Sankaran Naren is the Executive Director and Chief Investment Officer at ICICI Prudential Mutual Fund, where he oversees assets of around Rs 6 lakh crore.
He has spent 34 years as an investor, starting from 1989. Out of that, 19 years have been in the mutual fund space. At a talk at the Tamil Nadu Investors' Association on September 8, 2023, he shared the most impactful lessons he learnt over this period. In all the years that I have been following Naren's wisdom, never have I come across such brilliant and simple articulation.
I have taken the key essence and took the liberty to paraphrase. As well as added information from his earlier impartations. Do read and learn.
Lesson I: Investing is not a zero-mistake world.
It is NOT possible to avoid mistakes in investing, and it is foolhardy to think otherwise. Never walk into the investing arena assuming that you will never make a mistake.
Even the legendary Warren Buffett has erred, which he humbly and graciously talked about- IBM, Tesco, Precision Castparts, Dexter Shoe Co., and airlines for instance.
If mistakes are inevitable, it is futile to sweep them under the carpet. Every single time you make a mistake, never fail to introspect honestly. Learn from it so that you never make the same mistake again.
The key essence in all my 34 years in the market can be distilled to an important principle: Make fewer mistakes and get many other aspects right.
Lesson II: The most important decision is not what to buy.
In fact, I would go so far as to say that buying is the easiest part of investing. Nearly all investment literate is focused on this aspect of the process: Look at the balance sheet, annual report, the business, valuations, and try to understand what the company will do over a period of time.
When I started my investing journey, 1989 and 1990 was such an easy period to buy stocks. Then came the bull run.
We are in a bull market now. This cycle started in 2020. There have been a lot of advantages for investors who started their investing career in 2020. Their timing was inadvertently impeccable. They bought stocks cheap. Made phenomenal money. That was the easy part. The difficult part comes now.
Recognise that the situation in 2023 is very different from what it was in 2020. Hence, the possibility of making mistakes shoots up.
Lesson III: Due to cognitive biases, we inadvertently succumb to reverse asset allocation.
What is asset allocation? It is taking out money from an asset class that is topping the charts and reallocating it to an asset class that is probably in the doldrums, comparatively speaking.
The most important lesson I learnt from 1994 and 1998 was that asset allocation can never be ignored. One could not have an allocation to equity in the same measure as one had in 1990 when the market was very cheap.
In 1998, interest rates were 16%, making it logical to invest in debt.
In 2002, interest rates were 4%, making it logical to move from debt to equity.
Today, in 2023, the 10-year return of the small-cap index and mid-cap index, is 20% and 22% CAGR, respectively. The right thing to do would be to take out money from smaller fare and shift it to something safer. But the fund flows point to the exact opposite- reverse asset allocation.
Look at the situation today.
- Is anyone investing in debt? No.
- Is anyone investing in a cautious product via the fund industry? No.
- Is the derivative exposure and open interest in stock options and futures high? Yes.
So what investors are doing is reverse asset allocation. They have thrown caution to the wind.
I saw this play out in 2007 too. Money flowed into my infrastructure fund, but I struggled to get money into the value fund.
Lesson IV: Identifying where you are in the cycle is an art.
Post the Global Financial Crisis (GFC), I developed a tremendous respect for understanding cycles.
What Howard Marks refers to as the pendulum of investor psychology. He likes to use the pendulum as a metaphor for understanding the market because the swings are often towards extremes, with relatively little time at the "happy medium", where it is as rest. You need to comprehend the exuberance and the panic. You need to comprehend when it is frothy and when it is cheap. It will then guide your approach to investing.
These are some factors you can employ to determine cycles:
- Institutional ownership in the sector
- Valuation of the sector compared to the past
- Sentiment in the IPO market in that sector
- Margins in that sector
What you do in asset allocation should always be a function of where you are in the cycle. When the cycle is extremely exuberant, exercise caution. When the cycle is extremely pessimistic, be aggressive.
Lesson V: Use extremes to your benefit.
When the market goes to extremes, you need to move fast. In such times, you have to act in a very decisive and relevant way to capitalize on it.
This is not a something that happens frequently. In fact, it is very rare when such opportunities come knocking. I have seen them in 2002, 2008 and March 2020. When Warren Buffett visited India, he touched upon this and said that such opportunities come around once in a decade. He mentioned five such opportunities over 50 years.
Extremes can be used to generate phenomenal returns. Infotech in 1999, Infrastructure in 2007, Pharma in 2015, FAANG in 2021 are all examples. In 2021, at a talk at the CFA Institute, the extreme was that PSUs as an aggregate market cap was extremely cheap compared to most large caps. No one would have envisaged the kind of outperformance that would come from PSUs. It was not that large caps did badly, but that the PSUs outperformed them.
The point I am making is that it is not that the market cap that is high that needs to go down. It is the market cap that is high that needs to be sold or switched into the market cap that is low.
Market caps in extremes have displayed huge ability to deliver alpha.
