[Podcast] A Structured Approach to Cash Calls[Podcast] A Structured Approach to Cash Calls

In this episode, recorded in early October 2024, we’re diving into a topic that’s on everyone’s mind: Is holding cash a smart move in these unpredictable markets?

We’re in what some are calling one of the most “unloved” bull markets—stocks keep rising, but investors (ourselves included) are uneasy, waiting for the other shoe to drop. To help us unpack whether cash can actually give your portfolio an edge during uncertain times, we brought in none other than Deepak Shenoy.

Together, we explore whether holding cash can protect you from potential downturns or even help you outperform the benchmarks. We also dig into the challenges fund managers face with cash calls, why getting back into the market can be harder than it seems, and how strategies like STPs (Systematic Transfer Plans) play out in real life.

Deepak shares some great insights, comparing today’s market to historical events like the 2020 Crash, Russia-Ukraine war, Brexit, and the 2008 financial crisis. Plus, we look at what Warren Buffett has done with cash during past downturns—and why even he hasn’t always gotten it right.

This episode is packed with practical takeaways including:

1) When holding cash makes sense—and when it doesn’t
2) Why fund managers sometimes get cash calls wrong
3) The emotional side of staying invested vs. going to cash
4) How IPOs and market liquidity can impact your cash strategy

If you’ve ever felt that itch to “do something” with your portfolio when markets are shaky, this conversation is for you. We break down the mental tug-of-war between holding cash and riding out the market, with Deepak sharing actionable advice that will help you stay prepared, no matter what happens next.

Hit play, and let’s dive in!

If you enjoy the episode, don’t forget to subscribe for more market insights. Check out capitalmind.in for articles, or head over to capitalmind.in/podcast for more episodes.

00:00 Introduction and Market Overview
00:33 The Role of Cash in Your Portfolio
01:26 Strategic Cash Allocation: Pros and Cons
02:42 Market Trends and Timing Investments
05:36 Historical Market Performance and Predictions
07:24 Cash Calls and Their Impact
15:32 Examples of Cash Calls: Successes and Failures
21:51 Professional Fund Managers and Cash Calls
35:24 Market Volatility and Fund Manager Challenges
36:31 Investor Expectations and Cash Calls
38:06 Framework for Cash Calls
42:15 Emotional vs Rational Decisions in Investing
49:43 Asset Allocation and Cash Management
56:06 Challenges of Market Timing
01:02:02 Liquidity and Market Movements
01:02:16 Final Thoughts and Recommendations

Transcript of the Podcast

Shray: [00:00:00] Hi everyone. We're recording this in early October, 2024. And I hope that's when you'll be listening to it as well. What looks like history's most unloved bull market continues both unabated and unaffected by how irritated and worried we are all about it. And so given this dynamic, we thought we'd bring in Deepak Shenoy to help us understand whether cash can be a useful position to have in this time and whether a strategic cash allocation in your portfolio can help us outperform the benchmarks and help your portfolio do better in the months to come.

Shray: So do listen in to see what Deepak has to say.

Shray: Deepak, we're looking at the role that cash can play in your portfolio and see whether it can help you outperform or help you manage your downside. People feel this is an unusually prolonged bull market. It's a pretty unloved bull market. We're all just waiting for it to collapse.

Shray: And it hasn't been very cooperative. So here's the question. We have people who want to add new money to their PMS account or just want to open a PMS account with us. They have money sitting idle. How do but they're worried that this will be the moment they invest and then the [00:01:00] market's going to fall right away.

Shray: And so if it was a mutual fund, they knew what to do. They put their money into a liquid fund and over say six or 12 months, they do an STP from the liquid fund into an equity allocation. But on the other hand, the more you think of it, this is a very actually precise bet they're taking. They're saying that, look, I'll put my money in, the market is going to cooperate and fall within this timeframe.

Shray: And then when I entered in over the next six, 12 months, I'll be averaging at a lower price and then enjoy the upside that comes thereafter. But here's my question. Is this a good idea? Do you think this is worth it? Can in an environment like this, a cash position actually help you outperform the benchmark?

Deepak: This is a great question. I think the problem with doing this is like you said, it's, you've got to get the timing absolutely right. That the market's going to fall in six months. There's a typical thought processes that markets go up and down. And therefore, if I were to invest over a six month period, I'll get some of the ups, some of the downs.

Deepak: So I'll kind of average myself over the six months. So if my fear is that the market will fall, I'll actually be able to buy at a lower [00:02:00] rate as the market falls rather than all at the top. If this was the top, the issue with this is in a strongly trending market, you assume that markets go up and down on a monthly basis because you're putting monthly money every month, but in a trending market, the market might actually go up only for the next six months or mostly for the next six months.

Deepak: So you're actually at a disadvantage comparing it compared to having bought at one shot in the beginning. Now, the comparison is simple. I have the money. Should I spread it or should I invest it at all? At one shot? Nobody gives you the answer to this because the simply the tools that actually they're not very complicated to do, but they just simply don't exist for the common man.

Deepak: And I'll, I'll give you an example. Let's say you had 60,000 rupees today, and the market went up 20 percent in six months. So, it has happened and I am aware in October 2024 and from April 2024 to October 2024 the market is up around 20 percent or something like that, it is roughly a little bit more than that.

Deepak: But [00:03:00] if you assume that you are getting a 20 percent in 6 months kind of a return, you might say well you know what I could have spread it across over those 6 months. The answer to have I done, what's the difference between the two would be, can we do a like to like comparison of if I had 60,000, how much money would I have ended up with after six months?

Deepak: In both cases, the answer is if you have 60,000 and you put it in market goes up 20 percent in six months, you have 72,000 at the end of six months. That is number one. The other one is I put 10,000 a month and assume, let's say for whatever reason I got about three and a half percent a month kind of averaged up.

Deepak: I would actually have 65, 700 plus some money because you made some money on the liquid fund. So you've got about 66,000 maybe a little bit more than that on the SIP or STP kind of investment. STP is the systematic transfer plan you talked about. The comparison now is between the 72,000 and the 66,000.

Deepak: So how is it possible that I did the right [00:04:00] thing or spreading, spreading it across six months? And yet in one case, I made roughly double the returns, 6,000 versus 12,000, right? And the way the tools are designed and the mutual fund websites are designed, the mutual fund even the AMCs themselves are designed, they don't actually tell you the difference between having invested all at one shot versus having invested over because they're different mutual funds.

Deepak: And they give you the IRRs of each mutual fund. So they'll say, Oh, the liquid fund give you an IRR of. 7.2%. Your your equity fund give you an IRR of this much. And you look at it, it doesn't look odd because you might say, oh, well my 60,000, 10,000 per month became 66,000. What's my IRR over the six months that I invested in it.

Deepak: Say, oh, well, you want an IRR of 19.75 percent or something like that. And you look at it and say, well, the market's turned 20 percent and I got 19.75 big deal. What's the difference? But if I told you that that 19.75 percent is fine, but. You made 72,000. Your 60,000 became [00:05:00] 72,000 at a lump sum versus 66,000 for the same IRR on STP.

Deepak: Because you're looking only at the IRR of the money that's actually invested, not at the cash that was uninvested. You are looking at me and saying, Deepak, how can I get 20 percent in both cases? And one case end up with 66,000 and the other case end up with 72. That's because the tools are wrong. They don't consider the cash drag because you put the cash in a different fund.

Deepak: So therefore, I think we have perhaps underestimated the value of investing lump sums. And perhaps over invested, or we were over invested in the concept of systematic transfer. Because it feels like that's the right thing to do. And the data shows that in the long term, the market goes up.

