In the ninth episode of Insider Investing, we look into what's happening in the equity market. There's a massive sell-off in growth and innovation economy stocks, and some of the most celebrated funds have lost a significant amount of value. Our Co-founder Sandeep Jethwani & Vaibhav Porwal sit down to discuss why this is happening, and what investors should do in this environment of turmoil. We look into past events in history to understand how narrative driven behaviour of the crowds have taken us into a bubble territory time and again.
Tune in to learn why most thematic opportunities become attractive at the peak of performance cycle, and how investors are better off focusing on the business fundamentals for long term wealth creation and many other interesting insights.
Hi, on this ninth episode of insider investing. I welcome back Vaibhav, who is just recovering from COVID by the way. And he talks about a cautionary note when it comes to investing in 2022, we also discuss a very interesting concept of a clash of civilization that's happening in the investing world right now. To find out more, watch, listen to the rest of this episode.
Sandeep: Hi Vaibhav, welcome back to insider investing. 2022 started off with a big bang and not necessarily in a good way. Right? We've seen a massive sell-off in growth and innovation economy stocks, as they are now called, I was looking at prices of Peloton, which is this home fitness gear company. That's apparently down from $120 to $27, your Ark Innovation ETF, which some of us called the rocket ship of 2021 has lost $14 billion in size. And even the NASDAQ index is down 10%. And it's an interesting time in investing because you feel like there's a clash of civilizations that is playing out in front of our eyes. On one side, you have the Warren buffets style old world, boring, fundamental analysis driven investing.
And on the other side, you have this exciting narrative driven, YOLO, thematic/ conceptual investing that's going on. What do you think about this whole narrative style of investing? And it's a new term that even I have learned very recently.
Vaibhav: It's always been there Sandeep and I am glad that I'm back here and you know, I was down with COVID, and a good that I got from it and could come for this. Honestly, on this narrative of based investing, it's always been there. Most of the bubbles, which get formed in the market are formed around these once in a lifetime opportunities, which are easy to communicate. So if you go back in time, look at the Tulip Mania, or you look at the South Sea Bubble, for which Newton has also fallen for, or you look at the Mississippi Bubble or you look at the Tech bubble of the 90's. Most of these are built around strong narratives of a once-in-a-lifetime opportunity consistent and across, that's how bubbles can be formed and can get us steam, from more and more people who believe in that narrative.
Sandeep: But what are the recent bubbles? And before this one, and assuming that I think it's too early for us to call it a bubble, maybe that history will tell us. But if you just go back in time, in our living history, which other bubbles that you've seen globally, or in India, or like this narrative driven style of investing, which you've seen globally or in India.
Vaibhav: So first off we were exposed to the dot com. When number of eyeballs per website was the criteria to define the valuation of the companies. And, none of us know how it ended. In India also, I remember the period between 2003 to 2007, most of these businesses in real estate, there was a strong narrative, which was at play a real estate company was valued based on the land holdings that.
Everyone said that they will have an ability to develop so many squares over the next four to five years and on a discounted basis, their cash flow should be valued at so much. And therefore our share price should be so bad. And these narratives, the thing about narratives is it's easy to communicate these narratives.
If we go back further and look at Harshad Mehta type, the replacement value narrative? If you were to set up a plant for ACC cement today, what would be the replacement cost was the narrative which was being played. So these narratives have always been there. The good thing is people buy it easily. And the bad thing is that the outcomes are always bad.
Sandeep: You see some like, like, you know, probably we are too. But we see some very easily identifiable ways of looking at narrative styles, right? Yeah. You, you heard about this concept that you should buy the stock of the product that you use. Yeah. That's a narrative style of investing, easy to explain, easy to understand and easy to buy.
These talks, you hear about this fact that the founder is a rock star. Okay. And it's almost like demigod status being given to the founder and therefore value being attributed to the company that the founder. You called out the once in a lifetime opportunity that this is so good that you have to, you have to get into this, you know, and I feel like we are all intelligent human beings.
So we in private people talk about the fact that there is something wrong, but the public commentary is all positive. I've seen fund managers privately, talking to us about how certain stocks are super overwhelmed. Yeah. But when I hear them on, on public media, it's all normal and it's all fine. And there's no reference to profit and all of those terms sound a little boring.
So sometimes maybe these are like easy ways of identifying what a narrative style is. It would be actually interesting to Vaibav to understand, like, why is this done so well? Like what is happening in the last couple of years that this narrative stylist caught on
Vaibhav: There are two, three reasons And so for us to address your questions around why we fall for it, it's a, it's a collective action problem.
All of us want to act in quotes right?. So individually it's difficult to stand out and say that I'll take a contrarian bet. You don't want to appear stupid. So nobody would want to act against the crowd. And that narrative is becoming stronger and stronger where you don't want to act against them. Most of the fund managers have fallen for it because they have access to easy liquidity and they don't know how to move with that liquidity.
So that's been another reason. Third and a very interesting reason is your ability to communicate the idea, social media has given you that platform where you can distribute your idea or do a mass distribution of your philosophy and idea to a much larger audience than what it was possible earlier. And, COVID gave us that time.
