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Kuntal Shah is a partner at Oaklane Capital, co-founder at Needle.ai, and a board member at Flame University. An electronics engineer by qualification, Kuntal bhai is a first-generation entrepreneur, a business leader and a prominent value investor with three decades of experience spanning various aspects of the capital market.
I look up to him as a fountain of knowledge and wisdom, especially when it comes to investing, business analysis and the economy. I’ve had the opportunity to learn from him and his experiences, through his various talks and presentations, and I must thank him for all the wisdom he has shared over the years.
Vishal Khandelwal: Kuntalbhai, welcome to The One Percent Show. Thank you for agreeing to do this.
Kuntal Shah: Thank you Vishal, for having me over and I hope I can do enough justice to the august audience you have cultivated. Your blogs attract some of the most learned minds in India and abroad. It is my pleasure to be in this august community with the likes of the investors you have interviewed before.
Vishal: I generally start my interviews asking my guests about their background and life story, but I have a slightly different question for you to start. I remember sometime back you shared with me the 12 equations of your life, and I think those were brilliant insights. So, for the benefit of the audience here I would want you to talk about those one dozen equations?
Source: Oaklane Capital
Kuntal: Well, yes, Vishal. We got talking over it and these are not my observations. I have borrowed from the works of giants, whom I’ve read about and interacted with. So adequate disclosures, these are not original, but I think as a compilation they would add value to the investing community.
The first of the equations is – anything multiplied by zero is 0. So many activities and outcomes in our lives are multiplicative, in the sense that they multiply over a period of time, and if there is any situation or any outcome that leads to 0, then the pasts doesn’t matter. You could make tons of money, but if you lose it in the end it doesn’t matter.
Secondly, happiness is a function of achievements plus aspirations, divided by regrets. This is a very powerful statement because happiness is what all of us strive for. And since regret is in the denominator, one of the easiest ways to increase our happiness is by leading a life of no regrets. And technically, if you have no regrets, it is infinite happiness. So, the one way to improve our happiness is to never regret. The second is to aspire to have a decent number of achievements.
Conversely, the reverse is also true. Disappointment is a function of expectations divided by reality. As expectations grow and reality fails to catch up, you become a victim of your image. This is what my mentor had told me, and the key to avoiding disappointment in life is by keeping expectations within the meaningful fold.
The 4th equation is kinetic energy is equal to ½MV^2. This equation is important in this era where the rate of change is accelerating, an organization or a person can use his mass or velocity to gain competitive advantage and velocity being exponential, speed is of essence. Since velocity is also linked to the direction, it is the direction in which your efforts are guided that matter. So be conscious of the direction and the rate of change of speed. These are very powerful.
The fifth is that opportunity cost is always higher than sunk cost. Many of our decisions in life are sunk cost fallacies, which many of our behavioral economists and scientists have spoken about. We all have fallen victim to our sunk costs at some point of time and the fine line between perseverance and stupidity is very low. One has to be always mindful of opportunity costs.
The next one is, destruction is far swifter than construction, and this applies in the stock market and businesses to a large extent. Rome was not built in a day, but Hiroshima got bombed out in one day flat.
The next one is, EBITDA is not equal to cash flows. Many investors don’t bother to read the cash flow statement and they are focused on shortcuts like EBITDA and P/E, which give a very narrow, limited, and twisted view of the business environment, and I think one has to avoid that.
The next one is the role of luck. The role of luck is supreme in life and the formula of luck, is joy square divided by effort. If your joys have been plenty, be mindful of what efforts have been responsible to get them, and if your joys are a result of some inheritance or winning the lottery, be mindful that you are a winner of some lottery.
The next one is, despair is equal to suffering minus equanimity. Whenever you are in a mood of stress, doubt, self-pity, loathing, self-doubt, remember suffering can only be handled by reminding yourself that this too shall pass.
Next is the fourth law of motion, which is for investors as a whole. Returns decrease as motion increases, and this is rightly so because this interrupts compounding. A wrong decision taken disrupts compounding.
Which brings me to the next equation, which is something all of you know – Future Value = Present Value (1 + R) ^n. So as investors we aspire to have a long duration of growth without disruption, but growth has to be accompanied by high returns. Cancer is also growth; however you don’t want such undesirable growth. So, growth accompanied by high returns is what you are looking for, but investors are also looking for low risk. And the triangulation of this happens when you are in a win-win environment. Here Vishal I want to highlight, many corporates talk win-win, but in practice they are win-lose. This was very evident during covid where companies with a lot of cash on their balance sheets refused to pay rent to their landlords or pay their vendors. This doesn’t create longevity, but causes reputational risk.
Yes, and the last equation which is very dear to me is that gratitude + the right attitude = permanently high altitude. The right attitude, combined with gratitude and the right frame of mind makes you eligible for success in life.
So, these are some short equations which have stayed with me during the course of time. And I hope the audience learns from them.
Vishal: So, I’m sure I think this is a great amount of learning that you shared, and I couldn’t have asked for a better start to this show. Thank you for sharing those equations. We last talked in detail in 2016 when I interviewed you for the Value Investing Almanack six years ago, but it seems like a different time period. I’m sure like you have constantly learned over the years, you must have been a different kind of investor in 2016 than you are now. So how has your evolution been over these years or what have you picked up along this journey? And what have you given up?
Kuntal: I will answer the second part of the question first. I have gained enough weight and lost enough hair. I have also given up my formal dress code on the personal front.
The two important things that have happened since 2016 are that I have become extremely choosy of the company I keep. I have learned the hard way that a marriage of convenience leads to a life of inconvenience and you can’t make a good deal with a bad person.
Another big change that has taken place, is that earlier I used to keep a decision journal, chronicling my logic, my emotions and my rationale for major investments decisions and activities in my life. I also started including a gratitude journal, which chronicles all the good things the Almighty has given me, so that I have a proper perspective and equanimity in life.
A marriage of convenience leads to a life of inconvenience. For a proper perspective and equanimity in life, maintain a decision as well as gratitude journal.
Coming back to your first question, what has changed for me personally, is that while earlier I used to be driven by my internal scorecard and what I perceived was right for me given my personality, now I incorporate legitimate feedback received from well-meaning and more capable people, so as to improve my journey. Also, as I said earlier that company matters, a man is known by the company he keeps.
The second layer is whom you consider as mentors and role models. Mentors are the people who help you improve your game. They are the people who instill discipline and help you weed out the noise and make you wiser, so I have carefully chosen my mentors and my role models.
My role models are my true north and help me overcome my biases and limitations. Every situation and problem that I am probably going to face, has already been faced by far wiser people, thousands of years ago and it has been well documented. So why not make use of it?
These are the three main changes that have occurred at the personal level. Coming back to the market, the situation since the last five years has enforced the learnings I received in 2008, that macro matters. A lot of things can happen because of interlinkages of the capital market and the information flow, and the way the world economy is now interlinked. Small events in far corners tend to have higher impact here. For example, liquidity, interest rates, and the transmission mechanism are not properly understood, and they can have a ripple effect.
Macro matters and interlinkages can lead to a ripple effect.
Another thing I’ve learned in the last few years is that all IT enabled businesses are not tech businesses. Just to prove this point, a company delivering food is in the business of logistics and food. Will it be wise to equate it with a product company delivering high profit margins and consistent cash flows? That’s a question which is not clear to me yet. The same applies to a company selling insurance policies – is it a distributor of a financial product or is it a tech company? The verdict is not out, and I think the market has already started distinguishing between what they call big tech and superficial tech. So, these are the key learnings since we last spoke.
All IT enabled businesses are not tech businesses.
Vishal: Great Kuntal bhai, so the last six years we have also seen the world go through a rapid change like it has always been for the past 20-25 years. We are going through a period of rapid change, especially the last few years where things have risen exponentially, and we also saw what happened with the COVID pandemic. I bring back Sir John Templeton here, who said that the four most dangerous words in investing are “this time is different”. And my question to you around that is, going on what we are seeing in the financial markets – is this time really different?
Kuntal: Vishal, the answer is loaded in your question. ‘This time is never really different’, and you know that they are the four most dangerous words in financial history. The reason is very simple. The financial markets deal with the pricing of businesses and assets. Businesses are run by people, regulated by people, assets are created by people and the pricing of those assets are set by people. So, people are central to what happens in the market and the crowd psychology and the time horizon with which it acts, and the narrative by which it is seduced, remains change.
