Wise Advice

Implementing a low risk - high return investment strategy

In the introductory article of this series, we discussed Mohnish Pabrai's famed and counter-intuitive "low risk - high return" investment strategy that he has so successfully adopted in the US (Click Here). There are many insights that we discussed in this article on the famous "Dhando Investor" - including his ability to differentiate between risk and uncertainty, his advice on the virtues of patience, his focus on moats, his penchant for investing in copycats rather than innovators and his high conviction, big bets style.

Its great to read about his fantastic style and enviable success - but the key is an understanding on how we can imbibe, how we can adapt his insights and actually apply them in our own advisory profession. We asked 5 smart and successful advisors from different cities to do just this, for the benefit of the advisory and distribution fraternity. Here is the collective wisdom from these leading IFAs on implementing a low risk - high return investment strategy.

To see the original article on Pabrai's wisdom, Click Here

Dhiraj Mittal. Prime Capital Services, Delhi

Mohnish Pabrai is a fund manager, while we are advisors and distributors. That is and will remain a big difference. Having said that, there are some valuable insights from his style, which we are adopting, and which is working very well in terms of client outcomes:

1. Low risk - high return investing. We implement this in every market downturn. Every correction sees clients coming to us with concerns, and we make it a point to persuade them not only to stay invested, but to add, however small amounts, in the correction. Those who don't call - we call them and suggest adding in a correction. We are the most active during market downturns. It is these small amounts that they add in downturns that deliver the best results in their portfolios over time. It is these small amounts that build their confidence in equity as an asset class, and enable them to increase allocations significantly over time. Every market downturn should be viewed by all of us as a great low risk - high return investing opportunity.

2. High conviction bets. For us, our bets are on fund managers and not on individual stocks. We do a lot of homework before picking 4-5 fund managers who we develop high conviction in. An ability to generate consistent alpha in different market conditions is one key parameter that influences our fund manager choice. Once this selection is done, we leave the fund manager to do his job and focus on our job - which is client communication and education. Maintaining our conviction in markets and in the managers we have picked is critical to transmitting this conviction to clients, which in turn is what encourages them to stay invested for the long term, which is what delivers a superior investment outcome. Without conviction, you get nowhere. And to develop conviction, you need to do your homework well.

Our job is to gradually move clients from an existing risk profile to an optimum one - to an asset allocation that enables them to achieve their financial objectives. This does not happen overnight - but by demonstrating conviction, and by seizing low risk - high return opportunities that present themselves from time to time, and delivering good outcomes from these, we make steady progress towards the optimum asset allocation.

Shyam Sekhar, iThought, Chennai

There are a number of lessons an advisor can learn from Pabrai.

1. Keep the number of investments in check. Hold no more than 10 funds.

2. Believe in the "value" theme. In uncertain times you don't lose too much. In good times, they outperform indices.

3. Cultivate ample patience within yourself and in your customer. Never focus on the short term returns.

4. Bet big. Ensure investors invest to their potential.

5. When you see high uncertainty, analyse how you can benefit from it.

6. Identify lower risk plays that get routinely hammered.

7. Learn to differentiate between uncertainty and risk.

8. Invest based on low risk even if there is high uncertainty.

9. Believe in the economy.

Ashish Chadha, Chadha Investments, Delhi

Dhando Investor - Learning from the Gujaratis-Why reinvent the wheel? I am not kidding you on this but my personal submission is that the smartest folks in India in the financial markets are Gujaratis, Sindhis, Calcutta Marwaris and Baniyas in no particular order. I love their company as coming from a military background, it was almost completely contemptuous to discuss money in the mess, there is so much to learn from them. My golfing 5 ball has 3 Marwaris/ Sindhis/Baniyas, they teach me something every day, my Sardar and self stick out like sore thumbs! The other community I like to hang out with when I go for my Top of the Table meets is Jews. I just think Mr Pabrai figured this very early, good to copy him, think the NJ guys in distribution, check the surname of most fund managers??, think India's largest IFAs, these folks just think differently as a community. Distributors would do well to seek these guys out on distributor meets- I am friends with India's top distributors and advisors and benefit from the interaction.

Risk and uncertainty- My big trades have happened in bad markets, our business does best in bad markets. There is very little risk in equity markets that have crashed aka 2009/10/11, in 2012 we sold no long bonds in the boom , we had a lovely run in 2013 in equity but had a terrible equity run from last year July onwards. When there is certainty, consensus - money never gets made. It's a very lonely walk and one has to say no to business if valuations are out of whack, the downside risk is you could go wrong and look like a complete fool like we looked in 2007-2008 not selling mid cap and infrastructure, like we looked last year from November to May this year, like we steered clear of tech funds in 2001. One needs an enormous amount of luck as well, the power of prayer shines through when times are uncertain.

