Hope is a very bad investment strategy

This looks like an interesting development. Another “new” thing has cropped up. Some regional language movies are doing great – low cost and high revenues – amazing success stories and very high RoI (I mean, return on investment). Many investors are looking at the “alternative” investment to “diversify” their portfolios and at the same time earn very high returns.

Even start ups have come up to help people channelise their money into such ventures.

Regional movies are the buzz at crowd-funding startups

This seems to be great for regional movies, at least. There are many talented movie-makers, who could not compete against the mega-star, big-banner movies with deep pockets. Now, they seem to have found their source of funding.

Well, here is the caveat for the investors. This seems to be another case of “too much money, where to invest?” for the investors. Once one has run out of investment options (psychologically, at least), we start searching for newer options.

If you get success in some early investments, please be even more careful. The chances are that you might simply be lucky. However, we love to attribute all the success to our superior abilities – that is a human tendency. This would build your confidence, which eventually turns into overconfidence.

This overconfidence in one’s abilities leads to the search for even more risks. One tends to start looking at something that nobody is looking at – the spirit of adventure in us wants to seize this opportunity. And we leave the shores and dive into the deep seas.

Just as a side note, please check why did you think  of investing in movies? Is it because nobody else was doing it and you wanted to take the early-mover advantage? Or is it just that someone told you this was “exclusive”?

The combination of overconfidence, exclusivity and greed lead us to take interesting decisions.

Let us analyse this option from an investment point of view. Do regional movies make money? Well, yes they do. Do all regional movies make money? No. If we are clear on these two answers, any prudent investor should ask the next question: “How can one identify the next many-making movie? Do I have the capability? Or can I hire someone who has the capability?”

If I cannot identify the next money-spinner or if I do not know someone who can, it is imprudent to put my money on the block. That is not an investment, then. It is hope – a really bad investment strategy.

In the event of an investor recognising one’s inabilities to spot the right investments, the tendency is to look for what is cheap. This could be another trap.

Be careful. Understand the economics of the business before investing your money. If you don’t, stay away. Warren Buffett has famously said, “Invest within your circle of competence. It is not how big the circle is, it is how you define the parameters”.

 

#RidingTheRollerCoaster – 168

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To all the Kindle readers …

Dear all Kindle fans, do you know that “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget” is available on Kindle?

So go ahead, if you have yet not bought it …

The Pied Piper of Hameln

If you search on Google for the “Town of Hameln”, you are led to a website www.hameln.com, which has a tag line: “The official website of the Pied Piper’s town”.

The story of the pied piper is very old. They say it happened in the year 1284, when the town of Hameln (also referred as “Hamelin”) was suffering from the menace of rats. A stranger claimed that he could get rid of the rats. The town mayor promised him a huge reward if he succeeded. The stranger took out his pipe and began to blow on it. Rats and mice came from all over the town. He led them to the river and then he walked into it. The rats followed him only to be drowned.

Successful in his mission, he came back to the town asking for his reward. The town elders thought the reward they promised was too large for the task. They offered him a small token amount or nothing. Angry, the stranger went away. In the evening, he came back with another pipe in his hands. He started to blow on it. This time it was not the rats, but the children of the town that followed him. He led them to a mountain nearby never to return.

This is known as the legend of the Pied Piper. Scholars debate whether the story is true. They argue over the cause of the disappearance of such a large number of children. The jury is still not out on whether it is possible for so many children to be led by just the music of a pipe. How is this possible?

The Pied Piper of Hameln came around 730 years ago, and we haven’t seen another one.

Welcome to the financial markets, where the pied pipers make frequent appearances only to lead many to the mountain of tall promises. Whereas in the pied piper story, the children disappeared, the modern day pied pipers (a.k.a. Ponzis) make money disappear.

#RidingTheRollerCoaster – 167

AIG – Was it overconfidence?

“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.”

— Joseph J. Cassano, a former A.I.G. executive, August 2007

AIG was  bailed out by the US Government roughly a year later.

