Ninad Kunder majored in finance and after a brief stint in the corporate world, moved on to entrepreneurship. He currently runs a venture in the HR staffing space and manages family money. Shuffling between these two hats has helped him both in business and value investing.
Safal Niveshak (SN): How did you get into value investing, and how has your process evolved over the years?
Ninad Kunder (NK): Lottery tickets! That’s what the 10 buck equity IPOs were like, when I started dabbling into investing in my engineering days. Those early years I tracked the markets without any framework or thought process.
Luckily I didn’t lose too much money because we were a growing economy in which it didn’t take too much intelligence to stay afloat, if one didn’t indulge in stupidity. Guess my innate conservative self kept me away from stupidity which helped me survive. It’s really in 2006 that I encountered Charlie Munger, Prof Bakshi’s blog and other value investing resources. It was a eureka moment and there has been no looking back since.
SN: Great! So how has your investment process evolved over these years? I mean, like many value investors who start with a Grahamian (cheap stocks) approach, did you also begin that way? Or was it a Fisher kind of approach of sticking only to high quality businesses? Please take us through the evolution of your investment process over these years.
NK: You are right that the starting point of the investing process was Grahamian before one evolved to appreciate Fisher. Along the way I encountered special situations which continue to be a part of my investing process.
The real evolution process for me has been in resisting the urge to put myself into either the Grahamian or Fisher bucket or as a matter of fact any other bucket. It has been to scout the market for ideas where there exists a gap between value and the price that I have to pay. It could be a 50 crore or a 50,000 crore market cap company. It could be a Graham opportunity (with clear unlocking trigger) or a Fisher growth story which the market has not priced it in.
As a matter of fact, disproportionate returns can come when a Grahamian cheap stock moves into the Fisher growth bucket with the advantage of a tailwind. There have been instances where examining a demerger special situation has thrown out a good business with wonderful metrics which was hidden behind a bad business. So the opportunity could have been examined as a special situation but ended up throwing up a Fisher opportunity.
SN: How do you find your ideas? What are the necessary conditions that you would look at before you invest in a company and the additional conditions that that will just go about reinforcing your confidence in the company?
NK: Anything could be a starting point for an idea – an annual report, corporate events, news reports or the occasional stroll down a departmental store. Try to catch up on BSE announcements for the day, another great source for origination of ideas.
There are just two necessary conditions that I look for at the start of the process –
- Is there a margin of safety or an element of mispricing in how the market is valuing a business? and
- Is there a competent and more importantly honest management who will ensure that a) It doesn’t destroy intrinsic value, and b) It doesn’t steal from minority shareholders, siphoning away the gap that exists.
This then becomes the starting point of the process and taking it forward ascertain –
- Is the mispricing a one off instance? Hence, at which point, is there a trigger to fill the gap in mispricing? (Markets can take long periods to fill in mispricing if the underlying intrinsic value is not growing beyond the investment hurdle rate)
- Is there a long term mispricing done by the market in understanding the business and the opportunity that lies ahead in growing the intrinsic value?
SN: How can investors trapped by irrelevant information make independent investment decisions? What are the few factors investors can use to improve the quality of their decision making?
NK: There are two lines of thought that I have here.
The mind is a natural sponge. Its default state is to garner as much information as possible, stemming out of a natural survival instinct. In the scavenger hunter phase, you had to process every rustle of leaves to figure if it was danger lurking to threaten your existence or if it was food coming your way. It is the same instinct that captures every information that comes our way and evaluates whether it is a danger to our investment position or beneficial to it.
The challenge exists because the survival instinct makes you act first and think later, which is good in a jungle, but not so good in the investment process. It doesn’t mean that we take action in our investment position but our mind acts quickly in forming a view which is difficult to dislodge latter. Multiple rustling of leaves in all directions freezes the mind in its ability to recognize danger from food. Deer struck in the headlights syndrome.
The ability to wait (would recommend a book by Frank Partnoy – Wait: The Useful Art of Procrastination) de-clutters the mind greatly and enhances our ability to differentiate between signal and noise.
The second line of thought is from Maslow’s hierarchy, the huge need for self-actualization. Are we in the business of investing to make money (crudely put) or are we in the business of getting intellectual kicks? There is a huge amount of information that we garner, process & assimilate because it makes us look and sound smarter. So there is an element of self-delusion and social delusion where self-deluded intelligent people get together and sound extremely intellectual and intelligent to each other. This trap is very difficult to recognize, hence difficult to break and I plead guilty of indulging in this. Information garnering on this front occupies precious mind space which could have been otherwise fruitfully engaged.
