Category Archives: Market Psychology

On Turning a ULIP into a TULIP

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In sixteen hundred and something, the world went bananas about tulips. What ensued was an enormous boom in the tulip market, with species selling for thousands of gilders, and with futures quoted for shoots which were planted or even about to be planted. Murders were commited, all for tulips. Nobody knew this at the peak of the mania, but a virus had hit the tulip plantation industry, resulting in tulip species emerging in all kinds of exotic colour combinations, which were so intriguing, that it led to the mania. Now this virus was a one time thing, it didn’t happen after that. So, as the exotic species and their shoots died, it became apparent to the market that there would be no more exotic specie supply, and a bust followed. Fortunes got wiped out. Suicides resulted. Nevertheless, a tulip remains what it is, a serene flower, adding harmony to the environment, currently fairly priced.

Now what’s a ULIP, or a Unit-Linked Insurance Policy? As the name suggests, it’s an insurance policy, which is linked to units (of equity / debt). When I entered the world of investing, my office got swamped with ULIP salesmen, and I invariably ended up buying 4 ULIPs from various companies because of the excellent sales pitch, and because I didn’t know any better. The killer and sealing remark in the sales pitch was that what form of investment could not be confiscated by any authority, were one to land in trouble or jail? The answer – an insurance policy. And what better an insurance policy than one that is linked to the markets?

Each ULIP has a lock-in, typically 3 – 4 years. So there I was, locked-in with products I knew nothing much about. Hmmmm ULIP – sounded like tulip. I thought to myself – “What if I can find a way to get maximum benefit from these ULIPs? I’m stuck with them anyways.” And my mission statement became – “I’m gonna turn these ULIPs into tulips.” Later, when I had succeeded in this, I even concocted a new name for them, i.e. TUrbo cum Leveraged Insurance Products or TULIPs.

As I set about doing research on ULIPs, all the negatives came up first. Apart from the fee structure being irritating, each premium had a huge additional deduction to go with it. One ended up investing only 80 – 85% of what one paid as premium. The rest went to the insurance authorities. After all, they would charge for an insurance cover. Then, the salespeople held all my passwords in their hands, as per the power of attorney I had signed while investing. They switched in and out of equity at all the wrong times, and my investments were taking a hammering. Then, while switching, one could only catch the end of the day NAV etc. etc. etc.

Slowly, I invited each salesperson for tea in the office. This was much before the financial meltdown, and the merchant banker / investment sales agent was still king, whereby the investor was starved for new investment products. After boosting up their egos, I pulled each login ID and password out of their clutches, and immediately went online to effect a password change. OK, I was no longer under their control.

I noticed that switching between equity and debt was free of cost. What if I switched 50 times a year, not that I was going to, but what if I did? Free 24 times, Rs. 100 per switch after that. Hmmmm. Any direct equity investment would have resulted in brokerage generation, and in ULIPs, there was no brokerage generation. The fund house put up the money for whatever brokerage was generated by ULIP clients. They were probably their own brokers, so they didn’t end up losing much anyways. So, how much was I saving on brokerage per switch. Typically, 0.75% of the total investment if I looked at a complete buy and sell transaction, i.e. switch in to equity and switch out of equity. So, how much money would I save in brokerage if I switched a corpus of Rs. 1 million 50 times over? Rs. 3,75,000/-. Hmmm, sizable. A trader with a high turnover didn’t need to trade directly, he could do it through ULIPs. And the trader would be in and out of the market with one click, there was no need to sell or buy 20 or more different scrips. Still, one would only get the end of the day NAV. The bottom-line was that the trader would save huge amounts on brokerage with this kind of turbo ULIP switching.

What further made this avenue attractive for the trader was the fact that ULIPs did not require one to pay any short-term capital gains tax because of the lock-in. Wow. This was big. So, If I made a million on a million in less than one year, I got to keep all of it, and would not have to part with 15% as short-term capital gains tax. Such tax-saving leverages the portfolio, because one invests the tax-saving back into the market, and future gains are compounded owing to a larger initial investment corpus. In fact, the brokerage saving component was adding to this leverage too in the same way.

So there I was. I had put my investment philosphy regarding ULIPs together, and had actually turned them into TUrbo cum Leveraged Insurance Products, or TULIPs. After recovering my losses and gaining some, I soon got bored, and when the lock-ins ended, I got rid of the TULIPs.

