Lessons

from
Investment
Gurus

KASB Research
Lessons from Investment Gurus
Mark Mobius – the father of emerging markets.
Peter Lynch – the professional investor.
Warren Buffet – the legend of long-term investing.
Sir John Templeton – the adventurer.
Ray Dalio - the principled investor.
George Soros - the speculative trader.
Jim Simmons - the mathematical genius.
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Foreword from Team KASB
In this book we have tracked investment lessons from the careers of seven
investment legends. We hope that this book will help our clients gain insights
into the techniques and investment framework used by some of the leading
investors in the world.

One of the main reasons why only a few people invest in Pakistan is lack of
financial education. Most people feel that they have no knowledge of how to
invest and consequently feel compelled to follow the advice of others. We think
investment is a basic education which is now a necessity for everyone.

The times of guaranteed job till retirement and social protection due to a
steady pension are gone. Now it is critical for everyone to actively think about
investing, both in order to save for the future as well as to complement current
income.

Most people put their savings in a bank account where they earn less than
inflation. The result is that their savings fail to keep pace with the prices.
Investing is the best way to protect your savings.

At KASB, our mission to democratize investment. This detailed report is a part

our effort to improve investor education and to help our clients. Some of the
important lessons which we learnt from them was to focus on the long term,
diversify the portfolio, do not follow the herd and to make calculated
investments after analysis of the companies.

Our team is available for you to help you manage your savings and thinking
about your investments.
Ten Lessons from
Mark Mobius
Mark Mobius: “Pied Piper o
emerging markets”
Born in 1936, Mark Mobius did his bachelors and
masters from Boston University and later did PhD in
Economics from MIT.

Dr. Mobius is known as the “dean of emerging

markets” for his notable works which span over 40
years with funds totaling $50 billion assets, spanning
17 different markets in Asia, Latin America, Africa and
Eastern Europe. He is currently the founder of Mobius
Capital Partners LLP which focuses on investments in
small and mid-cap companies in emerging and
frontier markets. Before that, Dr. Mobius retired as
executive chairmen of Templeton Emerging Markets
Group. During his 30 years tenure at Franklin
Templeton, he had expanded Assets Under
Management from US$100 M to US$40,000 M. He has
also served as director on Lukoil, chief Executive at
International Investment Trust. In 1999, Dr. Mobius was
selected at World Bank’s Global Corporate
Governance Forum as member of Private Sector
Advisory Group and Investor Responsibility Task Force.
He is also member of Economic Advisory Board of
International Finance Corporation.

Due to his numerous services in the industry, Dr.

Mobius has earned numerous accolades including 50
Most Influential People (2011) at Bloomberg Magazine,
Africa Investor Index Series Award (2010), Top 100 Most
Powerful and Influential People (2006). He has also
penned several books like “Passport to Profits”,
“Mobius on Emerging Markets", "Invest for Good” etc.
Apart from authoring books, Dr. Mobius has written
140 articles on LinkedIn too!
Lesson#1 Advices for youngsters!
Here are some of the advices we have picked from different Mark’s articles:

Explore the World, explore the new Frontiers: “My best advice to you is to
immediately apply for a passport and/or obtain visas to travel to China,
Japan, India, Russia, Brazil and any other countries you can afford to visit
while you are young and carefree”. According to Mark, travel and living with
foreigners not only widens mind but also plays a key role in the future
decisions one can take. Travelling also provides local knowledge, new ideas
and opportunities needed to make a good investments in foreign markets.

Be humble, before markets teach you: “Your success depends on the success
of other people around you, and by helping them succeed you also succeed”
Mark was given a title of “best citizen” in his high school due to his friendly
helpful nature, and was recommended to be a “coach”, which he believes he
has actually in turn become: An emerging markets coach!

Focus on People “Get to know For Mark Mobius his

vocation is avocation
the people around you well:
their problems, their worries and
their passions”. By talking to the
people, one learns about
themselves. Mark strong thinks
that this generation needs to
bring one to one human contact
from their virtual connections.

Keep asking why? “By asking

(such) questions, I’ve been able
to avoid a lot of possible disasters” This attitude really keeps the disasters
away and certainly did for Mark Mobius.
Lesson#2 Invest for Good- Invest sustainably!
“Left to their own devices, companies tend to behave badly because they take
insufficient account of externalities – the incidental impact of economic activity
on unrelated third parties – in their quest for value”

Dr. Mobius in his book “Invest for Good” asked the investors to incorporate
Environmental, Social and Governance (ESG) framework in their investment
analysis. Good ESG practices are not just some philanthropic activities but are in
fact good business practices which increase the stock prices. Hence this lesson is
not only for investors, but for companies as well to change their practices in line
with ESG standards.

According to Global Sustainable Investment Alliance (GSIA) 2018, there have been
$30.7 trillion amounting assets that follow ESG requirements with biennial
increase of 34%. Almost 90% of ESG investing is happening in Europe, US and
Canada. In Asia, increasing number of companies are aware that their profitability
will hit if they don’t comply with ESG standards. KASB in July 2020, did publish a
report on ESG framework on KSE30 Companies.

Globally, MSCI has a rating methodology which ranks companies according to the
ESG credentials. There are 35 ESG Key issues frameworks, that are weighted
according to industries. Governance is the only pillar which is universally applied
to all industries. Each company is evaluated, scored and then rated in comparison
to other players in the industry. It is to be noted that MSCI ESG EM performance
beats the MSCI EM index.
MSCI ESG Ratings framework
Lesson# 3 Emerging Markets and their
growth potential!
“Emerging markets are the financial markets of economies that are in the
growth stage of their development cycle and have low to middle per capita
incomes”.

Being known as the father of emerging markets, Mark Mobius was asked by sir
John Templeton in 1987 to manage the first emerging market fund. Before 1980’s,
there was no proper definition existed for such markets and world was using terms
like “underdeveloped” or “developing nation”. The investment options were a
“Why invest in emerging markets? Because that’s where the growth is!”

IMF predicts annual growth rate for 2021 in Emerging markets to be 6%, while
global average is 5.2% and advance economies are predicted to be growing by
3.9%. What makes these markets promising, is the low base and shortages
creating unfilled demand which makes the growth potential. For example, the
potential of urbanization or internet penetration is much higher in emerging
markets than in the already developed countries. Similarly the capital markets are
yet to be matured, with privatization and higher number of IPOs, there is potential
for volume and value of trades to grow at faster rate than mature markets.
Although recently some of the Emerging markets have matured like China/India,
but lowering growth rate doesn’t mean they don’t have higher growth rates than
developed nations. Some of the factors which Mark look in emerging markets in
comparison to developed economies are: accumulation of foreign reserves, lower
Debt/GDP ratios, strong fund inflows, growing investor confidence, higher returns
compared to bank returns, stocks being undervalued by their global peers. Until
these are present, emerging markets have the potential.

MSCI Emerging Markets Index 1987-2019

MXEF Index

MXWO Index
Lesson# 4 Tips on investing in Emerging markets!

Dr. Mobius in his book “The Little Book of emerging markets” and “Passport to
Profits” mentioned about his acronym FELT criteria of entering into emerging
markets:

Fair: Equal treatment of all investors, is there one class of shares or equal voting
rights? How minority shareholders are treated?
Efficient: Rapidness and efficiency in sale of stock and also the regulatory
efficiencies in a country.
Liquid: Sufficient turnover and volume for not only able to easily buy but also able
to sell shares.
Transparent: The quality of financial reporting in the annual reports and availability
of information.

Below are some tips from Mark Mobius:

Value investing undercovers the potential if used in the long term horizon and
incorporates the future.
Buy wet (liquid) stocks in wet (liquid) countries, not dry (illiquid) stocks in dry (illiquid)
countries.
It always pays to go with locals.

When everyone else is dying to get in, get out, when everyone else is screaming to
get out, get in.
You don’t maintain high performance by holding on to old blue chips that are no
longer blue. Find the next batch of blue chips before they turn blue.

Low-tax economies tend to be good places to place your investment dollars.

Both bottom up and top down research are good.
Other sources of information could be customers, staff of the company and it’s
competitors.
If the net asset value (NAV) divided by the number of shares gives you a dollar figure
higher than the share price and the company has competent managers, then you
could consider it an undervalued stock (Mobius).
Lesson# 5 The best time to invest is..........!

“The best time to invest is when you have money” – John Templeton requoted by
Mark Mobius

This lesson was a joke made by sir John Templeton in an investment conference
when a woman asked him about when to invest her inheritance money. Dr. Mobius
realized the depth of his words and conducted a historical study for markets where
he found that:

“bull markets have gone up more, in percentage terms, than bear markets have gone
down, and bull markets have lasted longer than bear markets. So, if your “dollar cost
average,” meaning that you systematically invest the same amount each month or
each quarter over a number of years, you would have found that over the long term
you were in a bull market more than you are in a bear market. And, while past
performance is not indicative of future results, historical studies show that, in
percentage terms, the bull markets have grown more than the bear markets have
declined. In addition, if you have the discipline to continue adding funds during those
bear market cycles, that same amount of money would’ve bought you more stocks.”
– Mark Mobius, 2013

So even if you make small, but consistent investments over the period of time, your
value of equity will grow with at least a factor of inflation if nothing.
Bulls and bears in KSE 100 Index bulls and bears since 2008
Lesson# 6 Take on Active vs Passive debate!

Merits of passive funds and ETFs:

• Low commission fees.
• Diversity as portfolio follows Index
• More Intraday liquidity for ETFs as compared mutual funds settling at day end
Mobius take: “if you are in a bull market and believe it will continue to move up
consistently, then passive investing in a diversified index fund is attractive” This
means that investor can leverage the highest upturn without any incremental costs
as compared to a risk averse active investor.

Demerits of passive investing, case for active investment:

• More weight on blue-chip companies, and less weight on small growth stocks
with lesser market capitalization.(You must be loosing out on future blue-chips!)
• Risk in the Intra-day liquidity of ETFs in bear markets.
Mobius take: “Just as an investor will benefit from the bull market rise, they will
also suffer the consequences of overvalued stocks during bear markets.” Mark has
explained in his article that companies with large index weights will face greater
selling pressure in the bear market and thus it would result in major hit in the ETF or
passive funds who will follow the index. There would be large selling pressure by
passive funds algorithms, who would hit the circuit breakers, making investors to sell
at lower prices than NAV of the fund. Perhaps that’s where Mark thinks that active
investment has role, despite the growing popularity of passive funds who have
growing positive inflows.