Deepak: So the more you spread your investment, the more likely it is that you're going to hit an uptrend and therefore hit this exact problem that we have. And by the way, in the same time that we were talking about, [00:06:00] market has gone down maybe 10 or 15 percent sometime in the middle, come back up, except at the end of the month, everything's been hunky dory.

Deepak: We've had six months of almost a stellar bull run. Some months are one or 2%, some months are seven or 8%, but it's all been up for the last six months. So if six months ago the markets looked like they were gonna fall, and and here we are today, and I'm telling you the IRR is the same for having done the STP and you ended up with double the money in having, by having done a lump sum.

Shray: Okay. Three responses come to mind. The first is that. Clearly, there's a limitation of the tools and that's very understandable. I mean, people just look at it in silos, your AMC or whatever, just give you the return of each silo and don't tell you how they sort of interact and end up leaving you poorer.

Shray: So that's, that's certainly a limitation and that point is well taken. But the next thing that comes to mind is, look what you're saying is, does make sense. But the fact of the matter is that while markets may go up over say any, any medium period of time. Right now feels [00:07:00] particularly vulnerable.

Shray: We've had this very prolonged bull run. There's like two wars going on as we speak. There's a US election coming in November. So with this level of uncertainty, don't the numbers look very different if the market trends downwards? And I was thinking about it. Is there only diversification time?

Shray: I mean, you could also have a diversification that comes from potentially some other criteria, but let's start with this. Okay. What about cash now? Not cash in general. I mean, it's October, 2024. Does cash make sense today?

Deepak: This is a, you know, this is an interesting reason because I think this talks about, oh, well, there's a lot of things to worry about.

Deepak: And maybe there's more to worry about today than there ever has been in the past. But honestly, the, I look at this as, as impassioned because I'm with you, because I think the, you know, the world could be coming to an end with a nuclear war between Iran and Israel. There could be escalation further of the conflict between Russia and Ukraine.

Deepak: The US is getting involved in all sorts of things and there's some Syria, some Lebanon, [00:08:00] some other countries. Then, within India, you've had so you, you've had a, a Russia attack Ukraine two years ago. You've had a Silicon Valley bank collapse last year. Silicon Valley Bank at the time was bigger than HDFC Bank in India at the time.

Deepak: And yet the collapse of a relatively large bank and, and its rate, therefore, reconstruction has resulted in almost no change to equity returns both in India and in the US, but more pronounced in India. We've had crazy situations. The majority party that was supposed to get a super majority this time ended up not even getting a majority and needing a coalition to come.

Deepak: Markets go down 6%, back up. So we look at the budget where they introduce, I mean, in the, in the strangest of phenomenon, July budget, they announced that there was going to be an income tax increase in terms of capital gains taxes on all capital gains transactions, a higher securities transaction tax, a bunch of rules that have come.

Deepak: All of these things [00:09:00] should have resulted in my view. A big fall in the market at, for any of these reasons, at any other point in the, in the past, we would have seen this happen and yet it hasn't happened. So if you were worried about each of these things having happened even in the past, so, oh, there is going to be a Russia Ukraine war, worry, and then you say, well, I'll take my money out of the market and go to cash.

Deepak: Guess what happens? Market goes on up and down for a few weeks and then it's back up. It was in fact almost the perfect timing to get into the market rather than getting out of the market almost. Silicon Valley bank collapses in March 2023. Perfect time to get into the market because while the market wobbled a little bit at that time, it just went up like crazy from then.

Deepak: The reason we know this is because we had a bunch of cash in the company's account and we said, let's put all of that money to use because we were saving it for ensuring there was no mark to market volatility because we wanted to be profitable. Okay. at the company level and saying, oh, well, markets go [00:10:00] up and down.

Deepak: It's going to affect our profitability. But April, we said, well, you don't need to be profitable because of some rule changes. And we can actually you know, because anything that's not profitable is only temporarily not profitable. So we can just say, well, we'll, we'll invest this money.

Deepak: Interestingly that formed a greater part of our own profits. In the next year, simply because the market went up like crazy after that. It was investing in a time of fear in a way, but there's always fear. So this fear that cash should be created is always there. And when it's there, it feels pronounced that, you know, if I don't do this cash call now, I will at some point regret it because the market has put a fall.

Deepak: I think we've had some very interesting points to measure these things in the past. There was Brexit in I don't know, 2015 or 2016. Markets go down 6 percent in India. I mean, India was the greatest Brexit, and we've done fairly well for ourselves. But yet, we are talking about [00:11:00] you know Brexit, and then the world is going to collapse, and guess what?

Deepak: Brexit actually happened. This was the Brexit vote. Brexit actually happened, and nobody seems to care. And you know, Britain seems to be running around exactly where it is right now. Every of these events has caused short term volatility, but long term is like, okay, once the uncertainty is over. So your selections are coming.

Deepak: There's going to be either one of the two parties in town. And I keep thinking of this and saying, Oh, tomorrow if I got to know that Trump is one or Kamala Harris as well, what will happen to the market afterwards? I don't see a reason that the markets will say, Oh, well, you know, my God, it's Trump we need to follow.

Deepak: or my God, it's Kamala Harris. We need to fall. I don't think either of these consequences is going to happen, but we're worried about it upfront. It's just that when we transport ourselves into the future, we'll be like, okay, they're done. And they're not kind of doing something like saying, let's shut down the whole world.

Deepak: And as long as, I mean, Trump, you can never say, but assuming [00:12:00] that you, you know that, that statements, those statements don't come out, the uncertainty goes away. Right. And with uncertainty, the fear of downside volatility goes away. Then markets start to, you know react maybe positively or something like that.

Deepak: I think this is the, you know, this is the interesting part because we could take the cash call and we would be right in our own minds for taking that cash call. I feel that perhaps, Data is telling us that this is, you know, data versus rationality, right? So in Russia, it's a rational environment. You look at the past and say, you know, all of these things have happened in before 2000, maybe 10 or something like that markets would have fallen for any of these given reasons.

Deepak: And after 2010 markets fall for none of the above reasons, except it falls for some strange reason, like COVID it fell quite a bit. And so forth. So I think. Predicting that the market will fall because of a reason that is evident to us today is dangerous [00:13:00] because you will be so like, you know, economists have predicted 40 of the last two recessions because there's always a reason to go into recession.

Deepak: And sometimes you don't know when that happens. So making a cash call too early can result in the fact that you'll, you're upside continues and you're sitting in cash. Cash. And you don't see the impact of that because you haven't lost money. It's just that you haven't made that money. And when you compare yourself to the market, you're almost like, wait, if I hadn't done the cash call, I would have been much better off today.

Deepak: And that I think is the unfortunate situation right now. So it sounds like today life is really bad, but I'm sure there's this feeling of the life is really bad has come many times in the past as well. And somehow we seem to have come out of it. In fact, in recent times, we've come out of it even without seeing a short term downside, which is quite remarkable if you ask me.

Deepak: So the cash call has this problem and going back to what we said earlier, as a [00:14:00] PMS, we actually see the impact of cash calls because while a mutual fund will not tell you that you invest in liquid fund, you're in STP, what's the, as a PMS, you get all your money up front and you maybe in, conjunction with the customer, sometimes in your own you know, in your own intelligence or wisdom or sometimes lack of it, we put the money into a debt fund and then transfer the money slowly over six months.

Deepak: Now the customers would, if I told them all your liquid fund gave so much and your equity fund gave so much, maybe they wouldn't notice the difference, but we're not allowed to do that. We're saying you give us this money. This is what the return has been over six months. We don't care whether it was little liquid.

