Why to Invest – The Purnartha Take

Why to Invest - The Purnartha Take

Why Invest?

Well Having a savings account isn’t enough

Saving money is important, but it’s only part of the story. Smart savers start by building sufficient emergency savings within a simple savings account. But after building 3 to 6 months of easy-to-access and withdraw savings, investing in the financial markets offers many more potential advantages.

Why smart investing matters

Investing is an effective way to put your money to work and potentially build wealth. Smart investing may allow your money to outpace inflation and increase in value.

The greater growth potential of investing is primarily due to the power of compounding and the risk-return tradeoff.

The power of compounding

Compounding occurs when an investment generates earnings or dividends, which are then reinvested. These earnings or dividends then generate their own earnings. So, in other words, compounding is when your investments generate earnings from previous earnings.

If you invest in a dividend-paying stock, for example, you might consider taking advantage of the potential power of compounding by choosing to reinvest the dividends.

The risk-return tradeoff

Different investments offer varying levels of potential return and market risk.

Risk is an investment’s chance of producing a lower-than-expected return or even losing value.
Return is the amount of money you earn on the assets you’ve invested, or the investment’s overall increase in value.
Investing in stocks, for example, has the potential to provide higher returns. In contrast, investing in a money market or a savings account likely won’t offer the same return potential, but is considered less risky than investing in stocks.

The amount of risk you carry depends on your appetite — or tolerance — for risk. Only you can decide how much risk you’re willing to take for the potential of higher returns. But if you’re seeking to outpace inflation, taking on some risk may be necessary. An increase in risk may provide more potential for your money to grow.

To maximize the benefits of compound interest, start investing as soon as possible and automatically reinvest your dividends and other distributions. Read how purnartha.com has given returns that beat benchmarks on investments using long term stocks.

CNBCTV18 and Reliance MF Honors Purnartha MD Rahul Rathi

Purnartha MD , Rahul Rathi was felicitated recently in an event organised by CNBCTV 18 and Reliance Mutual . The awards were presented to fund managers for creating an impact by their game changing investment philosophy and delivering phenomenal returns.

Seen receiving here the award on behalf of Mr Rahul Rathi is Purnartha Team Member Saurav Jain Jain.

Why Your Investment Advisor MUST Be SEBI Registered

SEBI Registered nEquity Investment Advisor

SEBI Registered nEquity Investment Advisor
Investing in stocks? Check if your investment advisor is SEBI Registered. Here’s a quick look about why it matters

About SEBI

Securities And Exchange Board Of India – SEBI is “THE” regulatory body for the investment market in India. The purpose of this board is to maintain stable and efficient markets by creating and enforcing regulations in the marketplace.

The good part about working with a SEBI registered investment advisor is they have to follow certain rules and regulation that put clients or customers first.
SEBI Advises the Following tio Investment Advisors which automatically ensures your protection.

Honesty and Fairness

An investment adviser shall act honestly, fairly and in the best interests of its clients
and in the integrity of the market.


An investment adviser shall act with due skill, care and diligence in the best interests
of its clients and shall ensure that its advice is offered after thorough analysis and
taking into account available alternatives.


An investment adviser shall have and employ effectively appropriate resources and
procedures which are needed for the efficient performance of its business activities.

Information about clients

An investment adviser shall seek from its clients, information about their financial
situation, investment experience and investment objectives relevant to the services to
be provided and maintain confidentiality of such information.

Information to its clients

An investment adviser shall make adequate disclosures of relevant material
information while dealing with its clients.

Fair and reasonable charges

An investment adviser advising a client may charge fees, subject to any ceiling as
may be specified by the Board, if any. The investment adviser shall ensure that fees
charged to the clients is fair and reasonable.

Conflicts of interest

An investment adviser shall try to avoid conflicts of interest as far as possible and
when they cannot be avoided, it shall ensure that appropriate disclosures are made to
the clients and that the clients are fairly treated.


An investment adviser including its representative(s) shall comply with all regulatory
requirements applicable to the conduct of its business activities so as to promote the
best interests of clients and the integrity of the market.

