The Bitcoin Dream

The Bitcoin Dream

 

Last night, I dreamt of my friend who always talks and tweets about Bitcoin. For the sake of hiding his identity, I have named him Bittu (for he is a Bitcoin buff). The dream went like this:

Bittu: Hi Ankur

Me: Hi Bittu

Bittu: Did you read my latest tweet on Bitcoin?

Me: No, I am absent on Twitter.

Bittu: Why? You know there’s so much of valuable information available on Twitter.

Me: I know. But I also remember what my teacher Buffett says: “Value is what you get and price is what you pay”. I think, for me, the cost in terms of distraction and time spent on Twitter would be more than the value I would get. It would be a losing trade. Hence, I stay away.

Bittu: As you wish. By the way, did you invest in Bitcoin?

Me: No, I don’t understand it. My teacher Buffett teaches that one should stay within one’s circle of competence. I don’t understand Bitcoin and its dynamics and the chances are low that I would understand it even if I made an attempt.

Bittu: I suggest that even if you don’t understand Bitcoin, you should invest 1-2% of your networth. If it works out, it would make you rich.

Me: But I am already comfortably rich for my lifestyle. My teacher Buffett also teaches that one should not risk what one does have and does need in order to get something one doesn’t have and doesn’t need. More importantly, putting 1-2% might be a relatively small amount but it would break my discipline. Soon enough, I am sure there would be many opportunities which I don’t understand, vying for 1-2% each. I feel it would be a slippery slope- easier to start but difficult to stop.

Bittu: The way the governments around the world are printing money, it’s quite likely that there might be massive inflation. Bitcoin would be a good hedge against inflation.

Me: I don’t understand that part well enough. For the sake of discussion, if we assume that there might be high inflation, I feel that people would still require necessary products and services. And strong businesses would have the pricing power to pass on inflation to their customers. Hence, strong businesses too should serve as a hedge against inflation.

Bittu: People also say that if not a wealth creator, Bitcoin might act as a wealth protector.

Me: By whatever name you call it, ultimately every financial transaction has 2 components: cost and value. You need to have a fair idea of both in order to enter deals which first protect and then create wealth. If you don’t know either of them, you are entering quicksand. I know the cost of Bitcoin but not its value.

Bittu: The narrative around Bitcoin is changing. Even some of the best-known investors are throwing their weight behind it. You would get left behind.

Me: I don’t want to fall for social proof. I have fallen for it earlier and have learnt precious lessons out of it. If other investors understand Bitcoin and make money, they deserve it. The fact that they make money and I don’t, shouldn’t bother me.

Bittu: You are raving too much about your teacher Buffett. Do you know he has underperformed the benchmark for so many years and his investing methods have become a passe?

Me: Underperformance is partly because of the gigantic amount of money that he oversees and not   necessarily because of obsolescence of methods. I manage small sum of money and understand his investing methods. His methods have worked for me in the past and hopefully they should work in the future as well.

Bittu: His methods won’t work forever. Till what point will you follow him?

Me: He has shown the path till $300 bn. Once I reach there, I will see.

Bittu: What’s the path?

Me: Buy good quality businesses run by good quality people and available at a fair price. Buy in sizeable quantities and hold them for a long period of time.

Bittu: Okay Ankur, I need to go. Good luck for creating wealth through investing in such businesses.

Me: Thanks, Bittu. Good luck to you too for creating wealth through Bitcoin.

Risk can come from anywhere

In life, risk can come from anywhere. More so, in equity investing. This thought has been captured very well by the following quote :

“Condoms aren’t completely safe. A friend of mine was wearing one and got hit by a bus.” — Robert Rubin

Lakshmi Vilas Bank (LVB) has been in the news for poor functioning and an aborted attempt to merge with Indiabulls. That tells a lot about both. As Yogi Berra said "You can observe a lot by just watching".

On Nov 17th, RBI put LVB under moratorium and decided to merge the same with DBS India. Merging LVB with a strong entity like DBS would ensure safety of the depositors' money, I think. But what happens to the shareholders ? Read the following :

So, the entire equity capital of LVB stands written off and the shares are now worth zero. Didn't I tell you, that in life, risk can come from anywhere. And more so, in equity investing.

Knowledge is like sunshine

Once upon a time, there lived a group of 4 friends: Cleverwit 1, Cleverwit 2, Cleverwit 3 and Dumbwit. As the names suggest, three of them were quite clever and one of them was considered dumb according to conventional standards.