Deepak: That's not your problem. That's ours. So we did this thing and your return is well, you know what? 10 percent below the market returns. So 10, six months later, you're going to look back and say, Deepak, you said there would be a problem because you know US elections, but US elections are done and the market is up [00:15:00] and you're underperforming the market.

Deepak: Like, no, because we wanted to do this over six months because you were afraid. No, I understand. But how can we underperform the market so much? Why is the market giving me 72,000 and you're showing me 66,000? So I'm like, Oh, okay, you're, you're right. But I can't help it because unfortunately I gave you the tools that nobody else gives you, which would have to be, which therefore exposes the problem to you.

Deepak: So, I think the issue with what we're seeing right now from the cash call perspective is and, and I'm not saying that this is a problem with other people. I have this problem. I'm, I'm sitting here right now, almost sitting like I'm on the edge of a precipice and the only way forward is down. And I've had this feeling for the last five or six months myself.

Deepak: And yet I'm still standing there. And the precipice is just, I'm just seem to be climbing every step I take. And there's no seem to be fall at some point. Every point I climb, I see that the precipice end is coming sometime, but it's there and you, [00:16:00] and the only thing you can do is go to cash because you can't stop a fall.

Deepak: There is no way you can, right? So I say that, you know, the, the problem I think is our fears more than it is the market where the market doesn't seem to be showing any fear of any veneer.

Shray: This almost sounds like that some Pollyannish. It's like markets have done so well for the last 15 years that I think we might be overlearning from this episode where they seem to keep going up.

Shray: As you yourself pointed out, just pre 2010 markets would actually fall every now and then when it came to bad news. But now it seems like we're able to just take these on the shoulder and just keep moving on. I'm even reminded that like Jeremy Grantham had this article where he was like predicting the mother of all bear markets.

Shray: And it sort of came true as well. I mean, things really did collapse, but unless you were like in meme stocks or in NFTs, or I don't know, in completely in crypto, you've kind of done fine. Have you ever just like soldiered on through the next couple of years? So I guess the question I have to ask is are the last [00:17:00] 15 years going to be viewed as this completely anomalous phase of the stock market And you can't just buy stuff and come back in 10 years and enjoy your riches?

Deepak: Shrey, the, the last 15 years have been insane in terms of if you told me that 15 years ago that you would have near zero interest rates and then interest rates would bump up to 5 percent in the U S 5. 5 percent in the, in, in like six months. And then nothing would happen to the stock markets almost during this entire timeframe.

Deepak: And definitely not to Indian stock markets. I would have laughed you out of the room. And guess what? I think it's, it's just. Crazy that we've turned into this phase and I come from the time when markets fall 30 percent every year or every other year. And you haven't had a, even a 10 percent fall in 2024, not even 10 percent on the index.

Deepak: And that's like astounding. They're in October already. And how do you get to this point without almost incredulous disbelief that says, Well, at some point this market has to [00:18:00] fall and at some point it has to, you know, kind of change track, but you know what? It's not doing that at all. The last 15 years I've been an exercise in understanding how even low interest rates, high interest rates, wars Brexit, whatever it is, have not shaped the market market trajectory in any way compared to the earlier few years.

Deepak: Now we've had a situation like this in 1929, just before the big. Mother of all crashes, mother of all bull markets was that one. There was this situation where newspapers were unlike Jeremy Grantham writing the exact opposite side of this equation saying markets are only going to go up because they've been going up for a long time.

Deepak: They said markets have reached a permanent plateau. That means not that the markets will not go up. They were like, oh, well, maybe it will go up, but it won't go down. Plateau just means that there's no down. There's just, you know potentially some up, but not, not, not much of a down. So effectively encouraging people to say, well, you can put your savings here because it's not going to go down too much.

Deepak: And then we had the 80 [00:19:00] percent fall in the next five or six, four years. In fact, the bear market of 1929 is actually the bear market of 1930 to 1932 because 1929, what fell about 40 percent or something like that came back up to nearly just a 20 percent fall from the top, within the next year by 1930.

Deepak: And then it fell 80 percent from there in the next two years. So it was so crazy that eventually, of course, America even banned the private holding of gold. I mean, this is we think of, we don't think of this as the liberal America that you could do where people are allowed to, you know, cannot be told not to own guns, but at some point you're to be actually told not to own gold, which is a remarkable, but I mean, I digress on that situation, but the issue is we didn't see it coming then.

Deepak: Perhaps. That experience and the subsequent series of experiences have made us over vary on the other side, which says, let's just keep seeing things coming and then let's be very varied a lot of [00:20:00] times. It's imbibed in what we do. Perhaps people who are born that generation after me and perhaps maybe 10 years after you or something, people in their 20s today have probably never meaningfully seen a bear market and they don't know what it's like.

Deepak: So for them, we are over worrying on, on bear markets. For them, a 10% fall is a bear market, whereas for me, a 10% fall is, is perfectly fine in, in, in life. So to, to the extent where these cash calls matter is about how you perceive that the markets will fall. Some of the very interesting things, and we should go back to this because you know, surely this can't last too long.

Deepak: Surely we will get back to an era of higher volatility. I think you're right. The problem is when and if you had told me 15 years ago that it would last 15 years, I would have even laughed you out of the room then because I would have been like, oh, you know what? There is a maximum 10 years. You know, oh, when the interest rate regimes change, we're going to, we're going [00:21:00] to fall.

Deepak: Guess what? The interest rate did change. We got five and a half percent interest rates in the US the US mortgage rates were higher in the US than they were in India at some point in time. And yet the mortgage market in the US didn't collapse, the market in India didn't change too much or meaningfully increase.

Deepak: But you are talking of a situation where it sounds like the past is no longer, the, the long past is no longer an indication of what the current past is. And therefore, if you're using only the current past to project the future, we might just get complacent enough to say, well, we can't fall too much.

Deepak: You didn't even fall 10 percent in 2024. The max you've fallen is 20 percent in the last three or four years. And yeah, you fell in COVID, but that was for a four month timeframe. So if you removed COVID, you haven't really fallen meaningfully. So what's the big deal? I think that's a bad idea. And that's one of the reasons why people will take cash calls.

Shray: And that's so has anyone given that it's been a one way street up by and large, is there anyone who's managed to [00:22:00] take cash calls famously successfully in this time period?

Deepak: You know, there have been, and I'll, I'll be honest. I think I remember you did one and that was fantastic. And that was before 2022 when in the, in the non India portfolio that you had, and that was fantastic.

Deepak: But I, I think we should take the greatest example of them all. The greatest investor of them all is Warren Buffett. He had cash in 2008 and he did very well in 2008 simply because he had cash and everything was falling. And if you have cash not falling as much as, as good as being better than the rest of the universe.

Deepak: And he was having the cash. He could go and get to Goldman Sachs and say, well, you know what? You're going to give me an interest rate if you go up or you're going to allow me to convert myself into shares. So I get the equity upside, but the debt downside. And he could negotiate such a deal because he was Warren Buffett and he had cash at a time when nobody else had cash.

Deepak: He took this fantastic cash call. And then he also made the statement that said, nobody will be able to beat the S&P 500. If you're a hedge fund, I'll take a [00:23:00] combination of hedge funds and you will not beat this and be able to beat this and be 500 over the next 10 years or something like that. He won that bet, but unfortunately his own company's stock or earnings weren't able to match up to what the earnings were of the S&P 500, the same index that he's talking about.

Deepak: Not because he didn't make the right decisions, but because he had so much cash. The cash drag for him brought down his returns to a point where it was lower in terms of returns in the S&P 500. And that particular problem you know, versus the, maybe the stock, the stock price didn't do as well till 2020 approximately, or just, you know, it was kind of hovering around the same level.

