July – September 2011
October 31, 2011
Whilst your individual returns are with you, I would like to share how we think about our performance at Jeetay.
1) We look at a “representative” portfolio. Most of the older portfolios usually have in the past had performance numbers clinging around the numbers of the “representative” portfolio. Newer portfolios take time to build up and usually mask true performance and may even distort it. This “representative” portfolio is that of our oldest client.
2) We benchmark our returns against the Sensex. We are size agnostic but usually find values in the mid-cap space. However we carry fairly large amounts of cash and so a mid-cap index may not be the right benchmark. We have chosen the Sensex to give you a sense of the “opportunity cost” of not being in the market and not as some sort of a competitor with whom we are in a quarterly rat race.
3) Short-term underperformance does not bother us and short-term outperformance does not excite us. What should count are long-term figures. Our idea of the long-term is very long. We will be honest – we do not have performance figures for our definition of the long-term. So we have sliced the performance figures into various shorter-term horizons, to suit your perspective of what should be a sensible investment horizon.
4) We usually measure the cheapness of our portfolio in relation to each security’s historical valuations and not against the current market valuation i.e. we would like to have some sort of absolute cheapness and not relative cheapness.
5) The figures cited are before taxes and fees. This is because the taxes are paid by you and vary depending on whether you have short-term capital losses and the quantumof short term gains. The fee structure varies due to 1) different plans 2) different entry points (high watermarks). These should shrink the magnitude of outperformance, although not eliminate it.
6) We do not only look at returns, but at risk-adjusted returns. We do not measure risk by simple volatility, but by downside volatility, drawdowns and portfolio cheapness. On a risk-adjusted basis, our returns, even after taxes and fees, should compare well with the Sensex. Since we believe that markets are unforecastable, we usually hedge our positions by carrying fairly large amounts of cash.
7) We continue to use the “representative” account methodology so as to be consistent (Tables 1, 2 and 3).
8) We have found that the “representative” account, which has been that of our oldest account, now has a different portfolio composition from newer accounts and even some of the older accounts. It may thus in the future not properly track overall performance. We have included Table 4 in which four sets of figures are shown:
a) The “representative” portfolio returns.
b) The weighted average returns of all the discretionary portfolios in the Jeetay PMS.
c) The weighted average returns of those portfolios with over 60% equity at any point since inception. These may be generically thought to be the “older” portfolios since “newer” portfolios take some time to build up and may not be representative of portfolio performance. They are of course included in the weighted average returns of all the portfolios.
d) The Sensex returns.
9) We will therefore be reporting “weighted average” returns along with those of the “representative” portfolio.
Table 1
| Since Inception | ||||
| Period | Portfolio Return (%) | Sensex Return (%) | % in cash | |
| June 07, 2003 to June 07, 2004 | 80.80% | 48.00% | Almost fully invested | Audited |
| July 05, 2004 to June 30, 2005 | 31.45% | 42.10% | Around 65% | Audited |
| July 01, 2005 to March 31, 2006 | 30.32% | 56.80% | Around 40% | Audited |
| April 01, 2006 to March 31, 2007 | 33.73% | 15.62% | Around 20% | Audited |
| April 01, 2007 to March 31, 2008 | 7.41% | 18.60% | Around 30% | Audited |
| April 01, 2008 to March 31, 2009 | -22.26% | -37.94% | Around 35% | Audited |
| *April 01, 2009 to March 31, 2010 | 85.16% | 80.50% | Around 30% | Audited |
| April 01, 2010 to March 31, 2011 | 29.09% | 10.93% | Around 27% | Audited |
| April 01, 2011 to June 30, 2011 | 6.26% | -3.08% | Around 20% | Audited |
| July 01, 2011 to September 30, 2011 | -3.75% | -12.69% | Around 7% | Audited |
| Cumulative Return | 742.06% | 375.51% |
Table 2
| Since 2006 | ||||
| Period | Portfolio Return (%) | Sensex Return (%) | % in cash | |
| April 01, 2006 to March 31, 2007 | 33.73% | 15.62% | Around 20% | Audited |
| April 01, 2007 to March 31, 2008 | 7.41% | 18.60% | Around 30% | Audited |
| April 01, 2008 to March 31, 2009 | -22.26% | -37.94% | Around 35% | Audited |
| *April 01, 2009 to March 31, 2010 | 85.16% | 80.50% | Around 30% | Audited |
| April 01, 2010 to March 31, 2011 | 29.09% | 10.93% | Around 27% | Audited |
| April 01, 2011 to June 30, 2011 | 6.26% | -3.08% | Around 20% | Audited |
| July 01, 2011 to September 30, 2011 | -3.75% | -12.69% | Around 7% | Audited |
| Cumulative Return | 172.95% | 44.21% |
Table 3
| Since 2010 | ||||
| Period | Portfolio Return (%) | Sensex Return (%) | % in cash | |
| April 01, 2010 to March 31, 2011 | 29.09% | 10.93% | Around 27% | Audited |
| April 01, 2011 to June 30, 2011 | 6.26% | -3.08% | Around 20% | Audited |
| July 01, 2011 to September 30, 2011 | -3.75% | -12.69% | Around 7% | Audited |
| Cumulative Return | 32.03% | -6.14% |
*A mistake we hope never to make again – at low levels of the market, do not wait for even lower prices. Ignore all the negatives, because they usually are already in the prices. Mark-to-market losses should not hurt, only permanent losses of capital.