All of them lived in the ashram of their guru to attain education. After having spent many years in the ashram and having completed their education, they headed home. The journey home was long and encountered forests on the way. While passing through one of the forests, they came across some scattered bones.

Cleverwit 1:  Hey! Let’s utilize our guru’s education and test ourselves. By looking at these bones, I can tell you that these belong to a lion. I can arrange them.

Cleverwit 2:  And if you could do that, I should be able to put flesh and skin around it.

Cleverwit 3:  Well, if both of you are successful, by the grace of our guru – I should be able to infuse life into the lion.

Dumbwit who was until now silent and patiently listening to their conversation shivered at the idea and expressed the danger, all of them would get into should the lion come to life. All cleverwits, too consumed by their knowledge and an opportunity to show it off dismissed his apprehensions and called him a coward.

Having realised that it would be difficult to rationalise with his friends once they have made up their mind, he requested them to let him climb a tree before they brought the lion to life. Cleverwits agreed and Dumbwit quickly climbed the tree. The Cleverwits were successful, the lion came to life and filled its belly with the bodies of 3 cleverwits. Dumbwit witnessed this sad scene from a tree and wished his friends had listened to him.

Cleverwits were all clever but they made a fundamental error. Dumbwit may have been otherwise dumb but he got his basics right.

In investing too, we encounter situations where the business is all good and we may think we are clever to spot such a business but there is this element which if comes to life would devour the capitalist. The risk could come from a single supplier, single customer, single geography, single asset or dependency on a favourable regulation etc. The risk could also come from a questionable quality of management. Dubious related party transactions and schemes of arrangement are fertile grounds to perpetrate wrongdoings on minority shareholders. 

IF we encounter such a business or a management with a fundamental flaw, we should think like Dumbwit and climb to a safe vantage point. Investing in situations fraught with grave risks is stupidity not bravado. Sadly, in investing stupidity often appears camouflaged as bravado.

I read this story in Amar Chitra Katha (a popular comic magazine) and added to my mental framework. The message here is Buffett’s Rule No 1 in investing “Never lose money”. 

 

Another favourite story of mine is one from the book of Osho.

Once a dhobi (washerman) came for his morning rounds to pick up dirty laundry from his customers’ houses. He was accompanied by his donkey whom he used to transport laundry. In the village also lived a Seth (wealthy merchant).

Having arrived at the Seth’s house, the dhobi asked for laundry. The Seth saw a shining glass piece tied around the donkey’s neck.

Seth:    Hey! What have you tied around your donkey’s neck? And where did you get it?

Dhobi:  I don’t know what it is, Sir. I was passing through a road and found it lying there. I liked it, picked it up and tied it around my donkey’s neck.

Seth: Okay. It’s of no use to you and your donkey. Let me buy it from you. I will give you Rs 10 for it.

Dhobi thought for a few moments and agreed to sell but for Rs 20. Seth thought that the dhobi is going to come back in the evening and sell the same thing to him for 5 bucks. Seth spent the whole day thinking about the glass piece and waited anxiously for the dhobi to return in the evening.

The evening finally came and so did the dhobi with the washed laundry and his donkey. But the glass piece around his neck was missing.

Seth: Wherrrre is the glass piece?

Dhobi:  Oh! Somebody in the market offered me Rs 50 and I gave it to him. Good that I didn’t give it to you for Rs 20 in the morning.

Seth: You fool ! That was a piece of diamond and was worth atleast 10,000 bucks and you sold it for 50.

Dhobi:  Sir, I am ignorant and do not know anything about diamonds and their values. I asked you 20 bucks because my donkey eats grass worth that much in a day. And I thought either I would sell it for atleast that much or else I won’t. But you haggled for 10 bucks knowing very well that it was a diamond and was valued much more. Don’t you think you are a greater fool than me!

Most of the time in investing, we are like the dhobi. We are ignorant about the businesses and we don’t know their values. Market prices in isolation should not mean anything to us. But sometimes, we understand the business and we can also conservatively calculate its intrinsic value. IF we find ourselves in such a situation and the price offered by the market offers a good margin of safety, we should act decisively to buy and not act like the Seth and haggle for lower prices. 

This is a story which reminds me that historical prices are irrelevant. A business might have traded at much lower valuations in the past but we may have been the dhobi at that time knowing nothing about the business. The important thing is to know when you are the dhobi and when you are the Seth.

I would like to add a word of caution here. This story should not turn you into an unjustifiable optimist and buy any business that you like disregarding the valuations. 3 things are important: you should understand the business, the business should be conservatively valued and finally it should be available at a good margin of safety.

