15th anniversary essay: Thoroughly conscious ignorance

At the 15-year mark, I go back to my Nalanda origin story. It all started with “I’m an idiot”.

15 years and not counting

“If you like them, don’t count how many. Just enjoy.” – my Paatti, while serving fresh, crisp dosais.

Nalanda Capital, as well my stint therein, complete fifteen years this month. While this is a milestone of sorts, I haven’t been counting. I just enjoy a job where weekdays feel like weekends. Fifteen years in markets is too short for a victory lap (no period is long enough). However, it is long enough to reminisce about a few good things. Like the fact that we’re still around. Or the opinion that I’m less of an idiot than when I started. With apologies for self-indulgent bragging, I’ll pen a few highlights of this ongoing journey starting with this essay on how I got here in the first place.

Thoroughly conscious ignorance

“Thoroughly conscious ignorance is the prelude to every real advance in science.” – James Clerk Maxwell

How did my Nalanda journey start? At “I’m an idiot”.

I started as a disastrous private equity investor. I didn’t get what mattered: risk, moat, cash, trust, evidence. I focused on what didn’t: themes, stories, growth, resumes, XL. Weirdly, I was doing well career-wise, while doing poorly investing-wise. I had prior experience with this sort of disconnect between the veneer and the essence, having got good engineering grades while being a terrible engineer. So, I could sense that something was wrong without being able to pin down what or why.

Wise investors such as Sanjoy Bhattacharya and Prashant Jain showed me the right path, but I couldn’t steer onto it. I heard their words but couldn’t change my actions. I needed hand-holding, not directions. In McKinsey style, I summarized my problem into three bullet points:

·       I’m an idiot.

·       I can’t change this on my own.

·       I better apprentice with someone who knows this stuff.

I had been trying to unsuccessfully implement point 3 when, in late 2006, I saw an article saying that Pulak Prasad was leaving Warburg Pincus to set up his own fund. I saw a solution to my problem, as one of my friends had worked with Pulak and thought the world of him. I reached out to Pulak, through my friend, asking for a job. With hindsight, my “idiot needs help” pitch was weak on what was in it for the other person. But I got lucky, very lucky. I started at Nalanda Capital on May 21st, 2007. Looking back, that was a rare case of bullet points turning out useful. I’ll get to how apprenticeship helped me become a lesser idiot, but for now, let’s stick with idiocy.

I deliberately started my anniversary essay with the theme of thoroughly conscious ignorance. It didn’t merely help me get my best professional break. Conscious ignorance is at the heart of what we have done since. It’s why we survived fifteen years. It lies behind key tenets of our investment philosophy, such as being risk obsessed and demanding many levels of safety-margin. I realize that it sounds horrible to claim to be more self-aware than others. It’s like claiming to be humble. But let me illustrate a few ways in which we systematically implemented ignorance.

We don’t forecast. We haven’t in fifteen years. Not one XL sheet with future numbers, not even for internal circulation. Most think I’m mental or lying or both when I claim this. Truth is that buggy humans are disastrous forecasters. Future is nearly entirely unknowable. No reason to believe we’re any better. So, thoroughly conscious ignorance beats pretense of knowledge. It shifts our focus to constructs where good things are more likely to sustain than using XL to paper over dubious prospects. It also limits us to buy at valuations that don’t require decimal-point DCFs to rationalize fairytale scenarios. We do think hard about the future, but only in situations that are more amenable to such thinking and even then, in appropriately fuzzy terms.

We don’t have a view on macro shacro. No clue about inflation, economy, rates, stagflation, recession, commodities, currencies, market direction or epidemics. We have no idea how ongoing war will impact portfolio. We can’t tell a cyclical bear market in a structural bull run from the converse, assuming these words have meaning to begin with. Nor do we know how India will fare over the next few decades. We don’t invest in India out of excitement. We invest in India because we’re least ignorant here. This is the only country we know well enough to not get suckered by chor promoters. There’s no grand thesis on our macro prospects, notwithstanding hopes as citizens that we keep doing well. None of what’s mentioned in this paragraph is an input to our investment decisions. Ignorance leads us to investment constructs that have fared well over decades under diverse conditions. Hopefully, this insulates us from whatever will pan out in future.

We really don’t know any of our businesses. I know it sounds odd for someone who builds large positions in a few companies, but it’s true. Our job is to recognize a good business when we see one. At the least, tell a good business from a bad one. World is too messy for us to know exactly why it’s good or how it got that way. Or if it goes off track, what needs to be done to fix it. This ignorance makes us avoid hard problems, not attempt them. All we can do is to ensure that broad patterns common to good businesses (e.g. return on capital, competitive position, industry economics, balance sheet quality) hold true. If these don’t line up, no matter how exciting the story, we walk away. After investing, we have no ability to ‘add value’ at an operational level to any of our companies. We can only gauge if business stays good. If a company seems irredeemably off track (e.g. consistent erosion in competitive position or balance sheet), only thing we can do is to sell and move on. This ignorance keeps us engaged at the right level, without pretending to be experts in paints, underwear and potties. Outside of occasional discussions on capital (mis)allocation, we have nothing to add to our companies despite being a large shareholder.

I started by claiming to be a lesser idiot now. At best, that holds on the margin. I’m still an idiot when it comes to knowing what over 90% of Indian listed businesses are worth. With many, including fashionable ones, I don’t even know where to start. We probably understand fewer than a hundred businesses well enough to buy them at a price. Even in those, we don’t know if the price is right over 90% of the time. Even after fifteen years, we are consciously ignorant of over 99% of our part of the messy world. It is relatively easy, even fashionable, to plead ignorance. Harder part is to be truly indifferent about it over decades. Functioning normally with a cognitive hole in the head is unnatural to buggy humans. I feel good that we have managed to do this tolerably well for fifteen years.

Thoroughly conscious ignorance leads to a few other tenets that underpin sensible investing. It’s hard, though not impossible, to be overconfident while ignorant. Ignorance fosters an inclination to play it safe. It makes it easier to put most things in a ‘too tough’ bucket. Ignorance mindset has really kept out of trouble. We may have missed some opportunities, but we missed way more wipeouts. Counter intuitively, ignorance helped us capture opportunity at the other end. At times when it felt like world was ending, not thinking too hard about an unknowable future gave us courage to act.

“I’m an idiot” has been a great starting point for me. And it’s good in steady state too. Last fifteen years has essentially been about finding a small number of situations where we could claim to be a lesser idiot. No reason why next fifteen should be any different.