Tips from 'Fund manager of the decade'

'Bruce Berkowitz' Investors in India may not be familiar with this name. But the gentleman is a very famous investor in the US. In fact, in 2009, Morningstar, a renowned mutual fund research firm, made Berkowitz its fund manager of not only the year but also the decade. In other words, for the decade preceding 2009, Berkowitz's performance gave him the title of the best fund manager in the US.

Thus, on account of such a reputation, you would be interested in knowing Berkowitz's secret sauce i.e. how does he go about choosing stocks for his portfolio.
Fortunately, Berkowitz outlined his investing principles or investment lessons if you will, at a recent public gathering. Market folly.com, a famous financial website did the hard work of putting all of Berkowitz's investment lessons together and showing them up on their website.
Let us have a look at each one of them and our observations on the same.

• You always have to have cash, especially when no one else has it: Recall the tumultuous markets of 2008 and early 2009. Prices were falling like nine pins across all asset classes and how wonderful it would have been for an investor to be in cash. He would have had the opportunity of a lifetime by scooping up assets on the cheap. No wonder people like Warren Buffett always have some part of their investable surplus in cash. As they say 'Cash is king' and it truly is we believe.
• No free lunch- it's not free, or it's not lunch: As they say, there is no free lunch in life. It is no different in investing. Investors in India who invested in real estate stocks or infra stocks a few years back know this only too well. Land banks and bulging order books made them blind to leverage and execution risks. They forgot to pay heed to the fact that high stock prices can only come from higher earnings. Thus, when earnings disappeared or fell precipitously, the idea that there is no free lunch hit them really hard.
• You can't change people! You can change yourself, but not others: Beware the management that has taken huge risks and leverage in the past and now promises to turn over a brand new leaf. The reality is that it is very difficult to change people and thus, one would be better off investing in companies with a tried and tested management rather than the one that promises to completely reform itself.
• You only see reality under extreme stress- you want to get to know someone, you need to see them under extreme stress : A rising tide tends to lift all boats. Similarly, a buoyant economic environment can lead to all the companies doing well, even the badly managed ones. However, the true test comes when the economy takes a turn for the worse. In stressful times, only those companies that have a good business model and risk management practices in place will tend to survive. Thus, it makes sense to look at the performance of a company under all economic environment and not just the good ones. After all, when the going gets tough, it is only the tough companies that get going. A true character of a firm comes out only under extreme stress.
• Volatility is not risk: Risk does not come from the volatility in stock price. It only comes from not knowing one's investments well and from a permanent loss of capital.
• Always assume you will have bad luck: Investing, at the end of the day, is all about taking a bet on an uncertain future. And the future can turn out good or bad. Thus, it always makes sense to incorporate a margin of safety in one's purchase price. In other words, it makes sense to start with the assumption that you will have bad luck.
• Few variables to win. Once you have to think about more than 3 variables, your odds of winning are low.
• If you have to use more than 6th grade math, you're in trouble.

Shades of Warren Buffett or Peter Lynch? Certainly, we believe. Investing has to be simple. But it is not necessarily easy and requires lots of patience. Besides, your thesis should be such that even a sixth grader should be able to understand. Remember the complex mathematical models used during the sub-prime hysteria? Did they achieve anything? Certainly not. Thus, your ideas have to be really simple and should involve very few variables.
We believe that Berkowitz is bang on with all of his points and if followed closely, can do a lot of good for investors. - Equitymaster 
Equitymaster is a Mumbai-based independent equity research house