The above 2 stories remind me of the important elements of risk avoidance and acting decisively when things are within our circle of competence. These elements have been taught by investment masters over a long period of time. I have tried to understand these in the form of stories as stories have a powerful way of wiring our brains.

I read these stories in different books in contexts which were not related to investing. But knowledge is like sunshine and should be welcomed from all directions.

What say you?

Niti and Nyaya

Many a time, we come across a business which is of a good quality but the management has conducted itself in the past in ways which do not fully conform to ethical and legal standards.

Should we reject that idea? On what parameters should we decide? 

Niti and Nyaya

In Sanskrit, both these words denote justice. However, according to philosophical texts, there is a subtle difference between the two. “Niti” stands for moral conduct, correctness of behaviour and is abstract in nature. “Nyaya” stands for rules and procedures and is absolute in nature. 

A king had a wise minister who always spoke the truth. The king once decided to put-down his minister. He showed his closed fist to the minister and said “You are so wise and you always speak the truth. In my fist, there is an ant. Tell me if it’s dead or alive.” The minister thought for a moment and replied that the ant is dead. The king laughed and feeling victorious- opened his fist. The ant was alive and walking. The king told the minister that he had been proved wrong. The minister remained silent. 

Later on, one of the minister’s friend in the court asked if he knew that the ant was alive. The minister said, “Yes, I knew. But had I spoken the truth, the king would have closed his fist tighter and killed the ant. In order to save the life of the ant, I had to side with Niti (moral conduct) at the cost of Nyaya (legal conduct).”

Let’s look at some examples of management actions through the lenses of Niti and Nyaya.

1.     A pharma company has a monopoly on some drugs and raises prices exorbitantly. Assuming that the drugs were not under any price regulation, the company was well within its right to raise the prices. So, Nyaya (legal conduct) was intact. 

But raising the prices beyond a reasonable limit causes undue hardships to families who needed the medicines. Did the company’s management behave with the correct Niti?

2.     A company decides to pursue a buyback at a cheap price with negative consent from the minority shareholders and promoters do not participate in the buyback. Negative consent means that if the shareholders don’t opt out, it would be deemed that they agree to the buyback. Minority shareholders who didn’t understand the matter completely found their shares bought back (stolen) from their accounts at low prices. The company has followed all due legal procedures and hence has Nyaya on its side. But did it have Niti on its side? 

3.     Munger once bought a business and had a couple of widows on other side of the transaction. Unaware about financial matters, the widows quoted a lower price than what Munger had calculated. He decided not to take advantage of their ignorance and paid the higher price. He ignored the rule-based conduct in favour of an overarching moral conduct.

4.     A company under debt reconstruction gets settlement terms from all the creditors. There are hundreds of small depositors who had put their savings into the company’s deposits. Realising that even though under financial stress, it can still pay the small depositors, the company decides to pay in full to them. An example where the management is guided by the moral conduct and not by the legal conduct alone.

During our investing careers, we will come across many such permutations and combinations of intermeshed legal and moral conducts.

1.     When a management runs a business both with Niti and Nyaya on its side, one can quickly conclude that you have got the right set of partners.

2.     One can also immediately conclude when neither Niti nor Nyaya is present. Don’t venture close to such managements. You will lose both- character and money.

3.     If the management has been guided by a higher moral conduct at the expense of rules, look carefully. If you conclude that it is indeed the case, then it is a very good management to partner with.

4.     The tough situations are the ones where a management has followed all legal procedures but their actions do not pass the test of moral conduct. What to do in such cases?

I think about them in the following way:

• Is the issue-at-hand going to damage the core business of the company?
• What % of revenues or value pertains to this issue at hand? 

If the issue is small relative to the revenues/value of the business, I would tend to take it in my stride and not reject the idea outrightly.

• Does the issue make me question the basic DNA of the management?

Irrespective of the % contribution to revenues/ value, if the basic DNA of the management becomes questionable, I would stay away and not partner with them. Dubious schemes of arrangement and related party transactions are fertile grounds for such behaviour.

• Are there more than one distinct corporate governance issues?

Judging corporate governance practices in a business is quite a subjective call. Two well-meaning investors can have different perspectives on the same issue. It depends on one’s own tolerance level, risk appetite and overall attitude towards investing.

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Opportunity Cost

One of the most important and powerful factors and often ignored one while making decisions is opportunity cost. 

If it's so important, why does it get ignored all the time ? Because it's abstract. And since it's abstract it goes out of sight. And out of sight quickly becomes out of mind. 

Munger has spoken highly about Greg Mankiw who has highlighted the importance of opportunity cost in making decisions.

