Tuesday, February 12, 2019

Sanjay Bakshi on discovering Buffett, and how investors can profit from inefficient markets

Podcast | Sanjay Bakshi on discovering Buffett, and how investors can profit from inefficient markets

In part one of this interview, Professor Sanjay Bakshi traces his foray into investing.

Santosh Nair @sant0nair
Part 1 of Moneycontrol podcast with Sanjay Bakshi. Subsequent parts to be published every day this week.
Hello and welcome to Moneycontrol Podcast. I am Santosh Nair in conversation with Professor Sanjay Bakshi. Before I get chatting, here is a brief introduction about him.
Professor Bakshi is considered to be one of the best minds in India in the fields of value investing and behavioural finance. Besides these two subjects, he also teaches corporate governance and forensic accounting at Management Development Institute, Gurugram.
And he not only teaches value investing, but also practises it as Managing Partner at ValueQuest Capital.
Thank you for joining us on the show Professor Bakshi.
Q: Tell us what got you interested in investing? Was this your first choice as a career?
A: Well, almost everything that has happened to me in life has been sort of accidental. In this case, I used to see my dad, who was a value investor. He is the kind of investor that you profiled in your book--old school, faith-based investor who would pick up an entrepreneur and blindly follow him. The entrepreneur my dad picked up was a guy called Dhirubhai Ambani and he used to have a lot of faith in Dhirubhai’s ability to compound capital. We all know that Dhirubhai was instrumental in creating the equity cult in India. So, my father was part of that cult and he used to talk about him all the time.
I used to watch him as a kid at that time and it turns out that my dad did fairly well. He was a bureaucrat in the government and he used to invest in the stock market and his favourite stock was Reliance and he made money in that. I am actually grateful to Dhirubhai because he funded my first motorcycle, because my dad sold some shares in Reliance Industries to gift me a motorbike. I used to see dad work very hard in his office and he would go at like 8:30 or 9:00 clock in the morning and come late at the evening but his investing hardly took any time and I thought that this is really cool, you can make money and you can fund bikes from equities. So that’s how I originally got interested in the idea of investing. I was in school then.
Then I got into college and there I ended up partnering with a friend and we ended up investing in some IPOs and we lost money. So that was a big lesson. Fast forward, after finishing my graduation I ended up doing my chartered accountancy. In my chartered accountancy course, I learnt everything about accounting and how transactions end up becoming financial statements. I could pick up all of that but I had no clue about the quality of the business or the management.
I had no idea about that and I certainly had no idea about human nature in psychology. Then I ended up getting a scholarship to study at the London School of Economics. It was in the LSE where I accidentally discovered the idea of value investing. Till then, I had no idea about what value investing exactly was. I was just watching my dad and I was just speculating in the IPO market and blowing money.
At LSE, I was taught that standard academic finance papers that markets are efficient and there are no mispriced bets, you should just buy the market portfolio and then I accidentally came across an article in the newspaper about this obscure guy who operates out of a town called Omaha. This was 1990 and you know Warren Buffett wasn’t as well as known as he is right now and that article said a few things which was quite contrary to what I was being taught.
Things like he has a wonderful track record, he stays far away from the stock market and he believes that markets are often quite wrong and the article also said that you could get his letters in which he explained his thoughts on investing, about the world of business and you could get them for free.
I was very inspired by that and I wrote to him and his secretary wrote back that they would be happy to send the letters, but I had to send them the postage money, which is probably the best investment I ever made. I got those letters in about four or five days and basically I found the calling when I read those letters because as I mentioned I already had an accounting background, I was already a graduate from University of Delhi after having done B. Com (Hons).
So, I knew business law, a little bit of economics and in my CA, I had learnt accounting and auditing and when I read through those letters I could start connecting the dots that there is a way, there is a method of investing which can create a lot of value, will make you a lot of money. Through those letters I discovered Buffett’s teacher Ben Graham who taught him at Colombia University and of course I went and bought all the books of Ben Graham and all the editions of Security Analysis and I bought Intelligent Investor. As I was going through those books I discovered a very interesting piece; it has not appeared anywhere else to my mind.
In the third edition of Security Analysis, there is piece called ‘Special Situations’ where Graham describes how to make money in the stock market without thinking about fundamentals, without predicting future fundamental information, without studying balance sheets.
