August 30, 2010

The secret of high portfolio returns

There is none.

If you were expecting me to share some magic key to super high returns, you must be disappointed. It is amazing that there is an entire segment of the financial industry which is into selling all kinds of special ways of making very high returns with minimal risk and absolutely no effort. I will not blame the seller alone for selling
snake oil. They would not be able to sell this garbage, if there was no demand for it.

If one leaves aside the clueless and the greedy, the rest of the investors still live under several myths. Let’s look at some of the prevailing myths

Finding a multi-bagger is key to high returns
The number one aspiration of a lot of investors is to find the elusive multi-bagger or better yet a ten bagger. If one can find and invest in a multi-bagger, then he or she is all set for life.
I don’t deny the thrill of investing in a multi-bagger. However unless one has a focused portfolio (with 3-5 stocks), a multi-bagger will not make a huge difference to the overall returns.

The problem with focusing on multi-baggers is that one loses sight of the main objective (getting good portfolio returns) and ends up confusing the means with the end. A lot of times a mindless focus on multi-baggers blinds one to good opportunities, where one can make good returns (30-40%) in a decent period of time.

In addition to the above problem, new investors become susceptible to fly by night operators and other shady services which promise multi-baggers and quick returns.

Finally multi-baggers are the result of a good investing process, patience of holding the stock over a long period of time and ample luck.

Leverage
I have heard from some readers that they have considerable leverage in their portfolio and it has helped them to get high returns.

I am personally against leverage. High leverage is enjoyable when the going is good and one is making high returns, but it can kill your financial well being when things go wrong. The whole 2008-2009 financial disaster was a lesson in excess leverage, both by individuals and financial institution.

John maynard Keynes said it best – The markets can remain irrational longer than you can remain solvent.

Inside information
The other common myth I have heard is that the markets are completely rigged and the only way to get high returns is to have access to insider information.

That may be true. It is quite possible that there are several shady operators in the market who try to manipulate the market and have been able to make a killing as a result.

It is however incorrect to blame the market operators alone for the losses of the small investor. A lot of time, cheats and con artist are able to take advantage of others due to their greed and fear. This is not limited to stock markets alone and one has heard of such stories in lots of other cases, especially if money is involved.

Super high intellect
The other common myth is that one is born with some kind of ‘finance’ gene. Such super talented investors can make money effortlessly and are destined for greatness. This myth is not limited to finance alone and extends to a lot of other areas such sports and education.

This is an topic is of great interest for me and I have read a lot on it (as I consider myself to have no inborn talent for investing).

The question is this – Is extreme skill, such as being a great investor or great sportsman the result of an inborn talent or something which one can develop over a lifetime?

There are a lot of great books on this topic – talent is overrated and mindset. My personal conclusion for whatever it is worth is this – Extreme skill is the result of a lot of focus and hard work over a long period of time.

There are lot more myths and I could go on and on. The key question is what drives high returns?

The key points which I think drives portfolio returns are quite simple and can be listed in a couple of points

1.Continuous learning with the aim of constant improvement
2.Intellectual humility to learn from one’s mistakes
3.Hard work and intense focus

I don’t have any research to back the above points and state them from my personal experience and what I have read of other super-investors and top performers.

It is true that talent plays a part in one’s success, but intense focus and hard work drives eventual success far more than talent alone. I don’t think there is any great investor out there who has also not worked extremely hard over a long period of time to achieve that level of success. There is nothing natural in picking a good stock.

The counter point to the above statement can be – Do you think that working hard will make you a warren buffett or rakesh jhunjhunwala ?

I think this statement or thought misses the point. I may not become a warren buffett (highly unlikely), but working hard and focusing on this skill over a long period of time will definitely make me a much better and hopefully successful investor.

11 comments:

Multibagger said...

Good post,

Some things just take their own sweet time.

Concentration of portfolio with high conviction bet helps higher returns. Leverage can wipe out anyone. Real estate leverage works in upcoming townships.

9 years of 20% compounding and 10th year of 15% negative return underperforms 10 years of 16% compounding. Consistency is the key. But guess, why funds choose former approach, whose client will be happier and will get more fame and AUM ?

Amit

Anonymous said...

Hi Rohit - Great post at right point of time! I fully agreed with your points and that’s what makes a difference between a successful and no so successful investor.

Thanks
Prashant

VISHNU said...

Hi,

You missed another one: Starting your own company..Downside is NIL (since you are starting with little capital) and return (I heard) will be in excess of 200%.

Regards
Vishnu

Vidyanshu said...

Hi Rohit,

Good Post. Working hard can definitely overcome lack of talent. Moreover, in this field, it might be a combination of talent, behavioral investing principles and the ability to have faith on rationality. I read somewhere that Munger was endorsing Marcus Cicero and Housman..tells me that being a stoic also helps.

I have been a fan of your blog for some time. The diligence of publishing thought provoking articles and expanding your network should itself pay you back in spades.

All the best.

Regards,
Vidyanshu.

Rohit Chauhan said...

Hi amit
true ..personal investing is different from professional investing where the main focus is to gather assets

rgds
rohit

Rohit Chauhan said...

Hi prashant
yes, hard work and focus is somehow the most under-rated point, maybe because it is not glamorous and sexy to talk about it

rgds
rohit

Rohit Chauhan said...

hi vidyanshu
true talent can make you a great investor..but it has to be combined with a lot of effort. for lesser mortals like me, effort in itself can take one quite far

rgds
rohit

Rohit Chauhan said...

hi vishnu
oh i must have missed a more than that. having nerves of steel, ability to take lots of risk and many more such myths pervade the market

rgds
rohit

j said...

Hi Rohit!!

I have been a new visitot of your blog & have already become a fan.
Just a query-

Out of thousands of stocks available, I believe you be zeroing on some, analyzing them, & then finalizing a few.
I would like to know how do you zero in on some at level-1?

Vic said...

Beautiful article Rohit.

Your reasons for High Returns: 1.Continuous learning with the aim of constant improvement
2.Intellectual humility to learn from one’s mistakes
3.Hard work and intense focus

not only apply in Investing but to achieve success in other areas as well.

Vikas

rayhaan said...

hi rohit,
thanks for another post on the basic concepts of successful investing.
i had a few quetions-
q.do u use cash eps while evaluating a company or just eps?
and why?
q.i just saw a few stocks like coastal roadways and waterbase selling at very low free cashlow multiples.how important is free cash flow while investing? i mean, i find them selling at these ridiculously low valuations( basically wot im trying toask u , is wich one of us is going crazy, me or mr.market?)
q.what are your views on the above stocks?
q.what are ur views on teesta agro ?, i mean this is so looks like a ncav situation , u know, below cash,free cashflow,book value and even a low p/e(after u look at cash eps of course) . of course, there s 1 negative to the story of a preferential allotment taking place and 1 positive development that of their very 1st dividend.
last AND the least important question ,were u by any chance a writer of red herring prospectuses in a past life or are u by any chance,related to geff gannon(u reallly shoul chek out the podcast!) , i mean u r so tough on ur stock pics.....lol!
eagerly aw8ing ur reply,
rayhaan