What remains with me today is that this was my first victory in the world of investing, a feeling of harmony that never fails to energize me, just as the mere thought of a field of colourful tulips would energize / harmonize the mind

From Crisis to Crisis : Who said Investing was for the faint-hearted?

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The central focus while investing is on returns. Over the last 100 years, adjusted for inflation and tax-deductions, fixed deposits have given negative returns. And, over this period of time, the asset class of equity has yielded around 6 % compounded per annum (adjusted for inflation), which is more than 5 times what gold has yielded. There’s human capital behind equity, which strives to give returns despite inflation, and goes around taxes through legal loopholes. Gold is gold, there is no brain behind gold. It cannot evade the forces of inflation and taxation. Thus, equity is a higher yielding asset class. For those who don’t realize the value of a 6% compounded return per annum over the long run after adjusting for inflation, let me give you an example which might boggle your mind. Had the Red Indians who sold Manhattan Island to the Americans in 1626 invested their 60 Gilders (= sale proceeds, with the purchasing power of USD 1000 today) @ 6 % per annum compounded after adjusting for inflation, their principle would have been many times the total value of entire Manhattan today. See? In the world of long-term investing, one needs to be clear about the fact that the power of compounding can move mountains.

At the same time, drawdowns in the asset class equity are also the largest. During the 2008 meltdown, the likes of a Rakesh Jhunjhunwala saw his portfolio shrink by 60%. He took it without blinking, by the way. Why? Because equity is not for the faint-hearted. Steadfast investors know inside out that equity has given these returns despite two world wars, one great depression and many recessions / meltdowns. Today, there’s a crisis, and then there’s another crisis. One’s portfolio gets walloped from crisis to crisis, and needs to survive all crises to get to the good times. A potential USD 184 billion debt default looming in Dubai doesn’t shake the long-term investor. Why not? What if the potential debt default becomes larger, let’s say USD 1 trillion. Still nada. What’s the deal?

When a long-term investor puts money on the line, he’s willing to risk 100% of it. Why? That’s because in such an investor’s portfolio, there’s a whole range of scrips. Some go bust, others don’t do well, some remain at par, and a few outperform. Those scrips that go bust or yield below par have a loss limit of 100% of the principal. And the long-term investor has already termed this loss as acceptable as per the dynamics of his risk-appetite. What’s the outperformance limit on those of his scrips that outperform? None. They can double, triple, multiply even a 100-fold, or a 1000-fold or more over the long-run. 2 examples come to mind, a Wipro multiplying 300,000 times in 25 years and a Cisco Systems multiplying 75,000 times in 15 years. A steadfast long-term investor will strive to pick quality scrips with an edge, and will go into the investment at an opportune moment, such that the chances of these manifold multipliers residing in his portfolio are high. And, if 20% of one’s picks multiply manifold over the long-run, one doesn’t need to bother about even a 100% loss in the other 80% of the scrips. Not that there is going to be that 100% loss in this 80%, because these scrips too have been picked intelligently and at opportune moments.

So, what’s the best opportune moment to pick up a scrip? The aftermath of a crisis, of course. Such a time-period has something for all. Those who like buying at dips can pick up almost anything they like. Those who like buying at all-time highs can pick up the scrips that have been eluding them because these too will dip during a crisis. A crisis is not a crisis for the long-term investor. It is an opportunity.

Both Sides of the Coin

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What’s your personal style of investing, UDN?

Well, if you must know, and now that you ask, I like putting my money on the line when the underlying has hit an all-time high.

Um, isn’t that risky, a huge gamble, actually?

Well, what isn’t risky in life? Marriage is a gamble. So is business. And the farmer gambles on the weather when he sows his seeds.

You could invest in a more cautious fashion, like buying on a dip, you know.

Sonny, you asked about my personal style of investing, not the crowd’s personal style of investing. I’ve fine-tuned my personal style as per the threshold level of my personal risk-appetite, and risk-appetite is something one discovers after being in the market for a while, and after making mistakes and learning from them.

Fine. And what’s so good about investing at an all-time high?

Good, now you are asking some right questions. Ok, investing in something which has broken out and hit an all-time high, albeit risky, comes with a few advantages. First and foremost, there’s no resistance from top, i.e. there are no old sellers waiting to sell as the underlying heads higher and higher. This means that there is nobody stuck at these new levels waiting to off-load. There can be bouts of profit-booking of course, but a real resistance level doesn’t exist as yet, because the underlying has never entered these areas before.