Table 4
Jeetay Returns**
| “Representative” portfolio | Weighted average return of all discretionary portfolios | Weighted average return of “older” portfolios | Sensex Returns | |
| 2006-2007 | 33.73% | 28.66% | 30.11% | 15.62% |
| 2007-2008 | 7.41% | 7.12% | 8.68% | 18.60% |
| 2008-2009 | -22.26% | -23.85% | -23.85% | -37.94% |
| 2009-2010 | 85.16% | 78.40% | 79.00% | 80.50% |
| 2010-2011 | 29.09% | 18.57% | 18.40% | 10.93% |
| 2011-12(April 01, 2011 – September 30, 2011) | 2.27% | -1.26% | -1.15% | -15.38% |
**Returns are before fees but after all other expenses
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With images of “Occupy Wall Street” fresh in my mind come also thoughts of the growing abuse of power in corporates and dishonesty in governments. These revolts can only gather strength in the coming years.
Turn to executive greed first.
Mr. Charlie Munger has written about the power of incentives. “Never, ever think about something else when you should be thinking about the power of incentives.”
And undoubtedly financial incentives can cause higher levels of performance and productivity. Academic studies indicate that individual financial incentives increase employee performance and productivity on an average by 42 to 49%.
There are however “unintended” consequences of financial incentives, which are usually not considered.
When strong financial incentives are in place, ‘ethical fading’ will happen in many employees and unethical acts will result. The employees will convince themselves that they are doing no wrong. This process of reframing and rationalization has been well studied in psychology.
Financial incentives also carry the risk of creating large pay inequalities which in turn can lead to employee turnover and thus be inimical to performance. Compensation is more than money since it signals status in an organization. Furthermore it is judged in relative terms and a whole host of negative emotions like envy and resentment result from large pay inequalities. Peter Drucker has written extensively about this.
A further risk of financial incentives is that it reduces intrinsic motivation. The closest I can come to defining intrinsic motivation is probably what Mr. Buffett feels when he “tap dances” his way to work. In the 1970s, Stanford’s Mark Lepper and colleagues designed an experiment in which participants were asked to play games for fun. The researchers then started giving rewards for success. When they stopped giving the rewards, participants ceased playing. What started as fun became work when performance was rewarded. Psychological literature has a word for it – the overjustification effect: Our intrinsic interest in a task can be dwarfed by a strong incentive, which leads to a belief that we are working for the incentive. Numerous studies by University of Rochester psychologists Edward Deci and Richard Ryan have shown that rewards often come in the way of our intrinsic motivation to work on challenging and absorbing tasks – especially when they are announced in advance or delivered in a controlling manner.
Daniel Pink, in his wonderful book “Drive” has another word for the overjustification effect. Here is a small passage from the book so that you will understand the word he uses for it in the end.
“One of the most enduring scenes in American literature offers an important lesson in human motivation. In Chapter 2 of Mark Twain’s “The Adventures of Tom Sawyer”, Tom faces the dreary task of whitewashing Aunt Polly’s 810-square-foot fence. He’s not exactly thrilled with the assignment. “Life to him seemed hollow, and existence but a burden,” Twain writes.
But just when Tom has nearly lost hope, “nothing less than a great, magnificent inspiration” bursts upon him. When his friend Ben ambles by and mocks Tom for his sorry lot, Tom acts confused. Slapping paint on a fence isn’t a grim chore, he says. It’s a fantastic privilege-a source of, ahem, intrinsic motivation. The job is so captivating that when Ben asks to try a few brushstrokes himself, Tom refuses. He doesn’t relent until Ben gives up his apple in exchange for the opportunity.
Soon more boys arrive, all of whom tumble into Tom’s trap and end up whitewashing the fence-several times over-on his behalf. From this episode, Twain extracts a key motivational principle, namely “that Work consists of whatever a body is OBLIGED to do, and that Play consists of whatever a body is not obliged to do.” He goes on to write:
There are wealthy gentlemen in England who drive four-horse passenger-coaches twenty or thirty miles on a daily line, in the summer, because the privilege costs them considerable money; but if they were offered wages for the service, that would turn it into work and then they would resign.
