Behavioral Finance

Calm Investor at times of Volatility

Behavioral Finance and the Curse of Karna

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In the epic, the Mahabharata, on the final day of the lessons from his guru, Parashurama, Karna bravely bore a scorpion’s sting while Parashurama was resting his head upon his lap. As the blood from Karna’s thigh trickled down and disturbed the sleeping Parashurama, he realized that only a Kshatriya (a warrior) could bear such pain without a murmur and that he had been tricked by Karna into believing he was a Brahmana (of the priestly class). Karna explained that he was actually a Suta (a mixture of Brahmana and Kshatriya) in an attempt to placate his irate teacher. Furious at being deceived, Parashurama cursed Karna that he would be unable to use weapons, especially the Brahmastra, when he needed them the most. This curse came into effect when Karna was unable to remember the incantation to invoke the Brahmastra while fighting against Arjun on the battlefield.

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Calm investor making investment decisions

Staying Calm and Keeping Behavioral Biases Aside while Investing

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“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.”

 – Seth Klarman.

When Warren Buffett famously stated that investing was simple but not easy, he meant that the rules we ought to use in order to make good investment decisions are easy to learn but actually adhering to them is difficult. Disregarding rules while investing cannot be attributed to open rebellion but can be ascribed to the basic human survival instincts that have been ingrained in us since time immemorial. Certain traits favored in the process of Natural Selection and helped our ancestors survive in the jungle actually do not help in the market.
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traditional market conditioning approach

Traditional Market Conditioning: Why We Need to Break Away from It and How

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It is important to remember that all investments are subject to a certain amount of risk. ‘Risk” can simply be defined as the probability of losing whole or part of the sum invested. This probability must be considered before investing. Various tools may be employed to identify investment-worthy stocks such as fundamental analysis, price-to-earnings ratio, technical and quantitative analysis. Fund managers may combine two or more systems to determine the strength of investment.

By and large, traditional investment strategies are based on a fixed percentage mix of stocks, bonds, and cash for varying risk tolerances. It is often the money manager’s job to select the best investment options based on various theories that can be based on the long-term average performance of investment assets. For example, a moderate risk investor is likely to keep fully invested in 60 percent stock and 40 percent bond allocation without taking into consideration the risk. Institutions and fund managers may follow a relative investment approach, which in our opinion, has fundamental flaws as it focuses on short-term horizons and fails to incorporate emerging trends.

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Evidence based investing for S&P 500 companies

Rational Market or Irrational Exuberance?

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Since June 2015, we have been voicing our concern on market valuations on mid and small cap space. Irrespective of events like Brexit, demonetization or outcome of US elections, market momentum in mid and small cap space has been undeterred.

Since May 2014 with the outcome of Indian elections and NDA government coming in majority, we believe market has rallied on a complete hope based story where the gap between valuations and fundamentals has widened significantly. Focus has shifted from strong conventional businesses to emerging and turnaround stories where we believe the premiums paid are very high.

It is usually in a market like this when behavioural biases overpower an investor’s cognitive decision making ability where greed takes a precedence to rational thinking.

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Mis-defining Investment Quality

(Mis)Defining Quality: Counting When It Cannot be Counted

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This article originally appeared on Advisor Perspectives.

 “Ben felt that what I do now makes sense for my situation. It still has its founding in Graham, but it does have more of a qualitative dimension to it because, for one thing, we manage such large sums of money that you can’t go around and find these relatively small value-price discrepancies anymore. Instead, we have to place larger bets, and that involves looking at more criteria, not all of them quantitative. Ben would say that what I do now makes sense, but he would say that it’s much harder for most people to do.” – Warren Buffett 1 responding on apparent divergence from Graham, emphasis ours.

 “The number one idea is to view a stock as an ownership of the business and to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash-flow than you are paying for. Move only when you have an advantage.” –Charlie Munger

“Not everything that counts can be counted, and not everything that can be counted counts.” – William Bruce Cameron 2

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  1. Joe Carlen, The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham, 244.
  2. The quote is frequently attributed to Albert Einstein. However, it is likely an incorrect attribution. Read more here.
Bounded rationality investment decision making

Bounded Rationality, Unbounded Confidence

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This article originally appeared on advisor perspectives.

“The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required.” – Models of Man, Herbert A. Simon

“Boundedly rational agents experience limits in formulating and solving complex problems and in processing (receiving, storing, retrieving, transmitting) information.” – Oliver E. Williamson citing Herbert A. Simon Read More

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