I reiterate, this strategy can’t be used on a daily basis. It can be implemented only when extremes present an opportunity, and then must be acted upon boldly and resolutely.
Lesson VI: Money can be made in structural investing.
That's true. And I must confess that structural investing is not my biggest strength.
Investors who bought, say, private sector banks, or retailing, or IT services, or telecom, at the start of the cycle and stayed on for many years, would have generated stupendous returns. Yes, it would have required some amount of stock picking skills to narrow down on the right company to bet on. But then it would be patience that would help hit the ball out of the park.
That was India. But globally too, those who bought Apple, Tesla, Google, and Amazon have had a fantastic experience.
Lesson VII: Part-time investors have a lot going for them.
This is a controversial take: If you want to be a good long-term investor, you must be a part-time investor. Individuals who are part-time investors have a huge opportunity.
It is not logical to be full time in investing. Because the biggest challenge arises when you don’t give the time needed for returns to be generated. If you bought power stocks four years back, would you be patient with such a wait if you were a full-time investor? Or with Telecom six years back? Or with metal stocks? Would you wait and continue to wait for the cycle to turn to your favour and when the cycle nears the top?
Investing is not a business that gives you a monthly income. You have to make money over a period of time. This should come from your profession or job. You can be a teacher or a doctor or a professor or a CA, or whatever, and be a part-time investor. When I was in stock broking, before I joined the asset management industry, I came to understand that investing is a fantastic part-time profession.
We have seen such investors in India– one runs a retail company, another started an airline, another set up a university. Warren Buffett and Charlie Munger invest and then run businesses. As a chief investment officer, I have a lot of responsibilities. I have to learn about new age companies. I have to mentor and train my younger colleagues on how to approach equity research and how to approach fund management. I am involved in many things. So while I am a full-time investment professional, I am not bothered or obsessed with my portfolio on a daily basis.
Lesson VIII: “Value investing is at its core the marriage of a contrarian streak and a calculator.”
Who can forget Seth Klarman’s astute observation?
This is what we implement at ICICI Prudential. And it is this guiding principle that has helped us manage humongous sums of money over long periods of time.
It was the calculator part of the equation that steered us away from NBFCs and private banks. Nevertheless, there have been instances where we erred by not paying careful heed to the calculator. One such mistake was an investment in a tea plantation company.
If you want to be a successful contrarian, you cannot ignore the calculator. If value investing was just about buying cheap, then you would end up with junk infrastructure companies from 2007 and the wrong NBFCs in 2017.
I would also like to point out that contrarianism is not restricted to a style - growth or value or quality, or a particular market cap. It hunts for intrinsic value upside.
Lesson IX: There is a time to measure your performance.
Today, if you are a small-cap investor, it is not the time to measure your performance. If you are a managing a China fund, today is not the time to measure your performance.
It is futile to measure performance when markets are at extremes – too high or too low. It is dangerous and gives you a flawed perception of reality. Measure performance in the in-between phase. If you measured performance in December 2007 or December 2008 or March 2020, you will get the wrong signal. Today, if you measure your performance as a small-cap investor, because performance is extremely good at 20% CAGR, you will be misled. Neither should you measure performance in the midst of a bear market cause bear markets can also be irrational.
And measure performance over long periods of time.
Lesson X: The rewards go to those who patiently stay rational in an irrational market.
Never underestimate common sense. If you practice common sense consistently, and over the long run, you will have a fabulous track record.
Did we not know that in March 2020, the market was cheap? Did we not know that in December 2008, the market was cheap? Did we not know that in December 2007, the market was costly? Do we not know that mid and small caps are overvalued when compared to large caps today?
In the long term, common sense always wins. Never fear the near term even if the market goes irrational.
Be rational in an irrational market. And patiently wait through it.
Lesson XI: Investing is NOT simply arithmetic.
India is at the stage where every theme is likely to do well in the long run – be it Consumption or Infrastructure. But at various points of time, some theme will be cheaper and another costlier. In 2007, Infrastructure was very costly. In 2015, Pharma was costly. In 2021-2022, some of Infotech stocks were costly. In 2020 or 2021, people said value investing is dead and it's only FAANG stocks and the likes, and nothing else.
At various points of time, themes get overvalued because everyone looks at the last two years growth and extrapolates it for the next 10 years. People are so focused on thinking that they can make money out of the last bit of news. Use it to your advantage.
Identify themes where the risk/return reward ratio looks good. Move from one theme to another, as you spot opportunity. Buy cheap relative to intrinsic value. Have patience. Your investment won’t do well every month or every quarter or every year.
Greed and Fear are as important as knowledge. Avoid getting carried away by the news of the moment or the mood of the moment.
Using temperament to make money has been one of my biggest learnings.
Larissa Fernand is an Investment Specialist and Senior Editor at Morningstar India. You can follow her on Twitter
This Morningstar Learn From The Masters article is sponsored by ICICI Prudential Mutual Fund.