Passive vs Active Funds (USD Trillions)

Lesson# 7 Inflation? The system is broken!

Mobius in his book “The inflation Myth and the wonderful world of deflation”
explains the “political nature” of inflation and it’s measurements which are a center
of attention for government policies like Interest rate and money supply decisions.

In this book, Dr. Mobius discusses history of inflation and how governments
manipulate these measures to cook the numbers they would like to see in regulating
economic programs like social security, insurance payments which can have million
dollar impact in the political agenda and in turn affect the voting and election results.

Furthermore there are extreme difficulties in measuring the inflation itself, which
makes one question the reliability of “basket of goods” and their changing nature
overtime in consumption patterns. Another, issue in the measurement of inflation is
the error of currencies, which are “continually debased by the governments who use
them”.
Curious to know more, check this book out!
Mostly deflation only has negative
connotation, because economist believe
in direct relation between inflation and
economic growth (y), and this growth is
engineered by statistics departments
who come up with 2% inflation target in
developed countries. This is not a
necessary condition to stimulate growth,
as according to Dr. Mobius, growth is
going to come any way in the economy
as a result of innovation and technology
which is increasing productivity, deriving
down the cost of goods and services
because of the supply side increase.
Lesson# 8 Your best protection is diversification!

“Unfortunately, many investors have Best performers count (1998-2012)

portfolios that invest in only one country…
their own. I see this as a big mistake
because they are missing out on potential
opportunities all over the globe, which is the
job of my team and I to uncover.”

Diversification for an international markets

fund manager is not only limited to putting
weights into the different industries and
companies. It also crucially involves
diversifying portfolio risk across different
geographies where there is low correlation
with each other. This is where Mark builds his
case for active management and job of fund
managers. He studied the data from
1988-2012 to examine 72 different stock
markets and according to him:

“There wasn’t a single market that was the

best performing for two consecutive years”

This builds the case strong for country based

diversification. More surprising to Mark was
to find that “US and China didn’t make it to
the list” in these 25 years. This shows that in
the world of equities some of the most
comfortable places are not always the great
places to invest and it doesn’t actually hurt by
being “being different”
Lesson# 9 Make volatility your friend!

“Any progress requires risk, since progress is made by moving into the unknown or
the unexpected, with the possibility of making mistakes. To make progress we must
be able to adapt and diversify so that any one mistake will not destroy our entire
portfolio”

Investing in the emerging markets has been considered risky. One proxy for risk is the
volatility in the markets. With illiquid markets, the buy and sell spread is high, and
which means that with little selling pressure, prices can drop crazily, while on the
other hand with just a few buys, prices can be rocketing too. This is good and bad
both! Volatility is also seen in the mature emerging markets and even developed
markets too, because of high velocity trading and speculative trading etc. This means
that volatility comes part and parcel with all the markets and assets, and what one can
do is to make it a friend. Apart from diversification or hedging techniques, what is
more needed in the making the right investment decisions is a good psychological
sense of events creating volatility in market. For example, the world currently is in the
Covid recovery phase and everyone is talking about V shaped recovery, if you were a
global fund manager, would you question about how these would vary country by
country, if so then why? Such are the small questions, which answer the big picture!

“If you can look beyond the emotional roller coaster of the volatility and use it to
your advantage, you might be able do rather well on your investments”.
Lesson# 10 The World Belongs to Optimists!

“The world belongs to optimists. The pessimists are only spectators.” François
Guizot, requoted by Mark

In the end, you cannot explore new frontiers unless you have optimism to do so. You
cannot move ahead of the crowd, nor you can see the gap in the macro and micro
view, unless you are optimistic and daring to do so. People like Mark Mobius go the
extra mile to look at the big picture and connect the dots at times of uncertainty. Mark
did it by exploring the emerging markets, he saw the fall of communism an
opportunity rather a disaster! He got the first mover advantage at many Frontiers
which were not recognized by the world. Mark always ask people to come out of
comfort zone and look for potential opportunities in the problems. After all this,
optimism not only helps one in going ahead in life, but is also a good way of keeping
yourself physically and mentally healthy!

“If you can look beyond the emotional roller coaster of the volatility and use it to
your advantage, you might be able do rather well on your investments”.
Must Read books by Mark Mobius
Must Read books by Mark Mobius
Ten Lessons from
Peter Lynch
Peter Lynch:
Born in 1944 at Massachusetts, Peter Lynch is a legend known as the most
successful fund managers in the history. Lynch graduated from Boston College in
1965 and later did MBA from Wharton School of University of Pennsylvania in
1968. Lynch started his investment career as an intern in Fidelity in 1966, he
joined Army for 2 years, then ultimately joined Fidelity and to date has association
with it, as Vice Chairman Fidelity Management & Research Co.

In 1977 at age of 33, Lynch was given responsibility to head Magellan Fund at
Fidelity. This turned out to be the career mark for Lynch who made Magellan
Fund the best performing mutual fund in the world with 29.2% annual return in
the period of 1977 till 1990. From $20 million, Lynch grew the fund’s assets under
management to $14 billion. This Fund had a rock star performance in 1987 U.S
market crash. This was a record making growth ever seen in history of asset
management and making the industry of mutual funds popular.

Peter Lynch has also penned down three books on investing where he talks
about his strategies and philosophies which he applied at Magellan Fund.
Currently, his net worth is $450 million. He has also been a philanthropist and the
founder of Lynch Foundation.
Lesson#1 Your arts major, doesn’t
limit you in stock market!
“As I look back on it now, it’s obvious that studying history and philosophy was
much better preparation for the stock market than, say, studying
statistics…….Logic is the subject that helped me most in picking the stocks, if only
because it taught me to identify the peculiar illogic of Wall Street”

The fact that world’s best fund manager, Peter Lynch studied in an art school at his
undergraduate, might sound bizarre to most of the Pakistanis who can’t think a
career outside of the subjects they are majoring in. In fact, most of the international
banks like Morgan Stanley, Goldman Sachs, JP Morgan & Chase, RBC all welcome
students from diverse educational backgrounds.

For Lynch his part-time work as a

caddie boy in a high-end golf
course, actually developed his
interest in stock market, where he
would listen to people talking
about stocks and later found those
up in newspapers. This work also
got him a caddying scholarship
from “The Francis Ouimet
Scholarship Fund”. With his own
personal savings, Lynch did his first
investment in Flying Tiger Airlines,
by doing research in freights
industry which he thought would
go up in 1960’s. These first 100
shares which he bought at $7 each
later increased 10 folds, making
this his first Ten Bagger. He sold
this to fund his MBA later.
Lesson#2 Invest in what you understand!

“If you like the store, chances are that you’ll love the stock”
“I've never said, 'If you go to a mall, see a Starbucks and say it's good coffee, you
should call Fidelity brokerage and buy the stock.” A few years later, he clarified.

Lynch encourages people to invest in stocks of the industries where one knows
more about than an average person does. This could be because he/she works in
that industry or are frequent consumers of that product. An amateur knows more
about the companies than an analyst, by simply through their daily interactions.
This first hand research and micro level view, is what an analyst cannot get with
hours of research or sometimes aggregate numbers slip the story.

Ironically, many people working in the industry miss opportunities in their

backyard. For example, how many doctors buy stocks of the drugs they prescribed
regularly to their patients? For instance, when Glaxo got approval for a profitable
ulcer drug in 1983, it stock was $7.5 and it went to $30 in 1987. Be it doctors running
pharmaceuticals or computer engineers, running Tech growth firms, these people
know their industries and forthcoming change in the demand & supply drivers
roughly “6 months before” any professional in the wall street!

A writing of Peter Lynch hinting how doctors

and patients missed an investment opportunity!
Lesson#3 Do your own research!

“Investing without research is like playing stud poker and never looking at
the cards”

ne shouldn’t just simply go and invest blindly in the company just because it’s
product is selling. The right question to be asked is: “What effect will the
success of the product have on the company’s top & bottom line?” Does the
product actually contribute to a major proportion of revenue for the
company? And if so, then does it actually trickles down to the bottom (profit or
earnings) of the company? Here are some homework tips:

Attend the Analyst Briefings, Investor presentations and quarterly earning

calls.

Simply buy just 1 stock of the company and attend the shareholders meeting.

Call to the company and network with people to better understand the
balance sheet, which you are going to own. Peter whenever interviewed CEOs
asked them a question: “which company impresses you the most?”

Check out the credit ratings of the company (PACRA and JCR-VIS in Pakistan).
 Lesson#4 Individual investors are
more capable than Fund managers!

In his book “One Up on Wall Street”, Peter Lynch mentions that individual
investor can beat the analysts of wall streets. According to Lynch, the
professional investor has many disadvantages compared to an amateur:

i. Large Size: The larger capital funds mostly don’t care for smaller value
projects, which can have higher growth. Individual investors don’t have
denomination or agenda issues. Most of the funds have market capitalization
restrictions When Lynch started, and the size of the fund was small or when
the fund grew larger, he didn’t overlook small size cap companies.

ii. Justifications: Fund managers spend 25% of their time explaining their
decisions, while individual investors are only accountable to themselves. There
are no rules and regulations like “can’t buy non-growth industries” holding
individuals back.

iii. Capital dependency on clients: who take out money in bear and put in at bull.
This makes fund manager have more money when stocks are expensive and
lesser money in cheap.
Lesson#5 Catch a stock before any
Analyst coverage eyes it !
When I talk to a company that tells me the last analyst showed up three years
ago, I can hardly contain my enthusiasm.

Portfolio of Magellan Fund, had stocks of unknown companies like Taco Bell,
Dunkin Donnuts. Lynch in Magellan Fund adopted this simple strategy to find the
stocks which are yet untapped by the Wall Street where approximately 3000
stocks are listed.

One way to weigh the coverage is to check the ownership summary of the stock
and look at the % of stocks owned by the institutional investors. If say 50% of the
stocks ownership is coming from the institutional investors, then it is a hint that
stock is widely followed. If large owners are institutional insurance companies then
that means owners don’t know the industry. On the other hand, overlooked
companies have a large proportion of stock owners as founders that is for them
“skin is in the game” and there is no conflict of interest between management and
investors.

