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Do nothing dammit
I do something shady - I tout returns - to belabour my point on value of "own forever" mindset. Hopefully, ends justify my means.
“All of humanity's problems stem from man's inability to sit quietly in a room alone” – Blaise Pascal
I am going to break a self-imposed rule. I will discuss Nalanda returns, that too business-wise. My intent is to use specifics to make a broader point about the power of doing nothing. Nevertheless, basing an argument on fickle stock-market outcomes is dicey. Be extra sceptical of this essay.
I don’t tout returns because investment is a game of aggregate odds, with patchy correlation between process and outcome at the level of individual decisions. Skill and luck get all muddled up. Because luck mean-reverts, what I tout as multi-bagger (I hate the word) can well become a mini-bagger if valuation excesses correct. Even at portfolio level, investment styles enjoy tailwinds that can quickly turn into headwinds (Hi Cathie). I’d rather avoid the cringe of touting returns when numbers are good and cribbing about market mispricing my companies when numbers are bad. Returns are also easy to misrepresent through cherry-picking, hindsight-bias or time-weighting. Talking returns also means I’ll take undue credit for what was a team endeavour. While process-outcome link strengthens over long timeframes, it is still noisy. Hence, I have never discussed returns, aggregate or stock-wise, in three years of writing.
I have kept my essays entirely about process, a way of thinking about investing. While I have basis to believe that my process can deliver reasonable results, I’d rather dwell on how I think than on how we’ve done. You can decide if any part resonates enough to be assimilated with your way of thinking. If not, stay for the jokes.
Why discuss outcomes now?
Because one idea that is super crucial to long-term compounding is also super difficult to get across. I refer to ‘own forever’ mindset. After investing, exclusively focus on the business and, if business is fine, entirely ignore stock-price and do nothing. I don’t think majority of investors, including self-professed Buffett devotees, have internalised this.
It is deeply non-intuitive at many levels. Taken to extreme, own at any price is absurd. Any middle-schooler can do the Maths on inverse relationship between current valuation and prospective returns. An approach that works in aggregate, while seeming wrong in each instance is hard to accept. Main benefit of this approach - to not prematurely exit good businesses – is a counterfactual that is hard to model. It is also discomforting to accept that best rewards accrue from doing nothing. All those entrance-exams seem pointless if wilful sloth is the path to success.
So, I’ll make a fresh attempt to belabour this point using our results. I’ll show how doing absolutely nothing would have worked for Nalanda over the past decade. My intent is to make the point stick, not tout returns that may not stick.
Let’s time-travel back to 2012
Nalanda’s structure is closer to private equity than to hedge fund or mutual fund. Our investors don’t give us cash on day-1 to build a portfolio all at once. When we find a business worth owning, we draw down just enough cash (from commitments) to buy as much of that business as we can. Our portfolio is an outcome of repeating such individual decisions and comes together over many years, without any grand design or top-down sectoral allocation.
At the end of our first five years (mid-2007 to mid-2012), we had gradually built up a portfolio of 22 businesses. In this essay, I will use this mid-2012 portfolio as the starting point to show how a “do absolutely nothing” approach would have fared over the subsequent decade (2012-2022). I’ll also compare this to how we actually fared with our “do nearly nothing” approach.
Before getting there, some colour on our mid-2012 portfolio. Our approach was basic: invest in decent-ROCE businesses run by decent people, with some basis to believe that these would sustain. And be disciplined on valuation. When all parameters lined up, we bought as much as possible. Our 22 business spanned consumer brands (8), engineering (7) and IT/BPO (3), along with a few stragglers from commodity, media and retail. 21 were India-listed and one was an ADR.
Before getting into how portfolio fared, it’s worth noting that this is a real portfolio, not a model portfolio. This was everything we owned, without cherry-picking. It was also sizable. We had cumulatively invested ~3000cr over 2007-12 into 22 businesses. This portfolio was worth ~4000cr in mid-2012. In 15 of these businesses, we owned nearly 10% of the company. In another 5, we owned over 5%. In all of these 20, we were the largest shareholder after the promoters. All 22 were midcaps, where we had gone through the tedious process of accumulating a significant stake.
What if we had done absolutely nothing since?
Thought experiment time. On evening of 30th June 2012, Nalanda team was kidnapped by aliens. The good kind, ones who got sarcasm and didn’t harvest organs. They let us watch Test cricket and Crazy Mohan comedies, but not stock-prices. When they finally dropped us back on evening of 30th September, 2022, I quickly ordered from Swati Snacks and checked portfolio for first time in over a decade. Here’s what I found:
My first reaction to this distribution of returns was “Whoa, that’s a lot of good for no work”.
17 of 22 investments delivered strong absolute returns (5.5x to 38x, or 18% to 43% cagr over a decade), while also being comfortably ahead of index returns (3.3x-4x, or 12-15% cagr). There was 1 capital loss and 4 with modestly positive returns. Median multiple was 8x (23% cagr) and average multiple 11x (26% cagr). If I use our actual portfolio weights from June-2012, entire portfolio would have multiplied ~8.5x.
