My meetings over the fortnight spanning July and August with over 40 institutional investors spread across four countries point to the following bull and bear stories being the flavours of the moment.
The bear story is that of an India spiralling towards a financial abyss (both in terms of Balance of Payments and in terms of the fiscal deficit) due to political and economic failures, which are compounded by a pullback from risk assets by global investors. In this vision, India is deemed to be heading for a painfully hard landing whilst China heads for a softer one. Accordingly, exposure to India should be reduced.
The bull story is that of an India which whilst being “down” is not “out”. So, India still has good companies and since such companies get bid up very quickly given the illiquidity of the Indian market, now is the time to build large positions in these companies. Whilst Indian politicians’ incompetence is a negative, it is not obvious that politicians elsewhere are dealing with the economic downturn more capably. In particular, China is in at least as tricky a macro situation as India.
What fascinates me is that institutional investors (with similar access to information) can have such starkly different perspectives on a large and extensively covered market like India. How do investors end up holding such divergent positions on the same subject at the same point in time? Listed below are some “behavioural finance” drivers which might explain such phenomena.
Driver 1: What you see is all there is (WYSIATI)
Jumping to conclusions on the basis of limited evidence is a natural tendency of the intuitive mind. Both the stories I outlined above have significant logical gaps in them but each of the stories (by itself) is consistent. Daniel Kahneman, the Nobel prize winning psychologist says that “It is the consistency of the information that matters for a good story, not its completeness. Indeed, you will often find that knowing little makes it easier to fit everything you know into a coherent pattern.”
Our intuitive mind is designed to think fast, suppress doubt and uncertainty and make sense of partial information in a complex world. Furthermore, much of the time the coherent story it pulls together is close enough to reality to support reasonable action. In fact, our minds are built in such a way that neither the quality nor the quantity of evidence that we have impacts the action that we are taking (due to our beliefs). We often fail to allow for the possibility that evidence that should be critical to our judgement is missing – what we see is all there is (“WYSIATI” is Kahneman’s acronym for this).
Driver 2: Anchoring and Priming
Psychologists have highlighted how easy it is for even rational people to get “anchored” and “primed” by even random data. For instance if 1,000 people are asked to guess, “How old was Churchill when he died?” versus “Was Churchill more than 130 years old when he died?” the answer to the latter question will be significantly higher than the answer to the former one. Reason: The figure 130, nonsensical as it is, offers an anchor and thus primes respondents to give a higher answer.
Similarly, if I anchor you every day with negative newsflow on India (corruption scandals, power blackouts, accounting scandals, profit warnings etc.), this is likely to anchor you and drag down your growth and valuation estimates for all things Indian. Conversely, if you have an Indian portfolio which is performing well, your portfolio could anchor your growth and valuation estimates for all things Indian, upwards.
Driver 3: An aversion to the unfamiliar
As Nassim (“Black Swans”) Nicholas Taleb has pointed out, our mind wants to make sense of the world around us by constantly seeking patterns and building stories of what we are seeing (even if there are no real underlying patterns or stories). Therefore, since it is easier for our mind to build patterns and stories of what is familiar, the mind prefers the familiar over the unfamiliar.
Not only is the squalid, decrepit milieu of most Indian cities unfamiliar to most FIIs (who tend to be more used to more scrubbed money centres such as Jakarta, Manilla and Hong Kong), the chaos of Indian politics (a multitude of parties, many different layers of politics) and the unfamiliarity of this downturn in India (even many domestic investors have never seen a downturn of this magnitude) makes it hard for investors to feel at ease about India. Whilst that makes many investors natural bears on India at this “unfamiliar” point in time, the core of the bull community seems to be made up of seasoned, deep pocketed Emerging Market investors.
Driver 4: Overweighting low probabilities
Our minds tend to overweight the probability of events which have happened recently. So, for example, if you have been thinking about plane crashes recently (perhaps because of a recent plane crash captured graphically on TV), it will impact your beliefs about the safety of flying. Similarly, if you are exposed repeatedly to newsflow about corruption scandals in India, it will have a bearing on your thinking regarding the pervasiveness of corruption in the country. That in turn could alter your perception of the trajectory of the Indian stock market (even if there is no link between political corruption and the direction of the stock market).
In contrast, if you are more exposed to the woeful state of the Western economies (either through personal experiences or because you own investments) and the helplessness of policymakers there, it could influence your view that politicians in India are no more or less likely to be incompetent than those elsewhere.
So how can we see the world without our behavioural biases?
I am as susceptible to these biases as my clients but to avoid big behavioural errors here are a few remedies that my colleagues and I have implemented:
- Look outside the community of brokers, bankers and investors and seek alternative perspectives on the economy, perspectives such as those of taxi drivers, doctors, check out clerks in supermarkets, regulators, etc. Such perspectives can provide a sanity check on what’s happening in the economy.
- Spend at least as much time on digging up “primary data” from customers, competitors, suppliers, policymakers etc. as you do on desk research.
- Finally, benefit from the experiences of those who have consciously sought to break free from the biases that their environment imposes on them. “I became a traveler. I travelled in the Caribbean region and understood much more about the colonial set-up of which I had been a part. I went to India, my ancestral land for a year; it was a journey which broke my life in two. The books that I wrote about these two journeys took me to new realms of emotion, gave me a world view which I never had…” – VS Naipaul in his 2001 Nobel Lecture.
(Saurabh Mukherjea is the Head of Equities at Ambit Capital. The views expressed here are his own and not Ambit Capital’s.)