One of the strategy which worked for Lynch was to invest in small cap stocks which
had niche and potential to grow. (Note: They are risky too!) Big companies like P&G,
Coca-Cola, GE don’t see the quick jack-pot jumps in their stock prices in very short
horizon period. In fact a company as big as GE back in 1980s was so fat that it
actually represented 1% of US GNP. Will the stock of such company move in inches
or jumps is the question which Lynch wondered, especially in a term.
Lesson#6 All investment opportunities
aren’t created equal!
“Keeping track of the growth rates of industry is an industry in itself”

Lynch emphasises a lot on getting to know the size of the company and divides
them in six categories.

1. Slow growers: Have large market share in a mature industry with low
growth which is probably equivalent to the GNP of the country. The only
purpose to invest in these is high dividend yield.

2. Stalwarts: They are medium paced growth companies with an average

earnings growth rate of 10%-12% a year. Under normal conditions one sells
these companies quickly if they make a 30-40% gain on it. Keeping some
stalwarts gives protection at times of recession.

3. Fast Growers: New enterprises growing with 20% or more per annum. If
the growth is sustainable they are the actual 10 to 40-Baggers. In 1970’s
Taco Bell, The Gap, Wall mart were the fast growers. However there is risk,
as small fast grower might risk extinction or fast growers can go plateau in
future.

4. Cyclicals: These are companies whose revenues and profits fall with
business cycle. Demand of such goods and services providers decline
when there is slump in the economy. E.g automobile, airlines, steel and
chemical industries. Buying a cyclical at right time is the key.

5. Turnarounds: Zero growers, declining earnings and problematic balance

sheets. However, if there is an upward turnaround or revival, then
stockholders are rewarded. If up, they are like the opportunity in crisis.

6. Asset Plays: Situations where markets have missed out something

valuable that a company owns. Assets like real estate, patents, natural
resources, subscribers which are undervalued by market. Look for
companies who have asset value higher than market cap.

Lynch notes that stocks over the life don’t remain in one category as it is a matter
of time that “highfliers turn to low riders” or vice versa. Also there is no one general
maxim of investing which one can apply to different categories of stock.
Lesson#7 Growth At a Reasonable
Price (GARP Strategy)
Growth investors, invest in companies that are traded on high P/E which basically
means that market is overvaluing the company on it’s existing earnings in an
assumption that it’s growth in future will make the current price paid very less
compared to it’s future earnings. Growth
investment get’s risky if the assumptions about
growth do not prove and market had overpriced
the growth as it happened in 2001 Dot Com Bubble
burst.

Value investors, invest in companies that trade on

discount to their intrinsic value (note: intrinsic
value is not similar as earnings, you can take
growth into the intrinsic valuation like Warren
Buffet who thinks growth and value as “hip-joints”). However, contrary to growth
investors, these investors find undervalued stocks with lower P/Es.

Lynch popularized GARP investment approach which uses the tenets of both
Growth and Value investing strategies. It takes the advantage of share price
increase from high growth companies, but it does not blindly accept “growth at
any price” and rather focuses on avoiding the overpriced stocks and looking for
growth stocks selling at discount to their value. Lynch gave a rule of thumb that:
“The P/E ratio of any company that's fairly priced will equal its growth rate“

PEG ratio is a valuation metric which tells about the stock price (P), earnings per
share (E) and expected growth rate (G) of a business. PEG ratio of less than 1,
means that P/E is lesser than growth, and thus the stock is undervalued. However,
PEG, itself has limitations if earnings growth forecast is not correct, or P/E ratio is
lower because of inherent risk in the company making one think the company
being undervalued.
Lesson#8 Seek the Ten Bagger stocks

Lynch has first coined this term “Ten Bagger” in his book “Up On The Wall Street”.
Ten Baggers are the stocks whose market price can make 10x times or more from
their purchase price. In market there are many Ten Baggers, but not many investors
are able to find these stocks. It is not necessary that every stock in the portfolio
performs well, but for a winning portfolio, these Ten Baggers are the lifters.

You have flops. Maybe you're right 5 or 6 times out of 10. But if your winners go up
4- or 10- or 20-fold, it makes up for the ones where you lost 50%, 75%, or 100%.

Here are some traits of the Ten-Baggers which might surprise you:
• Can have ridiculous and boring names like Peb Boys, Manny, Moe.

• Does something, which everyone is not yet excited about or is depressing.

Lynch invested in a burial service company with good records but was
shunned by Wall Street for years!

• Institutions and analysts have yet not discovered them.

• Is a spin off of divisions.
• The industry can be in no-growth phase. Burial industry had a 1% growth
rate, but Lynch saw an established company in that industry having no
rivals.
• The company has the niche or you say economic moat.
• The revenues of the company are recurring.
• User of Technology, even if it’s not a Tech company.
• Insiders are holding it in great proportion.
• Company prefers share buybacks than dividend payouts
Lesson#9 Don’t invest in a reverse Tenbagger
“If I could avoid a single stock, it would be the hottest stock in the hottest
industry”

Here are some traits of the stocks which Lynch wanted to avoid, which might
surprise you:

• Everyone want to be in that industry. Its kind of hot industry with explosive
growth which if not realized, the stock prices fell as rampantly as they rose.
These hot, the next big something industries are widely followed and attracted
the best of the brains to compete. In 1960’s Xerox was the hot stock, in 1972 it
was thought to be growing to infinity but we all know what happened to Xerox
when other players entered with innovations.

• Unrelated Diversifications. Lynch called these “Diworseifications” due to

getting into the unknown industry and overpriced acquisitions.

• Revenue dependence on single or few customers. Always check the revenue

streams of the company and it’s customer risk. One should be cautious if a
single customer accounts for 25% to 50% of the entire sales.

• A whisper stock. These are the stocks that have a lot of stories without
substance and one should really avoid them.
A writing of Peter Lynch showing how
expectations explode and burst
Lesson#10 Timing the market???
“If you spend more than 13 minutes analyzing economic and market forecasts,
you've wasted 10 minutes.”

"Far more money has been lost by investors preparing for corrections or trying to
anticipate corrections than has been lost in the corrections themselves”

For Lynch, the best stock is the best company, and best companies outperform the
market regardless of what the economy is doing. He believed in buy-hold investing
strategy as stocks are more predictable in 10-20 years. He was an active investor but
didn’t time the market. Instead of focusing on “when”, he focused on “what” of the
Buys.

Stock market news going from “hard to find” to “easy to find” and then to “hard to
get away from”, everyone is addicted to short-term investing without them
admitting! Hence in the world where people look at daily financial weather
forecast, one should look for the long-term financial climate change instead.
Books by Peter Lynch
 Ten Lessons from
Warren Buffet
Warren Buffet: “The Oracle of Omaha”
Born during 1930’s stock market crash in a U.S state of Omaha, Warren
Buffet currently is the fourth richest person in the world with over
$78.9 billion net worth (Forbes Billionaires 2020). In the world where
Finance is taught at Universities mostly, Buffet purchased his first
stock at age of 11 and filed his first tax return at age of 13. Warren
studied from University of Nebraska and Columbia Business School,
He is CEO of Berkshire Hathaway, a holding company which owns
70-80 independent businesses. Before Buffet acquired it, Berkshire
Hathaway was a dying textile manufacturing firm which he turned
into 8th largest public company (Forbes Global 2000).

Warren Buffet investment philosophies were influenced by his

professor Ben Graham at Columbia Business School, which made
Warren adhere to the concept of “value investing” and
“Founder-centricism”. In 2009 Warren Buffet and Bill Gates founded
“The Giving Pledge” a philanthropic campaign for billionaires around
the world to donate at least 50% of their wealth. Warren Buffet himself
has pledged to donate 99% of his wealth.
Lesson#1 Enterprise, money management
and saving habits – Have no age or class!
Well, this is what Buffet doesn’t speak directly but is a key lesson reflected in
his early life- which was the stepping stone in making him the future
idiosyncratic alpha of the Walls Street like no one else.

In his HBO bibliographic documentary (Click here to watch), Buffet mentions

about his early childhood times when he used to sell stuff like newspapers
door to door, read books like “1000 ways to make a thousand dollars” and
“The world of Almanac”. Just imagine a kid calculating demand for weighing
machine business on streets and estimating time required for it to
compound his savings to buy another weighing machine. Was he an outlier?
Yes. But can this positive outlier habit and values be adopted and taught?
Certainly yes!

These saving habits and frugality

in living style are what continued
later in life of Warren Buffet who
still lives in the first house he
purchased back in 1958. He had
the drive to enterprise and earn
from the very early age, which
came handy latter in his life.
Buffet’s early and later life
examples show, that people from
all walks of class, be it students or
stay at home moms can have
financial literacy and money
making skills. And fortunately
that doesn’t require one to be a
finance professional!
Lesson#2 Buy stocks as if you are buying a
business and not a piece of paper!
“When investing in business we view ourselves as business analysts—not as
market analysts, not as macroeconomic analysts, and not even as security
analysts”

What makes Warren Buffet extraordinary is the fact that he is an excellent stock
picker in the long term. Long term stock picking can’t be good, if one is not
assessing the business from an owner’s point of view. This ownership approach
in the business, is needed to ask the right set of questions like:

• Is there consistent earnings history?

• What are long-term prospects?

• Is Return on Equity good, with little debt?

• Is management competent and will it behave in the right way?

• Is profit margin thick and sustainable?

With this in mind Berkshire invested in stakes of companies like Coca Cola,
Gillete, Wells Fargo, Heinz which he believed were the companies which would
have good sustainability in long term.
Lesson#3 To identify the right company in
the industry, check the “economic moats”
“What we're trying to do is we're trying to find a business with a wide and
long-lasting moat around it, surround -- protecting a terrific economic castle
with an honest lord in charge of the castle”

The principle of “economic moat” was first termed by Warren Buffet in

Berkshire’s 1995 shareholders annual meeting. He called this as something
which keeps the castle standing for 10, 15 and even 20 years.

According to Buffet, economic moat is the a distinct advantage a company can

have over it’s competitors which ensures higher above the average market
share and profitability. This could be for one or more reasons like technology
advantage, patents, brand identity, lower production cost etc.