Then, as the nay-sayers grow, and the crowd joins them to short-sell the underlying, there can be bouts of short-covering if the underlying’s climb is not stopped decisively by the bouts of short-selling. Any short-covering propels the underlying’s price even higher.

Before you go on, why is all this better than buying on a dip?

Oh, so you want to look at both sides of the coin, do you? Not bad, you learn fast. Well, buying on a dip offers a margin of safety to the investor, no doubt about that. Nevertheless, the main point is that a dip is happening. Supply is high, demand is less. The underlying’s price is falling as per the demand and supply equation. What’s to tell you that the fall will convert into a rise very soon? Nothing. Nothing at all. For all you know, the underlying might continue to fall another 20%, or 30, or 40 for that matter. It’s a fall, remember? People are off-loading. When something falls, professionals off-load huge chunks to the crowds waiting to buy on dips. If the dip persists, the crowd gets stuck at a particular entry level.

Not the case in the all-time high scenario. Here, there is demand, and supply can barely meet it. Something makes the underlying very interesting. Then, as the story spreads, demand grows, making the price surge further. Add to this short-covering – further surges. Interesting, right? You just need to make sure that your entry is done and over with soon after the all-time high is broken, and not later.

And what if you get burnt? I mean, what if the price doesn’t rise any further after the all-time high, but dips nefariously?

Well, one does get burnt quite often in the world of investing. Fear will make one freeze. I’ve devised a set of rules for this strategy, and then I just go ahead with the strategy, no second-guessing. No risk, no gain.

And what are your rules?

Firstly, I only put that money on the line which I don’t need for at least a few years. Then, I don’t put more than 10 % of my networth in any single underlying entity. Also, after entry, I don’t budge on the position for a few years. I only enter stories which have the potential to unfold over several years. And I only close the position when the reason for entry doesn’t exist anymore, irrespective of profit or loss. Over the long run, this works for me.

It can’t be that simple.

It’s not. I’ve come to these personal conclusions after making many, many blunders, and after losing a lot of money. This knowledge can’t be bought in a bookshop, nor can it be learnt in a university. It can only be learnt by doing, and by putting real money on the line.

Well, I’d much rather still buy on a dip.

Go ahead, a few people are making money while buying on dips. But they wait for the real big dips. They’ve got one big quality that qualifies them for this strategy, and separates them from the crowd. It’s called patience. Prime example is Warren Buffett.

Who’s the prime example of your strategy?

Fellow called Jesse Livermore.

Man, you’re such a phony!

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You are such a phony, Uday!!!

What was all that talk about never owning a government company scrip, because of the inherent inefficiency in the way the government functions?

And then you go ahead and buy into a mutual fund that will only invest in PSUs! A mutual fund! One thought you were not getting into mutual funds at all, because on market highs they didn’t book proper profits owing to public investment demand, and because on market lows they didn’t invest all they had owing to public redemption requests.

Hold it right there, Mr. Holden Caulfield! Before calling me a phony, let me just point out to you the rationale here. Every investment has a rationale, okay, remember that.

Now listen carefully. Here the rationale is simple. India is opening up its Navratnas and extended Ratnas to the public for purchase for the first time. So the government is going to hype them up, to get a good price for them.

Then, 18 of such extended “gems” are practically debt free. They quote at a lower valuation than the market average currently. They pay out a huge dividend. They are going to be let upon the public soon. I want a piece of the pie.

After this disinvestment story is over, I will let go off this investment, mind you. I’m not going to be holding on to it for longer than 5 years. So let a fund manager have the headache of when to book profits. That’s why a mutual fund, do you understand? And that’s why the dividend payout option.

So I’m not such a phony after all, right? I mean this whole PSU mutual fund thing is a black-box approach. The fund manager does his thing during the disinvestment process, and hands me out about 3 or 4 dividend payouts and then the principal in 5 years. End of story.

I can see you nodding in comprehension, Holden, thanks for the dialogue.

Wake up Uday!

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Wake up Uday!

It’s a whole new world out there. Correction. It’s a whole new financial world out there.

Institutions Finshtitutions. As a retail investor, you have unprecedented rights today, man, so wake up. Nobody can bully you any more. And no one can sell you crap anymore. But only if you wake up to your rights and possibilities.

