This is the first post in a new series I’m calling the ‘let’s talk investing‘ series. In this series, I’ll write about my conversations with investment practitioners, people who have real-world experience in the field of investment decision-making. My objective in these conversations is to understand their investment philosophy and process, to demystify, at least to some extent, what they do, and to walk away with some thought-starters to help all of us become better investors.
Listen to any investment legend speak about what they think works in the markets. One of the recurring themes you will find is the investor’s ability and willingness to think differently. Different from what their peer set is thinking and doing. A quality that is so rare in capital markets that there are research papers on the impact of fund managers’ unwillingness to deviate from consensus opinion. My conversation today is with an analyst who does not have this problem.
Earlier this year, Mint reported based on Bloomberg data that of the 54 analysts tracking ICICI, 3 recommended ‘Hold’, 50 recommended ‘Buy’ and only one had a ‘Sell’ rating on the stock. The man behind that lone ‘Sell’ call is Gautam Chhugani – Investment Analyst at Alliance Bernstein.
Gautam works out of Bernstein’s Singapore office as Senior Analyst leading the financial sector. Our conversation covered several topics. From his varied professional background at Mckinsey & Co to venture capital and how other influences have helped him be a better investor. Why retail investors should do their own stock picking. How he gets his best investment ideas. His thesis on the most controversial asset class in recent times, cryptocurrency.
Anoop (TCI): Hi Gautam, Thanks for taking the time today. You’ve had a ton of diverse professional experience. Can you talk a little bit about your background and the path you’ve taken up to this point in your life?
Gautam: Hi Anoop, thanks for interviewing me. I have moved from investment banking to consulting (with McKinsey) to venture capital/private equity to public markets with Alliance Bernstein. I did my CA and did my MBA from ISB.
I have always ended up taking up roles in organisations that I admired and saying yes to people I liked interacting with.
However, what has connected all these opportunities together has been my interest in financial services as a sector. I have also naturally gravitated to investing and capital markets. I also like working in areas where psychology matters – so markets give me that psychological laboratory to experiment and learn. I enjoy markets a lot for the same reason.
TCI: Management Consulting to Venture Capital to Institutional Investing / Asset Management. Must have been quite a ride. What about institutional equities called out to you?
Gautam: I like observing that in the real world, markets can be very inefficient versus what is taught to us in finance textbooks. Venture capital taught me to analyze business models and management quality. I find in Equity markets am able to combine my shrewd understanding of business and management quality with investor psychology to find interesting ways to make money.
Sometimes, everyone knows it is a great business but investors want to find the next best thing and end up undervaluing the longevity of a great business. Sometimes, investors get over-optimistic about turning around a broken business or weak management and the market never rewards them.
I find all of this very fascinating. Human illusion and delusion is my favourite area of research. I find markets are full of such examples which makes it a fertile place for me to thrive.
TCI: What were the consistent themes across these professions?
Gautam: As I mentioned, the consistent theme has been banking and financial services as a sector of specialization. I also enjoy the interplay of technology and finance because finance has never changed beyond financial engineering. I believe the next milestone of disruption will be in high street finance.
In terms of learnings across these professions, I have consistently learnt that most things are about how do you define ‘good quality’. It could be a good quality business, good quality founder and management team. It could be a good quality operating model.
If we spend 80% of our time sharpening our understanding of quality, then whether we invest in public markets or private markets, the outcome is always great.
I believe my diverse exposure has helped me sharpen my definition of ‘quality’ day by day. To me, that is the consistent theme.
TCI: How does finance and investment theory from Business school carry over to real-world investing? In other words, to what extent does your work today rely on the Efficient Market Hypothesis, Modern Portfolio Theory and other concepts we learnt in finance courses?
Gautam: The basics of investment theory matter more vs complicated CAPM, efficiency theory. So basics of cash flow, good accounting, your ability to read quality business from the balance sheets matter more. I think accounting matters more than finance theory. Understanding the flaws of accounting are equally important so that you know when you are being taken for a ride.
The other basic theory that matters is ‘Probability theory’. Higher probability of success should mean more conviction which should ideally result in higher capital allocation. Simple ideas matter more than complex academic theories. Again, psychology of fear, greed, biases, human delusions matter
Self-education and practical learning (by falling) is more important in investing than any other formal education.
TCI: Coming to your current role, what does an analyst at a firm like Bernstein do? Keep in mind that for the regular person, it can get confusing to differentiate between Fund Managers, Wealth Managers, Brokerage Research Analysts and so on.
Gautam: Fund managers make investment decisions about stocks or decide portfolio allocation – whether they are hedge funds, PMS fund managers or at a private bank. The size and nature of money changes but the core decision-making function is the same. Brokerage analysts help Fund managers in the investment process.
Fund managers tend to be sector generalists. Analysts are sector specialists and hence by definition more clued into the depths of the sector. You should see Analysts as Sector specialists but with a strong investment lens and they use that expertise to drive a better investment process.
As a Sector analyst, you understand business models, you know and assess management teams, you understand the impact of technology and competition. Sometimes, you highlight governance issues within companies. You leverage all of this knowledge/insight to drive high-quality investment decisions within your sector. As a publishing Analyst, you also propagate your views by publishing and influencing the investor community.
I see my role in 2 parts – one is building investment insight or a point of view and the second part (which many miss) is influencing the investor community to my point of view. You do the influencing by publishing high-quality research, meeting investors and influencing their view, and working intimately with fund managers as they take investment decisions.
TCI: From what you just described, Institutional investment managers not only have smart folks specializing in specific sectors, they also have access to management, swanky Bloomberg terminals, databases and tools the regular investor does not. Given these structural advantages, should retail investors even try doing their own stock selection?