After identifying the moat, Warren buffet assesses how strong the moat is and
how long can it stand? If a business passes this stage then the final
management quality check is made and business is bought at the discount.
Lesson#4 Look for undervalue stocks at
right time - The philosophy of “value investing”
“In short term stock market behaves like a voting machine, but in the long
term it acts like a weighing machine” Benjamin Graham requoted by Warren.

Warren’s investment methodology is heavily influenced by his professor

Benjamin Graham, who is known as “father of value investing”. This school of
thought has a dictum to buy stocks that are trading at discount from their
fundamental intrinsic value. This is the margin of safety for the investment.

In 2008 Lehman Brothers collapse and the resulting credit crisis, Warren Buffet
wrote an NY Times op-ed headlined “Buy American. I am” where he quoted:

“Be fearful when others are greedy, and be greedy when others are fearful.
And most certainly, fear is now widespread”

Although he was early in his optimism, Berkshire investments in 2008 crisis after
some doldrums do turn good investments like GE and Goldman Sachs’ preferred
stocks.

Source: “The Warren Buffet Way”

Lesson#5 Low cost passive Index Funds
beat high cost active Funds.
“Active investment management by professionals – in aggregate – would over
a period of years underperform the returns achieved by rank amateurs who
simply sat still” (Berkshire 2005 Annual Report).

In 2009, Buffet made a bet wager of $500,000 at Long Bet platform with Hedge
Fund managers, that low cost Vanguard S&P 500 fund would beat the active
hedge funds in 10 years period. Five funds which invested in over 100 hedge
funds, were selected to reflect a single manager’s performance in the industry.
These funds of funds delivered only 2.2% compounded annual return while index
fund gave 7.1% till 2016, making Buffet won the $million bet.

Buffet thinks that “2 and 20” standard of Hedge Funds, i.e. charging 2% annual
fees irrespective of losses and 20% of profit for the year irrespective of losses in
future year, has made investment professionals richer in the aggregate level
underperforming investments. This leaves client in aggregate level worse off
than if they would have simply invested in an unmanaged low-cost index fund.
Lesson#6 Value investment beats the market
opposition of Efficient Market Hypothesis
Warren Buffet in 1984, published an article named “The Superinvestors of
Graham and Doddsville”. This was based on Buffet’s speech contest in Columbia
University against Michael Jensen who was a proponent of theory that markets
always correct themselves (are efficient). Michael used the coin flipping
experiment, and proposed that return of actively managed funds are same as
guessing the outcome of coin tossing. There would be small number of people
“by luck” who would get the heads or above average return.

Warren Buffet, built on Michael’s illustration of coin flipping and added that a
large proportion of those small number of investors who earn above the average
return are the followers of value investing school of thought. He presented 9
value investing Funds including his own company, as shown in the table, who
did beat the market return.

Hence for Buffet, to beat the market is not actually a random chance event but a
strategy to “look for value with margin of safety”

Source: The super investors of Graham and Doddsville

Lesson#7 True investors are calm and patient!

“Unless you can watch your stock holdings decline by 50 percent without
becoming panic-stricken, you should not be in the stock market” (The Warren
Buffet way)

Warren Buffet’s definition of risk is not the same as most of the stock market
analysts. As long as the business is doing good and has a good future, the idea of
dipping stock prices is actually considered as opportunity by Buffet to increase
holdings profitably. Hence, the right investor is a calm person who does not
distort his detailed judgements about a business from the short term market
noises, but rather sees them as an opportunity. Graham termed such people as
“Mr. Market” while Buffet called it “can’t miss the party” infection of wall street at
his Fortune interview in 1999.

This draws to psychology of misjudgement and many behavioural finance issues

like overreaction, loss aversion and mental accounting. What Buffet does is to
avoid the psychology of misjudgement and to adopt the psychology of value
investing which profits from the mistakes of the others, especially Mr. Markets
Lesson#8 Reinvestment in the business is the
best value to shareholders!
In the Letters to shareholders 2019, Warren Buffet discussed about the power of
retained earnings as:

“There is an element of compound interest operating in favor of a sound

industrial investment. Over a period of years, the real value of the property of
a sound industrial is increasing at compound interest, quite apart from the
dividends paid out to the shareholders”

This is warranted by the evidence that Warren Buffet’s company Berkshire

Hathaway since 1971 has never paid a dividend back to it’s shareholders. Even in
Q3 2019, Berkshire had an excess cash pile up amounting $128 billion but Warren
Buffet had always been an ardent believer creating value by retaining cash. This
value is proved by the fact that compounded annual gain in market value of
Berkshire’s share from 1965-2019 is 20.3% while S&P 500 with Dividends included
only gave 10% return in the same period.

In the end for Buffet, “One Dollar of retained earning, should create one dollar of
market value for a company” (The Warren Buffet way)

A snapshot from NASDAQ

Lesson#9 The exits of Warren Buffet- If you
see no value, don’t invest, slow down!
That (selling) may seem easy to do when one looks through an always-clean,
rear-view mirror. Unfortunately, however, it's the windshield through which
investors must peer, and that glass is invariably fogged- 2004 Letters to Shareholders

Buffet had previously sold stocks like IBM, GE and had keep changing his
portfolio stakes. Even recently, Warren Buffet has been trimming his portfolio
and even with cash piling amounting to $137 billion, he isn’t investing in any of
the “elephant sized acquisitions” like he used to do. During the first quarter 2020,
19 out of 69 stock holdings of Berkshire were sold. One major move was to sell of
84% of Berkshire stake in Goldman Sachs, which he invested in 2008 financial
crisis. This time he has sold most of the banks and all airlines stock holdings
during Covid’19. Now this is contrary to his general philosophy of being
opportunist in downturns and his optimism in 2008 crisis.

But Buffet actually sells stocks when he doesn’t see long-term value in them,
irrespective of how stock market is performing. For example, in airlines he
believes that load factor would not restore to prior levels even after pandemic
end. In his letter he quoted: “the world has changed for airlines”. Similarly Buffet
doesn’t buy stocks and chase equities in his sectors if he does not see any value
at margin.
A snapshot from NASDAQ
Lesson#10 No need to be jealous of lottery winners

“I mean, you know, if they want to do mathematically unsound things, and one
of them occasionally gets lucky, and they put the one person on television, and
the million that contributed to the winnings, with the big slice taken out for the
state, you know, don't get on -- it's nothing to worry about.“

For people don’t get the lottery, should “figure out what makes sense”. For
Buffet, one should be buying stocks whose businesses are making sense. One
should know how and why a stock is generating a return and which factors are
in favor of a business generating extra return. A business like McDonalds don’t
run their franchises by looking at what their quote is in stock market everyday.
Hence, a sound judgement in the long run makes one lucky.

A snapshot from NASDAQ

Books recommended by Warren Buffet
Ten Lessons from
George Soros
George Soros: The man who broke
the Bank of England
George Soros is the fifth legend in our Investment Guru Series. Our
earlier reports have covered Warren Buffet, Peter Lynch, Mark
Mobius, and Sir John Templeton. The earlier four were long term
investors who shared their investment style. They were all contrarian
and were looking for mispricing by finding good companies. George
Soros is quite different.

Unlike the earlier four, Soros made his name for being an aggressive,
speculative trader. He took short term bets mainly in the FX market
which were based on his view on global macro and politics. The
earlier four were mainly long only investors. George Soros however is
known for shorting the markets. This makes him also a controversial
character. Mahatir Mohammad, the Prime Minister of Malaysia,
famously blamed him for the East Asian Crisis. Nevertheless, he is a
legendary investor and has been very successful in his craft.

Soros was born in Hungary (1930) to a Jewish family who refuged to

England during the World War II occupation of Hungary by German
Nazis. Soros did undergrad and Masters from London School of
Economics and a Ph.D. from University of London where he was
student of famous philosopher Karl Popper. Soros has worked in
multiple merchant banks like Singer and Friedlander, F.M Mayer,
Arnhold and S. Bleichroeder. In 1970, he founded Soros Fund
Management, which managed the Quantum Fund, where Soros has
generated exceptional annualized return of 20% in 40 years till 2011.

Soros is known for his massive currency bets and large short
positions. His famous bets against the British pound led to the most
catastrophic financial event in UK’s history which marks down his
name in the lane of history as “the man who broke the bank of
England” by taking $10 billion worth short position on the British
pound. This ultimately resulted in UK’s Black Wednesday Currency
Crisis on 16th September 1992. Other famous bets of his include the
bet against Baht and Yen. Apart from currency speculations, Soros is
also known for his global macro strategies. Soros name is feared and
associated with many conspiracy theories which consider him
mastermind behind many global political and financial events. He
even had survived assassination attempts in 2018.
How did Soros make the Bank of England
Bankrupt? (1/2)
By taking a $10bn short position on the British Pound, Soros led to the famous
Black Wednesday crash on September 1992. Due to the large position against
the pound, the British government was forced to take out pound sterling from
the European Exchange Rate Mechanism (ERM). Black Wednesday led to a
£3.14bn cost to the UK. George Soros made a £1 billion profit in just one month.
On the back of this successful trade, the Quantum Fund managed by Soros grew
from $3.3bn to $7bn within three months.

Background context of ERM: Europe’s ERM was set up in 1979 by the European
Economic Community (ECC) to keep the European economies unified, with their
currencies stable against each other. However, to maintain the peg it was
required that the economic policies be coordinated. Great Britain joined ERM in
1990 with an exchange rate of 2.95 Deutschemark (DM) for 1 GBP with a limit of
2.78 DM to 3.13 DM. This shadowing of the GBP with the German Mark, led to
lower interest rates and high inflation in the UK relative to Germany which made
the GBP fundamentally overpriced. The British Pound only sustained these
levels because of the British government’s guarantee that it would commit
indefinitely to buy pound whenever it will go below the agreed level.
How did Soros make the Bank of England
Bankrupt? (2t/2)
Soros’ currency speculation
Soros’ realized that current low trading levels of the Pound were already
sustained by the central bank and there was virtually impossible for the pound
to go up in price. He initially took a $1.5bn bet and then increased the short
attack by increasing this short position to $10bn. As the market saw this, it led to
a concerted attack by other hedge funds as well. By the time regular market
opened, billions of Pounds were sold making it trade below the mandated levels
of ERMs.