Responsibility of senior management

The senior management of a body corporate which is registered as investment adviser
shall bear primary responsibility for ensuring the maintenance of appropriate
standards of conduct and adherence to proper procedures by the body corporate
To sum it up Equity Investment Advisors are expected to act in clients interest. Ensure your Equity investment advisor is SEBI Registered

Key Benefits of Investing in Equities

Equities Generate Money www.purnartha.com

Equities Generate Money www.purnartha.com

1. Capital gains over the long-term

Historically, equities have provided some of the strongest after-tax investment returns over the long-term. By owning equity in companies with growth potential, investors have the opportunity to benefit from capital gains as the asset grows in value over time. Investors enjoy unlimited participation in the earnings of the firm. Of course, investors cannot expect the company to pay out all its profits in a form of a dividend as this may come at the risk of future profitability and a lower share price.

2. A good source of income

The dividend yield on equities is another important source of return. Unlike term deposits, dividends from equities can have inflation built into earnings where companies are able to pass cost increases onto customers.

Income from Equities www.purnartha.com

3. Highly liquid

Equities are traded on major stock markets around the world. They are highly liquid which means that they can be converted into cash quickly and with minimal impact to the price received. Unlike direct investments, there is relative ease in the transfer of ownership and the movement of equities.

4. Tax advantages

The after-tax performance of equities is lifted by dividend imputation, a tax benefit not shared by other asset classes. The dividend imputation system allows investors who have been paid a dividend to take a personal tax credit (franking credit) since the company has already paid tax on the dividend.

5. Corporate control

Equities come with certain rights including the voting rights to which the investors are entitled. The level of corporate control depends on whether the equity is classed as ‘ordinary’ or ‘preferred’ and on the size of your shareholding.

Ordinary shares represent the majority of shares held by investors. When you own an ordinary share of a company, you usually have one vote per share that entitles you to participate in the election of the board of directors.

Despite their name, preference shares have fewer rights than ordinary shares, except in one important area – dividends. Companies that issue preference shares usually aim to pay consistent dividends and preference shareholders have first call on dividends. In the event that a company is liquidated, preference shareholders have prior claim to assets over ordinary shareholders. This feature allows the company to raise capital from venture capitalists before it goes public because most venture capital deals are structured as preference shares.

Effects of Inflation

Inflation Effects www.purnartha.com

Inflation Effects www.purnartha.com

Some of the major effects of inflation are as follows: 1. Effects on Redistribution of Income and Wealth 2. Effects on Production 3. Other Effects!

Inflation affects different people differently. This is because of the fall in the value of money. When price rises or the value of money falls, some groups of the society gain, some lose and some stand in-between. Broadly speaking, there are two economic groups in every society, the fixed income group and the flexible income group.

People belonging to the first group lose and those belonging to the second group gain. The reason is that the price movements in the case of different goods, services, assets, etc. are not uniform. When there is inflation, most prices are rising, but the rates of increase of individual prices differ much. Prices of some goods and services rise faster, of others slowly and of still others remain unchanged. We discuss below the effects of inflation on redistribution of income and wealth, production, and on the society as a whole.

1. Effects on Redistribution of Income and Wealth:

There are two ways to measure the effects of inflation on the redistribution of income and wealth in a society. First, on the basis of the change in the real value of such factor incomes as wages, salaries, rents, interest, dividends and profits.

Second, on the basis of the size distribution of income over time as a result of inflation, i.e. whether the incomes of the rich have increased and that of the middle and poor classes have declined with inflation. Inflation brings about shifts in the distribution of real income from those whose money incomes are relatively inflexible to those whose money incomes are relatively flexible.

The poor and middle classes suffer because their wages and salaries are more or less fixed but the prices of commodities continue to rise. They become more impoverished. On the other hand, businessmen, industrialists, traders, real estate holders, speculators, and others with variable incomes gain during rising prices.

The latter category of persons becomes rich at the cost of the former group. There is unjustified transfer of income and wealth from the poor to the rich. As a result, the rich roll in wealth and indulge in conspicuous consumption, while the poor and middle classes live in abject misery and poverty.

But which income group of society gains or losses from inflation depends on who anticipates inflation and who does not. Those who correctly anticipate inflation, they can adjust their present earnings, buying, borrowing, and lending activities against the loss of income and wealth due to inflation.

They, therefore, do not get hurt by the inflation. Failure to anticipate inflation correctly leads to redistribution of income and wealth. In practice, all persons are unable to anticipate and predict the rate of inflation correctly so that they cannot adjust their economic behaviour accordingly. As a result, some persons gain while others lose. The net result is redistribution of income and wealth.