“If you take the best text in economics by Mankiw, he says intelligent people make decisions based on opportunity costs—in other words, it’s your alternatives that matter. That’s how we make all of our decisions.” -Charlie Munger

We have read about opportunity cost of capital and opportunity cost of time. I recently came across a speech (~13:00) by Mr Dilip Shanghvi (Sun Pharma) where he explains the importance of thinking about opportunity cost of attention while thinking about acquisitions. He termed it dis-synergies in acquisitions. I found it a very interesting way to think.
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Lata Bajoria- Queen of Hearts

Jute business was big in Kolkata many years back and one man who ran the show with more than 25% of market share was Mr Arun Bajoria. There are other pieces about his takeover attempt on Bombay Dyeing and Ballarpur Industries. You can find more about him on the net.

This post is more about his wife : Mrs Lata Bajoria. There's a nice speech she delivered and you can watch it here.

I am sure her simple and witty speech will leave you motivated. If Mr Bajoria was "King of Jute", I would say Mrs Bajoria would be "Queen of Hearts".

2 Thought Leaders

In Ernest Hemingway’s novel “The Sun Also Rises”, there is a dialogue “How did you go bankrupt?”

The response is “gradually and then suddenly”.

It is so apt.

While reading about NPAs and the resolution process, I read a column written by Dr M S Sahoo- Chairperson of the “Insolvency and Bankruptcy Board of India (IBBI)” where he quoted Hemingway.

I was immediately drawn towards Dr Sahoo’s writings and found them here. You can find them under the resources tab.

Dr Sahoo delivered Dr R H Patil Memorial Lecture where he talked about important concepts of -

1.     Institutional Environment

2.     Institutional Arrangement

Using an example of stock exchange and anonymous screen-based trading system-he explains the above concepts in a lucid manner.

Another important concept he touches upon is that of Economic Liberty with an example of how 4 persons received show cause notices from the competition authority.

“Different conducts can invite the same outcome under economic laws and the same conduct may yield different outcomes in different contexts. So, it is not so much the conduct, as the context- who, why, when, what, where and how- of the conduct that matters. Rule of reason to guide economic liberty.”

This helps me to further understand the case of Intellect Design Arena which I wrote about in my last post. It is not the conduct alone but “context and conduct” meshed together which matters.

Dr Sahoo spoke very highly of Dr R H Patil – the “Father of National Stock Exchange” and how his thinking got shaped by Dr Patil.

I read up on Dr Patil and came across this beautiful interview in Moneylife magazine.

Some excerpts:

“After the Harshad Mehta scam in 1992, the government was groping in the dark about what to do…G.V. Ramakrishna was the SEBI chairman. The finance ministry had called a meeting and I only got to know what was to be discussed on reaching there. Montek (Ahluwalia, then finance secretary), Dr P.J. Nayak (then jt. secretary and now chairman, Axis Bank), Mr Ramakrishna, Mr Nadkarni (IDBI chairman) and I were present. The concept of NSE was born at that meeting. We wanted to do things differently. We discussed setting up a professional organisation with screen-based trading, a weekly settlement system, etc.”

“I then said, “I want to move over to NSE.” The company had already been formed and I was a director on its board. He was shocked. He said, “People aspire for power and you are saying that you want to go to an entity which nobody is sure if it will succeed or not. Aren’t you taking too much of a risk?” I said, “Sometimes one should take the risk.” He said, “Are you sure you want to take a risk at this age?” I said, “It is only at this age that I can take the risk. Both of us -- my wife and I -- have been earning; we both lead very modest lives. We have decent savings. If we continue to live modestly, I can take that risk.” In fact, many people said that I was a fool. But my own feeling was that, once you retire from IDBI, who remembers you? So, I decided that it does not matter whether or not I succeed in setting up NSE. My grandfather used to say, if you make a whistle out of a carrot, it is good if it plays; and if does not, you can always eat it.”

“As someone who creates new markets, where do you invest your money?

“In RBI bonds and in mutual funds - there too I invest in FMPs - so no risks. You need a different mindset to take risks. I prefer to devote my limited energies to do things that are more productive, especially from a social point of view. I have tried to create a world to protect others’ risks -- (laughs a lot) - that too through systems and design. Remember, systems and design only. After all, what are margins? They are walls so that the speculators don’t jump into the sea.”

Amazing clarity about building institutions, risks and priorities in life.

I am sure the readers will feel motivated- as I felt- after reading about the above thought leaders. They help us build layers of understanding and shape our own personalities.