British Treasury tried to buy the pound in the market but the attempts only
resulted in the depletion of foreign currency reserves without any uptick in the
demand. This is a classic, “run on the currency peg”. The second attempt
government took was to increase interest rate by 200 basis points from 10% to
12% but that also failed as internationally the market had faith that pound would
fall further and everyone was trying to cut their losses. The last option left for the
country was to leave European ERM and make it’s currency float in open market.
Caution: You are not George Soros, never take such a bold large short selling
position.
An investor takes a short selling position
when he is confident that price will fall

Sell at High

Buy at Low
George Soros attack on Thai Baht in 1997 (1/2)

In 1997, Soros took a large bet of $1bn on the Thai Baht which eventually
triggered the East Asian Crisis. Once again, he repeated the same trade where
he identified a currency peg and challenged the government’s ability to
maintain it. He was joined by other large speculators such as the Tiger Fund. He
believed that the Government of Thailand had pegged their currency to the US
dollar and the peg was not credible. After 1995, it was apparent that Thailand’s
economic growth had slowed down but despite that the Baht was appreciating
against the US dollar.

Reasons for Bank of Thailand resistance: Thai government officials opposed

devaluation in fear of high inflation resulting from expensive imports.
Devaluation would also hurt Thai companies who had taken dollar denominated
debts without hedging their foreign currency exposures. Baht currency volatility
would also impact the investor’s rate of return and increase the cost of foreign
borrowing.

Measures taken by Thailand government: The Bank of Thailand kept on

purchasing Baht in the foreign exchange market to maintain the peg. Interest
rates were also increased to make borrowing by speculators difficult. Some
other strict measures like restricting foreigner’s access to Baht were also
introduced.
George Soros attack on Thai Baht in 1997 (2/2)

Results were not fruitful: Thailand’s Foreign Exchange Reserves depleted from
$37.2bn in Dec 1996 to $30bn by June 1997, excluding off balance sheet
obligations of $23.4bn in 12 months forward market. Interest increased to 24%
further dampened the financial sector.

Consequently, what Soros predicted, happened: On July 1997, Thailand’s

government abandoned the decade long practice of pegging Thai Baht’s to US
Dollar. Just three months later, Thai Baht depreciated by 60% against USD. This
massive currency devaluation in Thailand triggered sweeping effects on other
South East Asian emerging markets. During the same period, Indonesian rupiah
depreciated by 47%, Malaysian Ringgits by 35% and Philippines Peso by 34%. The
series of events eventually led to Asian Financial Crisis of 1997.

“Prime Minister Mahathir of Malaysia accused me of causing the crisis, a

wholly unfounded accusation. We were not sellers of the currency during or
several months before the crisis; on the contrary, we were buyers when the
currencies began to decline—we were purchasing ringgits to realize the profits
on our earlier speculation.” – George Soros

Thailand Short term Interest Rate and Exchange Rate

Sources: FRBSF
Soros’ Theory of Reflexivity in Financial markets (1/2)

“Markets can influence the events that they anticipate”

George Soros doesn’t follow the fundamental approach of investment. On the
contrary he looks for bubbles. He believes that asset bubbles are a natural part of
the financial markets. In his book, “The Alchemy of Finance”, he put up his Theory of
Reflexivity”. He believes that not only do fundamentals impact prices of assets, but
the prices also impact the fundamentals of a company. This leads to a self fulfilling
cyclical relationship. “Prices can actually dictate fundamentals”. This means that
investors do not base their decisions on reality but their own perception of
fundamentals. These self perceptions then influence the real fundamentals which
in turn influence prices and then again investors’ perceptions, making it a positive
feedback loop.

For example, when a stock price goes up, the market cap increases and that might
help a company get more clients. Similarly, a company whose stock price goes
down might lose clients and struggle to raise debt.

Interpretation of reality influences reality itself Positive Feedback loop continues in the markets
Soros’ Theory of Reflexivity in Financial markets (2/2)

“The concept of a general equilibrium has no relevance to the real world (in other
words, classical economics is an exercise in futility)”
Soros theory of Reflexivity counter runs the classical economics equilibrium theory.
He believes that participants with imperfect understanding and irrational
expectations of world are taking actions against each other, making markets tend
towards disequilibrium more than equilibrium.

Prices persistently are in disequilibrium until they burst. Soros also illustrated this
theory at times of 2008 mortgage crisis where rising home prices increased banks
mortgage lending, and increased lending derived house prices, making a bubble
which would burst when prices deviate too far from the reality.

Classical economic equilibrium Theory of Reflexivity

1. Information becomes immediately available to everyone. 1. People act on incomplete information

2. People are rational actors 2. People are influenced by biases.

3. Economic systems go quickly to equilibrium 3. Social systems display boom and bust

4. A theorist is outside the system observed. 4. Observers are a part of systems observed.

5. Theories do not alter the system. 5. Theories are means to change system described.
Open Society vs Capitalism

Soro’s thinking was influenced by the philosophy of his teacher Karl Popper who
wrote it in his book, “Open society and It’s Enemies” that: no philosophy or ideology
is the final arbiter of truth, and that societies can only flourish when they allow for
democratic governance, freedom of expression, and respect for individual rights.
This concept of open society stems from the idea that our understanding of the
world is inherently imperfect. There is reflexivity in global politics, power and trade.

According to Soros, the biggest threat to open society is market fundamentalism

and issues in the free markets which need to be corrected. He has written books
about the crisis of global capitalism. His biggest philanthropic work is called the
Open Society Foundation where he funds political, educational and social activities
related to free speech and open societies.

This work also attracts a lot of criticism, skepticism and controversy.

In the end, if you think you are going
wrong - correct yourself
I'm only rich because I know when I'm wrong ... I basically have survived by
recognizing my mistakes. I very often used to get backaches due to the fact that I
was wrong. Whenever you are wrong you have to fight or [take] flight. When [I]
make the decision, the backache goes away.

Having opinion on all the major currencies and asset classes of the world is not
easy, especially when you are bombarded every now and then with new
information and events taking place. Soros does “real time experiment” to test
his hypotheses in the markets and records his observations real time to test his
predictions.

Soros is also famous for developing a network which provides him deep
understanding of global politics and how governments function. This allows him
to understand their thinking and reactions and then bet against them.

His macro investment style embraces volatility and market imperfections. He

uses his financial strength and the ability to influence other investors to make
large bets which even the strongest governments can't fight back. In 2013 he
made a $1bn gain by shorting the Yen, which subsequently depreciated by 20%
against the US dollar.

Soros’s trades also show why Pakistan’s policy of keeping the PkR fixed at 100
against the dollar under the previous government was doomed to fail. It was not
credible.
In the end, if you think you are going
wrong - correct yourself
I'm only rich because I know when I'm wrong ... I basically have survived by
recognizing my mistakes. I very often used to get backaches due to the fact that I
was wrong. Whenever you are wrong you have to fight or [take] flight. When [I]
make the decision, the backache goes away.

Having opinion on all the major currencies and asset classes of the world is not
easy, especially when you are bombarded every now and then with new
information and events taking place. Soros does “real time experiment” to test
his hypotheses in the markets and records his observations real time to test his
predictions.

Soros is also famous for developing a network which provides him deep
understanding of global politics and how governments function. This allows him
to understand their thinking and reactions and then bet against them.

His macro investment style embraces volatility and market imperfections. He

uses his financial strength and the ability to influence other investors to make
large bets which even the strongest governments can't fight back. In 2013 he
made a $1bn gain by shorting the Yen, which subsequently depreciated by 20%
against the US dollar.

Soros’s trades also show why Pakistan’s policy of keeping the PkR fixed at 100
against the dollar under the previous government was doomed to fail. It was not
credible.
Books by George Soros
Ten Lessons from
Ray Dalio
Ray Dalio: The man of “principles”
Born in 1949 at Queens borough, New York, Dalio belongs from an Italian
descent. Dalio holds a finance degree from Long Island University and an
MBA from Harvard Business School in 1973. In 1971, he worked as clerk on
New York Stock Exchange floor, which was the time when President Nixon
ended the Breton Woods agreement. He later started working as
commodity futures trader and became Director Commodities at Dominick &
Dominick LLC and later joined Shearson Hayden Stone.

In 1975, Dalio founded a Hedge Fund named Bridgewater Associates in his

apartment. He started off by providing risk consulting to clients for
exchange rates and commodities and offering a daily written market
commentary titled ”Bridgewater Daily Observations”. The scope of the
investment increased and adopted “global macro” strategy. In 1991,
Bridgewater opened a Pure Alpha hedge fund which was one of the first
firms to separate differentials between alpha and beta and earned an
average annual return of 18%. They also pioneered All Weather Strategy of
balancing portfolios. Bridgewater grew into the largest hedge fund of the
world with AUM worth $138bn in April 2020. Dalio has been serving as it’s
Chief Investment Officer since 1985.

Dalio is acknowledged by the Times Magazine as one of the 100 most

influential people and Bridgewater Associates has been named as one of the
top 5 influential companies in U.S. As of 26 July 2020, Dalio’s net worth was
estimated to be around $18.6bn, making him 69th richest person in the
world. He has also pledged half of his wealth to Giving Pledge campaign of
Warren Buffet and Bill Gates. Dalio has authored numerous best selling
books. He is one of the influencers at LinkedIn. We would highly
recommend reading his LinkedIn blog which we think gives a detailed and
interesting perspective on how Dalio invests.
Lesson#1 Pain + Reflection = Progress
“I have found that the biggest and most painful mistakes that I made in the
markets came because I didn’t study time periods that happened before my
lifetime”.

Most things—e.g., prosperous periods, depressions, wars, revolutions, bull

markets, bear markets, etc.—happen repeatedly through time. They come in
cycles and often cycles that are long or longer than our lifetimes.

Studying and reflecting on history might not be a fancy thought at first sight. But
these reflections are what make one go through lesser pain when unfavorable
patterns in history repeat themselves.
We make mistakes when we don’t know how to “judge things which hadn’t
happened to them before”.

For example, people who studied the past pandemics or similar natural disasters
and their effects on economies throughout history would be better prepared to
adapt to the COVID than those who hadn’t.