The effects of inflation on different groups of society are discussed below:

(1) Debtors and Creditors:

During periods of rising prices, debtors gain and creditors lose. When prices rise, the value of money falls. Though debtors return the same amount of money, but they pay less in terms of goods and services. This is because the value of money is less than when they borrowed the money. Thus the burden of the debt is reduced and debtors gain.

On the other hand, creditors lose. Although they get back the same amount of money which they lent, they receive less in real terms because the value of money falls. Thus inflation brings about a redistribution of real wealth in favour of debtors at the cost of creditors.

(2) Salaried Persons:

Salaried workers such as clerks, teachers, and other white collar persons lose when there is inflation. The reason is that their salaries are slow to adjust when prices are rising.

(3) Wage Earners:

Wage earners may gain or lose depending upon the speed with which their wages adjust to rising prices. If their unions are strong, they may get their wages linked to the cost of living index. In this way, they may be able to protect themselves from the bad effects of inflation.

But the problem is that there is often a time lag between the raising of wages by employees and the rise in prices. So workers lose because by the time wages are raised, the cost of living index may have increased further. But where the unions have entered into contractual wages for a fixed period, the workers lose when prices continue to rise during the period of contract. On the whole, the wage earners are in the same position as the white collar persons.

(4) Fixed Income Group:

The recipients of transfer payments such as pensions, unemployment insurance, social security, etc. and recipients of interest and rent live on fixed incomes. Pensioners get fixed pensions. Similarly the rentier class consisting of interest and rent receivers get fixed payments.

The same is the case with the holders of fixed interest bearing securities, debentures and deposits. All such persons lose because they receive fixed payments, while the value of money continues to fall with rising prices.

Among these groups, the recipients of transfer payments belong to the lower income group and the rentier class to the upper income group. Inflation redistributes income from these two groups toward the middle income group comprising traders and businessmen.

(5) Equity Holders or Investors:

Persons who hold shares or stocks of companies gain during inflation. For when prices are rising, business activities expand which increase profits of companies. As profits increase, dividends on equities also increase at a faster rate than prices. But those who invest in debentures, securities, bonds, etc. which carry a fixed interest rate lose during inflation because they receive a fixed sum while the purchasing power is falling.

(6) Businessmen:

Businessmen of all types, such as producers, traders and real estate holders gain during periods of rising prices. Take producers first. When prices are rising, the value of their inventories (goods in stock) rise in the same proportion. So they profit more when they sell their stored commodities.

The same is the case with traders in the short run. But producers profit more in another way. Their costs do not rise to the extent of the rise in the prices of their goods. This is because prices of raw materials and other inputs and wages do not rise immediately to the level of the price rise. The holders of real estate’s also profit during inflation because the prices of landed property increase much faster than the general price level.

(7) Agriculturists:

Agriculturists are of three types, landlords, peasant proprietors, and landless agricultural workers. Landlords lose during rising prices because they get fixed rents. But peasant proprietors who own and cultivate their farms gain. Prices of farm products increase more than the cost of production.

For prices of inputs and land revenue do not rise to the same extent as the rise in the prices of farm products. On the other hand, the landless agricultural workers are hit hard by rising prices. Their wages are not raised by the farm owners, because trade unionism is absent among them. But the prices of consumer goods rise rapidly. So landless agricultural workers are losers.

(8) Government:

The government as a debtor gains at the expense of households who are its principal creditors. This is because interest rates on government bonds are fixed and are not raised to offset expected rise in prices. The government, in turn, levies less taxes to service and retire its debt.

With inflation, even the real value of taxes is reduced. Thus redistribution of wealth in favour of the government accrues as a benefit to the tax-payers. Since the tax-payers of the government are high-income groups, they are also the creditors of the government because it is they who hold government bonds.

As creditors, the real value of their assets decline and as tax-payers, the real value of their liabilities also declines during inflation. The extent to which they will be gainers or losers on the whole is a very complicated calculation.


Thus inflation redistributes income from wage earners and fixed income groups to profit recipients, and from creditors to debtors. So far as wealth redistributions are concerned, the very poor and the very rich are more likely to lose than middle income groups.

This is because the poor hold what little wealth they have in monetary form and has few debts, whereas the very rich hold a substantial part of their wealth in bonds and have relatively few debts. On the other hand, the middle income groups are likely to be heavily in debt and hold some wealth in common stocks as well as in real assets.