Deepak: The problem that you have in some making a cash call of this magnitude is you've not only got to be right getting the cash call timing that I took went into cash, but you also got to get back in. So how do you stay in cash while watching the mother of all bull markets unfold in front of you? And yet not participate in it and therefore [00:24:00] underperform it.

Deepak: But you know, you're the greatest investor of all time, taking the greatest cash call of all time and nobody questions you that much. It's actually wrong, but data shows it was probably the wrong thing to do for someone like him.

Shray: Okay. But Warren Buffett is different, right? He manages hundreds of billions of dollars.

Shray: He is, as you've said, the greatest investor of all time. So he also has permanent capital. So his dynamics are different. Can we maybe bring some examples closer to home?

Deepak: Of course, of course. I think, you know, Warren Buffett is unfortunately over quoted and over misquoted also. So I have that problem. I quote him and, you know, maybe misquote him in certain directions.

Deepak: But let's say that he's not the example we're looking for, because none of us have the money he has. And you could tell me that, you know what, if I have, you know, I don't know, 200 billion dollars, how does it matter if I'm on cash or not? I can do the absolute amount of money so much that it doesn't matter.

Deepak: There are two kinds of investors, right? So you have a professional investor who has, who's going to be [00:25:00] measured as the report card against the market all the time. The issue with this is that at some point, your predictive ability to have been read right about this crash market has to play out. And let me take examples of cash call based prophecies, if you may.

Deepak: So one of the things that happened in January this year, January, 2024 was a famous PMS manager said, Well, I'm going to return my money to investors and you know what? It's time for it to go to cash. The market was maybe at 21,000 at that time or so. It's a 26,000. A couple of days back. So that's about a 20 or 25 odd percent return that you've missed.

Deepak: Now if you miss 25 to 28 percent of a return, that's more than two years of stock market returns on average, which is about 12%, right? So you're, you're looking at losing two years of returns for a prediction you made that stock prices will fall. And the market is already 20 percent [00:26:00] higher from here.

Deepak: So the cash that you've returned to investors is the cash track for the investors who are sitting there saying, I thought you knew this stuff. And then I've just lost 20 percent on the upside. So now if the market were to fall 20%, I would just return to the same point at which you took that cash call.

Deepak: And then maybe the market starts going back up again, because you know what, we haven't seen a 20 percent fall. So when he does, maybe enough people want to jump back into the market and boom, you're going to see this go, go back up. That's okay. That's a cash call that perhaps hasn't worked out. But then you will say, that's just one PMS manager.

Deepak: What about the regulator? Now SEBI had concerns on small cap valuations. When was this? It was in March, February, March, 2024. Markets were a little crazy at that time and they have been crazy all the time, but they were a little crazy at that time. And then people said, Oh, well, you know what, the nifty and all is fine.

Deepak: These small caps, they have no volumes in them. And it's possible that if you were to see a lot of investors exit the small cap mutual [00:27:00] funds, there would be a big crisis in the mutual fund in the stocks because all these mutual funds would sell these stocks. And so Sebi put out a statement that saying, well, you know what, managers need to be concerned about this.

Deepak: So I'm fine. We need to be concerned. What do we do now? So this is, Oh, you know what you, why don't you guys conduct a stress test? And you said so what image, what impression does this give to the lay investors? Sebi is worried about values. Sebi is worried that the market will fall. So maybe I should take my money out, right?

Deepak: This is the impression. So everybody does these complicated things and say, well, it's going to take me four days. It's going to take me seven days. It will be eight if I had to take 30 percent of my money out. What do mutual fund managers do? They go and say, well, you know what? SEBI is right. Maybe there is going to be a crash.

Deepak: I'm going to buy some of the large caps in my small cap fund to allow for the fact that if I get a redemption, I don't have to sell all the small caps. I can sell them over time, but I will sell the larger caps, which have more liquidity. So I get a profile in a small cap fund, which has a lot of large caps in it.

Deepak: You've [00:28:00] done this because of this. That's a cash. To me that's like an equivalent of a cash call because you're done doing something that you don't want to do in a small cap fund primarily to meet some kind of fear that in the short term I will see some liquidity challenges. I'll see some investors getting out or that I will see a market crash or all three of the above.

Deepak: On an aside, that's just as itself was very weird because it said in a bull market, how many days will it take you to get out? Based on the last, say, 6 months of volume. But in a bull market, everything has volume. And in a bear market, there are no volumes. So what is 4 days in a bull market, is 40 days in a bear market.

Deepak: People haven't seen enough of bear markets to know that 40 days is a bad, bad time.

Shray: I mean, you're making service point for them, right?

Deepak: I understand here, but the, the, the problem is they made the point, but the answer to that as a stress test was meaningless because I'll tell you it takes 40 days in a bear market, but even I don't know, it just took 40 days in the [00:29:00] last bear market.

Deepak: It's possible in this bear market it takes five. So even I don't know what the answer is. So the only answer they have is, well, let's look at the data. The problem is they're looking at recent data. The recent data is the problem. And therefore, you, you end up with So you, all of these things have weird consequences because the investors looking at this and saying, look, look, all this fine stress, stress, stress.

Deepak: Stress, stress means there's a word stress in it. So you're expecting some stress to happen. Guess what? Market goes up 20%, even in the small caps, or 28 percent in the small caps, since the stress, stress time. Which is quite remarkable because if you look at six month returns and six month returns of 28%, you're almost talking now four years of returns that are happening.

Deepak: Six months of 28 percent is, is annualized much higher, but assuming that even 28 percent as an absolute number, that's more than two years of a normalized stock market returns that are happening after a time when SEBI was worried that valuations are too high. So this is another famous. Cash call gone wrong in that [00:30:00] sense.

Deepak: A third example, again, I'll say, okay, well, the regulator is not a fund manager. How do they know? They, they're just being worried for investors. That's true. Absolutely right. And famously even Alan Greenspan, the regulator in the US, the Fed chairman in 1996 said that the markets have irrational exuberance.

Deepak: A phrase that later became a book and a TV series and I don't know, whatever. But if the word irrational exuberance was. at a time when the markets had gone up some 20 percent from the bottom. They went up another 35 percent and then they fell, but they fell to a point where the word irrational exuberance was way down below.

Deepak: And the bottom of this fall was like 10 percent above that point. It's like saying, Oh, the world is going to fall and I'm getting ordered a hundred rupees. The a hundred rupees goes to 130 falls back to 110. And I get to say I was right. The market has [00:31:00] fallen. But guess what? I've just lost Even the 10 rupees I would've made by just sticking along with my cash card.

Deepak: The problem on the let's, let's go to mutual funds, because now mutual funds are fund managers. They know their stuff now. Mutual funds have been taking cash calls for the last maybe four or five months. They've been also worried. So they, when they take cash calls, you are, you know, mutual fund.

Deepak: They're allowed to be about. 5 percent in actual cash and 15 percent in maybe 15, 20 percent in debt. In fact, some cases, 35 percent in debt. But one of the most famous funds of the last maybe four or five years is Parag Parikh Flexicap. Famous, has large amounts of capital, great returns, fantastic returns.

Deepak: Has a lot of money and has more than 60,000 crores in in AUM. Okay. It's 15% of its a in effectively debt or cash insurance. Wonder, well, 15% sounds like a lot of cash for a mutual fund that should be fully invested. But the answer is that maybe I have taken the cash call because the markets will fall.

Deepak: The consequences of this, the last six [00:32:00] month return is because of the cash that they own below the S&P five hundreds or the BSE five hundreds. Total return by a factor of maybe 0.5 to 1%, but still underperform. At some point, your risk is underperformance. And I'm talking about this after, say, there was a fall, let's say yesterday, of about two and a half percent.