Basically, he was doing what we now call as risk arbitrage - event-driven strategies, tender offers and buybacks and recapitalisations where the outcome of your investment operation is dependent on the happening and the non-happening of a corporate event, nothing to do with markets. So that was very interesting to me for two reasons; one you get uncorrelated returns, and two, you don’t have to predict things. You don’t have to even do a lot of fundamental analysis. So that was one piece which was very influential to me in Special Situations.
The second, essay that I read through was in the Appendix to the Intelligent Investor. In the 50th year of the publication of Security Analysis in 1984 Warren Buffett went to Colombia University and gave a talk that is a famous talk, all early investors know about. It is called The Superinvestors of Graham-and-Doddsville. In that talk, there was a certain passage which when I read just blew my mind.
Q: What was that?
A: That passage was that Buffett uses a metaphor of a gun and he says that if you have a gun which has got six chambers in it and If I put a bullet in one chamber and you ask me how much do you want to be paid to pull the trigger once, I am not going to pull it and even if it’s a million dollars and if somebody asks you that I will give you two million dollars, will you pull it now? And that’s a positive correlation between risk and reward.
But in value investing, it is the opposite. If you are buying a $100 bill for $110 it is risky, but if you are buying it at $60 it is less risky. But the expectation of reward is higher in the latter case that if you buy it for $60 and it goes back to fair value you make money. If you buy it $110 and goes back to fair value, you lose money.
So, over here you have less risk of loss, but the return is higher which was extremely counter-intuitive to me because as I mentioned I was studying in the LSE and the professors over there were telling me that if you want to make more money you have got to take more risk.
This guy is saying the opposite that if you want to make more money you got to take less risk and I said, this guy is saying something which is exact opposite of what I have been taught and I have got to know more about this stuff. As I worked through the examples of Ben Graham’s books I basically found my calling and decided that this is what I want to do and I came back to India.
Q: What was the experience like when you came back to India?
A: Very tough. Before I went to the LSE, I worked for a company called American Express for six months and that period of working in American Express they told me that I am unemployable, I can’t work for any boss or anything like that. So when I returned from London, I never wanted to work for another company. I had to be on my own, but I had no money. And I came back with Rs 3 lakh.
My net worth was Rs 3,00,000 at the time. If you want to start your career as a value investor you can’t do much with Rs 3 lakh. By then, I already had a daughter. I had been married in 1990 and came back with a daughter. I had a family to support. It was very tough in the initial years and I started writing columns for money and I used to write two or three columns a week. So, I did a lot of those and then I started teaching in a couple of business schools just to sustain myself while I was building a career as a value investor.
I then went to friends and family members and I collected a pool of capital, a princely sum of Rs 20 lakh, which was given to me more out of pity by my friends and family than out of any conviction, because I had really no track record at that time. They just knew that this is a decent person, let’s give him some money, let’s back him.
That’s what I tell all my students: if you want to start their career as a value investor and don’t have enough money to begin with, you will need other people’s money and those people are almost certainly going to be people who trust you, people who have known you, which is basically your childhood friends and your family members. So that’s how I started, but four or five years was very tough.
Q: So you collected Rs 20 lakh and invested all the money in stocks. How did it turn out?
A: It was very painful, because I had all this theoretical knowledge and I thought I was a hotshot value investor who has learnt everything, read up everything on Buffett and Graham and I am a qualified chartered accountant and I can crack this. In three years I lost 40 percent of the money and part of the money came from mother-in law.
Q: That’s tough.
A: That’s very tough. But it is a blessing in the sense losing money in the early part of your journey is very painful but it teaches you a few things.
Q: So, how did your friends take to the bad news early on? Did they eventually make a decent enough return on that investment?
A: Well ultimately, they all redeemed and I bought them out because it was sort of a loosely held investment partnership. As I became more evolved as an investor and got more clients, I bought all of them out over a period of time and they were happy about the outcome. I don’t want to say that they had great outcomes but nobody lost money and they did pretty okay.
Q: What were the learnings from that maiden venture as a professional money manager? What were the things you felt you did right and where did you go wrong?
