In our overall portfolio we need to get decent ABSOLUTE RETURNS – most of us should not care about:

• Our neighbor’s return
• Index return
• Rakesh Jhunjhunwala’s return
• Your Own Historical Return.

I am in that category. Frankly as long as my GOALS are met, I do not need to worry about what others are doing. Seriously. If my father’s goals can be met by keeping all his money in a savings account, so be it. Ditto for my own goals. I now surely have fewer earning years and more spending years so I too need a portfolio which will take care of my non earning ears till the end of life.

The advantage of being an absolute return investor is you need to be away from the crowds. Which means if you have capital protection as primary objective (like it should be in my dad’s case) he needs to be more in debt instruments. Also in a market which is hitting the roof, you can sit on a lot of cash – or use the cash to down pay the debt. Or even better book profits to reduce debt. Assuming of course that you have debt to repay. How much debt should you repay? Well any amount by which your debt is now around the Rs. 25L mark – for the self occupied house and Rs. 25L for the rented out property. This allows you a nice deduction in IT and you replay it in a depreciating asset like the rupee. It is times like these that  I am thankful I’m not required to be fully invested in what I think are inflated assets. With Central banks printing money and creating a world of inflated assets – all asset classes look dicey. With an absolute return portfolio currently focused on patience, I’m not very concerned about the short term direction of the stock market. It can go higher, much higher or it can go down. To accomplish  absolute return objective, the exact high equity prices reach this cycle or the next cycle is irrelevant!

On the other hand relative return investors (aka fund managers managing other people’s money) view patience and cash a little differently. Regardless of valuations, almost all mutual fund managers (and their investors) remain fully invested throughout the entire market cycle. For a retail investor allocating a small amount of money in non debt instruments, this is not so bad. However, as an absolute return investor, this has been very difficult to accept. Hence when the market is high I prefer deploying fresh money into funds which have a choice – dynamic funds, prudence funds, MIP, etc. where the fund manager has a choice of being in some debt instrument if he feels that the market will correct.  Think of so much literature that you have read on the principles of successful investing, such as: buy low sell high, don’t lose money, or be fearful when others are greedy and greedy when others are fearful. As a fund manager he cannot apply any of these laws. All these laws need a lot of patience. Patience – and how can investors be patient without the ability and willingness to hold cash? In fact patience is not just not doing anything during extreme periods – it is also the ability to sit tight and not FEEL fidgety during such periods. Maintain calm.

I want to make it clear that my patient ‘doing nothing’ or just trading and not taking delivery of any share with a long term view in mind is not an attempt to time the market. I know I cannot. Instead, it is the inability to find enough (or any) stocks within my universe of high quality business that pass my return hurdle rates. The Psu shares looked good from a dividend pay out angle, but in shares like Coal India the dividend paid out was MORE than the EPS LAST YEAR. This is obviously not sustainable and hence the price of sub 300 – the IPO price. You should also be aware that holding cash can result in significant opportunity cost. Hence I do keep trading in some good stocks – clearly if I am stuck with it, I will lose return ON capital and not return OF capital. However, during periods of overvaluation, I think opportunity cost is preferable to overpaying and risking substantial losses OF capital.

Opportunity cost can be recovered once market cycles end and prices adjust. Big losses resulting from overpaying can be much more difficult to recover from and can even be permanent.

Look at the commodities cycle – if you had bought Tata Steel at 900 and had not done regular investing on the way down, we could be talking of about 20 years just to recover cost and a decent return. Surely not worth it.