Risk(y) management in Value Investment.

I read an interesting article written by Alex at MacroOps where he emphasized on the importance of mixing technical with fundamentals.

I am not interested in stirring a pot here, to each his own and you should do what you are good at, do what suits your temperament and returns would correspond with the edge of your strategy complimented by the discipline you have to implement it.

What I am though interested in is bringing forward the inherent risk of ignoring risk management in the field of value investing. (And it is a lot easier to lose the anchor in this field rather than technicals). Let me explain what I am trying to say here.

A Price action based strategy has no escape route, if you consistently lose money despite the discipline, you can safely say that there is no edge in your strategy, may be the market has changed, what use to work doesn't work no more or what works on paper loses its edge in implementation due to transaction cost, slippage etc. A price action based player is willing to demean and discard his strategy because he receives instant feedback on the robustness. It is a like a backhand tennis shot, there is no Grey area, either it is OUT or you have hit an awesome winner.

Value investing on the other hand is based on narrative with a (very) slow feedback. Nothing wrong in it so far, Buying decisions of good value investors are based on sound valuation technique which gives them a decent margin of safety. Problems surface at the time of exit. If the public concurs with your story, the stock roars and all is fine and you can pat your back and say you are a superior human being who sees things before average Joe.

But if it does not work out, and the public narrative changes, you are in catch 22 situation. Now, price action is not at your rescue because you look down upon it. At what point you tell yourself that you are wrong. And in fact every subsequent fall makes your stock that much more attractive.

Problem with experts is that instead of realizing that Value investing has these inherent flaws where a successful man intoxicated with his previous success, suffering from endowment, commitment and consistency can throw caution to the wind and risk management with it, they simply isolate the culprit from Value investing finding mistakes and flaws in the ‘person’.

All those intelligent sounding blogs (majority of them) who are now saying what an idiot Bill Ackman is are suffering from that narrative fallacy. They have built their hypothesis after the price fall.They are all searching for a reason and they found it. I mean topic of ethics (a relative term) and deciding your investment based on that is all fine to fool yourself, it has nothing to do with returns. (That is probably a topic for another blog, Wild life extinction activists also fall in the same bracket). It stems from same arrogance that you the superior breed is doing something worthwhile.

I still remember the same story manifested in case of THOMAS COOK, on the other extreme. Before Prof Bakshi wrote an amazing narrative on it, i had a conversation with many Value investors and none of them found no moat in it and found it exorbitantly priced.

A week after the professor’s blog, everyone of them baboons were writing their own mini blog, thesis on the inevitable, omnipresent, vibrant moat of TC.

Before you demean and demolish Bill Ackman, keep in mind that he is (was) one of the most accomplished Value investors around. And if he can fall for the side effects of Endowment, commitment and consistency bias, what kind of overconfidence bias are you suffering from to think it cannot happen to you.

Sure, you can say that by following Bayes theorem, you will be able to quantify each fact as it comes but once again aren’t you over estimating yourself, arrogant value investor you. That kind of mental gymnastics cannot be expected from average folks. And yes I am talking to you, contrary to what you think, you are AVERAGE.

Now I am sorry for my rude language, if it is. That is the way I write. Let us not lose the main point in mudslinging shall we. I have seen and met a lot of idiots and geniuses on both sides to know that both intelligence and stupidity is not confined to any category and therefore the debate is not on which is better.

My 02 cents on the subject are A) Risk management in value investing is inherently more difficult and you are more likely to go astray because you are married to your stock. Which can be a great thing as you will be able to ride a 100 bagger but can also lead to your demise if your wife is a bitch b) I am not arrogant to say I am right and world is not and therefore just like Mark Minervi, William O Neil and Jesse Stine I pay due importance to price action.

Like always, comments are welcome.

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Insights for DIY investors on Risk management, Option strategies, Special Situations & Momentum.

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