Deepak: Despite that fall, this market has taken them to an underperformance. Because the market's gone up for the most part in the last last three or four months. And, and their, their cash calls are underperformed. So famous cash calls that have been taken whether it is by a PMS manager or regulator or a mutual fund manager have in fact not worked out though they're perfectly intelligent people and they're perfectly right to be worried about whatever, everything that they said.

Deepak: I won't blame them even one bit. I'm when I listen to them, I feel like, am I doing something wrong by staying in the market? I do this, I get this every day and every single day I just tell myself you [00:33:00] know, things are things are different. And I have to deal with this situation slightly differently.

Deepak: Eventually, it's going to be the same. There's going to be a crash. The problem is eventually when,

Shray: Okay first, I'd like to just kudos to all those people you called out. I think it's a, it's very noble for PMS fund manager to actually give money back to customers. I don't think anyone ever does that.

Shray: Sebi, I think was right to be, as you said, concerned, just that maybe perhaps not the right methodology. And I think PPFS has earned the right to take cash calls given the track record over the last many, many years. But then let me bring it to maybe what I'm hearing from this is the reason we take cash calls is because we feel we have to do something or your customers expect that you have to do something.

Shray: I'm not just here to give you money and you deploy it in the best stocks you see fit, but I also expect you to be able to try and outwit the market and even if you get it wrong, that's perfectly fine. So how would you react to that? Do you think that as a professional fund manager, even if it means underperformance and clearly it has.

Shray: The fact of the matter is that customers want to see you take some action because it gives them the [00:34:00] reassurance to be able to stay with you over long periods of time.

Deepak: This is actually a good point in the short term. I think the idea that if the market falls suddenly and I look at a mutual fund manager and he has cash, I like him a little bit more, but I think you give this person a little bit of time.

Deepak: For the first six months, you don't bother like, oh, he's taken this cash. After a year you start to worry. So, What are you doing guys? It's just this thing. In 2006 I remember this market, I was new to the market relatively, so I was this newbie doing a blog and writing about stocks and futures and options.

Deepak: And it was not very popular at the time, but I was writing about it. And people who tell me deep when people like you come into the market and the market is so overheated, it's time to get out. It's 2006 and 2006. to me, the market was not overvalued. It was about 20 times earnings, but at that time, 20 times earnings sounded like a lot because you came through a time of 12 and 13 times earnings, right?

Deepak: So now we're at 23 times, 24 times earnings, just as a context. Now, what's happened during this entire [00:35:00] phase of things is that we've built ourselves into a point where even smaller frenzies, are considered to be extreme overvaluation. So people who got out in 2006 watched 2007 happen. I'm talking about something where the market doubled and we have seen a bull run, but we have not seen the market double in a year.

Deepak: We are nowhere close to that 40 percent return, maybe 45 percent return, but to see the market double in front, the whole like the Nifty itself double in about one and a half, two years, And if you sat out during this time, you would be just absolutely miserable. Despite being right that the market was at some point overvalued.

Deepak: You know, so, yes, the market in 2008 fell to a level that was even below 2006 levels. So market fell some 60 percent and that 2008 crisis was, was, was bad. But you had to live through that. underperforming both [00:36:00] 2006, 2007, most of 2007, and then maybe parts of 2008. So your, your value as a fund manager starts to decline when you out underperform for a long period of time.

Deepak: And people start believing that you're just wrong and you need to you know, exit. It's only when you're eventually right, if you're eventually right. that people start giving you a lot of money saying you were right. It was right to take that cash. Interestingly, people have not been right for the last 15 years.

Deepak: Like you said, at what point does patient give patients give way to a person who's investing and to another person who's been sitting on cash almost for all of this time and then saying, well, maybe this is not the fund manager for me. And that is a question the fund manager has to ask because for an individual investor, you can be in cash as long as you want.

Deepak: It doesn't matter to you because you don't have to outperform the index. You just need good absolute returns. And you know what? Even with 50 percent cash flow, great absolute returns in the [00:37:00] last four or five years. But to the professional investor, the reason to beat the market, I think has requires that the cash call at some point be right.

Shray: Deepak, I get it. Now I have two questions that come to mind. The first is that let's say I'm an investor or customer. I want to become a customer of yours. And I would like cash or debt to equity ratio of 20s to 80s. I want 20 percent to be cash and 80 percent to be in equity. Should I keep the 20 percent cash with myself, give you the 80 percent of equity and say, look Deepak, I've already taken the cash call.

Shray: I don't need you to do that now. Just be in equity at all times and we'll see where this goes. So that's my first. And the second thing that comes to mind is, look, you've made this very persuasive argument about how. So, so many cash calls are wrong and, and I, I get it. I mean, the fact of the matter is that most people have underperformed when they've taken this call, but you do take cash calls in your PMS portfolio and you talked about people getting it right.

Shray: Anoop, our fund manager famously went into cash in March 2020 and was on the cover of well, investing magazines [00:38:00] to the extent anyone reads them because of that call. So people do make cash calls, including us. And sometimes they get it right as well. So what is your criteria or framework for figuring out when you need to go to cash?

Deepak: This is great. Let me answer the first part first. Are you as an investor required to make the cash call yourself, or do you just trust your fund manager to do so? This is complex because the answer has always been for a mutual fund manager. Boss, you gave me money. I was supposed to be invested in equity.

Deepak: I'm going to be invested. It is recently where more and more people have tried trusting a lot of their money to funds is that you suddenly realize the customers have no idea what this asset allocation frameworks are. Maybe some of them use advisors, but most of them don't. And that therefore they're not making the cash calls by themselves.

Deepak: So the fund managers have taken it upon themselves to do it. In a rational world, the fund manager should do what they're told if it was only institutional investing. So if you wanted to sell to a pension fund, The pension fund will be like, you [00:39:00] do the equity part. I will do my cash fund because we have a team.

Deepak: We understand when to go to cash, how much cash we need, all that stuff. We understand. But if you go to the retail individual investor is more, more like, I don't know. So please just, you guys are the bosses. How am I supposed to know how much I'm supposed to be in cash on? So in a certain way, just get it right.

Deepak: The problem is that just get it right part, which is, and I hear this a lot. And you know, Deepak, aren't you supposed to know? So I'm like, Listen, if I knew perfectly, I would not offer my services to other people because I just use all the money that we have because just borrow money from the bank money from the bank, right?

Deepak: Because you have that you can't be perfect. And because you're not perfect, you're actually, and you've chosen to do a professional fund management as a business. You have to admit that you can't be right all the time and you will have the layers of being wrong. But because now more and more people are trusting you with significant portions of their money, And, and this is a very important part, they're going to [00:40:00] measure you with the market every day.

Deepak: So they want you to beat the market on the upside, but not fall as much as the market on the downside. It's a bit of both. In fact, many times I tell you, and I've heard this into 2022, and the market didn't do so well. I mean, it was good. It was okay. You got a 4 percent return. So we were told that I could have put my money in an FD.

Deepak: Like, but if you put your money in an FD, you're never going to see the 30 percent returns in one year. But that isn't evident at that time, right? Because that time is now, oh, well, you got your 30 percent in the past. How am I sure you're going to get it in the future?

Deepak: And we said, well, that's how markets are. They give you 30 percent in one year. They give you minus 5 percent in the next year. So you get an average of 25 percent in two years, which is 12 percent a year. They don't give you 12 percent a year. That's the problem of how markets are. So you have to invest even during the minus 5 percent timeframes to be able to get that.

Deepak: And the cash calls will protect you from the maybe minus 40%, but not from the minus 5%. Minus 5 percent is meaningless from a protection point of view, right? So you, you, so to [00:41:00] make people understand this framework usually takes two things, a big crash and experience. That means when people experience volatility over a long term, right?