Over a decade where most investors struggled to beat index, total inactivity would have delivered top-decile performance. Had God revealed this future in June 2012, I could have cancelled Bloomberg and completed my bestseller “Indolent Investing” from a nice beach. The only condition to realize all this awesomeness is: WE DO ABSOLUTELY NOTHING. As bird-people say, let that sink in.
(I’ll get to “but how did Nalanda actually do”, after some more rambling.)
Problem is that good is apparent only after a decade, while bad is in my face every single day
How did I feel about this obviously awesome portfolio in 2012? Far from awesome. In 2011/12, I ranted to Pulak on everything we did wrong: “We overestimated industry attractiveness here, underestimated cyclicality there, overpaid here, shouldn’t have bought that one at all, blah blah”. Looking back, I was suffering from PTSD of seeing investments fall 50-90% during Lehman period. We had been around five years, but our average holding period had barely crossed two years. There wasn’t enough evidence for me to feel secure despite decent performance till then. It is only with hindsight that I realize that we got big things mostly right (promoter, business, valuation).
Every step of the way, bad dominated good in terms of mindshare. Macro of past decade is well known: PIIGS, policy paralysis, scams, Trump, Brexit, Demonetisation, Covid, lockdown, inflation, war. Even at company level, my mindshare was consumed by problems: promoter squabbles, M&A disasters, capex-downturn, execution missteps, uneven progress. Envy made it worse. Every time a hot stock was mentioned, I noticed that we didn’t own it. No Bajaj Finance, Eicher Motors, Asian Paints, Marico, private banks, speciality chemicals etc. Big-picture message that our sound businesses were chugging along with compounding faded into the background amidst all this gloom.
As a result, there was strong temptation to sell every one of these businesses at every stage of the journey, especially as valuations moved to the expensive part of the spectrum (as early as 2013/14). In real time, there were a hundred reasons to sell and little reason to hold. It always seems smarter to do something than do nothing. And there’s no shortage of advice to sector-rotate, position portfolio for some macro regime, play something-plus-one theme, switch into hot stock, buy next big thing etc. Human nature and stock market context makes it nearly impossible to do nothing.
How did Nalanda actually do?
Unfortunately, we weren’t kidnapped by aliens. Our mere existence did some damage. Fortunately, not too much because we didn’t do too much. If “do absolutely nothing” is 100%, I’d score us 75%.
We still own 15 of these 22 businesses after over a decade. Fortunately, these 15 delivered better outcomes than the 7 we sold (imagine my embarrassment had it been ulta). Among the 7 we no longer own, we held 5 businesses for between 4 and 9 years. Our actual weighted-average holding period was ~8 years compared to 10.25 years had we done absolutely nothing. We realized ~6.5x on the entire portfolio for this 8-year hold (~26% IRR) vs do-nothing multiple of 8.5x for 10.25-year hold (~23% IRR). Ergo, 75%.
We held onto enough businesses for enough time to allow compounding to do its thing. While we fell short of 100%, seen against typical institutional holding periods of 1-2 years, this isn’t too bad. Question is, how did we manage the atypical achievement of doing (nearly) nothing?
Main reason we did not interrupt compounding was “owner mindset”
We started badly, with one colossal selling mistake. When a commodity business went up 2.5x in a year, we fretted over high valuations and sold. Opportunity loss of that decision was 2000cr of investment-gains over subsequent 9-years. This tuition catalysed our shift to owner mindset. In 2015, Pulak reframed our description from long-term equity investor to permanent business owner. In the process, we formalized an approach of “if valuation is only problem, don’t sell”.
(Many just can’t accept this statement. If it helps, think of it as default setting. If valuations get truly absurd, this can be revisited. But, at anything short of absurd, this stays without doubt or debate.)
While we always viewed investing through a long-term lens, viewing ourselves as owners made a huge difference to holding without fretting. Shift from investor to owner had a profound psychological impact that went way beyond semantics. Long journeys are way more palatable when we stop asking “Are we there yet”.
Subsequently, we only exited businesses when there was a material adverse change to the underlying business. Even then, we gave it a few years to gauge if change was irredeemable and distinct from normal ups and downs in any business trajectory. Examples of what made us uncomfortable include consistent loss in market-share, abrupt change of promoter, sizable capital misallocation and/or M&A, balance sheet deterioration. Unlike the first exit that we regretted, we don’t regret our subsequent six exits irrespective of how stock price subsequently fared. In 3 of 6, price went up a lot after our exit, an outcome that goes by the technical name “shit happens”.
(On selling process, I could score us at over 90% based on the above, but I’d rather err on the strict side in an evidently biased evaluation.)
‘Owner mindset’ was the only reason we managed to hold onto remaining 15 businesses for the whole decade. Without it, every blue bar on the right side of the above graph would’ve been replaced by a quick 2x followed by leisurely regret. You would never have seen this essay either. What’s the fun in telling you that we scored 35%.
(Having sold, could we have zigged and zagged into other stocks to deliver solid gains. I don’t know but my guess is inactivity is better for our investors and activity for our brokers.)