All of us, while we were spending time at home, we got hooked onto our social media platforms and bought into these ideas. So that's been a big reason. According to me, for the last couple of years narrative based investing has picked up.
Sandeep: I love the fact that you spoke about how fund managers are also sometimes getting drawn into this thing.
Right? I empathize with a mutual fund manager. Who is, wanting to be right by the investors and being careful, cautious about the stocks that he or she is buying. But on the other hand, they are getting these huge inflows of capital coming into their fund and they also have to outperform on the near-term basis.
Otherwise, nobody wants to invest in that front. I see a lot of websites recommending specific mutual funds to investors under the category of top performers and top performers by the very definition are the funds which have done well in the recent times. So if a fund management has to get those funds and, you know, claim from investors that they should put money into them, they have to demonstrate near term performance.
Which then leads them to sort of buy more of these narrative style in sort of like a vicious cycle
Vaibhav: No, it's, it's been playing out and it's been, they are getting more and more pronounced, day by day. But the unfortunate part of this is that people invest or commit most of the capital at the peak of the performance cycle.
And we have spoken about thematic plays also, whenever a theme is becoming exceedingly popular, possibly that's the time to stay away from that theme. It's easy to raise money in a team because you have historical data, you can rely on that historical data to sell that narrative and people buy into that.
Sandeep: You know, I want to go deeper into this thematic investing issue. And we see a lot of things that have happened very recently. I've seen this concept that buy tech stocks and people creating these groups of tech stocks and buying into those. Then you see certain concepts like EVs are hot, so you should buy EV related businesses.
And people are creating groups of companies which are impacted. You know, the positive sort of momentum towards EVs. How should investors think about this Vaibhav because and where should it be, does it find part of your portfolio? Is it part of your long-term portfolio? Is it part of something that you want to play with?
What should investors think about it?
Vaibhav: Investor should leave it to the better judgment of the fund manager and I've seen over the last 20 years of my career, most of the investments in each of these themes come at the peak of performance cycle, and I can speak a few examples, in, 2000, the maximum amount of flows, came in tech companies, right.
That was the peak of the performance cycle. In 2007. Maximum amount of investment went into infra and real estate themes in the peak of the performance cycle. In 2013, the maximum amount of money got invested in the pharmaceutical cycle, now because seeing the maximum amount of investing, going into unlisted and tech places. And, I don't know whether it's too early, but it looks like some of these players who have become popular over the last couple of years, like to stay at home.
So you spoke about the company, which is into home fitness equipment. Have you seen results from Netflix also yesterday, the growth of subscribers is going down. So these are evidence that themes don't last for too long and it's hazardous for investors to invest money in themes because, by the time they hear about the theme, it's already way beyond, realizing its potential.
Sandeep: So I agree, themes don't last for long, great companies do, but analyzing great companies is not exciting. It's a boring activity. And sometimes it's a lot of detail, which you can't really put out on social media, which means that the fundamental analysis experts are finding it actually hard to gather attention from social media.
Because there's no narrative to sell, like, and it's early to decide whether the arc plays out because in the long run it might still do really well. But Kathy's whole narrative about innovative economy is a very seductive narrative. It's something that you can relate with. It's easy to understand for the brain, but at the same time, if you, the devil is always in the details.
And when you look at individual companies and you say, look, there is no profit visibility for many, many years. There's no business model here. Then you begin to question how it will perform when the liquidity sucks out. And that potentially is beginning to happen. Now we are seeing interest rates rise. We're now seeing the Fed finally talking about shrinking its balance sheet. The same investors who were doing the stay at home plays or who were investing from home. And now beginning to go out again and therefore beginning to break into their portfolios to take out money. So suddenly you have this situation where the easy liquidity was there. Chasing these teams is no longer there.
Vaibhav: Absolutely, and since you touched upon Kathy and the whole talk about innovation, the biggest issue, and the reason for which bubbles are formed, they always follow some big technological innovation and people find it difficult to estimate the productivity gains out of this technology.
Therefore, most of these bubbles get formed. You can, and, we tend to overestimate productivity gains more often than. And therefore the wealth loss, which happens on account of investing in these companies at the peak of valuation is pretty large. You remember, we were talking about this example of investing in Wipro in 2000 at the peak of a market cap at two like 2,20,000crores.It took 20 years for a company like Wipro, despite all the growth and profitability to come back to the same market gap. So that's, that's the issue. You can't clearly estimate what will be the productivity gain of this innovation and how it will impact other businesses and how competition will react to that.
The other challenge that I see Sandeep, is oversimplification of these ideas. Their path to profitability, how competition will react to these innovations? What kind of restrictions will they follow? They will have to face, well, how regulators will react to some of them. What will be the pace of growth once they achieve a certain size?