SN: Wonderful thoughts, Ninad! I have seen so many investors, including myself, making the mistake of gathering a world of information and then falling under illusion of control which is detrimental to sensible investment decision making. Add to that your point about social delusions caused by investors seeking social approval before committing their money, and you have a deadly combination.
Anyways, what are your thoughts on position sizing? When you find a good bet with great risk-reward, at what level do you stop and how do you think about it, whether it should be 10, 20, or 30% of your portfolio?
NK: Markets rarely offer opportunities to shoot fish in a barrel. More often than not such opportunities occur in periods where the entire market is maniacally depressed and there are multiple fish in the barrel. So pulling a 30% in a bet at the initiating process for me is a six sigma event. Comfort levels range from 10-12% in a stock at the initiation level.
I would be comfortable holding 20-30% in a stock if it has risen to those levels due to significant outperformance in the market. One argument that can be put across is that holding a 20% position and initiating a 20% fresh position is the same and it is a fair argument.
However, the level of confidence in a fresh position and a position that you have spent some time with, do differ significantly, at least for me.
SN: Fair enough. What are your thoughts on concentration vs diversification? Which of these styles do you follow?
NK: There is a famous tagline by the lizard king Jim Morrison for his group, The Doors – “There are things known and things unknown and in between are the Doors.” In the markets there are also the “unknown unknowns”. (Taleb was kind enough to write a book on this)
How many people who’ve had concentrated portfolio’s and have blown up been interviewed for this newsletter or any newsletter for that matter? History is written by the winners and so are the narratives.
I would hazard a guess that for every person who comes out looking like a winner with a concentrated portfolio, there are 100’s who are currently nursing their wounds in obscurity.
A concentrated portfolio of say three stocks with 90% allocation is telling me that the portfolio manager believes in the invincibility of his knowledge. To quote Stephen Hawking, “The greatest enemy of knowledge is not ignorance but the illusion of knowledge.” On the other end a portfolio of 30 stocks largely indicates a lack of confidence in your ideas. I would be comfortable with 10-15 stocks in the portfolio and a tail which are ideas under investigation or bring up a pipeline.
SN: Well, you gave me a brilliant idea for VIA. Let me start looking for people who’ve had concentrated portfolios and have blown up. They will serve as great lessons for others, in case they agree to share their thoughts here.
Anyways, given your reasonably long career in the stock market, you have gone through several periods of uncertainties and turmoil. How have you learned to deal with such situations?
NK: The efficient market theory has been largely debunked and I am in the same camp. Having said that, markets or individual stock prices tend to be efficient for significant intervals of time. It would be stupid to cross a street when the red lights are on just to be a contrarian. Periods of uncertainties and turmoil either in the entire market or in individual stocks are times when this efficiency breaks down.
All our theoretical readings of behavioural finance boil down to these moments where the theory needs to be converted into practice. So we could mouth Buffett’s quote of being greedy when others are fearful a zillion times, but when the actual time comes, has the years of reading and applying thought been translated into action?
There is a wonderful book titled The Hour Between Dog and Wolf by John Coates which dwells into the physiological aspects of risk taking and how our body drives the brain at various times as opposed to the other way around. Periods of high turmoil the body takes over, kicking in the natural survival instinct which drives decision making towards immediate survival and hence sub optimal long term results. Recognising this is half the battle won in dealing with the situation.
SN: Charlie Munger emphasizes about building a latticework of mental models in order to make better decisions in life and investing? Which models have served you the most over the years as far as investing is concerned, and how?
NK: When it comes to Charlie Munger, I always paraphrase Calvin & Hobbes – “The surest proof that intelligent life doesn’t exist elsewhere, is that they have not bothered to get in touch with Charlie Munger.”
The influence of Charlie Munger has been beyond the use of mental models many of which we use on a daily basis in all aspects of life like mean reversion, psychological biases, diminishing utility etc. It has been in inculcating a habit towards second order thinking as a way of life. Of course there is a long way to go but incrementally moving in that direction has helped immensely in all aspects of life.
SN: Can you please list and describe 2-3 mental models that have served you best over the years?
NK: The entire basket of psychological biases for me has been the most influencing variable in my investing process. Recognizing biases that shape your decision making process is something that we know. But it also enables us to think about the psychological biases that influence managements in their decision making process.