Gosh, look at the information flow available to you. It’s the same as to your banker, or to your financial analyst. In real time. Whooaahhh. Butterfly flutters wings in New York, you get the resulting price fluctuation on your currency live feed.

And private investment opportunities, they’re available to you now, on a chicken-shit ticket size. And you don’t have to go through any bankers for such investments, you can deal one on one with the private equity house concerned, who’ll gladly reimburse you 2% mobilization fees on your investment, because you’re doing it yourself. Man, times have changed. This is amazing.

Not so long ago, such private investments were available only upon invitation, through some hot-shot banker, for a multi-crore ticket-size. The banker cashed in on a huge deal fees. So, the more the banker sold, the more his bank account burgeoned. Thus, the banker began to sell only for the sake of selling, not for the sake of your portfolio, or for its further diversification, or what have you. Basically, the banker lost focus on you, and increased focus on himself. He didn’t care anymore if what he was selling to you was a bullshit investment. If you weren’t waking up, you were going to get slaughtered because of a weedy portfolio.

Well, you didn’t wake up in time, this time. It took a financial crisis to wake you up. But you’re awake now.

And you’re still lucky, for time is on your side. Not so for the retirees who woke up alongside of you. They don’t have any time left to win their money back and then some. Their financial game is over. And they’ve lost. Badly. Butchered.

Also, when the going gets tough, the tough get going.

The financial crisis was one thing, but there have emerged tremendous opportunities in its aftermath. People with liquidity have made a killing. Those who weren’t liquid but simply reallocated their portfolios have recuperated their losses of 2008. And those who have learnt their lessons have started to use their common-sense again while investing their money. And they’re not listening to bankers anymore.

But, alas, human nature is numan nature. People will forget 2008. There will be more financial crises. But for you, these will be opportunities. Because you will not forget 2008. Never. Because you are awake now!

Managing an Equity Portfolio

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1). Before getting into equity, pinpoint exactly your appetite for risk.

2). Buy with a margin of safety.

3). Buy with rationale.

4). Spread your buying over time.

5). Hold performance. Reward it with repeated buying, when markets are down.

6). Punish non-performance. Sell your losers when markets are up. Weed them out. Throw them away.

7). Let winners unfold. Be patient with them.

8). When a winner becomes a superstar, ride it till it shows signs of sloth and underperformance.

9). Learn to sit on cash when there’s no value or margin of safety available. VERY IMPORTANT.

10). Know your weaknesses. Be disciplined. Make mistakes, but don’t repeat them. Filter all information, using your common sense. Don’t listen to anyone. Learn to trust yourself.

11). What is your eventual goal? Identify it. I’ll share my goal with you. I would like to hold 20 multibaggers in my portfolio 20 years from now. It’s a tall order. But I’m gonna try anyways. Remember, 1 multibagger is enough to strike it big. I’ll give you 2 examples : Wipro multiplied 300,000 times between 1979 and 2006. Cisco Systems – 75,000 times in I think 12-15 years leading up to the dot-com boom and bust. Before the bust, it gave ample hints of slowing down, so one had enough time to get rid of it. Wipro still hasn’t shown signs of underperformance.

So best of luck, whatever your goals are, but please, know your goals exactly before you play.

The Difference between Investment & Speculation

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Investment is the low to medium risk art of conserving capital and protecting it against inflation, such that in the long run, capital appreciates. Speculation is the high risk art of trying to turn a small amount of money into a large amount.

Investment banks upon the power of compounding. It is an amalgamation of human, monetary and product capital, a combination that favours appreciation in the long run, not linear, but exponential appreciation, owing to the power of compounding. The key requirements are intelligence during scrip selection, patience and tolerance to allow multi-baggers to develop and blossom, and common-sense in handling one’s portfolio. Also, one needs to weed one’s portfolio at times, to remove poisonous scrips.

Speculation banks upon the power of leverage. This construct of finance is a double-edged sword. It can compound one’s profits, but also one’s losses. The speculator tries to cut losses and let profits run. This is easier said than done, because it goes against our natural instincts.

In the end, there are both successful and unsuccessful investors and speculators.

The key to deciding what line one should pursue here is a recognition of one’s own risk profile and appetite. What gives one sleepless nights? What is one’s pain threshold? How much loss can one bear without any effect on family life?

Such questions need to be answered before embarking upon either investment or speculation.