In other words, rewards can perform a weird sort of behavioral alchemy: They can transform an interesting task into a drudge. They can turn play into work. And by diminishing intrinsic motivation, they can send performance, creativity, and even upstanding behavior toppling like dominoes. Let’s call this the Sawyer Effect.”
In the book Daniel Pink summarizes a large amount of evidence that intrinsic motivation is often supported by three key factors: autonomy, mastery and purpose. High effort and performance often come from designing jobs to provide freedom of choice, the environment to develop one’s skills and expertise and the chance to do work that matters.
Let me briefly turn to another great multidisciplinary thinker – Aristotle. Aristotle’s lectures on ethics were intended for young men and were in response to the question. “What should I do to live a flourishing life?” This is not a question about what they should do to guarantee that their life contained the signs of success, such as money, power or public regard. They are not the essence of a successful life. The answer which came from his teleological metaphysics is that this will happen if they live their lives completely in accordance with the purpose or function of a human being. To do this, they must live both rationally and virtuously.
Aristotle pointed out that powerful men often seem to live a life of pleasure, perhaps simply because they can afford to. This sets the wrong example and many others attempt to emulate them.
For Aristotle, pleasure is something that leads to perfection in an activity. When we are absorbed in some useful and productive work we lose ourselves in it and experience a sense of ‘flow’, especially if we are doing it well. We can even cease to notice the passing of time and other distractions. This, for Aristotle, is real pleasure.
For Aristotle, to live virtuously and rationally also meant living well with other people – thinking of the “We” rather than the “I”. A business person becomes a “pillar of the community”, not by virtue of his wealth alone.
In India our tax laws are sought to be changed so that stock options are taxed as ‘capital gains’ and not ‘income’. This will lead to stock options becoming a bigger part of compensation packages in the future with all the potential for abuse like funny accounting, overstated profits and senseless buybacks.
In another fascinating book, “The Uses of Pessimism and the Danger of False Hope” the author, Roger Scruton, writes about the “unscrupulous optimism” being witnessed today. Here is a small passage:
“They would have known one thing that the world was striving to put out of mind, which is that when people are being everywhere tempted into debt, there will be a growing and eventually worldwide reluctance to pay up, that honesty will be increasingly seen as a weakness, and that eventually the habit will arise of paying off one debt by contracting another. At a certain moment the foundation of trust will be withdrawn and the structure built on it will crumble to dust.
Most important of all, scrupulous optimists strive to fix their hopes as best they can on the things they know and understand, on the people who are close to them, and on the small-scale local affections that are the foundation of our happiness. They know that they are vulnerable, like everyone, to external and public events, and that they must take provision against them. They know that they are members of a community, a nation and a species, all of which must take collective action for their survival. But their pessimism tells them that the lot of communities is not improved by unfounded hope, that small-scale work is the best route to peace and conciliation, and that rootless hopes are as much a threat to the human future as the dangers they hide from us. It also tells them that freedom means responsibility, and that a society in which people strive constantly to transfer the costs of failure is a society of ‘I’s without a ‘we’.”
Is this not true of ‘bailouts’, all done in the name of staving off collapse and disaster when the foundations have weakened beyond repair?
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Two years ago we made “an error of pessimism” by not utilizing the large cash levels in our portfolios when the market was at historically low levels. We may have now made another gigantic “error of optimism” by drawing down on cash when there are clear market downsides that can still be large.
The jury is still out on whether this is a secular bear market of the sort we witnessed from 1993 to 2002. Even secular bull markets have had large ‘corrections’. We have been way too early in removing our only shield in a hostile market – cash.
Even if we should not be penalized too heavily for this shift in asset allocation, it will go down in our books as a serious mistake.
Be warned: We are slow learners!
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For the reasons outlined above, you must not take the recent performance figures of Jeetay too seriously. The challenges ahead will test us and whilst we are sure about our process, we can never be sure about our short-term performance vis-à-vis the market. We certainly do not use it as any reliable measure of investment skill.
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Should there be any queries, I’m always available. Please do not hesitate to contact me or members of the Jeetay team at the office – Divya, Rashmi, or Shakir! There are some changes underway on the research side which I’ll write to you about in due course.
Warm Regards,
Chetan Parikh
1 The Problem with Financial Incentives – and What to Do About It by Adam Grant and Jitendra Singh
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2741
2 Aristotle – Rupert Woodfin and Judy Groves
3 Ethics and Excellence – Robert C. Solomon