2. Effects on Production:

When prices start rising production is encouraged. Producers earn wind-fall profits in the future. They invest more in anticipation of higher profits in the future. This tends to increase employment, production and income. But this is only possible up to the full employment level.

Further increase in investment beyond this level will lead to severe inflationary pressures within the economy because prices rise more than production as the resources are fully employed. So inflation adversely affects production after the level of full employment.

The adverse effects of inflation on production are discussed below:

(1) Misallocation of Resources:

Inflation causes misallocation of resources when producers divert resources from the production of essential to non-essential goods from which they expect higher profits.

(2) Changes in the System of Transactions:

Inflation leads to changes in transactions pattern of producers. They hold a smaller stock of real money holdings against unexpected contingencies than before. They devote more time and attention to converting money into inventories or other financial or real assets. It means that time and energy are diverted from the production of goods and services and some resources are used wastefully.

(3) Reduction in Production:

Inflation adversely affects the volume of production because the expectation of rising prices along-with rising costs of inputs bring uncertainty. This reduces production.

(4) Fall in Quality:

Continuous rise in prices creates a seller’s market. In such a situation, producers produce and sell sub-standard commodities in order to earn higher profits. They also indulge in adulteration of commodities.

(5) Hoarding and Black marketing:

To profit more from rising prices, producers hoard stocks of their commodities. Consequently, an artificial scarcity of commodities is created in the market. Then the producers sell their products in the black market which increases inflationary pressures.

(6) Reduction in Saving:

When prices rise rapidly, the propensity to save declines because more money is needed to buy goods and services than before. Reduced saving adversely affects investment and capital formation. As a result, production is hindered.

(7) Hinders Foreign Capital:

Inflation hinders the inflow of foreign capital because the rising costs of materials and other inputs make foreign investment less profitable.

(8) Encourages Speculation:

Rapidly rising prices create uncertainty among producers who indulge in speculative activities in order to make quick profits. Instead of engaging themselves in productive activities, they speculate in various types of raw materials required in production.

3. Other Effects:

Inflation leads to a number of other effects which are discussed as under:

(1) Government:

Inflation affects the government in various ways. It helps the government in financing its activities through inflationary finance. As the money incomes of the people increase, government collects that in the form of taxes on incomes and commodities. So the revenues of the government increase during rising prices.

Moreover, the real burden of the public debt decreases when prices are rising. But the government expenses also increase with rising production costs of public projects and enterprises and increase in administrative expenses as prices and wages rise. On the whole, the government gains under inflation because rising wages and profits spread an illusion of prosperity within the country.

(2) Balance of Payments:

Inflation involves the sacrificing of the advantages of international specialisation and division of labour. It affects adversely the balance of payments of a country. When prices rise more rapidly in the home country than in foreign countries, domestic products become costlier compared to foreign products.

This tends to increase imports and reduce exports, thereby making the balance of payments unfavourable for the country. This happens only when the country follows a fixed exchange rate policy. But there is no adverse impact on the balance of payments if the country is on the flexible exchange rate system.

(3) Exchange Rate:

When prices rise more rapidly in the home country than in foreign countries, it lowers the exchange rate in relation to foreign currencies.

(4) Collapse of the Monetary System:

If hyperinflation persists and the value of money continues to fall many times in a day, it ultimately leads to the collapse of the monetary system, as happened in Germany after World War I.

(5) Social:

Inflation is socially harmful. By widening the gulf between the rich and the poor, rising prices create discontentment among the masses. Pressed by the rising cost of living, workers resort to strikes which lead to loss in production. Lured by profits, people resort to hoarding, black marketing, adulteration, manufacture of substandard commodities, speculation, etc. Corruption spreads in every walk of life. All this reduces the efficiency of the economy.

(6) Political:

Rising prices also encourage agitations and protests by political parties opposed to the government. And if they gather momentum and become unhandy they may bring the downfall of the government. Many governments have been sacrificed at the altar of inflation.