So, what I have learnt is, because of recency bias, we learn a lot in the short-term, quite a bit in the medium term, but nothing in the long-term. Nothing changes, yet everything is completely different in a sense, and as Santayana says, those who don’t remember the past are condemned to repeat it.
Businesses are run by people, regulated by people, assets are created by people and the pricing of those assets are set by people. Those who don’t remember the past are condemned to repeat it.
Also, please remember that in science and in life, progress is linear but in the financial word it is cyclical. Also, the brevity in financial memory is breathtaking. So, when you look at it, nothing is different this time. The only thing I would say is that the cycles are getting more frequent. They are of shorter duration than the past and the amplitudes are far higher. This is very easily understandable by the logic that earlier you didn’t have a countervailing mechanism of central bankers intervening actively in the market, to the extent of buying stocks from the market, to the fact that capital and information flows are rapid. These two have changed materially from the past cycles and are getting more pronounced, but apart from that I don’t think anything has changed materially.
In science and in life, progress is linear but in the financial word it is cyclical. Cycles – more frequent, shorter duration and far higher amplitudes
Vishal: That’s a great insight. So, as I understand, you’ve been in the markets for the last three decades, about 30 long years, which means you must have been through multiple periods of extreme uncertainty. What has given you the courage to deal well with them and do they have any roots in your early childhood and upbringing?
Kuntal: Yes, definitely. The fact that I was brought up in a middle-class family, with very modest upbringing has helped me reset my expectations, my risk reward framework and what constitutes right for me, in a very different manner than many of the people I encounter in life. Your time on earth is limited and you can’t base it by living on somebody else’s opinion. Right from the beginning I’ve been surrounded by people who have been far more knowledgeable, richer and more experienced than me, but I have not allowed their opinions to drive my inner voice, because ultimately, I have to live my own life.
Secondly, I have stopped sweating over small things in life and focusing on the big picture. One thing I really feel helps me tide out over periods of extreme uncertainty is data – When I analyze 30 years’, rolling returns over multiple periods, they are almost uniform and each of those 30 years span several ups and downs, right from wars to pandemics to major events of liquidity, booms and busts, yet the long-term returns have been fairly stable.
What this has reinforced to me is that while volatility is guaranteed, as long as my time horizon is long enough, I’m not levered, and my capital base is stable, I should be in a position to overcome this uncertainty during volatile times. In fact, if I’m lucky, I could benefit and take advantage of them. The reason is that the markets are constantly in a state of uncertainty. They are always bouncing around and they tend to overshoot, and serious amounts of money can be made if you can take the right decision during those periods.
In the short-term volatility is guaranteed. A long time horizon and an unlevered, stable capital base can help overcome volatility.
What makes a great investor is not the number crunching or having differential insights, but the ability to make good decisions in extremely uncertain times. If this strong conviction is managed well over a period of time, companies tend to do well and beat inflation and taxes, which is my investing goal. This helps me stand and take a call, that this time too shall pass. That’s plain and simple. Inner intuition and voice, which drive me to face uncertain times.
What makes a great investor is not the number crunching or having differential insights, but the ability to make good decisions in extremely uncertain times.
Vishal: So, 30 years ago, around 1992, when you started investing and you made a mention of market cycles, which I understand is one of the most important things that an investor should understand. When investing we all talk about stock picking and asset allocation. But people forget that they also need to understand where they are in the market cycle. One great insight that I can draw from your previous response is the 30-year rolling return, right? Long-term thinking is a great insight for people who are worried about short-term volatility, ignoring the fact that in today’s world, in today’s times long-term thinking, long-term investing and focusing on the business and not the stock prices is the only edge that you have. It is not an analytical edge, it is not informational that everyone has the same information. People are smarter, so it’s not an edge, right? So, the only edge I understand from your insight as well is the behaviour, how you behave and how do you stick to your process through thick and thin and not really go by that fear of missing out that most people get caught into.
Talking about market cycles… 1992 to 2022, you have been through multiple market cycles. What in your experience are the common traits and subtle differences between these various market cycles that you’ve been through?
Kuntal: The study of financial markets is nothing but the study of cycles and human behavior with money. The cycles in the market are of multiple types. There is a monetary cycle, a business cycle and there is also a cycle of liquidity and investor psychology of how we perceive all these things put together by our feedback loops. Cycles are driven by interest rate liquidity, psychology, and it basically boils down to a confidence game – The degree of confidence investors enjoy in the current environment.
What I have observed is that rising liquidity and low interest rates coupled with a catalyst which has a seductive narrative, are usually the reasons why the booms happen. The converse is the cause for busts, namely monetary tightening and rising interest rates with the narrative being taken to extremes. These cycles keep repeating, again and while they don’t repeat exactly in a like manner, they definitely rhyme.
The study of financial markets is nothing but the study of cycles and human behavior with money. History doesn’t repeat itself, but definitely rhymes.
To give an analogy, Vishal, these cycles are like sequels of successful movies like say, Indiana Jones – they all have predictable common plot narratives, and the usual ingredients thrown in. There is a hero, a villain, a plot of some riches to be discovered etc. They are quite predictable. However, the subtle difference I observe in the current cycle is that we have just experienced a once in a century event, which a majority of investors have not experienced before. This has resulted in a global pandemic in an era of globalized supply chain and trade which has been disrupted. This has partially been responsible for inflation. Travel restrictions are still in place and because of free-flowing information and capital flow, what has happened is that these cycles have been extremely quick to price in, and as I repeated again the duration of the cycle has decreased.
Cycles are like sequels of successful movies.
We came out of COVID related issues in few months because of the liquidity infusion and the steps taken by the Fed. The corollary is that it has given rise to inflation and now we are seeing reverse feedback loops where asset prices are vulnerable to rising interest rates. This again reinforces what I said earlier that because of the central banks’ inventions, the cycle durations have shortened but their frequencies have increased.
This is what I think is happening right now.
Vishal: So, continuing with the insight that you shared. We’ve seen that in the last few centuries of documented history of the financial markets, booms and busts have lasted for long periods of time, and were not as frequent, but due to intervention, as you mentioned of central bankers and governments, what has happened is that not just the frequency of such market surge and crashes has increased, but also their amplitude.
So, what are your thoughts on this, and how should an investor position himself or herself to deal with the world which is changing so fast, thanks to the central bankers?
Kuntal: Vishal one has to first understand the reason why this is happening. Every boom and bust has roots in very credible catalysts. When the internet and tech disruption came, it was no different than what had happened when cars came and the steam engine came, so the catalysts were genuine and bona fide. Those catalysts changed the course of humanity forever, but what happened was that they were taken to extremes and a lot of misallocation of capital took place. Innovators were followed by imitators, and imitators were followed by idiots. This resulted in overshooting and undershooting of the pendulum on both sides. There are extremes at both ends. Bubbles are only perceptible after they have burst, because they are built on excessive liquidity and low interest rates. So, there are two things one can do as an investor. If you see, many of the market parameters are mean reverting. The profit margins of companies as a percentage of GDP, GDP as a percentage of market cap – all those are mean reverting. Valuations are also mean reverting because over a long period of time one can grow at wide rates, so valuation should become the anchor and our primary determinant of assessing which part of the cycle we are in. If you can’t it figure out, you will land up taking wrong decisions. One must also clearly remember that periods of above average performance invariably led to periods of below average performance. Having said that, the best way for investors to deal with this, is by creating cash at the time of booms, and having the cash and courage to invest when the bubble bursts. Easier said than done, but that’s the only way possible where one can really fight through the vagaries of these emotional roller coaster rides.
One must also clearly remember that periods of above average performance invariably led to periods of below average performance. Having said that, the best way for investors to deal with this, is by creating cash at the time of booms, and having the cash and courage to invest when the bubble bursts.
Secondly, one should be mindful that the markets are good at factoring in the current narratives. The collective wisdom of the market is quite superior, but at the same time quite flawed, and it corrects. One has to be ready to either have the sense of regret of missing out on an opportunity, or seeking safety. Once that mindset is very clear, it is very easy to follow up on subsequently, and position oneself for the roller coaster ride.