Deepak: They are more immune to it. And therefore they're like, okay, this is fine. The problem right now that we're having is that people aren't, even with experience they are not in your to volatility because there hasn't been any. So to that extent we have created the sense of, well, you know what?

Deepak: Markets mostly go up. I expect you to understand when the markets fall and whenever the markets fall, you guys know what to do, right? So I won't fall too much. The answer that has been your, you know, and a consequence of maybe the, the fact that mutual funds are now invested in by a large number of people.

Deepak: So you're going to have these small, so I think that the fact that investors are now not taking the calls to go to cash themselves and at the same time expect that the mutual fund managers beat on the upside and don't go lower on the downside forces fund managers to take cash calls. [00:42:00] And when I say force, I mean, it's not only that because they sound intelligent, but also because they have to meet these two criteria that investors are looking up upon them to make those calls.

Deepak: And also that they are you know, measured with the market every day. And I say this without any, you know, I don't want to sound philosophical in this, but cash is like buying a house. I could give you all sorts of rational arguments of how it's financially not the best thing to do. And yet, people buy the house for the emotional satisfaction of owning the house.

Deepak: So you know at some point, and I know, that it serves an emotional need. And I will do it any time to serve an emotional need because I know the emotional needs are important. More important than money. So, even though I'll make an irrational financial decision for it to be a rational emotional decision, cash is a rational emotional decision.

Deepak: It may not always be a rational financial decision because as we found out, [00:43:00] it hasn't been a rational financial decision just by outcomes in the last 15 years. And when you have 15 years of bad outcomes, at some point you're going to say this is not rational. So if you're going down the route of taking a cash call, I think you have to also understand that it's serving an emotional need for you and also the investor in you who's saying this person is conservative and therefore will not try to lose my money too much.

Deepak: I will give him a little leeway and saying, Oh, you took a cash call. That's fine. You can underperform a little bit. But these love affairs between fund managers and investors on the basis of, I took a cash call because I love you is going to only last so long because in the end it's almost like, listen, you have to bring home the bacon if you may, or maybe I shouldn't say the word bacon, but returns matter.

Deepak: But, either ways your, uh, your, your, your, your volatility, the, the, the fear of volatility has not resulted in any meaningful you know, movement [00:44:00] from asset allocation at the fund manager level versus the asset allocation at the investor level. The sophisticated investors do asset management and they will come and tell you don't take cash calls.

Deepak: But more investors are now unsophisticated and you're taking the. They want you to click the cash calls, even if it's irrational, even if it's an emotional decision, they want that decision to be taken by you as a fund manager. So that's one part of it.

Shray: My second question was how do you decide or how does Anoop decide?

Shray: Because we do take cash calls and I don't think we're doing it for emotional reasons.

Deepak: Yeah. So because I've realized I'm doing, I end up trying to do it for emotional reasons. I did this very badly, both did and did not do it. So during 2020, when the market was falling Anoop was Discovering in his algorithm that there was something majorly wrong with the market because the number of stocks that qualified in momentum as an algorithm was now the weakest in the longest.

Deepak: And this is like a month before COVID, like before COVID actually hit us. The COVID impact was already there from [00:45:00] January by Feb and markets had already corrected to a point where he's like, why is only gold showing up in my momentum algorithm and you know, a few other stocks. Like I need 20 positions.

Deepak: I'm seeing four. So he does something remarkable, which is at that time, he also shifts and says, instead of doing this monthly, we need to be doing this weekly because markets are moving too fast. But at the same time he said, I'm going to listen to the market. And he's and me on the other side is sitting, you know, what's the markets falling.

Deepak: It's a great time to maybe buy. And I let me sell whatever I take, whatever cash I have and start buying. And I ended up having a fully invested portfolio before the markets fell. And he ended up having 80 percent cash before the markets fell. So, at the time, he was scared that he was wrong. But he was like, I gotta stick to the algorithm.

Deepak: And I was not scared. And I was wrong to not be scared. So, to that extent, as much as I've learned, and I've learned this over a long time, is that I respect momentum as a as a very strong indicator. [00:46:00] Now, what I'm afraid of is not the 5 or 10 percent falls. And I tell this, you know, if you can't take a 5 or 10 percent fall it's the heat.

Deepak: Just don't bother. Just don't be. Don't bother me in the kitchen. You can't take the heat. But the bigger thing is the 30 and 40 percent falls. Now, I won't take a cash call. I want that 30 or 40 percent fall to be more evident. Markets don't fall 30 or 40 percent overnight. They first fall 10 percent and then another 10.

Deepak: So you don't have a decision point to be made at the top. , and the reason I say this is because a hundred can go to 130 before it falls to 80. So if it fell to 130 and it fell 10%, it would go to 117. And if I was able to take a meaningful cash call at 117, then I could therefore not fall all the way to 80.

Deepak: I will fall to maybe 95. So, you know, if I, if I do did this, so why don't I take the cash call when the [00:47:00] market is falling rather than the market is going up. Which is also true of momentum. Momentum takes cash, calls on markets are falling. And how does it do it? It just puts an algorithm that says, well, stocks have to have some momentum.

Deepak: If there are not enough stocks having some momentum, then you are in a dangerously wide broad illiquid, or not illiquid, but an non momentum market. And that is the time perhaps that you should, so instead of taking a cash call on the way up saying markets will fall, you're taking a cash call on the way down, there's still a risk of course.

Deepak: Because the markets could fall 10 percent from 130 to 170. And then people can say enough, and it didn't go back to 150. So you're taking a cash call and you've, you're like sitting out. So as much as it's important for me to take the cash call going into cash, I need to have a framework to get out of cash.

Deepak: That means if it goes back from 117 to 130 back up again, I better deploy whatever cash I have, because I was wrong. That cash call was wrong. You need to move out. [00:48:00] And yes, you'll underperform a little bit, but you hope that your alpha will kind of make up for it. This attitude is what is very counterintuitive because you're selling on the way down and buying on the way up.

Deepak: I think that is now a better framework to make a cash call. Make a cash call because the market is telling you that cash is where you have to be, rather than you're saying that the market is wrong and cash is where I have to be. So if the market is telling you, so markets, your money is designed to go up if you're interested in the market.

Deepak: If it's falling, then it's not doing what it's designed to be doing. And in that sense, maybe truly you should be listening to the market. And perhaps that is when the cash call gets made. So it's a framework that I use. There are many people who make fantastic cash calls at the top and fantastic investing calls at the bottom.

Deepak: And there are many ways to make money in the market, so I'm not going to belittle any of them. It's just that I find it more easy to do [00:49:00] this because it's emotionally gratifying that at least one data point agrees with me.

Shray: Okay, well, Deepak, we get a sense for how you sort of think about these cash calls, but then when you generate cash, how much cash should you generate?

Shray: The same way you said that you don't really care about the 5 or 10 percent falls. Is it okay to generate, say, 5 or 10 percent cash?

Deepak: You know, honestly, I feel like that is you know, that's, that's like generating five or 10 percent cash is almost like saying, instead of going at a hundred kilometers per hour, which is dangerous, I'll go at 95 at some point that's still too fast, which means if you're 5 percent cash, you're 95 percent invested.

Deepak: How much are you saving for your customers? So how much are we saving of our portfolio? So cash call needs to be meaningful and I'll put one point about asset allocation about this because your cash call being taken by an investor is different from a cash call being taken by a fund manager. It's a different beast altogether.

