Grouping the investment themes – a mental short cut

Grouping investment themes together is a mental short cut many investors take. We have seen many examples of such groups, e.g. Asian tigers, emerging markets, frontier markets, mid-cap stocks, suburban real estate, condos, precious metals, infrastructure stocks, BRIC countries, ICE stocks, unicorns (start-ups), e-com start ups – the examples galore.

In the process, all the individual investments are considered to be equally safe. In search of opportunities, investors often forget that the risks could be vastly different. Almost invariably, they land up with the investment options that appear to be “safe” only because these belong to a certain group or a club.

The truth is discovered much later.

By the time the realisation happens, many have highly concentrated portfolios with poor liquidity and high leverage – a lethal combination.

#RidingTheRollerCoaster – 178

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The seeds of the crash are planted in times of the boom and vice versa

The proximate causes of these successive crisis are very different – emerging market debt problems, the new economy bubble, default on asset-backed securities, the political strains within Eurozone – yet the basic mechanism of all these crises is the same. They originate in some genuine change in the economic environment: the success of emerging economies, the development of the internet, innovation in financial instruments, the adoption of a common currency across Europe. Early spotters of these trends make profits. A herd mentality among traders attracts more and more people and money into the asset class concerned. Asset misplacing becomes acute, but prices are going up and traders are mostly making money.  …

… Yet reality cannot be deferred forever. the misplacing is corrected, leaving investors and institutions with large losses. Central banks and governments intervene, to protect the financial sector and to minimise the damage done to the non-financial economy. that cash and liquidity then provide the fuel for the next crisis in some different area of activity. successive crises have tended to be of increasing severity.

The above paragraphs have been taken from John Kay’s book “Other People’s Money – Masters of the Universe os Servants of the People”.

Different market cycles appear different, but there is a lot of similarity in each. I have written about the anatomy of a market cycle in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget” that echoes the above words to a great extent. If you observe, the parallels are often staring you in the eye. However, very often, we choose to ignore the signals.

The seeds of the crash are planted in times of the boom and vice versa. As Lord Krishna tells Arjun in the Bhagvad Geeta

Bhagvad geeta 2-27

#RidingTheRollerCoaster – 174

Unicorns, cockroaches and investment decisions

Forget unicorns – Investors are looking for ‘cockroach’ startups now

The title of the above article is very interesting and enticing. Most people would be interested in reading what a cockroach startup is.

 

I have two observations to offer here:

  1. We love to coin new terms, sometimes only to explain the old. Nifty Fifties, Asian tigers, ICE, TMT, BRICs, BRICS, BRIICS, emerging markets, frontier economies, PIGS, PIIGS, the Fragile Five … the list goes on. Unicorns, cockroaches are also products of such thinking. Read the article and you understand that a unicorn startup is one that guzzles investors’ money in the initial years to achieve very fast growth and scale up to a very large firm, gaining market share in the process. These firms do not make money in the beginning. However, they hold the promise to reward the investors in the long run when it has acquired the lion’s share of the market. On the other hand, a cockroach startup is one that is making money – it is making profit – this is the good old way of doing business. There is a downside to grouping firms or investment opportunities. This is a mental short cut. Many times, money is thrown to a firm belonging to a group simply because, well, it belongs to the particular group. Not every investment opportunity may turn out to be a winner. Investors later discover that many firms that were part of a “so-called elite” group, turned out to be dud investments.
  2. Taking from where we left in the previous bullet point, it seems better sense is prevailing. “In a bull market, everyone becomes an expert. In a bear market, everyone becomes wise.” In 2015, when there was too much money and investors did not know what to do, they threw money at unicorns. Now that capital is getting costlier and scarcer, the question is asked to the same unicorns, “Show me the money”. New money seems to have found a new love – companies that make profits. Very often, when there is too much money at hand, one needs to exercise caution, since this is the time when emotions take over – one feels overconfident, wealthy, safe and tends to take unnecessary risks. Sometimes caution is thrown to the winds and some risks are taken without proper understanding.

Be careful when you see shortcuts, or when there is too much money in your own hands.

#RidingTheRollerCoaster –