Similarly, doing research on the historical financial debt crises or studying patterns
in rise/fall of currency reserves like Dalio did, would provide a navigation tool for
unseen of the future.
Lesson#2 Diversification
This is Dalio’s fundamental investment principal and it goes down with another
favorite core principle:

knowing how to deal well with what you don’t know is much more important
than anything you know.

Because when we are diversifying we know that:

a). Markets do not discount or price everything as “that which is unknown much
greater than that which can be known.

b). Diversification can improve your expected return-to-risk ratio.

Ray Dalio has a risk parity principle by which he created a balanced portfolio called
“All Weather”. Dalio also believes that people extrapolate the past consistently and
thus after a “certain market behavior (paradigm)” will be discounted. Thus, one has
to have a rebalancing strategy to maintain diversification.

Individual vs Equal Weighted Drawdown

Lesson#3 The Holy Grail of Investing
The real question for me was what were the marginal benefits of diversification
were like?

Dalio developed a strategy called “Holy Grail of Investing”. This was Dalio’s answer
to how to structure a portfolio that would maximize the returns at a lower risk as
possible.

The graph shows, portfolio standard deviation (risk) on Y axis and the Number of
Assets in a portfolio on X axis. Moving along the X axis the more stocks are added
lesser the risk gets until after 15-20 stocks the curve gets flat (as holding large
number of assets doesn’t mean diversification).

Dalio plotted curves with different correlation of assets, and the curve with the
lowest correlation provided him with lowest risk and probability of losing money.

“The magic is that you only need to do the simple thing.. The simple thing is to
find 15 to 20 good unrelated streams of investments. If you do this you can
improve your Return to Risk ratio by a factor of 5”

15 uncorrelated return streams- The holy grail of investing

Lesson#4 Separating Alphas from the Betas
Building Blocks for engineering a portfolio:

The return on of an investment product is a function of:

(1) Return on Cash i.e. Risk Free Return.

(2) Return From Betas. Excess return of the asset class over the risk free-return.
(3) Return From Alphas. The value added by managers (through stock selections)
by deviating from betas.

This builds upon the Post-Modern Portfolio Theory (PMPT) which separates the
returns from alpha and beta, then alters the sizes of alpha and beta and creates
more diversified portfolios in comparison with traditional Modern Portfolio Theory
(MPT). Betas are limited in numbers (as the universe of asset classes is small) but
are typically correlated with each other, with Sharpe ratio ranging from 0.2 to 0.3 as
their excess returns are low compared with the risk. Betas are reliable, as they
outperform cash in the long run. Alphas on the side, are numerous and
uncorrelated with each other. Their “expected” returns are unreliable and slightly
negative over the long run because a) adding value is a zero sum proportion b)
transaction costs and fees exist. Thus balancing alphas can result in huge penalties
and huge rewards at same time. However, if alpha selection is correct, it would give
a better portfolio than beta as they are uncorrelated returns. Thus the next
question is which risk are you comfortable taking in most?
Lesson#5 SAll Weather strategies:
Risk parity is all about balance.
What kind of investment portfolio would you hold that would perform well across
all environments, be it a devaluation or something completely different?

Launched in 1996, All Weather Fund at Bridgewater Associates pioneered portfolio

balancing concepts for asset allocation strategies also widely known as “Risk
Parity”. Since 1996, this approach has weathered through significant bull and bear
markets in equities markets, along with recessions, a global financial crisis and Fed
tightening and easing policies.
Unlike traditional equity centric approaches, All Weather uses a balanced beta with
fundamental understanding of environmental sensitivities in the pricing structure
of assets. It holds similar risk exposure in assets that do well when:

1). Growth rises.

2). Inflation rises.
3). Growth Falls.
4). Inflation falls.

This balances out underperformance of one asset class in a particular environment

which will be offset by outperformance of another asset class with an opposing
sensitivity. By balancing assets based on these structural characteristics the impact
of “economic surprises” can be minimized. A balanced portfolio gives higher ratio
of return-to-risk than a traditional portfolio.

Bond and Stock sensitivities Equal proportions of Assets classes

to Inflation and Growth in the 4 Quads different
Rising growth/inflation assets responded similarly
in magnitude but opposite in direction to falling
growth /inflation assets

According to Bridgewater Associates Research: A Balanced

Portfolio Achieves the Return as Equities with 1/3 Risk and
with less frequent, smaller & shorter losing periods
Lesson#6 Is the world order changing?
Where are we on the Big Cycle?
According to the latest series by Ray Dalio based, there are three major themes
happening currently across the globe:

1). High levels of indebtedness and extremely low interest rates.

2). Large wealth gaps and political divisions within countries.
3). The rising world power (China) challenging the overextended existing world
power (the US).

Dalio thinks these times are most “analogous with period from 1930 to 1945” which
is alarming, because these are similar to periods of 10-20 years transition phases
which exist in big economic and political cycles that occur in a span of 50-100 years.
These big cycles comprised of swings between:

1). Happy and prosperous periods in which wealth is pursued and created
productively and those with power work harmoniously to facilitate this.

2). Miserable, depressing periods in which there are fights over wealth and power
that disrupt harmony and productivity and sometimes lead to revolutions
/ wars.

As per Dalio, bad periods are the ones who clean (correct) the weaknesses (e.g.
High Debt Levels) and return the fundamentals in a painful way by changing who
is on the top of prevailing world order.
Latest upcoming book of Ray Dalio
Lesson#7 The World Has Gone Mad
and the System Is Broken
(In developed markets like U.S) investors lending to those who are
creditworthy will accept very low or negative interest rates because

1 they themselves have enormous amount of money to invest that has

been, and continues to be, pushed on them by central banks that are
buying financial assets in their futile attempts to push economic
activity and inflation up.

This money pushing isn’t pushing growth and inflation much higher

2
because the investors who are getting it want to invest it rather than
spend it. As a result of this dynamic, the prices of financial assets have
gone way up and the future expected returns have gone way down
while economic growth and inflation remain sluggish.(In U.S)

While the governments are still with large deficits, which means more

3
debt will be sold by governments and more money will be printed. At
the same time, pension and healthcare liability payments will
increasingly be coming due while many of those who are obligated to
pay them don’t have enough money to meet their obligations.

Money is essentially free for those who have money and

4
creditworthiness, it is essentially unavailable to those who don’t have
money and creditworthiness, which contributes to the rising wealth,
opportunity, and political gaps. The economists still don’t know how to
divide the pie.
Lesson#8 Post Covid Investment Landscape

As the world changes, investing needs to change with it

2020 has been a period of great uncertainty and great risk. The three investment
themes Dalio currently focuses on:

1). Diversification: Do diversify in currencies (including the reserve currencies

exposure), asset class diver

2). Liquidity: There should be flexibility for you do change your position.

3). Differentiation: According to Dalio there are two different worlds out there in
our world. These differentiations are reflected in market behaviors as well as well
political and social conditions.

Adding to that, Bridgewater's’ director of investment research advices the

following:

1). Diversify into China as it is an economy that runs it’s “own clock”. If you want to
hedge the risk of the economy, the best an American investor can get is to
invest in a totally opposite economy.
2). Invest in companies that are digitizing as markets are pricing digitization impacts
on businesses. In fact Tech stocks termed “safety stock” as they don’t have high
cyclical correlation. They are substituting Bonds purpose of diversification in U.S.
3). Don’t own bonds and cash. Holding cash is a negative yielding proposition.
With current U.S interest zeros, and central banks printing money crazily, bonds
have turned too. This is creating implication for investor asset allocation
strategy where typical investor portfolio is 60/40 equity and bond ratio. Bonds
give backdrop to diversification because they provide opposite sensitivity of
growth with respect to stocks. In lower growth times, bonds provide protection
when stocks markets underperform. But if the interest rates are at the lowest
points already in U.S, then there is no room for further decrease in interest rates
and bonds prices to perform well.
4). Invest in Gold and Inflation linked bonds: as the U.S is at the end of the long
term debt cycle and much of the liquidity is created.
Lesson#9 Confusion between risk and leverage

Many people still confuse leverage with risk, but the reality is that levering up
low-risk assets so you can diversify away from risky investments is risk reducing.

The first graph shows the basic linear relationship between risk and return of
different asset classes. Most investors end up being “forced” into a portfolio
dominated by the riskiest assets like equities through optimizations based on risk,
return and correlation. But with help of leverage, there is no longer need to be
forced into equities. The first graph shows big differences between return of
different asset classes but if you neutralize for risk (i.e., lever up lower risk assets, and
delever risky assets) the differences between asset classes disappear as shown in
the second graph. Thus in risk adjusted terms, asset classes have roughly equal
returns so you have to balance them based on their correlation. Most of the
investors yet don’t balance their portfolios and a typical portfolio still invests 60% in
equities making huge exposure from one stream of assets.
Lesson#10 Three lessons for young
people from Ray Dalio
Think about your savings? How much do you spend each month, and how much do
you save? Stress test these savings to check how many months can you survive
without your income? Don’t think about taking debt for personal consumption.
Debt should only help you increase your savings. So if you are taking debt for buying
an apartment or asset, you are forced to save. So debt should only be taken if you
think the marginal benefits from it will result

Think how should you save well? The least risky investment is cash but it is the
worst investment over time. So you have to come out of cash and look for other
investment assets. Think about diversification. Because when you think outside of
cash, all the investment have risk. People invest in one asset and if they turn a bad
one, then they stop investing.

Do the opposite of your instincts are. You should be doing opposite of what the
crowd says. You want to buy when no one wants to buy and sell when no one wants
to sell. This takes a lot of research and emotionally very difficult to do.
Books recommended by Ray Dalio
Ten Lessons from
Sir John Templeton
Sir John Templeton
the Maximum Optimistic
Born in 1912, John Mark Templeton graduated from Yale in 1934 and
studied law in Oxford as Rhodes Scholar. Sir John was also a CFA.
After studying law, Templeton travelled 35 countries in 7 months on a
budget, which inspired him for a career in international investment
opportunities. After Oxford, he joined what later become Merrill
Lynch. He famously started his investment career in 1937 with a
massive contrarian bet. He started buying one stock of every US
company which was trading below $1. He found 104 such companies,
37 of which were bankrupt. Some of these stocks went up 40x after
the War ended.

