Tuesday, December 29, 2009

What's luck got to do with investing? ..........

What's luck got to do with investing?
Vivek KaulMonday, December 28, 2009 21:53 IST Email

How do I define history? It's just one f*%&ing thing after another.
-- Rudge in Alan Bennett's The History Boys

I came across this sentence last night and it's been haunting me ever since. It reminds me of a situation which I encounter almost everyday: "What's the story?" my editor(s) ask, when I make a pitch to them about something I want to write on.

Well I don't blame them for asking the same question over and over again. After all, newspapers are in the business of making sense of what is happening around us. But are we really doing that? Or to ask a deeper question, can we really do that?

Take the case of the BSE Sensex rallying by a little more than 500 points on December 23. Now why did it happen? If newspaper reports are to be believed (including this newspaper), the market went up because the finance minister revised the GDP growth rate to between 7.5% and 8%.

Sounds reasonable? Yes. Or does it?The FM has made such noises of the economy doing well in the past as well. Has the market rallied to such an extent, every time he has said something optimistic? Or has it rallied to the extent it rallied on December 23?

Or was it, to put it a little more realistically, a case of investors getting up on the right side of the bed, and in the pre-Christmas good mood, going out and buying stocks, and thus pushing up prices? The point is, I don't know. But I can't say that to my editor. We are in the business of explaining things. (In fact, the word analysis is even built into our paper's name). And that's what I do on an occasion like this; I try and create a story which explains things.

John Allen Paulos explains this phenomenon in his extremely engaging book A Mathematician Plays the Stock Market: "Around stock market rises and declines, people are often prone to devise just-so-stories to satisfy various needs and concerns."

Having said that, what would be the correct way to report on such events? Nassim Nicholas Taleb, before he became famous for writing Black Swan, wrote a much better book called Fooled by Randomness. In this book, he elaborates what he feels should be a true role of a journalist. "To be competent, a journalist should view matters like a historian, and play down the value of the information he is providing, such as by saying: 'Today the market went up, but this information is not too relevant as it emanates mostly from noise.'"

Now, have you ever come across a story, article or column in a newspaper that says just that? Of course not! Anybody trying to do that is more likely to lose his job, as Taleb puts it "by trivialising the value of information on his hands."

This inherent need to construct a story around events leads to several other interesting situations. The media likes heroes. We create them now to destroy them later.
Take the case of someone like a Rakesh Jhunjhunwala in India, or a Warren Buffett in the US. Are they really as competent as they are made out to be or does luck play a huge part in their success?

As Taleb writes, "If one puts an infinite number of monkeys in front of (strongly built) typewriters, and lets them clap away, there is a certainty that one of them would come out with an exact version of the Iliad... Now that we have found that hero among monkeys, would any reader invest his life's savings on a bet that the monkey would write the Oddsey next?"

The investors we love to write about are survivors who have had a lucky winning streak of generating greater returns than the broader market over the years.

As Malcolm Gladwell explains in his new book What the Dog Saw and Other Adventures, "Suppose that there were 10,000 investment managers out there, which is not an outlandish number, and that every year half of them, entirely by chance, made money and half of them, entirely by chance, lost. And suppose that every year, the losers were tossed out and the game was replayed with those who remained. At the end of five years, there would be three hundred thirteen people who had made money in every one of those years, and after 10 years, there would be nine people who had made money every single year in a row, all out of pure luck."

Leonard Mlodinow, a faculty at the California Institute of Technology explains this phenomenon rather succinctly: "a simple calculation shows that if a the few thousand mutual fund managers who were managing funds... were simply flipping coins once a year, rather than investing in the market, and if we equated getting 'heads' with beating the S&P, then after a few decades, the chances of a streak of 'beating the S&P' for 15 or more years in a row would be 75%.This illustrates that a streak like this was to be expected, by chance alone, and hence does not indicate skill."

A good example of a person who rode this phenomenon is a mutual fund manager called Bill Miller whose Legg Mason Value Trust mutual fund -- one of the biggest mutual funds in the world -- beat the returns of S&P 500 Index for 15 consecutive years from 1991 to 2005.

Tomes got written on his legendary investing style and various reasons got attributed to his success. But Mlodinow feels Miller was plain lucky. And his performance regressed to the mean once the current financial crisis had an impact on the performance of his fund. As Michael J Mauboussin, Miller's colleague at Legg Masson, writes in his new book Think Twice, "We have difficulty in sorting skill and luck in lots of fields, including business and investing."

Over and above this, because these guys are famous, other investors follow their investing decisions, buy when they buy, and sell when they sell. This makes these investors look even more smarter than they are. As Paulos writes about Warren Buffett: "His phenomenal success... is often cited as an argument against the market's randomness. This assumes, however, that Buffett's choices have no effect on the market. Originally no doubt they didn't, but now his selections themselves... can influence others. His performance is therefore a bit less remarkable than it first appears."

