In today's Finshots we describe a few lessons from Prashant Jain's farewell letter

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The Story

30 years ago, a bright-eyed young man stumbled his way into a world that not many knew even existed — equity research. The industry was so raw. It was so new that only a handful of mutual fund companies even operated a full-fledged equity research desk. And the young man became only the second member of a very new team at SBI Mutual Fund.

But little did everyone know that they’d be singing his praises soon enough. Little did they know he’d become one of India’s longest-serving mutual fund managers. People speak so highly of Peter Lynch’s performance — about how he delivered over 29% annual returns in the 13 years he ran the famous Fidelity Magellan Fund. But Prashant Jain's performance is equal to it. His incredible 20%+ returns in the past couple of decades could rival any fund manager’s performance.

So when Jain penned a farewell message a couple weeks back, we knew we had to parse through it and summarise it for you.

1. Being in the right place at the right time matters

Sometimes, you could do everything right, make the right investment decisions, avoid the losers, be patient, everything that the experts tell you to do, but still, come out with nought.

You need to be lucky as well.

What do we mean?

Okay, let’s look at the US first.

Imagine that you’d started making money in the 1950s and you decided to set aside some of this in stocks. You picked out S&P 500 index to invest in (it’s a hypothetical scenario since there weren’t really index funds back then). You sat back and watched the market do nothing for the next 20 years after adjusting for inflation.

But if you’d started your investment journey in the 1970s, the next two decades would’ve multiplied your investment by 10 times (again, after inflation).

In some ways, your investing performance would have depended on your birth year. And that’s not something you can control.

What about India, you ask?

Well, if we look at returns from Sensex, we’ll see something similar playing out.

In the 1990s, the benchmark index of 30 stocks generated annual returns of just over 20%.

In the 2000s, the returns dropped to 13%.

And in the 2010s, it had fallen even further to 9%.

In a sense, Prashant Jain spent a large part of his investment career during the heydays. And maybe he wants to reiterate the fact that he too was lucky.

2. Pareto Principle

Now, this isn’t a hard and fast rule. But you can observe the Pareto principle in all walks of life. 20% of your actions drive 80% of your outcomes. The Italian economist Vilfredo Pareto coined the term when he observed that just 20% of people in Italy owned around 80% of all wealth. He even observed the same phenomenon in his backyard — 20% of the pea pods gave 80% of the peas.

The basic theory is that a limited number of actions create outsized results. And it applies to investments too.

For instance, Prashant Jain invested in around 465 stocks during his stint at HDFC. And here’s something that will blow your mind…just 55 stocks contributed to nearly 87% of the total gains!

And again, this isn’t an anomaly or something specific to Prashant Jain’s style of investing.

Let’s take one of the greatest investors of all time, Warren Buffet.

In 2013, he said that over his lifetime he’d owned around 500 stocks. But  only 10 stocks were responsible for most of the big money. So if you removed those stocks from Berkshire Hathaway’s portfolio, well, the track record would be pretty average.

In fact, it’s the same sentiment that was echoed by Buffet’s investing guru and father of value investing Benjamin Graham. He attributed his stellar performance to a single stock pick — Geico. He invested 20% of his firm’s money in the company and rode the wave as the stock price zoomed. And even though he preached diversification, he broke his own rules this one time.

The only problem here is — You can never know which stocks will outperform. As Jain wrote himself, “If only one had the wisdom of avoiding 90% of the investments and instead invested in the 55 stocks.”

3. Position sizing is very important…but it’s also not easy

You will not be able to avoid the duds in a portfolio. Period. That’s just the nature of the game. In Prashant Jain’s case, around 1/4 of stocks lost money and 1/100 lost big money.

But the skill is in assessing the risk-reward associated with each investment and placing your bets accordingly. So you could have a winner that gave you 250% returns on your hands, but if you’ve invested only 2% of your money in that  stock, that’s probably not going to move the needle for you in a big way. And all that effort at identifying the stock has gone to waste.

So you have to double down on high-conviction bets and allocate a larger chunk of your money here to make up for the duds.

In Jain’s case, his positioning was pretty much always on point. For every 20 stocks he picked, he had 1 stock that delivered colossal returns. But he took a sizeable position on this one stock, which meant that his overall portfolio gained from his conviction.

Retail investors on the other hand have a tendency to cut their winners too early. Once they buy a stock and it soars in value, they don’t double down on it. They want to cut their position and take home what little gain they make. They use their buying price as an anchor. On the other hand, they hang onto their losers and sometimes pump more money into it because the rupee value has fallen. And it ends up becoming an outright mess.

What truly matters is how much money you make when you get things right and how little you lose when you get things wrong.

So yeah, maybe you’ll keep these lessons in mind when you make your investments the next time around.

Until then…

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