Vishal: You have been an ardent student of financial history. I hope sometime in the future probably we can have one special session only on your lessons from financial history. But being a student of financial history also makes you a rare breed because I have not come across many investors who lay a lot of importance to history in financial markets, right? I would like to know your thoughts on this and maybe with one or two examples of how learning from history has helped you make better investment decisions in the past.
Kuntal: There is this incredible story of Isaac Newton – he was one of the most intelligent persons to have ever lived. He gave us the three laws of motion which dictate pretty much the entire physical world. So, the story goes that he identified the South Sea Company as a company of high promising potential very early and exited making lot of money. He got very rich. What happened subsequently was that many people around him got far richer than him, and he couldn’t tolerate it. So, he took leverage and entered the market at the top, and then exited broke. This led him to conclude that he could calculate the motion of stars and planets with accuracy but couldn’t predict the stupidity of human beings. If Isaac Newton couldn’t do it, then we should be very careful of our propensity to handle this. This requires you to have a playbook.
Isaac Newton could calculate the motion of stars and planets with accuracy but couldn’t predict the stupidity of human beings.
Booms and busts are like a cleansing mechanism of the capital markets, and they result from consequences of consequences.
I will give you 2 examples that really helped me navigate the market. It has been nearly impossible for me to completely take a cash call, but I gravitate towards larger caps when valuations become frothy. I have also been able to take subsequent cash calls. How does this happen? I don’t wait for the stock prices to reach to their potential peaks, which I have in my mind. I have this concept called having one foot in the door at the time of selling. What investors don’t realize is that while buying is important, selling is an equally important decision. As soon as you have a period of frothiness, large returns are made in a short period of time. Some amount of profit taking occurs every day so that their cash percentage keeps going up. These kinds of tactical calls actually help me to have cash during subsequent downturns.
What investors don’t realize is that while buying is important, selling is an equally important decision.
Another thing which has helped me is the portfolio construct. I am a concentrated investor, which means that I have a core portfolio of 5-6 companies, and a long tail of small positions which are almost like optionalities. During a boom these optionalities grow more in proportion to the entire portfolio, and that is the time to trim some of them. So, these are the two important constructs I have developed. The reason why this happens is because investors of different time horizons, different capital structures and attitudes are all interacting on the same asset price, and obviously all of them can’t be right at the same time. This leads to overshooting and undershooting, which one has to guard against. This is why the history of capital markets cannot be understated.
As a concentrated investor, I have a core portfolio of 5-6 companies, and a long tail of small positions which are almost like optionalities.
I also have an advantage that I have never studied from any Business School or done chartered accountancy. I come from an engineering background, and I think learning about the businesses of the past and the great investors of the past really, were the two pillars of my learning in the stock market, I didn’t have to unlearn a lot.
Vishal: I think probably that’s great inspiration for a lot of people who don’t come from financial backgrounds, like chartered accounts or MBA, but are self-learners, self-made, who can still do that right. Perhaps your story is as inspiring as can be. Preparing for this interview, I’ve been through a lot of your other interviews and lot of your other lectures that you’ve shared in the past, and I have pulled out some questions. I understand that as much as I can get out of you in this one session, I think that will be very less anyway. So probably we do another session in the future. But one of the things I read in an interview you gave some time back is that small changes in human psychology tend to produce exaggerated and amplified changes in asset prices And, we’ve seen a lot of that in the past. Can you explain what you mean by this?
Small changes in human psychology tend to produce exaggerated and amplified changes in asset prices.
Kuntal: Vishal, let me give you some anecdotal data. If you see, analyst GDP forecasts tend to be in the region of 1-2% here and there. Cash flow and earnings prospects of the broader market are maybe 5-6% off here and there, but if you really analyze the volatility around small changes in GDP forecasts and small changes in cash flows, the prospective of the businesses result in extremely large movements in stock prices. Let me give you a more nuanced reason. If I were to assume that the fair price of a company is the future value discounted at the appropriate interest rate, if I were to assume that the company was not to make any earnings or cash flows in one year, the maximum differentiation in theoretical value will be around 5 to 6%, because the terminal value is what matters. But in reality, if you see any of the blue-chip companies in any given year, the fluctuation between their high-low is in excess of 35% to 40%. What this implies, is that there are factors beyond fundamentals which are at work, and I’m reminded of James Grant’s quote on this, which I may not be able to quote perfectly, but it says – to suppose that stock prices are reflective of discounted future cash flows at appropriate interest rates and tax rates, we tend to forget that in the past we have supported Stalin, we have gone to war at whims, and when George Orwell said the Martians have landed, we believed him as well. This reflects that there are factors beyond fundamentals at work here.
“To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.” – James Grant
Human psychology tends to neglect the base rate it needs, it tends to neglect supply side considerations which can change overnight. Demand can’t change overnight, but the supply side can change and then the narratives can change. This can result in sudden disappearance of confidence and the mean reversion process starts. Asset prices being forward looking are subjective to assumptions. These assumptions can change overnight in the face of adversities, and also please remember that investors have a very large number of choices. There are a large number of permutations and combinations of portfolio construction.
Demand can’t change overnight, but the supply side can change and then the narratives can change, leading to disappearance of confidence and mean reversion.
When you overlay all this on the top, it becomes an extremely complex exercise, prone to disruptions and changes at the first instant. That’s why I said that small changes in psychology tend to produce very dramatic swings in the underlying asset price because ultimately the price of the asset is set by human beings, and it’s very well known that human beings are known to become mad in herds, but come to senses 1 by 1. We tend to be social animals seeking comfort in collective wisdom, and it is very difficult to be contrarian when the whole crowd is moving against you. That’s why the study of psychology is important.
Small changes in psychology tend to produce very dramatic swings in the underlying asset price. Human beings are known to become mad in herds, but come to senses 1 by 1.
Vishal: I completely agree with you about base rates, about the fact that we go mad in herds and get back to our sensibilities individually. Another issue which I think I’ve seen investors get into, which I have also been a culprit of, in terms of myself making that mistake is, that we tend to work around certainties, we tend to work around predictions and not probabilities, despite there being enough evidence that investing is a game of probabilities and that success depends on bringing the odds in your favor. Now there is a thin line between anticipating future events and assigning probabilities and possibilities versus predicting them. How do you try and stay ahead of the curve on this front?
Kuntal: That’s a very interesting question. As an engineer, I know that anticipation of events is all about examining a wide range of outcomes. Now, many things can happen but will not happen. So having a wide range of outcomes in your decision making and choice architecture is the first requirement. Second, it boils down to assigning probabilities, which means you weigh them, and you determine the odds of them happening. The prediction around it is forming a definitive view about what is likely to happen. Here the trick is very simple. I have four filters to examine – first is the range of outcomes, probability associated, what is the impact of each of those outcomes, and what is the frequency of those happening?
Define a range of outcomes, assign probabilities, anticipate the impact of the outcome, and lastly the frequency.
Probabilities and odds times the likelihood of that happening is the expected value of that asset price or the incident happening. So, what happens is, the current asset prices are a collective reflection of the stock market participants of varying profiles. This is very interesting. It’s very probabilistic and very noisy. So, value investing essentially boils down to examining the broad range of outcomes and assessing the probabilities associated with them. Here I was helped by this brilliant book by Stephen Penman, which I urge all of you to read. It’s called “Accounting for Value”. He clearly teaches us that as investors, we are always negotiating with Mr. Market, but the onus is not on us to come up with a fair valuation. The valuation is already told to us by the current prices, and it is our job to understand what the embedded expectations are in that valuation, and whether to accept or reject the bid offer price quoted by Mr. Market. Michael Mauboussin has also written a fabulous book on this called “Expectations Investing”, which says that the right framework is not to have a view on the range of valuations of the asset price, but to reverse the current expectations embedded in the current valuation and take a call whether it meets your needs or not. I think that this turns the whole investing culture on its head, but at the same time this is not a one-time exercise. You keep updating your views as more and more confirming or disconfirming evidence comes by. One thing as an investor is that beliefs are supposed to be loosely held and all the hypotheses, and all the confirmations which you have are meant to be stress-tested. They are not treasures to be cherished and protected, so one needs flexibility and an agile view. Getting these two things right, I think will help you land ahead of the curve.
The valuation is already told to us by the current prices, and it is our job to understand what the embedded expectations are in that valuation, and whether to accept or reject the bid offer price quoted by Mr. Market.