Market Note on Volatility by Purnartha

Market Note on Volatility News 1st February 2016

Market Note on Volatility News 1st February 2016
Markets in the Last Three Months

Volatility has hampered the Indian Equity markets in the last three months. Refer the Table below for the performance of indices:-

Indices Oct 1, 2015 to

Jan 21, 2016

Jan 1, 2016 to

Jan 21, 2016

CNX NIFTY (-)8.48% (-)6.6%
CNX NIFTY MidCap Index (-)7.94% (-)11.00%
CNX NIFTY SmallCap Index (-)8.75% (-)15.3%

Reasons for the Volatility

  • Redemptions in FII Funds, ETFs, oil countries, equity investments, etc., worldwide. FIIs have pulled out INR 14,226 crores from the Indian equity market in last three months.
  • China uncertainty of hard or soft landing.
  • Oil prices have hurt sentiment.
  • Momentum strategies of algorithmic traders have led to swings. Traders have built more shorts.

Is there a structural problem in India?


  • India’s GDP growth is expected to be 5+%.
  • A major portion of India’s GDP growth lies in service oriented sector which is insulated from global GDP cues.
  • A large percentage of GDP growth is driven by need (Roti, kapda and makaan).
  • There are no payment defaults noted worldwide which decreases the likeliness of another recession like 2008, Euro Sovereign Debt Crisis of 2009-10.

What has worked in the current market scenario?

A strong quarterly result overcomes all the negative sentiments of the market.

Example: INFOSYS, After the Infosys’s 3rd Quarter results (refer below table), the stock has gone up by ~4.1% while the NIFTY has fallen by ~3.9% in the same period. Thus, we can see the outperformance of around 8% by Infosys to Nifty after the results.

Particulars Q3- FY 16 Q3- FY 15
Revenue $2,407 $ 2,218
Growth (YoY) 8.5%
EBIT Margin 24.90% 26.7%
Volume Growth 13.6%
PAT Growth (YoY) 6.62%

 Volatility Roller coaster ride markets www.purnartha.com

What is the solution to the pain?

As seen in the above example, a good set of quarterly numbers could be a positive catalyst for the share price performance. Below is the list of our recommended stocks with result dates. Also, we have attached the result expectations of our stocks.


Company Name Result Date
Maruti Suzuki 28-Jan-16
Cera Sanityware 02-Feb-16
Just Dial 27-Jan-16
HDFC Bank 25-Jan-16
Bajaj Finance 03-Feb-16


Are there any multi-bagger opportunities in the market today?

If volatility continues for the next two-three months then we will be able to identify multi-baggers opportunities.

5 Things You Can Do When Stock Markets Are Down

Stock Market Panic www.purnartha.com

Stocks Markets Cartoon www.purnartha.comWell as Douglas Adams Says in Hitchhikers Guide to Galaxy .. DON’T PANIC! Stock markets do go through such tough times and the best way out is to think prudently and then proceed with rebalancing your portfolio. Here are 5 things you can do when stock markets are in a downward spiral.

Take a Deep Breath:

Markets do tend to correct themselves over a time and history shows with growing economies like India returns do improve over the long term. Stocks of zero debt and companies having strong structural and volume growth with large owner holdings often do correct themselves after taking hits.

Review Your Portfolio:

Have a hard look at the companies your are investing in. A good equity investment advisor can help you look into the facts and figure before you take decisions. If you haven’t planned your portfolio till date write down your investment objectives again. With significantly increased risks in lower markets writing down your risk tolerance and the time frames you can hold on too, can help you make the right decisions

Diversify Prudently:

Holding on to very few or very huge number of stocks can be dangerous Health your stocks portfolio with the help of equity investment advisors who can tell how to rebalance your units. Often certain sectors (eg Pharma) are hit while others do better.

Don’t Forget to Buy:

Yes with lower prices getting those dream stocks in your portfolio will be easier. Do buy them after talking to your investment advisor.

Don’t Worry About Headlines:

stock market cartoon www.purnartha.comReading to much into market news and viral tv videos and analysis can actually do you more harm then good. Don’t believe your astrologer either. Do focus on fundamentals, good operating cash flow, zero debts, sound management and past performance through rough weather

Steps To Do Before You Invest in Equities

Equity Investment Advisor www.purnartha.com

Equity Investment Advisor www.purnartha.comStarting to invest in equities? Make sure you do follow these steps

  • Pick the stocks based on certain criteria. (such as Sales Growth, OCF growth,etc)
  • Build your convictions through business understanding and financial statement analysis
  • Write down the pros and cons on a paper
  • Discuss with others (to cover things u missed)
  • Understand the risks involved in the company
  • Once, all your doubts are sorted, invest in the stock (keeping valuations under check)
  • Don’t let daily ups and downs steer your convictions.Simply SIT TIGHT!

