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Investment Managers : Historians or Soothsayer ?

Posted By: Admin

As investment managers, a lot of us are conditioned to considering data and studying patterns esp. of the past in arriving at our judgement of an investment. Before we recommend a mutual Fund, we study the past performance, its volatility, the consistency, the track record of the fund manager, portfolio construct and a host of other data patterns that finally alludes us to believe that the investment we are suggesting is a good one. So a large part of the decision making is based on the past performance. We do this because the future is unpredictable and the past is really the only data we have to go with. However having said this.. the future isn’t exactly past replayed. For instance, no projection in the world had factored in the Covid 19 situation that the world found itself in same for some of the other epoch making events in the past 20 years.. Most of the world was taken by surprise when the twin towers were felled on Sept 11 or when Lehman brothers collapsed in the midst of the Global Financial Crisis which was followed by tumultuous financial Crisis.

Sometimes the trends are easy to follow and at other times it is vastly difficult to predict. There is always something happening that has never happened before, how do you plan for something like that ? Lakshmi Vilas Bank, a 94 year private bank that failed last week was a AA rated bond three years ago with a solid track record of 90 years of performance history. That said RBI earlier last week reconstituted the bank and sold it off to DBS, Singapore to protect the interests of the depositors. While it did that, it wrote off the entire equity capital and Tier II bonds outstanding of the bank. The move was unprecedented and has never happened before. While the matter is subjudice now, the fact of the matter is that one of the key criteria one would have invested in the bond three years ago would have been its rating, its almost century long profitable existence as also the fact that Tier II bonds in banks were never before written off thus and were always protected. But If the future was nothing but past repeated, then all historians would be soothsayer.

What are the lessons we can carry for this as investors,

  1. The past has limited influence on the future and has a small bearing on taking an investment call ;
  2. We must count that all points in time some of our investments would be subjected to risks that cannot be predicted or planned for, the best way to overcome this is to have a deep diversification of one’s portfolio so that when things like this impacts the portfolio, its impact is minimized;
  3. Be proactive to constantly scan the horizon for risks and derisk the portfolio actively ;

Ultimately investing is about achieving the fine balancing between Risk and Return. Too much of safety will compromise the returns to the investors. Too much of risk will undermine the safety of the investment. Therefore the need for a fine balance.

A balance between Risk & Return that is much sought after , difficult to achieve in reality.

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