A: If you recall we just spoke about my experiences even before that I have speculated in IPOs. Everybody was making money in IPOs and I got in at the wrong time with the wrong issues and I lost money. When I read through Graham’s books, I came across passages telling why you should stay away from IPOs. He wrote that there were lots of salesmanship behind these issues and there was the timing factor as well.
Entrepreneurs are not going to come and give you their companies for a song at the bottom of bear market. Typically, it will be in a bull market cycle that you will see a lot of IPO activity happening. In the secondary market, shares trade every day. So, the probability that you will find a bargain in the secondary market is so much higher than in the primary market. I could relate as to why those losses occurred by studying the reasons. I gradually learnt about what to avoid, how to avoid those things. So, that was one thing that happened.
The early experience for me was really about learning from losses and one thing which I have learnt over the years is you are going to have losses in this field all that time.
Taking losses or facing losses in the early part of your journey has been good for me and it is good for almost everybody, provided you can get the right lessons from that. One thing which I have learnt by reading a little about behavioural economics is about the power of framing. If you frame those losses and the money that you lost in those losses and just give them a label of tuition fees paid then that helps. Psychologically it helps you, number one.
Number two, if it is a hefty tuition fee that you have paid then, you are not likely to make the same mistakes again and it also gives you hope. You have learnt something, move on and don’t make the same mistake again because you have already graduated and you paid the tuition fees. So, education will come from your losses in that sense. The idea of framing losses as tuition fees has been very helpful to me. That was one thing which happened.
There is something else that happened to me and I have rarely spoken about it. It is the first time I am doing in public. In 1990 when I was a student at the LSE, one of my father’s friends settled in England took me and my wife to a casino, Victoria Casino, Edgware Road in London.
There, I gambled for the first time in my life in a casino. It was the first time I actually entered a casino and I made money and when I made money I felt happy. I thought that I had discovered a way of becoming rich quick. To you and the listeners, it may now sound ridiculous, but at that time when I made money for the first time I thought I had invented a new way of life, that I could double my bets and double them again, using the Martingale strategy that people use. I made money, you could say it was beginners luck, but I got hooked on to it.
Q: Do you recall how much money you exactly made on that bet?
A: Initially I made about 20-30 pounds. Because, I was now hooked, I was bunking classes and going there. I was there before the casino opened and I was there right till the evening and I would gamble. One day I made 2,000 pounds which was an enormous amount of money for my net worth at that point of time. It was an enormous sum of money for a student living on scholarship…it was huge.
I felt that this is what I can do for life. I have found a way of gambling and I was using some methods, so-called methods, which almost always will make you go broke ultimately, which is what happened to me too.
But I got hooked and I gambled more because one thing which happens in gambling is that if you make money you are going to go back, you gamble more, very few people actually say that I made money I was lucky, let me walk away. It’s extremely difficult to walk away. You go back. I went back and I lost everything and more and then I became extremely emotional about it because my wife was working early mornings in the winter to support me, because I didn’t have money for financial support for living expenses and living in London was very expensive.
So, she was supporting my education and I blew up all of my net worth and I felt terrible about it and then I made a pledge that I am not going to go to a casino or if I go I am not going to gamble and I stayed with that since then. Many years later, my wife and I went to Las Vegas and I gave her all the chips that the hotels give you for free, I said you go to the tables, I am not going.
The reason I mention this today is that those losses you suffer are emotionally very distressing, but they are also very instructive. At least for me they made me aware of risk, as to what can go wrong. In his book, Ben Graham defines what is the meaning of investing, and he starts with a very simple definition. He says, “an investment operation is one which upon thorough analysis promises safety of principal plus an adequate return”. Safety of principal plus an adequate return. Safety of principle comes before, the adequate return comes later and this is very important and lot of people don’t get this and I certainly didn’t get it at that time. There is another guy called Will Rogers who said pretty much the same thing in a much more entertaining manner and he said, “I am more concerned with the return of my money than the return on my money”.
And if you look at the history of financial markets, you will find that there are periods during which people don’t follow this advice. They would be more focused on the return on their money than the return of their money.

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