If you are unsure how to proceed do consider getting services from an expert equity investment advisor. We suggest taking services from a SEBI Registered Investment Advisor

Selecting Top Equity with Purnartha Research Process

Purnartha Research Process www.purnartha.com

Our equity investment research process at Purnartha comprises of the following stepsPurnartha Research Process www.purnartha.com

  1. We look for companies with Volume Growth in sales. It’s the most basic criteria. Additionally, we do check the pricing power of these companies.
  2. A company must operate with stable EBITDA margins. Fluctuations in margins are signs of poorly run businesses where the external factors have more influence over the company’s operations.
  3. Investors very often ignore the Cash from operations as a not so important parameter. Their simple focus is on Net Profit /(Loss). BUT Cash from operations is an utmost important number which summarizes the way business has been done by the company. It shows the level of cash generated from operations by taking into account the WORKING CAPITAL requirements. A mere scrutiny of the same can clear several doubts on business operations.
  4. Company with high leverage finds it difficult to service their Loans in worst times. They fail to generate enough cash to pay off their Loans. Hence, we focus on the companies which have NET CASH balance in their balance sheet as they can easily survive the ups and downs of normal business cycle.
  5. A promoter frequently diluting his stake in the company is the one who’s losing the interest in his own business. We always look for the companies with high promoter stake and that too, not declining.

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Investor Behavior Has Entered A Zone Of Imprudence

Howard Marks on Equities www.purnartha.com

Howard Marks on Equities www.purnartha.comHoward Marks, Chairman and founder of Oaktree Capital, warns that investor behavior has entered the zone of imprudence and thinks that China is the biggest threat for the US economy.

If you want to know from Howard Marks which stocks are going to do well next year, you’re going to be disappointed. The chairman of Oaktree Capital, one of the most successful investors on Wall Street, does not need to pretend that he can look into the future. Instead, he focusses on the things that are most important to investing for the long run: risk control, a good sense of market cycles and inspiration which, for example, he finds in the world of sports.

Mr.. Marks, we’re at an interesting point in time. For the first time since the financial crisis the Federal Reserve has raised the interest rate. How does the world look like from your perspective at this historical moment?

We’re in a very strange market. Most people are doing a good job of thinking and the consensus is not necessarily wrong today. On one side, the world is a very uncertain place and I think the average investor understands that. Most people are sober and sensitive to all the uncertainty. You don’t see many people who are massively bullish. Nobody is saying stocks are going to the moon. Back in 1999 there was a book published with the title “Dow 36’000” predicting that the Dow Jones Industrial would almost triple. Well, that book is not being re-published today.

And on the other side?

Security prices are not low. I wouldn’t say high, but full. So people are thinking cautiously but they’re acting bullish and they’re behaving in a pro-risk fashion. While investor behavior hasn’t sunk to the depths seen just before the crisis, in many ways I feel it has entered the zone of imprudence.

How do you explain this juxtaposition?

The answer is that they are forced to be buyers by the central banks. The rate on money markets is close to zero and treasuries yield between one and two percent or even negative in Europe. Most investors can’t live with that. They have to move out the risk curve in order to try to get five, six or seven percent. That has induced or forced risky behavior. To me, this is the most important thing that’s been going on over the last few years, and it still is here at the end of 2015.

There are a lot of risks lurking out there: Monetary policy divergence between the US and Europe, a high degree of stress in the emerging markets and the specter of further terrorist attacks. What’s the most important risk for investors?

Academics say risk equals volatility

and the nice thing about volatility is that it gives them a number they can manipulate and use in their formulas. But I don’t worry about volatility and I don’t think most investors are worried about volatility. We know prices will go up and down. But if something is going to be worth a lot more in the future than it is today we’re going to buy it regardless. So people don’t worry about volatility. What they worry about is the potential of losing money.

You wrote extensively about risk in one of your recent memos. What does risk mean to you?