Vishal: That’s a great insight that comes by and the more I listen to you, the more I realize how stupid I have been all these years and how it is great sitting here and talking to you.
Kuntal: Vishal, if you were to read my book, Hall of Mistakes, you would refuse to take my interview.
Vishal: No, no, we all go through this journey, right? Some more, some less, but we all go through it. The important thing is to realize the mistakes that we make and made, and to create that hall of shame.
Kuntal: Mistakes are given in our business. Nobody can take all the right decisions. As George Soros said, “It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong”. But everybody gets a lot of things wrong and we are aware of acts of commission and omission, and we can’t drown ourselves to death because of the past. It is inevitable. That’s a part of the investing journey.
Vishal: I also take solace from the quote that that there are no mistakes, there are only lessons. Later I was reading another interview you gave in 2019 where you said, and I quote “early in my career luck played a lesser role and skill played a bigger role, but now one has to be luckier. The current investment process is all about the elimination of what not to do”. I think I know what you’re trying to say here, but I would like you to expound on the same. Also, what are those things an investor must eliminate or avoid doing to generate a good investment track record over the years?
Kuntal: Vishal the answer lies in what you said in the past, that as investors we have three kinds of edges. One is information, where you know you tend to process large amounts of information. Currently, because of the technology boom, information which was earlier in short supply has now become torrential. In fact, now we have to think about how to filter out information and it’s no longer an edge. Filtering the information is definitely an edge.
The second one is analytical. Again, thanks to technology, the general skillsets level of the investing population has improved. More and more smart people have entered the market and as the base rate of the investing population becomes more and more intelligent, both information and analytical edges erode away.
Then what is left is a behavioral edge. Technology has resulted in democratizing information, and if you were to stick by only an informational and analytical edge, the law of diminishing returns kicks in. Then what is it left, behavioral?
So, there are two things at work here and I would like to reference Peter Kaufman. He was asked this question, what explains success? He said that skills contribute to 7% or so of success, courage is some ~28% and the rest is luck. Why luck? Because when a large investing population is as skilled as you are, when skill is no longer a function of your outperformance, it boils down to luck. Why behavior leads to luck is counter intuitive. The harder I work, the luckier I get. It’s a reverse feedback loop that if I make efforts, I tend to get exposed to the right idea and that leads to the right outcome. Luck and risk are two sides of the same coin, but we treat them very differently. I’ve heard a lot of institutional investors say risk adjusted return, but I have not heard anybody say return adjusted for luck so far. Therein lies the thing that the financial market is a great teacher, but it sends expensive bills, and I have paid many bills.
Skills contribute to 7% or so of success, courage is some ~28% and the rest is luck.
I’ve heard a lot of institutional investors say risk adjusted return, but I have not heard anybody say return adjusted for luck.
Vishal: I think the concept of luck adjusted returns is a wonderful insight and I’m sure luck is one of the most important factors in an investor’s survival in the long-term.
Kuntal: I remember a story of Napoleon. While deciding which general would fight the battles, he would examine them, see their skillsets, and question them. Eventually he would ask who among them was lucky. What he meant was who’s the luckier one given the hard work put in and the probability of winning. Luck favors the courageous and the prepared.
Vishal: That’s right, so whether they are generals or investors I think luck is what really helps us survive over a long period of time. Of course, there’s some element of skill, but I’m sure luck plays a good enough role even over the long-term. Talking about survival, one of the best investor interviews I have come across is the one where Jason Zweig interviews Peter Bernstein, in which Peter Bernstein said that the only road to riches is through survival. Buffett also says that if you want to finish first, you must first finish. All this is known and proven for decades now, so why do you think most investors chase multi-baggers when the key to sound investing lies in avoiding blowouts?
Kuntal: So, Vishal this is one of those counter intuitive things which works in market. Most investors want superior returns. What it does is, it makes them oriented towards returns only and not to the peril. They pay very little attention to the risk involved in attaining them. Many investors have not read about Charles Jacobi, who said invert, always invert. I think Charlie Munger has also propounded that some of the most complex problems in life cannot be solved forward but you need a forward and backward twin track analysis, where you have to invert the whole situation. Peter Bevelin has also written this wonderful book “All I Want To Know Is Where I’m Going To Die So I’ll Never Go There”. It’s a great day book and I urge all the investors to read it.
For complex problems you need a forward and backward twin track analysis, where you have to invert the whole situation.
Also, one of the success factors is that you can’t be focused on what to do all the time. Equal attention has to be paid to what not to do. The failure to do this analysis is the reason why investors are constantly looking at the upside but are oblivious to downside risk. The way to prevent this is by conducting a pre-mortem. You assume your investment hypothesis will not work. Then you work backwards, looking for reasons as to why the investment hypothesis won’t work. This will make you a more alert investor and will change your hypothesis. More importantly, you will be alerted to the rapid signs of what could be faulty a hypothesis. Basically, what I’m trying to say is that the aggression of getting returns has to be balanced by the conservatism of protecting capital. This requires you to handle contradictory topics. Investors by large have a risk seeking attitude in good times and their attitudes reverse during bad times where they actually become risk averse, where in reality they should be doing the exact opposite.
What to do versus what not to do.
Pre-mortem versus Post-mortem.
Risk seeking versus risk aversion.
Also, I think the success stories of large hedge funds and venture capital investors create a kind of FOMO. People start focusing on tail events and power laws and all this makes them sharply focus on multi-baggers, where actually the key to success is to ensure that you don’t have large blowouts, because capital preservation and its long-term compounding is the surest way to attain financial security.
Vishal: What about the underlying risk of investing in a business? We’ve talked about the behavior of investors, we’ve talked about how we make mistakes or the problems that we get into while not behaving well as investors. And not understanding what the real risk of investing is, but what about the risk to businesses that you’re looking at, which include, say moats which deteriorate or valuations which go haywire. How do you think about risk apart from the general definition of having permanent loss of capital and how do you employ that mindset of keeping risk low in your investing?
Kuntal: Risk is a multifaceted hydra. Businesses face many risks – risk of funding, disruption, competition, regulations. Besides these risks that businesses face, there is the risk of the management taking wrong capital allocation calls, the management doing something stupid and all kinds of frauds. Then there is valuation risk – the risk of overpaying for good companies. So, investing is not about maximizing return, it is about eliminating each of these risks.
Also, risk is never a number, it’s a safety valve for the ecosystem where you actually need to have a checklist against risk. Investors have a limited understanding of most of the aspects and many times will end up accepting risk without getting compensated to do so.
Risk is a multifaceted hydra and never a number. Investing is not about maximizing return, it is about eliminating risks.
The second worry from an investor’s perspective is over quantification. We have a large number of theories employing calculus, but the biggest problem I face is that risk is about losing capital. Let me rephrase this statement. If there are four stages of risk, first is some of the risk can be eliminated. Let me give you an example. One kind of risk which can be eliminated is concentration. You can have a sufficiently diversified portfolio, but not overly diversified, so as to have superior returns. Another risk which can be diversified away is size and liquidity. All these things can be done up front, but many of the risks cannot be eliminated. You have to be careful while at the driving seat, to be alert towards them and mitigate them as they arise. I’m talking about risks like capital misallocation, overvaluation, adverse regulation etc. So, it’s a twin track analysis that certain risks can be addressed upfront by your processes and portfolio construct, but certain risks can be only mitigated as they evolve.
Also, I think most of the new financial innovation embeds some kind of leverage or risk, but both are many times perceived advantages by investors. I think this needs to be avoided.
The standard competitive edges disappearing, Porters 5 force framework turning adverse for you, value migrations are all well known. But what is not known is that you need to be compensated for taking risk. Even the best companies when bought at sky high prices tend to be risky assets. Likewise, the worst of companies bought at throw away prices can end up giving you multibaggers returns. Thus, valuation is also one filter against risk. Cash allocation is also a filter against risk, and these are in the hands of investors.
Valuation and cash allocation cash can be effective filters against risk
Vishal: What about value drivers? So, in the long-term, businesses that create value and wealth for shareholders have certain drivers that create that value. In your insight, in your experience as a business analyst over the past three decades, what are those value drivers you look for in a business? If you can give some tangible cases of using them in your analysis and approach?
