The fault finding and finger pointing in the Manpasand Beverages case have hit a crescendo. Everyone seems to know what was wrong with the stock; and every fund manager who has it in the portfolio has been hung out to dry. The only hero in the saga is Amit Mantri, whose incisive blog post of 2016 is so much in the spotlight now that the website crashed under the weight of unexpectedly high activity. Why do such stories recur?
We love the rags to riches theme. Equity investing for many investors, both individual and institutional, is about discovering the next big multibagger and making tons of money off it. There is only one time-tested method of doing that; it is a meticulous and intensive approach called value investing.
However, not everyone has the patience for research and identifying stocks that they are convinced are undervalued, while waiting for prices to respond. A value investor buys a stock worth Rs 100 for Rs 50 and hopes to sell when prices move up. But a value stock can remain unnoticed for a long time, and the price could move down to Rs 30 in the meanwhile. A true blue value investor will acquire more.
But then, the retail investor is unable to do this because of behavioural limitations. Social approval is important to the lonely investor who is searching for value, and except for a few dedicated loners who hold on to their beliefs, the others are disappointed when the stock fails to perform.
Institutional investors are no exceptions. While they can afford high quality research, field visits and due diligence, and pursue strategies that enable them to identify and accumulate value picks, they operate too much in the public eye to afford the lack of price appreciation. A fund manager who holds a high conviction value pick will not be able to consistently explain the fall in price of the stock and the drain on the portfolio’s value. We don’t trust such justifications either, when stocks prices don’t match the enthusiasm of the manager.
Enter momentum. Stock picking by most investors relies not on fundamental research, or intensive search for value, but on mere price action. It is somewhat reckless and short-sighted, but yields immediate results. A momentum investor who picks up a stock at Rs 100 does not care if it is overvalued or undervalued, as long as it appreciates and can be sold at Rs 150.
The proliferation of television shows that discuss stocks; the obsession about tickers and updates; the thirst for names in most online chat forums; the deterioration of most conversations about stocks to buying tips; and the surge in trading volumes around rising stocks are all the outcome of the overt focus on momentum investing.
The problem is not in the strategy itself, but its masquerading as if the stocks in question are potential cases of undiscovered value. This is endemic in the Indian markets, where entrepreneurship is cherished and encouraged by even the simplest of beginners in equity investing. Every IPO is exalted as the next big thing, and if it opens with a premium to
issue price, investors laud themselves to have participated in the next big multi-bagger.
Momentum enables small investors to celebrate quick victories, and helps fund managers to stay above water as their portfolios appreciate with the prices. It is not uncommon for investors in mutual funds to highlight the stock picks of fund managers that have shown the highest momentum, and make it a talking point. There have been funds run by erstwhile star managers that moved up purely by momentum, only to crash and disappear as prices corrected. While the play was on, the said fund manager, who later quit the fund, was celebrated as a top value investor who identified unknown pearls. It is just that we are not discerning enough to see the difference between momentum and value, and fall into the trap too often.
That is how stocks like Manpasand Beverages and Vakrangee Ltd jump up even when their fundamentals are questionable. It is striking that the research note put out by Mantri is now being appreciated and celebrated, while it remained unnoticed in public domain until the dramatic exit of the auditors. Fundamental research is stamped out by price runs, and as long as the stock is moving up, every naysayer’s concerns are brushed aside. When price falls, or when what we call a trigger event happens, all research that supports and explains the now exposed stock come into limelight. When we care more about price action, than about intrinsic value, we are not value investors by a long stretch.
There is valid concern that institutional investors who should have done fundamental research, failed to see the shortcomings of the stocks that have now lost so much in price. These are the perils of short termism, which is also a disguised phenomenon. For all the talk of long-term investing, NAV is a daily number and most funds won’t get more than two quarters of time to correct their rankings in the league table.
Investors in mutual funds also chase momentum, by looking at past winning funds. There is evidence to show how performing funds attract the most new money and how investors and distributors highlight immediate past performance as an important metric. Therefore, appreciating NAV, and rank in the top quartile of the league are essential to keep the money flowing in. It is unthinkable how this can tie neatly with value investing as a strategy.
Fund managers would therefore follow a mixed approach – a few stocks for value, a few for growth, and a few for momentum. This not only provides a shot at consistent performance, but also reduces the overall risk due to diversification benefits. Now that these falling stocks are in the news, there is animated discussion about funds that hold these stocks. There would then be justifications and eventual paring down of the losing stocks.
That would not, however, absolve institutional investors fully. Due diligence is a responsibility that institutional investors such as portfolio managers and mutual funds must bear. To know, verify and own up to each name in the portfolio is something we expect from professional investors. Instances like Manpasand and Vakrangee show up the shortfalls in that trust. If investors with expertise, access to research, and strength of size behave like noisy and uninformed traders, we have reasons to worry.