Most people think that there is a positive relationship between risk and return: If you make riskier investments you can expect a higher return. That’s total nonsense! Because if riskier assets could be counted on for higher returns than they wouldn’t be riskier. The reality is that if you make riskier investments you have to perceive that there will be a higher return or else you have no motivation to make that investment. But it doesn’t have to happen: If you increase the riskiness of your investments the expected return rises. But at the same time the range of outcomes becomes greater and the bad outcomes become worse. That’s risk and that’s what people have to think about.

Where do you see potential for bad outcomes?

Investors are not doing what they want to do. They’re doing what they have to do. They are like “handcuff volunteers”. Today, if you want to make a decent return you have to take risks. And most people have been willing to do that. And because of that money has flown into high yield bonds and leveraged loans. For example, at one time there were ninety-five straight weeks of inflows into leveraged loans mutual funds.

Now, credit markets have become quite nervous. What goes through your mind when you look at the rising spreads on high yield bonds?

That’s a good thing. If you’re a buyer you would rather buy at a high risk premium than on a low one, everything else being equal. Maybe the onrush of money was too strong, maybe the attitudes were too optimistic. Now people are a little more worried, especially since they already had a little bad experience in Ukraine, in Greece and in China over the summer.

Then again, the consequences of a full blown crisis in high yield bonds could be severe.
The riskiest thing in the world is the belief that there is no risk. When people think there is no risk, they do risky things. By contrast, when people think there is risk than they behave in a safe manner and the world becomes a safer place. That’s why I welcome the recent developments. They remind us that today the risks are substantial and they should be undertaken only with considerable forethought. My dad used to tell the story of the gambler who went to the race track and said: “I hope I break even because I need the money.” The market is not an accommodating machine. It will not go where you want it to go just because you need it to go there. So if you’re talking about money that you can’t afford to lose then you can’t say: “Just give me the highest yield.”

Investors aren’t the only ones who behave riskily. The central banks themselves have placed venturous bets on unconventional policies like quantitative easing and negative interest rates. What’s the price we’re going to have to pay for that?

This is one of the factors that contributes to making the world a risky place today. In the United States, we had seven years of super low interest rates to try to stimulate. That has never happened before. What are the long term effects on the economy? What’s the effect on lending behavior? And, how will that go now that the Fed has started to raise rates? What will that do to the world? The answer is very simple: We don’t know. And anybody who thinks he knows is kidding himself.

Some kind of wild card is the steep fall in energy prices. Has oil reached a bottom now?
There is nothing intelligent to be said about the price of oil, as I wrote in a memo at the end of 2014. Oil prices have been controlled by OPEC (editor’s note: Organization of Petroleum Exporting Countries) for the last forty years. So clearly, the past doesn’t tell you anything about the free market price of oil. There are assets we feel we can value: stocks, bonds, companies and buildings. They all have in common that they deliver a stream of cash flows that can be valued through a proper discounting process. But how do you value an asset like a barrel of oil or an ounce of gold that doesn’t produce cash flow? You can’t!

Oil was one of the most important factors for the financial markets this year.. What’s your outlook on the eve of a new year?

Everybody would like to know what’s going to happen a year from now. What the economy, interest rates, exchange rates, earnings and all that stuff is going to. But it’s very, very hard to know. My favorite quotation on this subject comes from the economist John Kenneth Galbraith: “We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

So how should investors prepare themselves for the next year?

The most important thing to do is to assess not the future but the present. Awareness and understanding of cycles is an essential tool for investment survival. That’s why I always say: “We may never know where we’re going, but we’d better have a good idea where we are.”

Where are we today?

The point is, we had a crisis in 2007-2008. The central banks all moved to stimulate the economies to get them going. But all around the world economies are growing slowly: Europe, America, Japan – and China is slowing down. That’s what’s happening today. The last six years have been slow and most people believe that the next ten or even twenty years will be slow compared to the ‘eighties and the nineties. And I must say, I am pretty convinced that they’re right. I happen to believe that the nineties especially, but maybe also the eighties, were in many ways the best of times and are not going to be duplicated. So in my opinion we’re not going back to a high growth environment.

As a matter of fact, some people fear that the US economy could even fall into a recession.
There will always be cycles and that means there will always be a recession coming. But is it one year away or five? That’s the question! I think we’re going to limp along in a slow growth mode. There is always a possibility of some acceleration. But there is no boom so there is no need for a bust. Booms usually create overexpansion and when it turns out that it was excessive it turns into a bust. Today, I don’t see boom and I don’t see bust. So I don’t see anything that could cause a recession in the short term, at least not in 2016 – and I’m not characterized an optimist.