Kuntal: That’s a very interesting question. So by and large investing communities focus on companies which generate healthy free cash flows on a consistent basis. The compounding equation is longevity of growth and high returns. Obviously, companies which deliver this tend to enjoy investor benefits and are highly valued in the capital market. Another way is growing earnings with no cash flows, but they are redeployed in the future to generate growth at high returns without too much dilution. This is also a growth investing strategy which is quite popular among investors.
There are two other important sources of value drivers which are many times ignored by the capital market. One of them is companies which are repositioning assets to a greater use. And let me give you an example, that if your company was generating inadequate returns in the past but has now chosen to repurpose the assets to a greater use through corporate restructuring or M&A or, you know, return of capital I think that can be also source of generating good returns.
Lastly, and what is not obviously talked about many times, and I haven’t come across literature which deals with it is that companies which enjoy access to the capital market at favorable terms tend to create significant value for their investors. If you raise money at a high valuation, your return on capital employed drops and you can’t fight the cash flows and so on and so forth. But let me give you an example, say you are a retailer, and you raise money at extremely high valuations you can do two things. You can buy the properties and own the properties and save on rent, which expands your margin and you stay in power, or you can set up franchises by giving them loans to set up the franchises and collect both, higher sales or royalty or interest income through loans. Both improve your cash flows. Also, many times companies have access to the capital market, resulting in lower dilution for the remaining shareholders and turning that capital raise into a superior competitive advantage, because they use that as a currency to acquire businesses or to further their goals.
Lesser-known value drivers – Repurposing assets, restructuring of businesses and raising capital at favorable terms.
So, these two sources of value drivers are by and large ignored by investors, and even I used to fall prey to them at times when my stocks used to get overvalued. I used to sell them without realizing the fact that as companies scale, they change their orbits. Liquidity improves and they attract investors with lower return expectations than me, which leads them to a much higher valuation, for a longer period of time than I was ready to pay for.
As companies scale, they change their orbits, liquidity improves, and they attract investors with lower return expectations.
Another thing is that people ignore economic, social and political, and financial systems in which businesses operate. They have a huge bearing on their successes and failures. Keeping this in mind, that I tend to under-weight companies in their early stages of life where the failure rate is the highest.
Also, I’m on the watch out for companies with the inability to cannibalize existing products, because this is the Achille’s heel of many successful businesses, which are generating healthy cash flows. They are so enamored by cash flow that they don’t take small experiments and fail to innovate. Dependence on patronage, political connections or illegal gratification is also a source of value at times, but I don’t think it is sustainable in the long run, so I tend to avoid it.
Also, one should be aware of the ABCD of culture – arrogance, bureaucracy, culture, decay, etc., because as a firm expands and attracts more talent, the culture of the firm is something that can change dramatically and obviously there is the risk of the management getting defocused or burnt out. So, these are the value drivers, and you can use them to create value.
One should be aware of the ABCD of culture – arrogance, bureaucracy, culture, decay, etc.
Vishal: We talked about mistakes sometime back and as investors and decision makers we all make a lot of them. Some more, some less as I mentioned, I’m sure you have made your bag full of investing mistakes and you actually wrote a paper called the “Hall of Shame” or something like that, right? So, when you look back at your bag of mistakes which has been the most memorable one that led you to learning a valuable lesson that helped you later in life?
Kuntal: When I completed 2 decades in investing, I actually wrote a paper called “Mea Culpa”, which means my biggest mistakes. I chronicled all the biggest mistakes I’ve made in two years. The footnote of the article said that when I come back after 30 years, the list is going to be longer, but hopefully they will be new mistakes, and not a repetition of the old ones.
As I said, mistakes in our business are given. So, the common mistakes in the earlier part of my investing career were, firstly, premature selling. I would sell for the wrong reasons, promoters selling some shares, or valuation going haywire. The corrective action which I have realized over a period of time, is that every investment of mine has a buy zone, a hold zone and sell zone. The hold zone is one of the longest because, please remember when you find a good investment, whose hypothesis you understand, whose value drivers you understand, whose managements you like and are delivering, those kinds of companies are very rare. Only 4 or 5% of the entire investable universe creates value, and of that a small fraction creates superlative value creation. If you were to just end up selling them because of temporary overvaluation, you would give up the longevity of compounding which follows. I made this mistake multiple times over. I bought excellent businesses at very defensible prices but got out too early and then they went up 50-60x later and I could never enter them again.
Every investment has a buy zone, a hold zone and sell zone, with the hold zone being the longest. Only 4 or 5% of the entire investable universe creates value, and of that a small fraction creates superlative value creation.
Which leads me to the second mistake, I used to buy the share and get anchored around the price. What would happen is, that I could never buy it again as the management continued to deliver. What have I changed now? I’ve developed a philosophy called “foot in the door”, both at the time of buying and selling. I have no qualms in averaging up as the hypothesis plays out, as the management delivers and as the market starts recognizing that something incredible is happening in the company. The same happens at the time of selling, you sell some but not all, so that you are not anchored to the price.
Foot in the door strategy – do not buy or sell all at once.
The third aspect is on portfolio construction. In my early journey I used to put almost 90% of my capital in the top five six ideas and the remaining part used to be cash. The result was, that I would do very deep studies on those companies, but I would lose the breath.
What has started happening now is that I tend to be concentrated, but with a long tail where 20 to 30% of my portfolio has optionality, where I don’t tend to lose too much money, but many of those optionality trades at some point of time could deliver and become the core part of the portfolio. I realized that the biggest problem comes from my psychology. I am more focused on not getting an analytical and informational edge, but focused on the behavioral edge.
I can give you some of the mistakes – the acts of commission which are visible on my balance sheet, but acts of omission are not. If I were to aggregate, if I had bought and retained those shares, my orbit would have been different. So, that really hurts and I have compounded those stupidities many times over in the last three decades of my journey. However, I think I have learnt from them.
Focus on gaining a behavioral edge, rather than an analytical and informational one.
Vishal: That soothes my nerves because I have enough number of such omissions. I think hearing you out, hearing such a wise investor in front of me, talking about mistakes and the fact that the orbit could have been something different, is relieving. So, thanks for sharing all that.
My next question is about the idea of non-linearity, which is a very hard concept to grasp. In investing, we talk about the idea of developing an exponential growth mindset but we saw in the COVID pandemic, and again proved the widespread inability of even the best decision makers, including policymakers at the highest levels, to grasp this basic idea of exponential growth. As an ardent student of human behavior, how does that surprise you? What have you learned about how one goes about developing such a mindset that is so important while investing and also while just living in a world that seems to be changing exponentially?
Kuntal: A great question. All of us are aware of compounding equations. All of us are aware of the significance of tail events and how getting those few decisions right can change our orbit. What is not clearly visible is that our horizon tends to be extremely short. Many politicians, regulators, businessmen and investors have extremely short-term horizons. By definition, if you have a short-term horizon, you will end up disturbing the compounding equation. Secondly, many of the incentives are misplaced, so if you allocate your money to a professional fund manager who is constantly valued on a short-term time horizon, you are actually indicating to him to act short-term. This action of your portfolio manager again breaks down compounding. The last question is moral hazard, where you know people in decision making, even regulators, would not like to be held accountable for something going wrong. And it’s easy to pass the buck. When you combine all these factors, it’s no wonder that though we understand what is exponential and how it helps us, in reality, it’s extremely difficult to implement, and as a student of human behavior, anything which is short-term oriented, one needs to filter out by visualizing whether it matters. It could even be in the compounding of your relationships. There the question to ask is, will this person matter to you after 10 years, will they be around to challenge you and make you a better person. The same thing goes for almost anything which is long-term. The mismatch of time horizons, incentives and moral hazards creates all kinds of funny outcomes and one has to guard against these consequences of consequences.
The mismatch of time horizons, incentives and moral hazards creates all kinds of funny outcomes and one has to guard against these consequences of consequences.
Vishal: Thinking long-term, I think that the idea of zooming out is such an important insight. I learnt it late, but I think I couldn’t agree more with you regarding the idea of looking at compounding from a long-term perspective. Actually, living through it and not just talking about it. I think that’s a great insight. Talking about behavioral finance, we talked about some ideas that you have to share about how people behave and how we behave as investors. You have been a practitioner as well a teacher of behavioral finance. How can you specifically as our teacher try to chip away at the biggest problem in investing, which is the problem of how people behave as investors? Here I would love to hear tangible examples of things that you have done, or the systems that you have set up for yourself, to stop making or to minimize those stupid common mistakes that we make as investors?