AIG, then one of the largest insurers in the world, was expert at insuring what are known as the insurable risks – life insurance, property insurance, etc. These risks are such that history is a good indicator of what to expect since most risks do not manifest together. Not all insured would die simultaneously. History suggests that even in case of wars, natural calamities or disease outbreaks, the number of deaths are not unusually high. This turns out to be  astable business for the insurers.

During the great liquidity rush, practiced by the US Federal Reserve Bank under the chairmanship of Alan Greenspan, the financial intermediaries found a very lucrative opportunity to make money – insuring against the default risks of borrowers. Thus came the CDS or the Credit Default Swaps. These risks were very different from the insurable risks we discussed earlier. There is a higher possibility that an unusually large number of borrowers may default together, if the economic conditions change, e.g. interests rise – thus making the floating-rate home loans costlier to service or if the house prices fall – thus reducing the value of the house collateral less than the outstanding loans.

This was (probably) not understood by AIG FP or to respect their financial acumen, one may say that they preferred to ignore the risks. Was it overconfidence in their abilities?

Be careful of the overconfidence. It can lead one to make very costly mistakes.

#RidingTheRollerCoaster – 166

Is it really Greek and Latin? Or is it just a game of musical chairs?

“The adoption of a common currency by these countries in 1999 (Greece followed in 2001) led to convergence of interest rates across the continent. Traders no longer discriminated between the euro liabilities of different Eurozone governments, believing that not only currency risks but also the credit risks that had once distinguished well-managed European economies from those with unstable public finances had been eliminated. …

… By 2007, yields on Greek government bonds were barely higher than those on equivalent German bonds. Several states, including Greece, took advantage of what appeared to be inexhaustible supplies of credit at low rates. …

… As European banks struggled with the global financial crisis, the quality of their assets was viewed more sceptically. Credit risks were appraised much more carefully, and interest rate differentials across the Eurozone widened again. Greek bonds appeared less attractive, as interest rates rose and the refinancing of Greek credit became more difficult. The country effectively defaulted on its debts in 2011.”

This is an excerpt from the book “Other People’s Money – Masters of the universe or servants of the people” written by John Kay.

The Greece government was playing the game of musical chairs. As we wrote in the book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, liquidity was the music in this game. The only difference is when the music of liquidity stops, there are no chairs to be found.

Rolling the credit over and over again is a dangerous game. So long as the liquidity is abundantly available and at cheap rates, the game continues. A few victories in this game makes one believe that one is skillful. However, history is replete with examples of disasters when the music stops.

#RidingTheRollerCoaster – 165

Buy high sell low … or is there another way of making money?

Success in the stock market is based on the principle of buying low and selling high. Granted, one can make money by reversing the order – selling high and then buying low.” – Said Sir John Templeton.

Sir John, a bargain hunter as he was, found a bargain in the internet stocks – well, the bargain was not in buying, but in selling. However, since he did not own any stocks, he had to short-sell the stock by borrowing the same from the market and later reverse his trade, i.e. buy back the stock.

Sir John Templeton took out the list of DotCom (or Internet) companies that raised money through IPOs and then further filtered on when the lock-in period was getting over. He started short-selling the shares a few days ahead of expiry of the lock-in period anticipating large amount of stock being off-loaded once the lock-in was over. He was right on target and in a falling market reaped huge profits.

What did the other great investors do in that time? Read it in “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”

@RidingTheRollerCoaster –  164

 

The fact that I got away does not mean there was no risk at all …

Amit - python

In the photograph here, I have draped a live python around my neck at the night safari at Singapore. The fact that I am alive means that nothing happened to me – I did not lose life. Does it mean I did not take any risk at all?

Same thing happens with investments.

One tends to get confident when nothing untoward happens to the investments even when one has taken risks. this confidence soon turns into overconfidence. This overconfidence in one’s abilities leads to the search for even more risks. One tends to start looking at something that nobody is looking at – the adventurous in us want to seize this opportunity. And we leave the shores and dive into the deep seas.

#RidingTheRollerCoaster – 163