And how about further down the road?

I don’t think the world has to worry about the US. But it has to worry about China. So if you’re asking me when the US will have a recession then the question is how long will China go without a recession?

How come?

China has been going for the last twentyfive years with superior growth and without a recession. It’s not going to grow 25 years in double digits again. China is going to grow in single digits and it may have ups and downs. And if China has a recession, that’s very significant for the whole world. Looking at the statistics you might say China is not too important for the US. For instance, the percentage of the profits of the S&P 500 (SP500 2053.13 -0.38%) companies that comes from China is just 1%. But a recession in China would have significant effects on other countries we sell to. The US would not be untouched. So if you need a culprit for a future recession in the US then it’s likely China will contribute.

Another concern are weak earnings. Yet US companies are paying out dividends and buying back shares at a record pace. How healthy is that for Corporate America?
One of the worst things is when a business behaves in a short term way. When the management does things which are not desirable just to please shareholders, either to make the stock go up or to hold on to their jobs. I’m not saying that all buybacks and dividends are wrong. But stock prices are on the high side of fair. The Price/Earnings ratio on the S&P 500 today is 19, whereas the post war average is 16. So if I wouldn’t buy the stock as an investor, why should the company be buying it? Don’t they have better use for their money?

Obviously, there seems to be a lack of good ideas.
There is an interesting book called “The Outsiders” by William Thorndike. He follows the careers of eight outstanding CEOs like Henry Singleton of Teledyne, Katharine Graham of the Washington Post, John Malone of Liberty Media and Warren Buffett of Berkshire Hathaway (BRK.A 199259.5 -0.93%). They all were outsiders because they behaved differently from the crowd. For example, when an industry would go through an acquisition wave these CEOs would not participate. They would think: “Everybody else is buying and that’s driving up the price of companies so we shouldn’t buy.” They were called capital allocators and they treated cash as a valuable resource. And today, with the average stock on the expensive side, these CEOs wouldn’t be buying their stocks back.

Those CEOs were also good at investing. What does it take to be successful in investing?
For me, the definition of a great investor is one who performs well in the good times and doesn’t get killed in the bad times. In other words: When the tide goes out he’s prepared because he has a margin of safety in his portfolio. It’s like in the world of sports: Pete Sampras for example, who is widely regarded as one of the greatest in tennis history wasn’t always an exciting player. His highlights were hard to distinguish from his low lights. But that means his worst moments were almost as good as his best moments. That would describe a terrific money manager: Consistent and not too much excitement, no big ups and downs – and that’s what we try to do at Oaktree Capital.

In your recent memo you worte about inspiration taken from the world of sports. What else can investors learn from top athletes?

If you want to be a superior player you have to have self confidence. The same is true for the superior investor. At some point you have to act boldly.. You have to say: “This is my conviction” and you have to act on it. You can’t have five hundred different stocks and expect to have a great return because you’ll be diversified into mediocrity. Also, you have to think different from the crowd because if you think the same you act the same and you perform the same. That’s what I call second level thinking. A first level thinker says: “It’s a great company so I should buy the stock”. In contrast, the second level thinker says: “It’s a great company. But it’s not as great as everybody thinks so the price is too high and I should sell.”

In your memo you also refer to the baseball star Yogi Berra. He was famous for saying things like “It’s too crowded, nobody goes there anymore”. What kind of trades are too crowded in today’s markets?
Today, I don’t see any glaring exceptions. Of course, I see some asset classes that are somewhat more attractive than others. But I don’t see things that are dirt cheap or crazy high, except the possibility of social media stocks and technology IPOs. But other than that I don’t see anything glaringly wrong. I just think the whole world is priced for a better future than we have.

So what’s your strategy in this kind of market?

We are living in a low return world caused by the central banks pulling down the risk-free rate to zero. And yet, even though the returns are low, the risks are substantial. That’s why at Oaktree our mantra for the past four and half years has been “move forward but with caution.” The outlook today is not so bad and prices are not so high that they demand complete caution and defensiveness. But at the same time prices are not so low and the outlook is not so good that we should be aggressive. So our strategy is not maximum defensiveness, not aggressive. It’s somewhere in between, but with a significant emphasis on caution. And that means you have to select your investments carefully.

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