The other area which has greatly helped me is understanding elementary probability (base rate) and the application of it in various areas of investing.
SN: What are your thoughts on investment cycle
NK: Let’s look at a classic text book cycle of Government spending to kick start an economy followed by corporate capex as the economy moves forward and finally the consumption cycle kicking in leading to inflation, interest rate tightening, slowing down and back to the government spending cycle.
There are two cycles that play out from an investors standpoint, one is the business cycle and the other is the investment cycle. Invariably the investment cycle will lead the business cycle where the markets tend to discount the cycle much ahead of time. The problem typically happens when the investment cycle drags on even after the business cycle has turned.
This originates from a failure to recognize the tailwinds which blow through a cycle. At various points of time markets tend to extrapolate this into a sustainable moat.
SN: How do you think about intrinsic values?
NK: This is a tough one because beauty lies in the eyes of the beholder. Intrinsic value will always be a range and not a precise point. More importantly it’s a moving target so it is important at every stage to evaluate margin of safety that exists in a particular investment.
There are instances where market price could run ahead of intrinsic value which is not a sufficient condition to sell. It however becomes a necessary condition to examine how large the gap is and at what pace the intrinsic value is expanding to fill in the gap. A quick and dirty metric here is to ascertain how much of the stock price movement has come out of earnings expansion and how much due to multiple expansion. Too much through multiple expansion should take you back to the drawing board to examine how much of hope is driving the price and how much reality.
SN: What are your thoughts on selling stocks? How does one get discipline into the selling process because there are more biases at work here than when one is buying? What selling rules do you follow?
NK: The most dangerous four letter word in investing is “hope”. Hope partially driven out of loss aversion and partially out of innate human optimism is the quagmire in which lot of investing mistakes get sucked in.
Over the last few years I have learnt a lot from traders. I strongly recommend reading books by traders like Jesse Livermore or the Market Wizards series by Jack Schwager. A trader cannot afford to hope when his trade has gone wrong because the market delivers the bad news to his leveraged position immediately. In case of an investor, losses over hope play out over a longer period of time akin to a boiling frog syndrome.
You sell when you are wrong. Period. You don’t hope. Wrong doesn’t mean a quarterly miss in earnings. This is the most important rule of selling for me but the toughest one to execute. Of course you sell when you know that the stock has gone significantly beyond intrinsic value.
SN: Most experienced investors say that volatility is your friend and the only real risk is permanent loss of capital. But we’re talking about human beings and they have a bad history of dealing with volatility. So if history has any significance, isn’t volatility the real risk? How do you deal with it?
NK: Volatility is the enemy of the trader and the best friend that a value investor can look for. Moments of volatility provide great opportunity for an investor to deploy capital. Well one largely hopes and prays that there are six sigma events happening every six months.
As I said earlier, periods of volatility are when inefficiency seeps into the market and a job of an investor is to see through the uncertainty and act decisively.
SN: Technology is disrupting every industry, be it services or manufacturing. The rules of game are changing very fast. Companies are getting into oblivion very fast, thereby making finding sustainable businesses and thus investing in them difficult. The old school rules of value investing may not sometime be very helpful. How does one deal with such a situation? What precautions need to be taken?
NK: Two thousand years of human history and it would be difficult to find a castle with a moat which has never been captured. Imagine sitting in the lawns of your castle sipping tea feeling secure about your crocodile filled moat. Well somebody goes and invents the airplane to drop these cute little bombs on you. Look at the wonderful FMCG companies with amazing brands and moats and a half naked baba comes with a small pump and drains all the water out of their moats.
Human progress has largely happened because of irrational people who don’t believe that a castle can’t be breached. Thousands will fail in the attempt but invariably one will breach the moat. This is a given and all change invariably happens through the route of irrational risk taking.
So change is a given. As a matter of fact, it is really the old school rules of value investing which will always be helpful and applicable. As Howard Marks puts it nicely, “High quality assets can be risky, and low quality assets can be safe. It’s just a matter of the price paid for them.”
Well sitting in 2016 if you are willing to pay for 2020 earnings with the hope that the moat will be there in 2040 then I salute your courage but I’m more comfortable with my meekness.
SN: Where have you made the most of your mistakes over the years – omission or commission? And what lessons have you learned out of these mistakes?
NK: I have lost track of the mistakes that I have made and they are innumerable. In some cases, I’ve had to pay tuition fees and in some cases made money on mistakes but mistakes nevertheless.
