gains on listing
I will elaborate on first two situations in Part I and the other two in Part II

Situation 1: You have given a miss to an investment idea after thorough research based on your reservations while your friend has made an investment and it has turned a multibagger for him

I am sure many of us would have faced this situation. We study an investment idea from various angles and decide not to invest due to many reasons including mediocre business quality/reservation on management on quality/extremely high valuations. However, promptly after we have given it a pass, the stock starts moving up at breakneck pace continuously. You still hold your forte/rationale and stick with your decision on not to invest. As if "missing the bus" was not enough, one fine day you come to know that, one your friends who was also looking at the company along with you, had invested in it and is already sitting on 2 bagger. This compounds "missing the bus" pain and make you envious of your friend. From here on, envy will take over your psyche and may lead to one of the following thought patterns

  • My rationale/thesis was not correct and the reservations that I had are "ignorables" thus I have made an mistake of "omission". I must reconsider my investment decision
  • Though I have missed the bus, it is still not too late. I can still ride the story if the investment thesis plays out over long term. 
  • Even though, valuations have risen significantly, there will be enough growth to justify this valuation hence I can make decent money from hereon as well
Now, each one of this thought patterns, on its own and in conjunction with each other may have merit. However, on the other hand the combination of "deprival super reaction" and "envy" can lay a perfect trap for an investor to suck him into making a mistake of  buying an inferior quality business or business run by mediocre management at high valuation. This can be perfect recipe for a disaster! I have fallen into this trap for Sintex and Opto Circuits. Both these investments have cost me money!

So, what I have learnt from it and what should one do in such situations? With my limited experience, what I have learnt is that it is very important to stick to basics like follwing.

  • Do not try to re-assess your conclusion based on the same data points/information unless you realize you have made gross mistake. Re-assessment based on same data set may lead to "rationalizing" what you want to infer! Wait for more data points or clear management actions contrary to your hypothesis before re-assessing
  • If you have done a thorough work, have confidence on your work and stick to it. It is not a good idea to use market movements to vindicate the "merits" of your hypothesis. Market movements, in the short run, are seldom good indicators of correct hypothesis! Always remember, Ben Graham's words that you are neither right nor wrong because people/market agrees/disagrees with it but because your reasoning and data is correct or incorrect.
  • Even if you feel you have made a mistake in investment hypothesis, do not invest if you do not see valuation comfort. Market, from time to time, gives us a chance to make investment on favorable terms to us. Remember, patience is a very profitable virtue!
  • Last but not the least, accept that in one's investment journey, one is bound to commit both the mistakes of "omission" and "commission". Learn from it and move on!

Situation 2: Some stocks/sectors grabs fancy of the market continue to run unabated while one's portfolio or stocks remain range bound at most!

Again, many of you will be able to relate to this. This, typically, happens in the early stages of bull market when certain sector/sectors lead the charge of the bull market. However, it may also happen in sideways markets, where defensives continue to advance while the other stocks barely move. 

For example, mid cap infrastructure stocks like Kalpatru Power, J Kumar Infraporjects, Sadbhav engineering, MBL Infrastructure, ITD Cementation have risen from 50-100% in last one year.  When you look at some article like this and see you portfolio returning 10%, one feels one has missed the rally and start looking at the next big thing that will catch the fancy of the market so that next time you do not miss the quick multibaggers that lie ahead of you. 

So what triggers this thought process?  Here is how philosophy Kant describes envy 
"a reluctance to see our own well-being overshadowed by another's because the standard we use to see how well off we are is not the intrinsic worth of our own well-being but how it compares with that of others"  

Thus, it is clearly an "envy trap". The only motivation here  to look for "next big fancy of the market" is nothing but the pain arising from the fact that some one else has made more money than you. You are judging your well being (10% return) based on the another's well being (top performing stocks) thus ignoring the intrinsic worth of your well being (10% return). In fact, contrary to the pain of losing out one should be elated by one's performance if we use absolute standard of the intrinsic worth of  well being
  • You have out performed the market by a wide margin as bench mark has only returned 4% in last year
  • If it indeed is a bull market, as many proclaim, you have beaten the odds as value investor. Typically, value investors, are more likely to under perform the benchmarks in bull market and outperform in bear/sideways market 

On the side note, although, I strongly feel that it is futile to look for "next big fancy" of market,one may come across many market participants, who firmly believe in this theory of each bull market led by certain "sectors"! Even if this is the case, it is important to keep following in perspective.

None of the investment wizards like Warren Buffet, Phil Fisher, Seth Klarman or Peter Lynch have made tons of money betting on sectors/next bull market leaders. So, even if you miss the "golden opportunity" of identifying the next bull market leader, you still can make lot of money! Hence, there is no point losing sleep over the "next big thing" 

Coming to how do I try to handle this "envy trap" of missing out on multibaggers of the market?
  • Always set the absolute return expectation and compare your performance with respect to that. So, I have set the goal of outperforming the market by 5-7% over long term. As long as I am able to meet this goal, I should be happy with my performance.
  • Do not compare your portfolio's performance with the top 10/20 performing stock of the year. It only creates agony and pain and leads you to direction where one is more likely to make a mistake. 
  • Always remember, one is not entitled to outperform everybody and anybody in the market. That will never be the case. There will always be people/funds in the market who will outperform you in a year/over a period. 
We must keep in mind that the objective of Investment is wealth creation over a period of time and wealth creation is journey and not a race. As long as one reaches his/her destination in stipulated time, it is deemed success.