Kuntal: Very interesting question, part of which we have dealt with earlier, but let me start. For compounding to work, your holding period has to be long. But two things are happening today. The rate of change has picked up dramatically because of easily available capital, technological changes, new business models, and if you don’t factor this rate of change in your underlying businesses then there could be a holding period mismatch. Let me tell you if you are a VC investor investing in a non-profitable startup, which is spending huge amounts of money in customer acquisition costs, you better have a long-term horizon. That’s the only way it works. But if you are, suppose, a secondary market investor and you are holding a company where the rate of change is excluded dramatically, you have to be aware of discontinuation of your initial hypothesis. It’s a duality of these forces at work, when you consider the problem of investing, how do you deal with it? I told you that first you need to keep decision journals.
By definition, if you have a short-term horizon, you will end up disturbing the compounding equation, which works only over a long time horizon.
Humans do not have rational minds, but rationalizing ones, and though the finance theory assumes that we are a logical engine, in reality we are an analogy driven by narratives of aesthetics, and we are a self-corrective action engine. So, how we correct ourselves, is by documenting our processes and revisiting them during times of dislocation.
Another good exercise to improve your results is by playing devil’s advocate or the 10th man in your system, thereby forcing you to challenge conventional wisdom in a very calm, comfortable environment, so that you legitimize your doubt upfront. It is a safe place to gather disconfirming evidence rather than continuously gathering confirming evidence.
Seek disconfirming evidence playing devil’s advocate when it comes to your views or hypotheses.
Also, one has to learn to bundle the contradictions. So, investing requires you to believe in your views and your hypotheses, believe that you are right, but at the same time it requires you to have humility, that the collective market could be right, and you could be wrong. While your portfolio needs to be diversified enough to prevent blowouts, it also needs to be concentrated enough to move the needle and not have your portfolio resemble a warehouse. It should be like a curated museum. You have to balance momentum with regression to mean. So, what it basically entails is that sometimes you have to take the helicopter view and see the Amazon for the forest it is, but there are times when you have to conduct bottom-up stock picking, likened to hugging the trees and seeing which one of them is infested by termites. This kind of dual thinking, twin track analysis is the only way you can chip away the biggest problems in investing.
Twin track analysis – balance diversification with concentration, momentum with regression to mean, and top-down with bottom-up approach.
Vishal: The biggest problem I see right? You talked about independent thinking. The biggest problem that I see all around is that we have too much dependence and we’ve started getting too dependent on technology. What the machine tells us, what artificial intelligence tells us. So here I want to bring what the noted American entrepreneur and software engineer Mark Andreessen has said, and I quote that “software is eating the world”. If you agree with him, how does one, as a decision maker and not just investing as a general decision maker, safeguard human judgment that risk getting replaced by artificial intelligence or machines?
Kuntal: Well, I have reflected over this issue myself because of my startup, which is in the AI space. And here’s my view – based on where I know technology stands today, I don’t think it is likely to replace human beings in decision making in the near future. Currently, as technology stands, it is highly prone to over and under fitting the data. In fact, it recognizes patterns when none exist. It doesn’t have context or intuition. Also, it can’t weigh probabilities or impact frequencies, or read psychological reactions via feedback loops. In short, the stock markets and the capital markets are driven by humans, regulated by humans. Underlying businesses and the assets that they represent are human centric. Since the decision making of humans is largely driven by biases, heuristics and bouts of fear, greed and stupidity, I believe technology is unlikely to understand humans, though humans can understand the technology.
What I think today is that technology will enhance our cognition by allowing us to process incrementally larger amounts of data, newer datasets and enabling more number crunching. Improved productivity and technology have amazing roles to play, be it a system of records where we can store and retrieve large amounts of data at the click of a button; a System of processing, where we can manipulate and slice the data and draw inferences; and lastly a system of collaboration, where we can share data in our ecosystem, with colleagues and clients very easily. However, it is unlikely to be a system of decision making on its own. Technology as it stands today, is even struggling to recognize fake data, propaganda and dubious and pirated content. Please understand that market participants are smart, and they adapt quickly to new realities. It will require tweaking, or entirely new algorithms which again only humans can design, for machines to get that level of smartness. So, in short, I think technology is going to be a wonderful companion to humans. It will enable them to process large amounts of data, keep getting better at informational and analytical edges, but will fall far short on the behavioral front and decision making.
Currently, as technology stands, it is highly prone to over and under fitting the data.
Vishal: I hope it does because I think there has been a general concern every now and then about how technology is becoming so big and powerful that one day it probably destroys humanity? Probably we are not in that state as of now. We are not talking about what they call singularity, where technology advances to become better and more intelligent; so, heartening to know your view over that, as an ardent onlooker in this space. We are going to talk about the kind of work you are doing on the AI front.
Before that, I want to change the trajectory a bit, the idea of the One Percent Show is not just about investing and principles of investing, the bigger purpose that I have with the show is to help youngsters, who are getting to their carriers, who are maybe investors or otherwise as well. When they are starting on their 1% compounding journey, it is to have the right insights. And of course, we all learn by experience. We all learn by faltering ourselves and not just by listening to others and learning from other people’s experiences. But I think, that is one of the most important questions that I ask people and I look forward to the insights when they share lessons for youngsters, young adults when they are starting out their journey. You love sharing this since you have done that for the past many years.
My next question to you is about the most important lessons from your experience, which a young person must practice to break into and succeed in finance. I will come to general work as well, but what about someone who wants to get into finance? What do you know about your chosen field of finance that you wish you knew when you were starting out three decades ago, probably because that advice could be helpful for someone who is just starting out now?
Kuntal: Vishal, as you are aware, I started with a clean slate. I was an engineer with no experience on the financial or the business side entering into the stock market, and I had to learn things the hard way. If I were to re-look at my business and what I would have wished I knew when I was 22. Incidentally, there’s a book by Tina Seelig titled “What I Wish I Knew When I Was 20”, and I urge all the young guys to read it. It is a brilliant book worth reading. And I am copying it to an extent.
What I wish I would have known before was that- being an engineer, one was very scientific, one was very precise, one was very numerate, and one had a very precision-seeking mindset. But the way the world works, the way the businesses are run, and the way people work can only be learnt by developing mental models which can only be built upon multidisciplinary learnings drawn from diverse set of fields and literature. This was one thing that was not explained to us at that point of time, and we had to learn it the hard way, and we have paid a high price for those learnings.
The way the world works, the way the businesses are run, and the way people work can only be learnt by developing mental models which can only be built upon multidisciplinary learnings drawn from diverse set of fields and literature.
Secondly, the business of finances, the business of cycles, and how human psychology interacts with money and for that, we need to learn the role of cycles and the role of financial history. In fact, it was very late in the day, when I learnt about cycles through wonderful work of people like Edward Chancellor, who has written the books, “Capital Returns” and “Capital Account” at Marathon Asset Management, where he talks about long term cycles. Also, books on financial history like “Devil Take the Hindmost” by Edward Chancellor and “Manias, Panics, and Crashes” by Charles P. Kindleberger and so on.
I think these two things, if I had learnt at the onset, it would have really shortened my learning curves and lessened my learning bill. What I want to leave away with your audience is- that to assume that a value of a common stock of a corporation is determined purely by discounting cash flows by appropriate interest rate and marginal tax rate is to forget that, we as human beings have burned witches, have gone to war and have even believed that Martians have landed, to speak about James Grant. This highlights that investor needs to be multidisciplinary and have contradictory skill sets and opinion. A healthy dose of skepticism is required, and also avoidance of blind contrarianism. Hence, the biggest mistake I think, young students should understand is that you should not believe that what has happened in the recent past is likely to persist going ahead. If there was one lesson, this would be it and that markets will surprise you, all odds on that account.
Vishal: I think that is a great lesson. Like all the fundamental forces that we are surrounded with right, as far as physics is concerned, even within investing, I think my experience and looking at the experience of others tells me that there are fundamental forces acting upon us. Things like luck, uncertainty and surprises, the more we ignore them, the more mistakes we will make or bigger traps we are going to fall into. I think your insight of believing that there is uncertainty, not starting with certainties, is a great Idea.