For a portfolio biased towards decent businesses, a lot of good can come out of doing absolutely nothing for a long time. Since doing nothing is both valuable and difficult, it is a topic worth thinking about. As stock-markets are innately biased towards activity, this thinking has to be biased towards fostering inactivity. And woven into an investment process, to bridge the gap between thinking and doing (or in this case, not doing).
Our answer to this problem is based on an if-then. IF business stays good, THEN do nothing. We are paranoid about the IF part. But once past it, we are sanguine about the THEN part of owning good but overvalued businesses. For us, this “owner approach” has done way more good than bad. To such a degree that I believe this shift from investor to owner to be the most significant evolution of our investment-thinking since we started (mildly embarrassing since Buffett articulated this in 1989).
You don’t have to adopt our approach. You shouldn’t read much into our numbers. They need not be representative and will not sustain even for us (especially since we’re an order of magnitude larger in 2022 than 2012). If there is a lesson from our experience, it is that when there is a good thing going, activity can be a bigger risk than inactivity.
I would be most happy if this essay is viewed philosophically, directionally and methodologically. Philosophy is about time being a friend of good businesses. Direction that most investors need to move is towards giving more time through less activity. Methodology that helps achieve this is greater emphasis on business and lesser emphasis on squiggly lines. Taken together, this is the owner mindset, which doesn’t interrupt compounding unless there’s a compelling reason.
I started life believing that centum is Maths is ticket to a brighter future. It’s quite a U-turn to now believe that centum in Laziness is ticket to a brighter future. And laziness is harder than maths.
In the spirit of readability, I didn’t add clarifications and technical details along the way. While I’ve lumped them below in spirit of completeness, you’ll be fine even if you don’t read what follows.
I left out fees, the four-letter word of investing. My limited goal is to show underlying returns of a basket of businesses left alone for long. Investor returns are, naturally, lower. Without getting into our fee structure (well below 2 & 20), difference between gross and net returns is between 0.5% and 3% per year, depending on level of returns.
Of many possible ways, I chose one way to show returns (point-to-point, decadal, excluding dividends). My choice was governed by simplicity, as I write for a broad audience. I could well have chosen to start with our respective buy-prices/dates for each business. Or a different 10-year period. Without getting into all alternate ways, what I have shown is roughly representative of how we’ve done in totality since inception.
There are 2nd level details. Few businesses saw demergers, where I had to combine two entities. In a few businesses, we had to sell a small part of our holding to meet redemptions by our investors (i.e. forced selling, not voluntary selling). When I say “we still own 15 businesses”, we still own between 75% and 100% of shares we held in June-2012 and didn’t sell a single share other than to meet redemptions.
There are other messages, beyond ‘owner mindset’ that flow out of the same graph. To keep this essay focused on this one message, I’ll cover others at some later point. Some of these include:
Highly asymmetric and favourable skew to returns (75-80% good, 5% bad). Picking stocks is highly risky. There’s a reasonable chance of blowing up. There’s high chance of lagging index. This asymmetric skew is my favourite metric to demonstrate a low-risk, repeatable approach. While there is no guarantee of a satisfactory outcome, this offers evidence of staying well clear of a disastrous one.
No distortion of time-weighted IRR. Most funds report time-weighted IRR, which usually mixes up high returns on small-money with subsequent low-returns on big-money. Dollar-weighted returns tend to be worse than time-weighted returns. In what I showed (and in how we generally report returns), there is no time-weighting. 100% of portfolio compounded over entire duration at the mentioned rate.
Don’t confuse outcomes with process. High multiples on the right half of above graph didn’t result from chasing high multiples. In fact, they resulted from the exact opposite. Above distribution of outcomes is a consequence of (1) cautiously managing risk and (2) giving time (with luck thrown in, although this will mean-revert). Positive outliers arose out of caution, not aggression. Dravid didn’t score centuries because he chased centuries. He scored them because of sound technique and exceptional temperament, applied over and over again.
When I wrote “a lot of good can come out of doing nothing”, my emphasis was on doing nothing. Unfortunately, some readers shifted emphasis to “a lot”, likely because it’s the only part of my message that is reduceable to a number. I received questions on how “a lot” splits into X and Y. I wasn’t planning to address this since “a lot” that is mentioned is for one portfolio over one specific decade and is an arbitrary, unsustainably high number.
Nevertheless, look-through earnings of the 22 companies (i.e. sum of PAT x Nalanda ownership %) grew ~4.2x between 2012 and 2022. PE multiple of portfolio (i.e. portfolio value divided by total look-through earnings) grew from ~15x to ~29x (since I don’t forecast, any PE multiple I share is on historic/TTM earnings; forward PE is an abomination). I suspect that fair value of a 40% ROCE portfolio that is mostly in ‘good’ industries is higher than 15 but lower than 29. However, deriving the exact split between fair and unfair is left as an exercise for the reader. What I refer to, in the essay, as luck that will mean-revert is that part of valuation expansion that appears unfair.
(I only show earnings movement for ‘do nothing’ scenario and not what we actually did because latter involves different hold-periods for different companies & gets messy to aggregate. I stick to earnings growth, not EPS growth, as dilution is negligible, possibly negative if I account for buybacks.)