Patience - The wait can be agonising - we piled into unknown midcap and infrastructure funds and took some sectoral calls on products which AMCs gave up or shut down, but they tested my intestines and made me vomit for a year plus, they turned out to be spectacularly right. I remember a fund manager telling me he just doesn't understand the boom in 2008, we went whole hog into fixed income and got saved, the problem is one can go wrong, look like a fool for long periods of time and loose business, that my friend is the skill and conviction which will come in its own time if you choose to walk that path. It means loss of face, lost revenues - going against clients' opinion, media opinion and losing business to clients by saying no to particular hot selling products. That be said after doing due diligence, being patient the trade falls more or doesn't go up, now what so add resilience to the list!

Moats are critical - in our context I would think asset allocation is critical, never ever violate it, irrespective of markets, media hype, bullish/ bearish articles by all market players. Don't use your brains to think this time is different, it never is.

High conviction, big bets - We can take strong bets within asset allocation, sometimes it goes wrong, one has to have the courage to accept change of circumstances can lead to an error in decision making. We end up with egg on our face and have learnt to say sorry and change a decision if facts change.

Copycats - we are a big copycat business, I look for investment- distribution ideas from everyone, I share information, as a result I have made loads of friends across the country.

Ajay Laddha, Vantage Wealth Management, Pune

1. Being a Copy Cat: Pabrai's idea of being a Copycat helps an investor to cut out a lot of noise, and focus only on the best ideas of the most successful investors, thereby significantly improving the odds of beating the market. For example, investors, who invested in Rakesh Jhunjhunwalaji's top bets of Titan/ Lupin and Crisil, have significantly outperformed the markets. In a business landscape, combination of copying the idea, rectifying the practical errors, and scale can outperform the innovator himself.

2. High returns, low risk: Premium fund managers like Prashant Jain of HDFC MF, who has consistently demonstrated that higher returns can coexist with lower risk completely debunking the theory that high returns only coexist with high risks. They were able to do this through investing into high quality stocks with competent management and strong moat.

3. Moat based concentrated portfolio: Pabrai's style of investing to only include companies with wide moats (strong and durable competitive advantage) and betting big on a few high conviction ideas (concentrated position) has been consistently followed by successful investors. Investors like Ramdeo Agarwal took concentrated bets in stocks like Bharti, Hero Honda and Eicher. He also replicated the philosophy in their MF investments by holding only 15-20 stock against over 40 stocks in other MF portfolios.

4. Risk and Uncertainty (Price is the king): The price movements in the markets are majorly governed by the human tendency to err due to greed and panic. Any negative news in a moderate to negative trended market, can hammer the prices even of some great assets and vice versa. The negative/ positive news is extrapolated in the far future, forgetting the cyclical nature of the economy where there are always good times followed by bad times and back. A prudent investor finds comfort waiting for negativities hitting some of the best asset's prices and then, when its available at huge discounts, he goes for the kill. Pabrai followed Warren Buffet in accumulating stocks of financials/banks post the 2008 crisis, when prices were hammered mercilessly. Pabrai bought CITI Bank at huge discount to his perception of intrinsic value and made huge profits when the markets stabilized.

Killol Ringwala, Safe Assets, Ahmedabad

1. A good advisor should always look for beaten down asset classes and assess its fundamentals and if there is a genuine case of turnaround in the medium to long term in such asset class then it should be advice to customers to enhance their overall portfolio returns.

2. Value funds should find place in every equity investors portfolio to the extent of 10 to 30 percent of the overall equity allocation depending upon the risk profile as well the time horizon of the investor. These are typically low volatility funds with moderate returns over long term and hence can genuinely appeal to risk adverse investors.

3. World over people have made money by investing funds in deep value asset classes when they are available at distressed prices. Fund houses could launch deep value funds to tap such investor base.

To conclude

Pabrai's principles can be very effectively adapted and implemented in the advisory and distribution businesses, as these leading IFAs have demonstrated. Wisdom is about knowing how to apply knowledge and insights to achieve a desired outcome. Without application, knowledge is wasted. Let Wise Advice and the articles we create here, be platforms to discuss application of knowledge and insights - and not just to gather more information and knowledge. That's how knowledge can be transformed into wisdom.

We hope the wisdom of these IFA leaders helps you gain useful insights. Do share your own insights and experiences on how to make "low risk - high return" investing a reality, by posting your comments in the box below: its YOUR forum!

Content is prepared by Wealth Forum and should not be construed as an opinion of HDFC Mutual Fund.

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