Kuntal: There is a nice saying which says that “seeds of chaos are planted during the times of calm.”
Vishal: Yeah, that’s true. We have been through a period of chaos, the covid pandemic. We have all suffered in some way or the other, be it physically, mentally, emotionally, or financially. But there have been people who survived, and I am sure there have been a lot of lessons that we take out from what we have been through in the last two 2 – 2 ½ years. What has been your biggest lesson from the covid pandemic, both in terms of life and how you look at the world out there? What has changed for you in the post covid world from the pre covid world? Though we are not really in a post covid world, we are still going through the pandemic. But how has the pandemic changed your outlook on life and living?
Kuntal: The biggest lesson of the covid pandemic for me is- it has debunked all those optimization theories where capital had to be optimized, business had to be optimized to just in time, hire and fire policies, and so on. I think the era of optimization had its drawback, and covid has highlighted it. In fact, covid has reinforced that survival is the most desirable characteristic for businesses rather than optimization. This has a profound impact on how investors and businesses will factor this into how they conduct themselves. The second biggest trend I have seen is, covid has accelerated the trend towards digitization because in no other past pandemic was the world still connected like we had in this covid pandemic, and also the sciences responded very well by coming out with large numbers of vaccine alternatives in a short period of time.
Optimization has drawbacks, and rare and extreme events highlight them and reinforce that survival is the most desirable characteristic for businesses.
Technology has accelerated, and what could have taken years to accomplish was accomplished in months. People reoriented their workflows, habits and adapted. This resulted in one thing at the economics and business level- strong businesses which were run with clean balance sheets and clean management emerged stronger in an environment that was weakened competitively because fragile businesses got taken out. The offshoot of this is the word ‘resilience’ has entered the lexicon of corporates, and I have heard a business leader say, which has stuck to me, is that you can play offense only if your defence permits. This is a brilliant statement.
Strong businesses which were run with clean balance sheets and clean management emerged stronger in an environment that was weakened competitively because fragile businesses got taken out. Play offense only if your defence permits it.
For this to happen. One has to realize that both corporates and regulators have to talk win-win instead of practicing win-lose kind of a situation. What is visible right now to me is that there were policy errors. We have had too loose a monetary policy and too loose interest rates, and usually, the tightening of interest rates by the FED had always resulted in a financial event, which I think is unfolding even this time. On a personal front, antifragility and reprioritization of relationships came to the focus. What one wants to achieve and do with his life, and where one wants to spend the time, and the priorities got rewritten. Health, friends, family, relationships took priority over business success and so on. Also, the role of building a margin of safety and buffers in your day-to-day affairs, so the journey becomes more enjoyable, and you finish the trip was highlighted by the covid pandemic.
Vishal: I completely agree with you on this. My next question is about Peter Thiel’s wonderful book “Zero to One”, and there is this favourite interview question that he often asks. And the question is, what important truth do very few people agree with you on? My question to you is the same, what important investing truth do very few people or very few investors agree with you?
Kuntal: Well Vishal, it is a loaded question and controversial too because it requires you to have a view, and your view needs to be different from the large swath of the population. And also, you need the courage to speak up. One thing I did was reflect upon this question because I have heard this question being asked in many recruitment interviews. I believe, truth is relative. And to prove this, I have done a thought experiment. In fact, Peter Thiel explained that one of the answers he had was, the world at large is defined by globalization, which is what the world thinks, but the truth is, technology matters the most. What I did was, I reframed this question differently and asked many of the young students, whom I teach, what is more important for the progress of humanity? – In the first set of students, I asked them with a choice of globalization or technology, and most of them responded technology nobody voted for globalization. And then I gave them no option. They came up with answers like geopolitics, climate change, disruption caused by regulators, technology, and so forth. Globalization never even turned up. So, Peter Thiel was probably looking for his version of the truth, not the absolute truth. And there is nothing known as absolute truth, it is a relative concept. There is a frame of reference, and Galilean relativity matters in answering such deep questions.
Coming back to the investing truth, I think there are many. If you look at what is taught right at the inception when a person is studying finance and investing, he learns all these fancy theories like efficient market hypothesis, CAPM, Gaussian Copula, value at risk, or modern portfolio theory. All of these assume that markets are rational and that human beings operating in markets are rational. But the truth is that people are anything but rational, they are highly irrational, I could go on and on. Many of the market participants feel that you have to take a lot of risk to earn high rewards, but nothing could be further from the truth. In fact, if returns were good, those underlying assets would not be risky in the first place, it is counterintuitive.
Many of the market participants feel that you have to take a lot of risk to earn high rewards. If returns were good, those underlying assets would not be risky in the first place.
Thirdly, in investing world there is a lot of nuttiness and there are many ways to skin the cat. And what is true for one can be poison for another. At the cost of repetition, I would say this thing that every one of us has a different question paper, so the answer has to be different, same applies to truth, my truth is related to me, it is not related to you, and one has to live and die by one’s inner voice and once inner truth.
Vishal: Kuntal bhai, you have been a teacher for long, and you are also on the board of FLAME University, you have seen formal education very closely. In a world where the pace of change is multiplying, a formal education system seems insufficient, largely, to teach all that is required to thrive, what is your advice to students and young adults in self-educating themselves. You have been a self-learner all your life, what is your advice? What are those key work and life skills they must learn and hone to do well in this century?
Kuntal: Young adults and students who are inclined towards finance and well-being, in general, should learn about good productivity hacks from people who have cracked it, which makes them productive.
Some of the books I would suggest here are –
• “Mindset” by Carol Dweck,
• “Ego is the Enemy” by Ryan Holiday,
• “Grit” by Angela Duckworth,
• “The Talent Code” by Daniel Coyle,
• “Atomic Habits” by James Clear, and
• “The Compound Effect” by Darren Hardy
Some, old classics like the
• “The Power of Positive Thinking” by Norman Vincent Peale,
• “How to Win Friends and Influence People” by Dale Carnegie,
• “Deep Work” by Cal Newport,
• “Getting Things Done” by David Allen,
• “Tools of Titans” and
• “Tribe of Mentors” by Tim Ferriss
All these are good self-help and self-improvement books. They should also study books on the right ethics and culture.
Military leadership and sports teach you that, there are books like
• “It’s Your Ship” by Michael Abrashoff,
• “The Carolina Way” by Dean Smith, Gerald Bell, ,John Kilgo, Roy Williams
The works of Peter Bevelin and Charlie Munger on culture and right ethics are also good.
I would also urge them to read business biographies, and draw inferences from the books of what caused those famous people to have extreme success and failures in their life. Also, I would be mindful of highlighting that, though success is very seductive, the critical learnings are from failures, because human mind is far more adaptable at learning what not to do than what to do. But in reality, we keep chasing what to do instead of what not to do, which we have discussed earlier. Also, from the financial markets’ viewpoint, the three critical components to learn are- how businesses compete and strategize, how financial markets work and their history, how prices move which is psychological and how risk evolves.
There are many books on these written by various people which can be read upon. On risk and financial history, I would suggest a book –
• “Devil Take the Hindmost” by Edward Chancellor,
• “Extraordinary Popular Delusions and the Madness of Crowds” by Charles MacKay
Incidentally, there is a story about it, Charles MacKay was a famous historian who chronicled the entire railway mania. But Vishal, he lost a bundle in speculating on the railway stocks, so it is easier said than done, it is easier to write great books but very difficult to follow their advice.
Some other book recommendations are –
• “Stabilizing an Unstable Economy” by Hyman Minsky,
• “The (Mis)Behaviour of Markets” by Benoit Mandelbrot and Richard Hudson,
• “A Short History of Financial Euphoria” by John Kenneth Galbraith
Also, the books of Charles Kindleberger, where he talks about the framework of how bubbles evolve and how they burst. The writings of Peter Kaufman and Peter Bevelin are recommended readings.
Also, to succeed in business, I think they should inculcate the habit of reading the annual reports, accounting footnotes and try to take advantage of the market by creating the right framework of investing, which is very well taught by reading books like
• “The Investment Checklist” by Michael Shearn,
• “The Checklist Manifesto” by Atul Gawande and so on
There is a long list of books, but these are the top most ones which came to my mind.
There is a lot to be learnt from exemplary people and businesses.