Deepak: The cash call being taken by an investor can be for two reasons. One is simply [00:50:00] that you need the money in the next year. I invest in the PMS for my son's longer term education. And when I invest from my son's longer term education, the point has come where I will need some part of the portfolio to be liquid in the next, say year or so.

Deepak: So I'm going to take out some of that money and start saying, okay, I need that much portion liquid funds and made available for me to be able to invest at some point in time and to give it to him at some point in time in the for his education. So that part is a cash call I have to take. There is no timing or choice for that.

Deepak: The second one is when my asset allocation is wonky. Now, I personally don't mind going 80, 90, 100 percent equity, but if you are a person who's more conservative and needs a slightly lesser, because it's just kind of a volatility trims your portfolio as a whole you might say, I want to be 75 percent equity.

Deepak: You invested a year back. You started building into 75 percent a year back. And then today it's at 90 percent equity because the markets have gone up. The debt portfolio has not gone up so much. So now you're at 90 [00:51:00] percent equity and you're thinking why should I be at 90 percent equity? I need to be at 75 percent and then you bring it down to 75.

Deepak: So you've taken a cash call in the sense of moving equity profits to debt, but you have not taken this cash call because the market is going to fall, but because you're off your ratio. You don't want to do this too often. Like you don't want to do this every month because it has a tax consideration.

Deepak: So maybe once a year or once in two years is when you'll rebalance your portfolio to bring it back to that asset allocation. So that cash call is a given and its percentage is determined by a number of other factors non market related. Either you need the cash or you need an asset allocation to be met and so on.

Deepak: But let's say you have this fund manager, the fund managers who said, no, I want to protect my investor from a downside. That's the only reason why I'm here. And I, okay need to protect them from a deep downside because five, 10 percent of course, everybody can take five, 10%. So if I do a 5 percent cash portfolio, if I have the market falls 40%, I'm falling 37, 38%, which is meaningful enough for my mom, for my investor to say to [00:52:00] just don't, what are you doing?

Deepak: I mean, I, you were supposed to make the cash calls. The second problem, and this is weird taking cash calls and the market's falling down. actually results in cash as a percentage of your portfolio coming down, not going up. And it's a weird, let me explain here. If you're a fund manager and you've taken I don't know, 10 percent cash, right?

Deepak: And you're thinking, Oh, well, I have 90 in cash in stocks and 10 percent in, in equity sorry, in cash, in cash. Yes. So in the market falls 25%. Now, you are roughly 65 66 maybe in equity, 19 to 27 63, is that correct? Probably. Well, 25 percent. So maybe 66, 67 rupees in equity and you still have 10 in cash.

Deepak: So you have fallen to 77 rather than 75, which should be good, but the answer is investors are not thinking so. [00:53:00] Around 6% of your investors decide that they want your money back. So they say, well, you know, gimme my money back. You have 67 rupees in equity. You have 10 rupees in cash. Guess what you're going to use to pay the investors?

Deepak: You're gonna take the cash and say, well give it to them. Now I have 67 in equity and four in cash. My cash as a percentage of this entire portfolio has actually come down. Not stay the same because when redemptions come as to the fund manager, they're just going to keep using their cash to funnel investors back.

Deepak: They're not selling their equities because the fund manager hates to sell equities on when the markets are falling because they think it's irrational regardless of whether markets are overvalued. They will continue to think any fall is irrational. You're going to wait a little bit. So you're going to use your available cash reserves to meet redemptions.

Deepak: Essentially your, your cash percentage is going to come down. So you need a reasonably high buffer to both meet redemptions and be able to use the [00:54:00] cash to reinvest and build your, your, your war chest, if you may or other deploy your war chest to benefit from the, when the market comes back up.

Deepak: What's the optimal percentage? I think anything below 30 percent is not really a cash call and you can go up to 50, 60 percent on cash if you can. And we will come to that. But the idea over here is you have a 30 percent cash buffer because that is what will protect you meaningfully from a deep downside and meet your redemption problems, right?

Deepak: Because hopefully with 30 percent cash you and because I don't generate cash at the top, I would have already fallen 10 percent before the markets allow me to go to cash. So I will generate my cash at minus 10%. Now I'm expecting another minus 20 to minus 30 percent from there, which is why I'm generating that cash and in that time, I hope to outperform enough for people to say, well, you know what?

Deepak: Maybe Deepak's portfolio is not where we should be doing from, because he seems to have done much better in this fall compared to everybody else. I'm making that [00:55:00] assumption, but even if I don't, I have 30 percent cash, so I'm not going to get 30 10 percent redemptions and that allows me to kind of benefit from having this extra cash still available, which is a reasonable portion of the portfolio to go back up.

The dependence on you know, having this redemption, one day redemptions available is going to make cash calls more precise. And that's why I feel that it should be a calibrated path. So I'm not going to go 10 percent to 30 percent on day one. I'm going to build 10%, maybe add another 5 percent every 2 percent fall after that or something like that, which allows me to build these cash buffers over time.

Deepak: This will both help me meet redemptions. Because they may be coming in during that time and also have enough cash to say when it goes down to a 40%, I will have the cash to deploy it. This kind of a calibrated approach may work only in a deep downturn. And unfortunately it only it works very well in V shaped markets where the market goes [00:56:00] down and you're able to quickly deploy the cash at the bottom, or if you think it's the bottom and go back up.

Deepak: But the problem is this, the market falls 20%. You're a person who looks back and say, 20 percent is enough. You've done it. You deploy your cash and then the market falls another 20%. You know, okay. Oh God, I made a wrong call. Then you go back into cash at minus 40 percent saying, Oh, it's going to fall another 20 percent and then the market goes back up and then you're like, Oh wait, I took the wrong cash call, but I can't deploy it now because the market's gone back up, but it's not gone back up as much.

Deepak: Then you sit on the sidelines and watch and this is how individual investors do it right with their money. Fund managers are no different. They just sometimes get to time it a little bit better and regulation helps them because you can't go below a certain percentage in equity in any case. Because in a mutual fund, you can only have a minimum 65 percent in equities if you're an equity fund, which means you're going to have to generate maximum 35 percent of cash.

Deepak: So 65 percent is invested, but as an individual, there's no such things. So you can go 90 percent in [00:57:00] cash. As a PMS, by the way, we have that advantage because we can go 80 percent in cash. We have to have the good sense to go back into equities. But when as an individual you go, you, you have this problem of, Oh, this is the bottom.

Deepak: Let me deploy. Oh, it fell another 20%. Oh God, these markets are horrible. Let me take out some money because it may be falling, falling a little more. Markets go back up 20%. You're like, okay, wait, wait, wait. I was wrong at that time. But I can't buy now because it's so much higher than when I sold the last time.

Deepak: The markets go up another 20 percent back to the point where you actually started. And this V shaped recoveries ends up being very, very let's say if there was a point where you measured heart disease and heart stress for fund managers, a V shaped recovery would probably be the highest amount of stress for them.

Shray: Okay. But then how do you decide when to get back in? I mean, I can see, I keep hearing all the reasons why it's, it's very difficult to get this right, but let's say you've managed to successfully or semi successfully take a cash call. Okay. And you've managed to sit out some of the downside that's come.

Shray: [00:58:00] When do you know when is the right time to redeploy?

Deepak: This is a great point also, because one of the reasons why what I talked about as I use as a framework to say momentum tells me when to get out is momentum also tells me when to get back in. In fact, momentum tells you also where to get back in, because the stocks that fell the most on the downside are not the ones that recover the most on the upside.

Deepak: It is a different set of stocks. In COVID, the stocks that fell was everything, but you may have had a bunch of banks and stuff like that in our portfolio. But the stuff that started to recover first was the pharma stocks and the healthcare stocks, which makes, it's kind of obvious because many, you know, medical things were the bigger things.