Gautam: I actually disagree that retail investors should not indulge in direct stock picking. I believe the rewards of learning direct stock picking are so great, that every retail individual should learn to invest (within their own limitations). I believe investing is eminently learnable. But there are some ground rules of learning investing.
Swanky terminals have zero impact on decision making. In fact, management interaction is also no advantage as management teams are constantly giving interviews. Recorded analyst and investor calls are easily available to anyone who’d like to read them. I get the best investment ideas when I am alone walking in a park versus when I am in front of a terminal.
From my experience, these are the ground rules of learning investing:
- Decide businesses/sectors that you intuitively understand by virtue of your unique experience or your personality e.g. my mom really understands food businesses well just because she is interested. She has no training in investing but her insights are really good.
- Spend time learning and reading investing books. But practically, study companies and stocks that made money historically to understand the core ingredients of those companies. Don’t just study stocks but study companies as well. You will start building your favourite investment styles
- When you start direct stock picking start pathetically small in amount. So that if you lose money, it doesn’t change your life
- But when you lose money, take the lessons from that as seriously as you lost a fortune of a million dollars
- I am confident through reading, practical observation, losing money (hopefully very little) and iterative learning, you will start honing your instincts to become a better investor. It is not easy but as I said it is learnable. Investors should see this as learning any other skill e.g. Building muscles in the gym. Finally, everything is muscle memory and training.
TCI: Sounds like you recommend a learn-by-doing approach to investing. What is your own investment philosophy? What are the criteria that make a company a candidate for your portfolio? How have these criteria evolved over time?
Gautam: I look for the following elements in my investing ideas:
- Huge market opportunity with a decade or more of a runway
- Find a company that is leading the market or find a company that is creating a market that could be huge in the next 5-10 years
- Other investors are under-estimating the long runway or not believing that a new/less known company can execute
- Build conviction on the uniqueness of the business model or exceptional talent that lies within the management team
- You want to find these opportunities early in their lifecycle (or listed lifecycle in capital markets) or you want to find markets that are early in their life cycles.
- There is no better substitute for making money by being early. Or having the faith before the crowd follows
These are some of the elements – But I like a combination of fast growth, inflecting market, exceptional management talent (almost sounds too good to be true) but the skill lies in being early to it before every other investor has discovered it. You get paid in the market for having a firm conviction while others are scrambling away building theirs.
TCI: That’s a comprehensive framework. Interesting that you also listed others having a negative view as one of your criteria. Now, who are the top three investors and/or books that have influenced your investment-thinking the most? How have they influenced you?
Gautam: I love Fisher and his style. His book Common stocks and uncommon profits is a great read but his book/notes on ‘Developing an Investment Philosophy’ is much lesser known than his popular book. I learnt a lot more from the latter. I believe developing your personal investment philosophy is most important. Personal investment philosophy should be seen as an investment style personalized and customized to your natural instincts, biases, even personality flaws. This makes you a successful investor just through the mere process of self-awareness.
I follow whatever Chamath Palihapitiya (@chamath) is up to with his firm Social Capital. I believe following Buffet from another era may not apply to investing in the digital age. We need new investing heroes – I find Chamath amazingly insightful, innovative, articulate and very bold in a new connected world.
I read J Krishnamurti, who actually does not talk about investing but is an amazing thinker/philosopher. He is all about embracing the reality of life. Investing is a lot about objectively understanding and viewing reality.
And finally, learn investing by doing, falling, dusting out and trying again. No investment guru can substitute learning by iteration.
TCI: I find the phrase you’ve used ‘learning by iteration’, is a powerful one. Based on what you’ve seen in the markets, what is the most counter-intuitive piece of advice you would give an investor starting out today?
Gautam: Try not following Buffet verbatim. It may become commoditized as every new investor is asked to follow his writings. Plus Buffet himself is trying to adapt to a new world i.e. investment in Apple and Airline stocks. I believe a lot of Buffet’s principles are valuable but don’t try to build what he did in a different world. We are in the information age and Buffet invested in the industrial age.
TCI: Now that’s not an opinion you hear every day. Let’s talk about another controversial concept. You wrote an interesting article on cryptocurrency “Is Bitcoin Money?“, and have been a proponent of its potential on your twitter feed. How should the conventional investor, who looks for future cash flows as a means to value an asset, think about cryptocurrency. Where could they go to improve objective understanding of the topic?
Gautam: Cryptocurrencies and public blockchains are global trust systems and crypto tokens are mechanisms to incentivizing and securing those trust systems. Talking of trust systems, markets are trust systems where multiple parties have to build consensus and trust. Thus, any application that requires global/local scale trust can be on the blockchain. Now, this is evolving technology, so blockchains are far from where we want them to be on efficiency and performance without compromising security. But blockchains are not companies with cashflows. Hence, intrinsic value does not apply here. There are some lessons from network effects from internet businesses but again in a decentralized blockchain world, those lessons do not fully apply. I believe to understand blockchain, you start from a zero base. Erase whatever you understood about corporate finance and centralized systems and start learning fresh. Begin with Bitcoin – read the Bitcoin whitepaper and go through this resource put together by Jameson Lopp here – https://lopp.net/bitcoin.html
Then extend that understanding to Ethereum and other public chains. Like everything you build your understanding block by block and crypto is no different. But important in crypto is to ignore the cynics and start learning with no biases. Don’t start by saying I don’t believe in Bitcoin because it is volatile because some Nobel economist says so. Take a step back and think if the world will build new applications for a volatile decentralized currency like Bitcoin.
TCI: This has been a lot of fun Gautam. Thank you for sharing your insight and candour. I look forward to continued learning from your experiences in capital markets.
Gautam tweets @GautamChhugani