We have had a few conversations with partners on why we are reluctant to take a 20% cash call at present despite the current uncertainty to re-enter when prices are more favourable. I thought it may be appropriate to share our thought process with all our partners.
I want to separate the question into 2 parts
a) The cash call on “Asset Allocation” – which is for partners to make
b) The cash call on “portfolio construct”- which is for Solidarity to make
The cash call on “Asset Allocation” – which is for partners to make
Partners need to decide how much of your Capital you choose to allocate to “safety” vs “growth”. To try and impress you with jargon, the industry calls this “Asset Allocation”.
The choice of how much goes into each bucket is a personal choice and should be a function of
a) Your long term goals
b) Your belief in the merits of Equities
c) Your short term cash flow requirements
d) Your tolerance for mark downs in Equity
There is no one right answer here. It is a very personal choice. The right answer is what helps you sleep well at night and not feel overexposed to risk.
The mistake many investors make is to allocate too much to “growth” over “safety” when markets are doing well, typically because they fear missing out during a bull run. When the inevitable correction happens, their ability to tolerate markdowns/need for short term cash flow is exposed and they tend to sell at the worst possible time making temporary losses permanent.
However, if one needs to redeem funds because you need to recalibrate “growth” vs “safety” exposure, it is an appropriate thing to do at present. The right time to correct errors is the first instance when one realizes a mistake has been made.
The cash call on “portfolio construct”
This brings us to the key question at hand whether Solidarity should sell existing positions to keep some cash in buffer at present.
Our view on cash exposure/cash calls is as follows
a) We will not be fully invested if we don’t find opportunity. We will wait on the side-lines till prices are at levels we find reasonable.
b) We will sell down positions gradually when valuations are Euphoric
c) We don’t believe in selling positions to create cash “just” because the environment is uncertain, if we can find opportunities to deploy Capital.
Point c) merits more explanation
a) The Mathematical risk-reward trade-off of taking unnecessary cash calls is not attractive – Assume one sold 20% of the portfolio and on this earned a 30% incremental return because one successfully timed re-entry. Over 5 years, post taxes, this would be a ~1% extra IRR over what one would have earned by not trying to time the market.
b) This 1% extra return needs to be weighed against the probability of getting this trading call right. We would not have guessed that the markets will collapse 30% in March; neither would we have guessed where they would bottom and how steeply the market would recover. Selling is easy, timing re-entry is very hard.
c) Inevitably, one will end up taking a decision which provides emotional relief, but is adverse to long term outcomes
So this leads to the question whether valuations for our portfolio construct are euphoric at present.
a) In our assessment, other than FMCG and some pockets of Specialty Chemicals, valuations are not euphoric.
b) Rather than take cash off the table, we are using the current uncertainty to add to positions in Telecom, Digital, Banking and Life Insurance till we reach our sector caps.
Fund Managers are supposed to have ice water in their veins and hence tolerate large market movements. Nothing is further from the truth. We too feel the whole gamut of emotions, including fear, when we see prices collapse like they did in March. However, we remind ourselves every day that the only sustainable edge in this business is Behaviour. By replicating what the market is doing, just for short term comfort, we are unlikely to generate superior outcomes.
There is a reason why Equities (Index) – over the long term – have earned a 6% premium over G Secs. This premium is the prize for the pain that is required to tolerate uncertainty and drawdowns. By participating when the environment seems benign, and exiting during uncertain times, returns will be sub-par as one will never be able to take advantage of attractive prices