In 1954, he created a global investment fund named “Templeton

Growth Fund” which performed with an average 15% p.a. growth over
35 years. The Templeton Growth Fund was the pioneer of
international investments. Like Warren Buffet, he was also the
student of Benjamin Graham getting value investing principles. He
liked making contrarian bets and looking for bargains. After the
World War 2 he invested in Japan. His main rule of investment was to
find bargains. He also made money by shorting technology stocks
during the 90s tech bubble and in 2005, he wrote a memo predicting
a major financial crisis over the next ten years (which came in 2008).

Besides being a legendary investor, Sir John Templeton was a

visionary and a philanthropist. In 1992, he sold his business and
started on a path of spiritualism and philanthropy. He believed that
giving money is more rewarding than making money. He set up
philanthropic works like establishing “Templeton Prize for Progress
Toward Research and Discovering Spiritual Realities”, “Templeton
Library” and Templeton College in Oxford University. He has written
numerous books on spiritual realities and way of living like
“Templeton Plan: 21 Steps to Personal Success and Real Happiness”.
He established Templeton Foundation to support the spiritual
discoveries and thought in answering “big questions” from the laws
of nature and universe.

Sir John Templeton passed at the age of 95 in 2008 at Bahamas.

Lesson#1 Living by and investing in spirituality
“I had spent my early career helping people with their personal finances, but
helping them to grow spiritually began to seem so much more important.”

This might sound crazy to the generation Z out there, but this legend in the field of
investment has worked more in preaching spirituality, discovering the laws and
meaning of life than say investing principles at large. As bizarre as it may sound to
put here as number 1, it would have done injustice to name of Sir John Templeton
and his great philanthropic works (like Templeton Prize) if we didn’t mention about
this.

Here are some teachings of his lessons:

• Risk taking appetite: “The actual frontier exists within your own mind”
• Thought control: “We’re not products of circumstances or accident; we’re
products of what we think”
• Hard work: “Difference between moderately successful and outstandingly
successful people is the extra ounce of effort”- Templeton called it “doctrine of
extra ounce”.

Some of the books by and written on the greatest stock picker of the century in this
domain are snipped in the end, do check those out.

Mother Teresa was the first awardee of Templeton Prize in 1973.

It is given to people who advance Spiritualism.
Lesson#2 Conserving resources and
managing personal finance
A major concern or hurdle in Pakistan is not only the economic inability to save but
also the lack of willingness to save. But little do people specially in rising middle
class realize, that unless they start saving and investing, they can’t break the
inflation trap which they keep complaining.

“The magic of compounding, is a magic that anyone can practice so long as he

first practices thrift”.

“If you want to become really wealthy, you must have your money work for you.
The amount you get paid for your personal effort is relatively small compared
with the amount you can earn by having your money make money.”

Thrift is considered universally a strength of character and discipline. Take example

of China with Confucian culture or Japan with minimalism & lean philosophies,
which if keeping other factors constant, do make these countries stand out from
advanced economies in their saving and investment rates.

Templeton’s personal life has many examples of thrift and he applied it in his
investments too, he took pledge to save 50% of his income even at times of
economic depression, always travelled with economy class, never borrowed money
for personal expenses with no return, never rented an apartment more than 16% of
his spendable income. Templeton with actions and words, has preached this virtue
of thrift.

Do you know that State Bank of Pakistan has recently launched a money
management game? Complete the game, learn and win a certificate!
Lesson#3 Be a bargain hunter of ”Quality” stocks
From cars to furniture to stock market to farms, Templeton as a thrift was the
bargain hunter in every purchase he made. He learned this from his father who was
a bargain hunter in 1920’s for bankrupt farmland properties and would buy failed
auctions at heavy discount.

Bargain hunters are value investors who look for the mispricing in the markets for
good quality stocks. This was the fundamental principle of his fund, to go anywhere
in search for bargains. He says, that by definition you find bargains in places where
people are selling.

Some tips are:

• Any asset which trades at discount to 80% of it’s value
• It’s not just low P/E, but a rising P/E
• Don’t buy into the hot potatoes.
• Quality of Management.
• Technological leadership in industry.

Bargain hunting can fail too, as many bargain hunters get into the value trap by
investing in companies that fail to converge market prices to their estimates.
Markets need “catalysts” to move prices up to your valuations and that happens
when other investors in the future also start seeing the value which you perceived
a little earlier than them. In the end investment is like shopping but for long term,
you should never go gaga over the discounted cheap low-quality products that
don’t have the right value for money.

If you think running for discounts

is the bargain, then rethink
Lesson#4 Invest at point of maximum pessimism
“To buy when others are despondently selling and to sell when others are avidly
buying requires the greatest fortitude and pays the greatest ultimate reward”

During the Great Depression of 1930’s which lasted till the start of World war II, John
Templeton borrowed $10,000 (one of the two times he borrowed in life) and bought
104 companies stocks which were trading at $1 or less at NYSE. Templeton’s stock
selection was good enough, for him to make a little fortune after 5 years. It is to note
that only 4 out 104 companies which Templeton selected faced bankruptcy, while
the rest of them survived the financial turmoil and the season of bankruptcies. This
shows that he didn’t just shop cheap stocks crazily but actually made an informed
decision in picking the right companies in the greatest times of financial
turbulence.

Templeton, similarly was one of the first movers from U.S to invest in Japan in early
1960’s who was yet to experience golden period of it’s “economic miracle era”
which began after world war II nuclear bombing in 1945 and lasted till cold world
war in 1990’s. Templeton similarly bought airlines shortly after 9/11 attack to know
that he would get a good bargain and time of pessimism for such stocks.

U.S Walls Street crash in Dow Jones Industrial Average 1929

Lesson#5 Invest for maximum total real returnt
“The only rational objective for most long term investors is to return on dollar
invested after the taxes and inflation”

Factors like taxes on capital gains, taxes on interest and dividend income, inflation,
and trading expenses should be considered as they shrink the nominal returns
which investors have considered.

For Sir John “it is vital to protect the purchasing power of the dollar over time”.
According to him only 4% p.a inflation needs a portfolio of $100,000 to grow up to
47% in 10 years to give the same buying power, let alone other factors like taxation
to be ignored.

For taxation, is a matter subject to different countries laws for different types of
individuals. You will be surprised to know that sir John Templeton renounced his
U.S citizenship to become a little tax free and to settle in Bahamas.

Erosion of Total Returns of 30 years till 2013 in different U.S investments

Lesson#6 Remain flexible and open minded
with types of investments
There are times to buy blue chip stocks, cyclical stocks, corporate bonds, US
Treasury instruments, and so on. And there are times to sit on cash, because
sometimes cash enables you to take advantage of investment opportunities.

There is a right time for every asset class and industry especially if they are cyclicals
like automobile or have a catalyst impact on factors like interest rate or
government policy. There is always “a popular time” for every investment
opportunity. But over the history there is one asset class which is the top runner
for all time, and that is common stock in U.S market. If you have carefully read the
picture in the previous lesson, you would have observed that real returns of 30 years
were mentioned for different asset classes in the ranking where common stocks
topped other commodities. That is also the reason why Templeton Fund’s portfolio
is largely dominated in common stock over the past 40 years. Templeton also did
this same study from 1946 to 1991 and found that Dow Jones Industrial Average and
S&P 500 did beat inflation all the years more than U.S Treasury Bonds and Bills. This
lesson should be taken with caution, subject to many other conditions in different
investment horizons and economies. Also having more weight to some assets
classes, regions, sectors or markets than others doesn’t mean “no” diversification.

Sir John also emphasized that there is no “one way” of investing. He said that all
investment style needs to be updated, sometimes more than once in a year.
Lesson#7 Long term value oriented
Templeton Growth Fund, with aim for long term growth explains the principal
investment strategy as:

“Bottom up, value-oriented, long-term approach, focusing on the market price of

a company’s securities relative to the investment manager’s evaluation of the
company’s long-term earnings, asset value and cash flow potential. The
investment manager also considers a company’s price/earnings ratio, price/cash
flow ratio, profit margins and liquidation value”

And “The investment manager may consider selling an equity security when it
believes the security has become overvalued due to either its price appreciation
or changes in the company’s fundamentals, or when the investment manager
believes another security is a more attractive investment opportunity”
Templeton Growth Fund Summary Prospectus

Like Warren Buffet and Charlie Munger, Sir John Templeton also belonged from
value investing school of thought founded by Benjamin Graham. The aim of this
series in limited space is not to endorse or advocate any style of investment or give
any investment advice but to make people aware of the investing legends and their
styles. There are always the flip sides to every proposition and the lesson, and if you
go buy Templeton Growth Fund you will find a long disclosure list of risks
associated with every step envisioned or written above. What makes Sir John
Templeton and Warren Buffet succeed was not just the value-oriented approach
but getting and doing the value right.
Lesson#8 Learn from your mistakes
The only way to avoid mistakes is not to invest— which is the biggest mistake of all.

So, forgive yourself for your errors. Don’t become discouraged, and certainly don’t
try to recoup your losses by taking bigger risks. Instead, turn each mistake into a
learning experience.

If you keep repeating “this time it is different” and then keep on doing the same
mistake, then you are not going to be successful at all. You will mostly likely become
fearful and panic if you don’t learn and connect the dots. It is always said that “Faith
moves mountains” but fear is something which eats on faith and people who do
less homework are the people who will keep on fearing. Repeated luck is not an
accident or a chance event but rather an event where you didn’t make a mistake.

There are many people who feel that success depends on the flip of a coin. And, of
course, chance is involved in anything we do—things like timing enter in, for
instance. But good luck always seems to arrive when you’ve worked hard and
prepared for success. Without preparedness and plenty of sweat, luck is just a
word with no real application to reality.
Lesson#9 An investor that has all the answers
doesn’t even understand the question
Even if we can identify an unchanging handful of investing principles, we cannot
apply these rules to an unchanging universe of investments—or an unchanging
economic and political environment

These lessons covered mostly in our series are from 20th century but if there is one
lesson which to Sir John Templeton would never change in 21st century that is our
lesson 10 on the next page. What you have to realize is that there is no free lunch in
the stock market and if someone is giving you, then you should question the WHY?

Sir Templeton always said that “Never invest solely on a tip” but you would see even
the educated and finest people fell in the trap. Well would AI would do that? That’s
another question for 21st century to see.
Lesson#10 Buy low, sell high is easy to say
then to do in practice
As mentioned in lesson 9, this is a simple mathematical rule applied in stock
market which will hold true for ages until someone comes up and proves it wrong
that: “selling at lower price than purchase price is actually profitable”.