At times, investors themselves come up with stories and theories regarding their investment decisions. George Soros, the hedge fund manager, who once broke the back of the British pound, is said follow the Theory of Reflexivity, which was influenced by the work of the philosopher Karl Popper (who said and as Gladwell states in his new book, "You could not know with any certainty that a proposition was true; you could only know that it was not true"), while making his investment decisions.

But as Robert Soros once said about his more famous father, "My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking, Jesus Christ, at least half of this is bullshit. I mean, you know the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm, and it's this early warning sign."

Luck plays a much more important role in the investing process than people (which include journalists like me) are ready to admit. But if we in the media start attributing luck and noise to every time a market moves, or an investor does well, what will we ever write about? And we need our headlines, because headlines sell what we write, though they never tell you the real story.

As Taleb summarises it best "People do not realise that the media is paid to get our attention. For a journalist, silence rarely surpasses any word."


  1. This article is very timely, since I believe that Luck is 'Hand of God'. If the hand of God is over your head, then things go right. I still believe in it, but I just read yesterday (12/27/2009) a really great sentence on luck.

    "I'm a great believer in luck, and I find the harder I work the more I have of it." This is what Thomas Jefferson (US President) said and this makes SO MUCH SENSE to me.

    This is what I have done to my life and my families life. I put in 14-16 hour days everyday since I feel that sleep is over-rated and I don't need a lot also!

    Working with lots of good writers such as Rajeevbhai, good blogs (of all kinds) and good investors, gives me an edge after I spend all day building 'my career'.

    Guys, believe in Income Creation first, Wealth Generation second, and Investment Management third for 10-20-30-40 years. Put God on your side everyday (in whatever form) and you will have plenty of LUCK on your side.

    Good luck to all.....


  2. MUMBAI – Nirmal Bang has advised traders to buy PSL for medium term target of RS 230-250.

    Buy PSL from an investment view. The stock is about to give a huge breakout if holds above Rs 190 in the near term. Strong support is around Rs 155-140 region and minor resistance at Rs 166. If the stock holds above Rs 166 then look for Rs 190 shortly and Rs 230-250 in the medium term, the report said.

  3. rajeev, this is what i was asking you,whether fundamnetal works or person's luck to pick a momentem stock.
    why i feel so is that your stock selection generally have risker side financial ratios but still they inc. in price.also i went thru your earlier post during bear period of 2008 but never read a post of pesimism or better if u compare your buy price to their current price they are way below.
    dont think that i am peronslly attacking you. may be i am not able to write in words what i want to learn from u.i just want to learn to pick stock

  4. raj,
    If u feel that my picks prices are way below my call in 2008, then it means I am not doing the right thing.
    Then y u wants to learn my stock picking way....it is not worth it, isn't it?

  5. Mitz,
    PSL will run.This is not a new bull market.Untill we crosses 21k one can't say that.....according to some experts....
    So If that is the case then we have a very long way to go....

  6. Dear Raj,

    Here are my views to some of ur Q's.

    1) Rajeev has suggested all kind of stocks. A group , B group and even some totally unknown stocks.
    It is for you to decid which stocks u need to buy.

    For that you need to understang what is ur risk taking ability and need of capital. If you are willing to write of your entire capital and take risks then you can invest in unknown small cap stocks which show a promise to outperform in future. Some of them give more then even 500% in a few years and sum of them go bust.

    If you risk profile is low and yet you want to double your money in say two to three eyars then you shud go for mid cap cos with promising future and if you are happy with 15-25% a year then invest only in A group stocks.

    K now coming to the second point that Rajeev never posted a pesimistic view point when the markets were going down. Well those were the times that were unseen or unexpected by even the greatest of GURUS.

    Yet people who bought slowly and steadily through the entire down move are now sitting on piles of money. Equity investment is never supposed to be a one time investment. It is an ongoing process and the more you invest the more the profits you will make in 15-20 years.

    Yes if you compare the prices that were just six months ago to the present prices, everything has gone up. But is this the end. Will there be no more stocks that you cannot discover ??

    Well the answer is a definate NO.
    India will grow over the nxt few years and at times very very ferociously. Buy companies that you feel will benefit the most and then leave the rest to LUCK.

    Coming to luck there is a very nice statement made by Thomas Jefferson (Ex US President)

    “I find that the harder I work, the more luck I seem to have”
    So do your thorough research and leave the rest to lady luck

  7. Rajeev bhai
    please suggest your best pick from power sector...

    Howz Suzlon or rpower???

  8. RPower has started, one its of the four power plants in UP,the second one will be commissioned by Jan 15th 2010.
    As for the statement of the person quoted, it may be for divestment of PSUs to fetch higher prices.NMDC is due shortly.

  9. RPower has started, one its of the four power plants in UP,the second one will be commissioned by Jan 15th 2010.
    As for the statement of the person quoted, it may be for divestment of PSUs to fetch higher prices.NMDC is due shortly.