Moats and the Eternal Search to Build One – PART II…Investing

In the last article, I wrote about what sustainable moats for companies would be. Just as a company needs to develop a moat as it scales, or follow the path of mediocrity, an investor needs some sort of edge that he brings to the table, which gives him/her the ability to manage other people’s money.

There are 1,000+ alternate asset managers in India, and 500+ schemes of Mutual Funds in India and millions of individuals trying to play the public markets in India everyday. One has to wonder, at every stage, what is their edge?

Well, one thing that is not a source is reading a lot of books and magazines and newspapers. Anyone can read a book. Reading is incredibly important, but it won’t give you a big advantage over others. It will just allow you to keep up. Everyone reads a lot in this business. Some read more than others, but I don’t necessarily think there’s a correlation between investment performance and number of books read. Once you reach a certain point in your knowledge base, there are diminishing returns to reading more. And in fact, reading too much news can actually be detrimental to performance because you start to believe all the crap the journalists pump out to sell more papers.

Another thing that will not make you a great investor is an MBA from a top school or a CFA or PhD or CPA or MS or any of the other dozens of possible degrees and designations you can obtain. Harvard can’t teach you to be a great investor. I like to say that an MBA is the best way to learn how to exactly, precisely, equal the market return. You can reduce your tracking error dramatically by getting an MBA. This often results in a big paycheck even though it’s the antithesis of what a great investor does.

Experience is another over-rated thing. I mean, it’s incredibly important, but it’s not a source of competitive advantage. It’s another thing that is just required for admission. At some point the value of experience reaches the point of diminishing returns. If that wasn’t true, all the great money managers would have their best years in their 60s and 70s and 80s, and we know that’s not true. So some level of experience is necessary to play the game, but at some point, it does not help any more and in any event, it’s not a source of an economic moat for an investor. Charlie Munger talks about this when he says you can recognize when someone gets it right away, and sometimes it’s someone who has almost no investing experience.

So what are the sources of competitive advantage for an investor? Just as with a company or an industry, the moats for investors are structural. They have to do with psychology, and psychology is hard wired into your brain. It’s a part of you.

The truth of the matter is, our abilities are often overrated. Most successful investors understand their limitations better than others. They have an incredible amount of patience, they do not do much, unless they fully understand it. They have the ability to wait for good deals thrown at them. Operating within what’s prudent to do what your dealt with and your ability is what I call financial prowess. I call that ‘enlightened greed’.

There are a few traits that great investors cultivate through the course of their journey of becoming the best –

1. Ability to buy stocks while others are panicking and sell stocks while others are euphoric – this is often repeated, but to this day one of the hardest to follow.
2. Being obsessive about playing the game and wanting to learn. Investing is not a hobby, but a profession. It requires incredible patience and constantly learning.
3. The ability to learn from past mistakes
4. Ability to understand risk based on common sense – one aspect being, avoiding leverage
5. Having confidence in your own conviction and sticking to them even when facing criticism
6. Finally, and most importantly – the rarest trait of all : The ability to live through volatility without changing your investment thought process. I have heard many people say they have the uncanny ability to pre-empt the next growth phase and change their styles accordingly. While this sounds on paper, rarely does it happen in practice. This is one of the reasons, every fund manager will go through a period of underperformance, and even the best do not escape this.

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