What’s more surprising is that you will find all the traders sitting in the Wall Street
saying “we buy at low and sell at high” but that’s where the irony comes when you
will note that “not too many of these traders actually bought high and sold low”. It
is easier said than to be done in practice. If you remember from Warren Buffet’s
series, he called stock market as a “ voting machine in short run and weighing
machine in the long run”. In stock market people exhibit this social side of following
the crowd just like they do in giving the vote to the popular candidate based on
who their friends and family are voting.

Logic will tell you that whole structure of investment industry has inherent
mispricing. If you ask people or even fund managers “when they will buy the
stock?” You will get the answer: “when analyst agrees on favourable outlook”.
People forget that when Analyst gives a buy call, everyone in the industry is hearing
it. You are not the only one thinking to buy the stock. Hence it is recommended to
do your own research and pick a stock before everyone starts thinking about it.

“It is so simple a concept, but so difficult to execute”

Some lessons on the Philosophy of investments
from Sir John’s books:
• Bargain hunting
• Diversification
• Economic Awareness
• Flexibility
• Patience
• Analytical Research
• Extensive networking
• Positive Thinking

and

• Prayer
Books by Sir John Templeton
Ten Lessons from
Jim Simons
 Jim Simons– the man
who beat the market

Born in 1938, in Brookline, Massachusetts, Jim Simons is a renowned

mathematician, a former code-breaker and arguably the most successful
trader in the history of modern finance.

Before stepping into the trading world, Simons majored in mathematics at MIT
and then went on to pursue a PHD at UC Berkeley. After receiving his doctorate
at the age of 23, Simons taught at MIT and Harvard. Thereafter, he went on to
pursue a better paying opportunity at the Institute of Defense Analyses where
he worked as a code-breaker for the National Security Agency during the
Vietnam War. After being fired from his job due to his anti-war sentiments, he
rejoined academia and assumed the role of the chair of the math department at
SUNY Stony Brook, where he rebuilt the department into a world-class academic
powerhouse.

Being a mathematical genius, Simons is widely known for his breakthroughs in

the field of differential geometry, particularly the Chern-Simons theory
presented in the paper titled "Characteristic Forms and Geometric Invariants,"
which he coauthored with the renowned Berkeley geometer Chern.

Even while establishing his career as a mathematician, Jim continued to develop

an affinity for trading and financial markets. Finally, in 1978 he left academia and
launched his own investment company called “Monemetrics” which later
became Renaissance Technologies. Initially, he followed the fundamental
investment techniques but losses in a trading debacle in 1984 pushed him to
explore a quantitative style of trading. He then began amassing pricing data and
building algorithms to predict the market’s next moves and price inefficiencies.

Since 1998 Renaissance’s flagship Medallion Fund has returned 66% annually, or
39% after fees, racking up trading profits of about 100 billion dollars, thus
surpassing profits made by any other investors even Ray Dalio, Soros or Buffet.
Surround yourself with brilliant, outstanding people

‘Just hire great young people into the

business, it’s the best thing you can do.’

But by “great young people” Simons did not mean excited and chirpy business
school graduates.

Instead, quite unusually for a hedge fund, Simons hired high-powered intellectuals
from academia. People who had specialised in hard sciences such as mathematics,
astronomy or physics were preferred over people who had business school
degrees. Job applicants at Renaissance needed to know nothing about finance
and any Wall Street experience was considered a black mark! Rather, they had to
deliver a talk on an interesting scientific research to the entire firm, before being
hired. These people then used their skills to refine and continually improve the
company’s trading algorithms to make them faster and reliable.
More recently, Simons has been hiring a large part of the speech recognition team
at IBM because according to him: "Investing and speech recognition are very
similar. In both, you’re trying to guess the next thing that happens."

Simons’s radical management style can also be seen in the culture at Renaissance
Technologies, which is extremely collaborative. Everyone in the organization knows
what everyone else is doing. Unlike other hedge funds, where the centre of activity
is the trading room where flustered traders are shouting their calls, at Renaissance,
the heart of the company is an auditorium with exposed beams that seats 100 and
features biweekly science lectures. Exposure to new information, stimulates brain
activity and encourages people to think better, hence aiding their progress at work.

The success Renaissance Technologies has been able to achieve by hiring smart
people, people who have done “good science” according to Simons shows that
there is indeed no substitute for smart people. No algorithms or machines can
work on their own unless intelligent people keep upgrading them.
Rationalizing the model’s predictions is secondary

I don’t know why the planets orbit the sun.

That doesn’t mean I can’t predict them” – Simons

With little financial knowledge, Simons and his team of scientists treated market
data just like any other data. They focused more on how statistically significant a
market anomaly was, and how it could be used to their advantage, instead of trying
to discover why it existed and relying on their intuitions about it. Gregory
Zuckerman, in his book titled “The Man Who Beat The Market” points out:

“More than half of the trading signals Simons’s team was discovering were
non-intuitive, or those they couldn’t fully understand. Most quant firms ignore
signals if they can’t develop a reasonable hypothesis to explain them, but Simons
and his colleagues never liked spending too much time searching for the causes
of market phenomena. If their signals met various measures of statistical
strength, they were comfortable wagering on them.”

Thus, Simons and his team did not spend too much time wondering why their
models behaved the way they did. If something in their algorithm worked and
produced results, that was enough to include it in their trading model. While other
quant funds were trying to make sense of their models’ predictions, Simons
faithfully followed his models and took advantage of certain statistically significant
signals that his rivals ignored.

The total assets managed by Simons’ company, Renaissance Technologies,

have increased more than tenfold in the last 15 years.
The Law of Large Numbers can really help

I don’t know why the planets orbit the sun.

That doesn’t mean I can’t predict them” – Simons

Simons and his team believed that the edges they found in the market did not have
to be big. Finding smaller, overlooked edges and fully profiting from them instead
of wasting time looking for the perfect holy grail strategy worked wonders for
them.
Thus, while Simons did not have a high winning percentage, he did not have high
losses either. He accumulated small edges and over the long run these proved to
yield tremendous profits.

Therefore, in accordance with the law of large numbers, which states that in order
to derive the true (expected) value from some tested event, we should gather as
much event and its outcome(s) samples as possible, Renaissance Technologies
continues to make small, high frequency trades which then yield a bigger profit.
Simons acknowledges that trading opportunities are small and fleeting and says,
in a rare discussion about his trading strategy:

Efficient market theory is correct in that there are no gross inefficiencies. But we
look at anomalies that may be small in size and brief in time. We make our
forecast. Then, shortly thereafter, we reevaluate the situation and revise our
forecast and our portfolio. We do this all day long. We’re always in and out and
out and in. So, we’re dependent on activity to make money."

This law has also been applied by scientists to build trading algorithms at
Renaissance. “There is no data like more data” says Robert Mercer, Renaissance’s
long-time CEO. The firm uses increasing amounts of data to refine its models and
make better predictions.
Trade your system with discipline

“We don’t override the models.” – Jim Simons

Simons believed in following his models consistently, except in cases of extreme

volatility. He believed that for a trading system to work out successfully it is
essential for investors to let it work for a sufficiently long time and be profitable. In
short, all profitable trading requires discipline. It requires that investors remain
impartial and do not let their emotions override the models’ predictions.

However, even a quant as successful as Jim Simons has been susceptible to the
psychological phenomenon called ‘algorithm aversion’ which refers to investors’
panicked behavior when in cases of market volatility, they diverge from their
models. For example during the Quant Quake of 2007, when many quant funds
started making sudden, serious losses in a brutal downturn in the quant industry.
Simons interfered with the system and reduced positions. This was primarily
because he became afraid of the serious, unusual losses in the market. In the end,
when the losses subsided, it became apparent that the firm suffered painful costs,
far more than those they would have incurred had they followed their models.

This example is just an anomaly in Simons’ otherwise disciplined investing career.

It merely shows that even quant geniuses like Simons are susceptible to behavioral
biases such as loss aversion and algorithm aversion, but the key is to remain aware
of these biases and avoid them. Thus, a large part of Simons success can be
attributed to his ability to remain disciplined and avoid these biases most of the
time, as he says: “The computer has its opinions, and we slavishly follow them.”
Identify patterns and greater factors

“What you’re really modeling is human behavior.

Humans are most predictable in times of high stress
— they act instinctively and panic. Our entire premise
was that human actors will react the way humans did in
the past . . . we learned to take advantage.”
- Penavic, a researcher at Renaissance

Simons and his team created an edge by focusing on more detailed factors that
affected prices, far more diversified than the factors most investors appreciated.
For example, they analyzed market sentiments towards a stock by checking social
media feeds and barometers of online traffic. In essence, they took all possible
quantifiable data and analyzed it to determine trends and correlations that may
help predict the market’s next move.

Thus, much of Simons’ success can be attributed to his models’ ability to identify
greater patterns and predict moves. These scientists rely on the fact that humans
are susceptible to biases and emotions and in times of stress and panic, we all react
similarly. Based on this notion, the firm creates models and follows them
religiously.

Some common behavioral biases that affect the average investor

Read more about Jim Simons:

Jim Simons has lived a life that has

begged for a biographer.

However, few have been able to scale the

impenetrable walls of silence and shyness that he
has built around him. Wall Street Journal’s Gregory
Zuckerman has been able to surmount these barriers
and give some very interesting insight into the life of
one of the world’s greatest investors and how he built
Renaissance Technologies from scratch.
 For more details and our views on
investing in Pakistan, contact:
KASB Research

www.kasb.com

AUTHORS:
Faiza Arshad | Tehreem Siddiqui | Ali Farid Khwaja (Editor)

Karachi Corporate Office Lahore London Hong Kong Washington DC

Bukhari Tower, 16-C, COLABS, Gurumangat 31 Emperors Gate, Level 19, Two International 11432 Rowley Road,
Main Khayaban-e-Bukhari, Road, Gulberg, Lahore London, SW7 4JA. Finance Centre 8, Clarksville, MD 21029
Phase VI, DHA, +44 788 776 1538 Finance Street, Central +1 804 615 7161
PSX Office: Room 101 & 105, +852 3589 6535