All of these questions are always unanswered. Simply by saying that, this brand or product is something that I use on a day-to-day basis. It's not a good enough argument. In 2003, Nokia was as ubiquitous as Apple is today. If you had invested in Nokia with an assumption that I use Nokia and everyone around me is also using Nokia, then you'd have lost significant money or the narrative that people are using your services more and more investing in Telecom in 2005, with an assumption that more subscriber base is getting work over the last 15 years, subscriber base has gone up by almost 200 times, but wealth loss, which has happened in telecoms space in India is unprecedented because regulators and competition reacted very differently.
So, All of us talk about the growth in subscriber base, but nobody looks at how competitive competition reacted to him regularly. So oversimplification of investing is the biggest enemy of investors.
Sandeep: Yeah, it's a great point, actually, that you made that, you know, when we look at some of these thematic plays and we think of our innovation economy, the assumption is that everything else around that company will stay constant.
And only that part, that, that innovative, idea or the concept or the technology that that company has, will allow it to stand out. But that's a false assumption to begin with because the world will react. It is not a static situation that the equilibrium will be maintained and this company will break out.
There are many other things at play. There are external factors, interest rates etc. And which is why I agreed about this factor of oversimplification. But the other challenge is that the alternative to this is simple asset allocation, which is the age-old way of making money. But again, because it is age old, it is considered to be some sort of non sexy, non-smart way of managing money.
Vaibhav: It's always been like that. Whenever there is a new narrative, we start by saying it's different this time. What history and fundamentals of investing remain the same. If you're not doing anything but discounting future cash flow. If there are no cash flows, then there's no NPB. Well, it's a simple principle of cash flow discounting.
So either you're changing the metric of value in these businesses. And the financial gains out of it, or, we are just living in a fool's paradise.
Sandeep: But how do you feel as a chartered accountant and a rank holder at that and when you are told that all of those are old world ways of looking at it, and you know, there is a new age thing that is going on and you are not sharp enough to get it.
Vaibhav: I always go back to this book called Fool's Gold, which I read about the 2008 meltdown. And it gives me some comfort that what I'm thinking is not bad, more segregated fund managers lost their way. In 2005, 6, 7. They saw that risk was building up, but still a godsend into that.And it's very tempting. See, the thing with bubbles is it's very difficult to identify. And when the bubble is forming, it's very difficult to stay away from it. And it's very, it's even more difficult to fight it at the peak. We had this discussion and there's a lot of news media coverage about how Raghuram Rajan identified a subprime crisis, but he identified it in 2005.
So it lasted for three more years. Imagine he had gone shorter. This created lost all of his net. So that's the challenge. So sometimes it's best to stay out of it and maintain yours . It's great to not do some, uh, some things sometimes
Sandeep: I think that's the role of an expert, but it's really hard. I can imagine because you know, there's this us versus them thing playing out where, you know, one camp is telling you that you are, you are ancient. You're not in sync with what is happening. And the camp, which is saying we're talking about caution, has to keep a steady mind and stay focused on the long-term goals of their own money and the money that they're managing for others.
However, my last question is the fact that we have seen a crack begin to happen in the US and specifically within one set of companies, which is this a new economy, growth stocks. It has not come up to the mega caps just yet. If you look at Apple as a no correction, I mean, it's possibly up, in the last few months in the other stocks, this marginal correction that has happened, which you would put down to potentially, regular profit taking and so on. Is this going to, is this sort of going to expand? Is this a lightness that the rest of the market will also catch? Is this something that will potentially spill over to India is the natural concern that any of our listeners will have. What would you advise people to do right now?
Vaibhav: So I spoke about not spilling over to the big deck and that is where my point of profitable versus non-profitable gets approved. These businesses are highly profitable, and that's why they are better equipped to handle any kind of crisis in the market. It's likely to spill over to all the companies across the world where there's no visibility of profitability and there's a constant need of capital.
If there's a constant need of capital, then you need to raise capital regardless of the valuation. And if those valuations start going down, it creates a vicious cycle where existing investors will keep getting diluted and the value of their equity will keep going down. So that will play out all across the world.
Two factors, which will determine the course, first is, how interest rates behave over the next six to nine months. Because if your cost of capital keeps going up, your multiples will keep going down. And second, how much access to liquidity these companies will continue to get. We have always been careful about two things, not over simplifying investing, because investing has multiple nuances, you can't ignore those nuances.
And just say that because you are using this product or because you are seeing a high growth in this sector, you should invest in that and there are multiple other elements of which are involved. Second, thematic investing is something that we recommend all our investors to stay away from. If the theme is good enough and it justifies its place in the portfolio, trust your fund managers that they will give it a reasonable allocation in your portfolio.
Don't fall for, I've seen, uh, interesting, platforms and which offer thematic investing. And as I said, they are doing more disservice to invest in us then to other advisors. I'm not seeing it as an over jealous, competition or over jealous advisor who is not able to offer something like that.
But I firmly believe that they are doing dis-service to the entire industry and investors as a community.
Sandeep: So Vaibhav on that very cautious note, and I did not expect to begin 2022 another year with such a cautious note. It's great to have you back in the office and on the show. Thank you very much and hope to see you soon again.
Thanks. Thanks a lot Sandeep.
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