Before I dwell into omission and commission, I would want to dwell into how I look at mistakes. The way I see it, most investments are a bet that we make when the odds are significantly in our favour. For example, we buy a business where we see a runway, possible high return ratios, priced reasonably and a judgment call on the management’s ability to execute the opportunity. At the start of the process we ascertain that maybe 8 out of these 10 opportunities will work based on our positioning.
The two opportunities that don’t work out due to failure on the part of the management to execute or greater competitive intensity etc. are not mistakes in my mind. These were the odds with which we approached the investment process and the odds have played out.
Similarly, an investment which has worked out in spite of the odds being not in your favour (ex. airlines) is intrinsically an investment mistake.
There is another line of thought that I have on this subject. The mistakes of omission tend to be weighed much higher than the mistakes of commission. It is counter intuitive when you think in terms of loss aversion.
Mistakes of omission tend to hurt as it takes away bragging rights in a peer environment (crudely put). So we tend to weigh it much higher and there is an element of contrast bias which plays out.
Imagine a stock that has compounded at 20% over last 10 years so at the end of the 10th year it is up 6 times. On the other end, imagine you picked up 3 bets which doubled in a 3-year time frame and in the 10th year you are starting the fourth bet which is up 27% for the year and your capital is up 1o times. Now walk into a party and the guy holding the 6 bagger is centre of the discussion process as opposed to you though you are up 10 times.
Similarly, every stock that you sold which is now up 3 times since you sold, feels more painful even though you deployed that capital in a portfolio which could be up 5 times since then.
This over weighing of sins of omission can lead to the mistake where we tend to hold on to stocks which have run way ahead of intrinsic value. So a stock which is a 5 bagger at the end of 5 years and becomes a 6 bagger at the end of 10th year, in absolute sense played out well. But in reality we made a bad investment call in the second half of the holding period.
This is not a mistake when you are managing large sums of money and hence the investment space shrinks for the fund manager as the impact cost is extremely high or in some cases the fund manager might not be able to re-enter the stock. But at relatively smaller portfolio sizes it is something to be pondered over.
Finally, not sure how many 100 baggers Seth Klarman or Howard Marks have had in their career. Multi-baggers sound infinitely more sexy than mispricing
SN: I have come across several such investors over the last 2-3 years who have made my “happily adequate” returns look “sadly inadequate.”
Anyways, a hypothetical question here – Let’s say that you knew you were going to lose all your memory the next morning. Briefly, what would you write in a letter to yourself, so that you could begin relearning everything starting the next day?
NK: Intelligence is a necessary condition for investing not a sufficient condition. There is absolutely no match for hard work. Similar to money, knowledge also compounds over a period of time. If you can compound knowledge over long periods of time, then a happier well rounded life will follow. So much to read, so little time left.
Finally investing and money is the means and not the end in itself. Experience life in all forms to enrich the self.
SN: Which are some the books on investing, behaviour, and multidisciplinary thinking that have inspired you the most over the years? If you were to give away all your books but one, which one would it be and why?
NK: A significant chunk of my learning’s have come from diverse sources beyond the usual investment reads.
- Matt Ridley – Genome & other books
- Jared Diamond – Guns, Germs and Steel & other books
- Nassim Taleb – Antifragile / Black Swan / Fooled by Randomness
- Daniel Kahneman – Thinking, Fast and Slow
- Bill Waterson – Calvin and Hobbes
The second part of the question is a tough one so I am going to restrict myself to an investing book – The Most Important Thing by Howard Marks.
SN: Great list! Who are some of the people – inside or outside the value investing circles – who have inspired you the most over the years, and why?
NK: Charlie Munger for his intellect, Warren Buffett for his hard work and focus, Howard Marks for clarity of thought, Seth Klarman for discipline, Prof. Sanjay Bakshi for his teachings in behavioural finance are people in the investing space.
SN: If you had just five-minutes to advise someone wanting to get into investing, what would your advice be? What are the pitfalls he/she must be aware of?
NK: Will quote Buffett here – “Investing is simple but not easy.” We tend to overplay Buffett’s insights, quotes, thoughts but hugely underplay the amount of effort that he has put through in a lifetime and still does. So investing is a simple process on a bedrock of hard work.
SN: Thank you Ninad for the insights you have shared with Safal Niveshak’s readers!
NK: Thanks for the interview, Vishal! I really enjoyed it.