Vishal: Sure, the way you have outlined the list, it tells me how voracious a reader you are. I see a lot of people reading a lot. But given your reading experience, I want to ask you a question about reading. Given all the responsibilities you have in running a business, taking care of investments, family, friends, and everything, you still take out time to read. Is there a way to read effectively that you have practiced, that really brings you the most bang for the buck? I am not saying like skimming through chapters and books, just for the sake of it, but I am sure there is a way that you have practiced that helps you become a more effective reader and learner, and remember those things that you have learnt from all these books that you talked about.
Kuntal: There is a book “How to Read a Book” by Mortimer Adler, it is a classic guide to intelligent reading, I would urge all of you to read it and I have benefited from it too. A few hacks that helped me to make the most out of my reading are- making notes. There are three-four ways to make notes- Zettelkasten, Cornell notes, Guided notes, whatever suits you. You should start making notes in a very structured manner so you can connect the dots. That is the first hack.
The second hack is, classics are always worth re-reading over time because every time you re-read it, you re-introspect, and that self-reflection brings out hidden nuances which you might have missed in the first time. One more important thing forgotten about reading is that, it is a conversation between you and the author, where bulk of the heavy lifting, which is thinking, is done by the author, so if you were to shrink prep a large amount of reading in a short amount of time is very unlikely that you would draw inferences and takeaways from that. The way I have developed my reading process is, take breaks and reflect. I would spread out the reading of a book over a longer period of time instead of finishing the book, which I used to do earlier.
Last is, filter against reading bad books, which I think are intellectual poison and they destroy the mind, 90% of the books fail to add any value over a long period. One needs to have a well-defined way of what one wants to read, and that is a very individual choice. These are the things which come to my mind, for effective reading and making sense out of it.
Read effectively, make structured notes to be able to connect the dots. Take time to reflect on what you have read. Filter out books that don’t add value.
Vishal: Sure, thanks for sharing all that learning, I think the rule of inversion that you talked about in investing, I think, as you mentioned, also applies to reading.
Kuntal: It applies to all areas of life
Vishal: Coming to the thing that I think is close to your heart as of now, Needl.ai, the latest stage in your career. Talk us through what Needl is all about and how you came up with this idea, and what kind of problem you are trying to solve with this?
Kuntal: Vishal, since I have been working as an investment professional for three decades, and as I mentioned earlier, information was an edge, but now information is abundant, and it is a constant struggle to keep up with incremental information. The information is furiously flowing towards us. I agree with Marc Andreessen when he said that “software is eating the world” and the second order consequence of that is, as the computing power increases, as the storage capacity increases, as the transmission capacity increases, which is governed by Moore’s law, Kryder’s law and Butters’ law. The data has exploded in terms of volume, velocity, variety, and most importantly, it is residing in multiple venues. Today, when I look at it, I have a large amount of streaming data residing in various silos, which was proving to be extremely hard to find, process, and collaborate upon. Initially, Needl was started as an in-house division to make some sense out of this chaotic data framework which I was hurling towards. But when I reflected upon it, to build a proper system it cannot be an in-house endeavour.
We have seen that there is a massive unbundling of products. Small products which are narrow productivity tools or narrow content sources are emerging, and when you aggregate such a large number of productivity tools, spread over cloud, it is impossible to build a modern workflow on top of it. Because fragmented data leads to fragmented processing, which leads to fragmented collaboration, in turn leading to fragmented insights and which eventually leads to a very hard task of connecting the dots. This continuous friction and productivity loss was the progeny of why Needl was born. What Needl is trying to do is- bring all your data, such as email, chat, social media feeds, blogs, and what not, into a single cloud computing platform and apply uniform business logic on top of it. What Needl aspires to do is to free you from the tyranny of data management choices and help you focus. I think that is a stated goal of Needl as of now, and let’s see what happens.
Vishal: Well, I have been a user of Needl for some time. I completely agree with the kind of things it helps me do, in terms of removing the noise aside and focusing on what is important as far as information flow is a concern. And the ease of doing all that. Thank you for creating this platform. We are nearing the end of the interview Kuntal bhai, and I have just three more questions. The first question reminds me of what Einstein supposedly said that the difference between the universe and human stupidity is that universe has its limits. My question to you is, all of us have done stupid things in life. What is the most stupid thing you have done in your life and also the best decision of your life, and learnings from both?
Kuntal: The best career decision was trusting my own inner voice and entering the financial market, though I was not equipped to, and my entire ecosystem – my friends, family, relatives, all advised me against. They had a valid reason to do so, but I had my own reasons. The fact that I chose my own and the outcomes have been justified is a task well accomplished.
In a way, I was following the Japanese concept of Ikigai, which I was not aware of at that time. But if you look at it, I was driven by what I loved. That forced me to get better at that vocation, and obviously, financial service is something that the world needs and is ready to pay for. It eventually worked out, though I was not aware of the concept at that time but later on, when I read the book, I felt happy that I practiced it in real life at that point in time. What is the worst decision in life? It is a challenging question because I don’t know where to start. The number of mistakes I have made in my life is staggering. But there is one common thread to it, and if I were to risk my limb out, I have erred on trusting people, and I have not taken adequate care in verifying and vetting them prior to trusting them. This has resulted in some severe wasted time, effort, and emotional involvement without getting desired outcomes. The learning here is obvious, one has to be very careful of whom to allow in your inner circle, and you have to continuously promote and demote people in your life. Despite this, there is a bundle of contradictions here. Anything worthwhile, you want in your life- love, respect, trust all those things first need to be given before you can receive it, so I am mindful that I will occasionally end up giving to people who don’t deserve it or reciprocate it, but I am now more cognizant of what happens to my relations.
Trust but verify. Give first before you can receive, be it love, respect, trust etc.
Vishal: What about the single best piece of advice you ever received and the single worst piece of advice you have received?
Kuntal: The best piece of advice came from Charlie Munger when he said, “To get what you want, you have to deserve what you want…” This will depersonalize a lot of problems in life such as disappointment, failure, and so on. Because if you are honest to yourself, it will put the right perspective on your thinking. The worst advice I have got was the common folklore on Wall Street, which was “No one ever went broke taking profits.” Vishal, compounders which scale are a rarity and if you apply this constant booking of profit it leads to you missing out almost all the upside and I have suffered a lot following this advice in the initial phase of my life.
Best advice – “To get what you want, you have to deserve what you want…”
Worst advice – “No one ever went broke taking profits.”
Vishal: So, here is my closing question to you Kuntal bhai, everyone walks on their own journey of life, and everyone must play their parts well – but what, according to you, is a life well-lived?
Kuntal: Well, Vishal, there is a nice saying which puts it very well, “the purpose of life is that life full of purpose and meaning”. To me, it boils down to having a regret-free life of following your own inner scorecard, and personally to me, a successful life means – I am financially independent to do what I want at any point of time, and I get to contribute meaningfully to the society, which is in a way suitable to my personality traits also. So, I think, this boils down to the essence of life at this point of time.
Vishal: Thank you, Kuntal bhai, I think you are doing a lot for the society anyways by sharing your learning system with students, investors, everyone, and a special thanks to you for being so patient in answering all my questions. Great insights for me as always talking to you. I am sure the audience is going to receive a boatload of insights from what you have shared today. So, thank you so much for your time, and I look forward to interacting with you in person very soon.
Kuntal: Vishal, I must congratulate you on the depth of research you have done on me as a person and also bringing out questions that throw out differential insights. Because, I think, quality of any interview or any answers is as good as the quality of the questions asked and to that extent, I think, you have done a fantastic job, and it’s my good luck that you have chosen to speak to me, invite me on this show and more importantly, ask me penetrating questions. These two hours were a teaching experience and a learning experience for me too. Though I spoke the most, probably I am carrying away more learning than, I think, you carried away.
Vishal: Well, thanks Kuntal bhai. I think as we were talking in the interim about how the attention spans have shortened and how the average view time or average listening time for a podcast. Even the One Percent Show is around 20-25 minutes, but I am sure there is a big enough audience who appreciates free-flowing thought. The insights that someone has to share, a gist of the entire lifetime of learning, and that is the reason, I am just humbled and honoured to have you as a guest on my show, and thank you so much for agreeing to do this in the first place, and I look forward to talking to you very soon. Thank you.
Kuntal: Good evening and goodbye, Vishal. Thank You.
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