Deepak: But the idea here was that what was recovering was a different set of stocks and a different timeframe. So the broad market started to recover in November. Okay. but medical stocks are to recover in, in May on June. So you got momentum that helped you figure out where and [00:59:00] when to start coming back into the markets.

Deepak: And you were almost fully deployed when there was still fear in the, in the market, in people's minds, the market was doing different things. So one is to get back in using a framework like this, but I have this larger thought process, which says if the market comes back to where you left it, regardless of What has happened?

Deepak: You need to get back in. I mean, if you're 130 and you fell to 117 and you decided to take that cash call, the market goes back to 130. The worst thing that you can say is it is going to fall from here because you were wrong at 117. There's no reason you have to be right in 130. You should go back in and say, well, you know what?

Deepak: I was wrong. So it's like saying the, when the market makes a new high. You should be in, not out. If it, if, if you, if you chose a time to get out of the market because it had fallen, regardless of when you'd fallen, you need to make that call. [01:00:00] Most people tend to make calls when the markets go down saying that valuations will eventually come back.

Deepak: And the answer to this has, it's mostly been right in the last 10, 15 years, except people's magnitude of a fall. The definition of a fall has been 5%, 2%, 3%. Oh, markets are down 3%. We should buy. So I'm, I'm, I'm, I'm too jaded by the past, where I just see 30 percent is the time to buy markets. And I look at how can you buy at 3%?

Deepak: And three days later, guess what? They're right. Because their idea of deploying that money at 3 percent down was perfect, spot on, because the markets just kept and made a new high. But I think this is a terribly subjective thing. If there's one thing that markets have, have taught me is that In the short term, inflows and outflows determine a lot more about the positioning of markets than your earnings or your wars or your, the other criteria.

Deepak: So if you just are able [01:01:00] to get an understanding of inflows and outflows, demand and supply, you are better off in the short term making short term cash calls and therefore predicting that demand going forward. So I'll, one of the biggest things that has happened recently is India's weight. This is as of.

Deepak: 10 days ago, a month ago, India's weight in the emerging market indexes was higher than China's. Then China does a 30 percent month. In one month, Chinese market goes up 30%. So China's weight obviously increases to beyond India's. What this does is moves additional, incremental inflows more towards China than it does towards India, right?

Deepak: So effectively that incremental inflows to India has maybe gone up by a certain percentage, but not as much as it has gone to China. So to that extent, you've, you've got a temporary change in supply and demand from one of these points of equations that and I think determining that can tell you also where when to get back into the market [01:02:00] and when to take those cash calls in the first place.

Shray: So now you've laid out the theory pretty well for us. Now let's bring it to the question I opened with. It is indeed October, 2024. It's the most unlovable market in years. Everyone is weary and nervous about the future. What do you suggest?

Deepak: You know, this is the toughest question because in the end it actually forces me to make a decision, right?

Deepak: So it's like, here's the thing. So let me lay out a framework thought process. Let's say Deepak, this momentum thing is too complicated. Don't want, I don't want to follow that rule. I don't want to fall. I want to understand when markets are going to go down before they're going to go down. So, which is fair, I mean I want to, but I have my frailties, but let me try and work this from a different perspective, and I, what the point I just made, in the short term it's liquidity that drives markets, in the long term it's earnings.

Deepak: There have been bear markets even in earnings, so you see long term returns of, say, Japan. From 1992 to 2003 there were no returns at all in terms of, because 1992 the markets were way [01:03:00] overvaluing potential future earnings. They didn't understand the Japanese population was reaching a peak and the boom, boom, the eventual GDP itself didn't grow so meaningfully.

Deepak: Per capita GDP went up because population was going down, but that doesn't matter to stock markets because they want absolute numbers. So in absolute numbers, you made no money until 2023 and suddenly in one year you made a little bit of return. But that was that was an interesting longterm earnings based bear market.

Deepak: So you could have taken the cash call in 1992, And hopefully start out for most of this time and maybe, in fact, this is a great market for fund managers. And it falls suddenly, but it takes a long time to recover. So you get enough times in the middle to be able to deploy your cash and make meaningful XRR over your period of your portfolio, least amount of stress in terms of cardiac arrest and all for, for fund managers.

Deepak: However right now we can't predict where it's going to be U shaped recovery, V shaped recovery, no recovery at all. No idea. So the answer to what I would say right now is the [01:04:00] framework is this. In the short term, it's liquidity. What drives short term liquidity? We thought it would be wars. There's a war.

Deepak: People will get spooked, take their money out, no? There've been wars, nobody cares. We thought it would be US elections or Indian elections. No. There was unfavorable results in India and for, for at least for the stock markets and. No, the market didn't care. So maybe traditional measures of what impacted short term liquidity has no longer affected, but there is one law, a larger factor, which I think is a big deal and it's the, in the form of IPOs.

Deepak: So you have big IPOs that come usually IPOs come because there's a lot of demand and people are like, Oh, well, you know what? I can sell my shares also at high prices and we'll make more lots of money. So what happens is these companies start doing IPOs. Years the biggest crash in 2006. Nobody remembers this because very few people were participating in the market.

Deepak: Perhaps at that time was 2006. There was a share called Reliance [01:05:00] Petroleum an Offshore company owned by Reliance Industries. This is Mukesh Ambani in the, the company for that was, it was an IPO in 2004 or 2006 in April. Immediately after the IPO, it was a very large IPO for that time, 6 or 7,000 crores, some, some 10,000 crores or something like that.

Deepak: Market immediately fell 30 percent within the next three months, and then of course recovered from there, but it did fall 30%. 2008, just around the Bear Stearns crisis, was Reliance Power's IPO, which was about, I think, 14 or some 10,000 crores plus as an IPO. It was again a huge IPO, markets fell 25%, when the IPO was not even listed.

Deepak: So it listed like 20 or 30 percent below. Then there was, there was Lehman, but Lehman was a liquidity crisis of a different sort. There was global debt markets, liquidity froze in the world. When liquidity froze markets just collapsed because liquidity freeze, especially in debt markets, equity markets will, you know shed tears, shed buckets of tears.[01:06:00]

Deepak: So you've seen that in 2020, the debt markets froze because. People weren't on their desks and they needed to be at recorded lines to make trades. They couldn't make trades. The debt markets froze, equity markets collapsed. So effectively a liquidity squeeze, a short term liquidity squeeze is what causes markets to freeze up.

Deepak: IPOs are sometimes a short term liquidity freeze. One of the things that happens, I'll give you an example of what's happening right now. There's a lot of companies doing IPOs. There was Bajaj Housing which did a 6,000 crore IPO. There was 300,000 crores worth of bids for the, for those two days. But that doesn't necessarily cause a big dip because 300,000 crores is actually not leaving any market.

Deepak: It is just kept inside of people's bank accounts for only two days to be able to trade or to be able to buy a bid for the IPO. But there's a Swiggy IPO, which is 14,000 crores coming up. There's a 25,000 crore Hyundai IPO. That's going to be a bunch of other IPOs. Apparently IPOs lined up in the next, maybe the [01:07:00] rest of the year.

Deepak: We're talking of a fairly large number. 60,000 crores is more than the net investments of all SIP investors plus, because last month it was 38,000 crores. So 60,000 crores is a fair bid. If you take this much money out by, because people are either companies are getting this money or investors are getting this money.

Deepak: And Hyundai, for instance, intends to take this money out and go back to Korea. If, at some point, this causes a short term liquidity change. That short term liquidity change is what's going to drive markets down. So it's useful to think of the timing of those IPOs and the fact that even in India in 2021 there was Paytm and Nykaa which did a 20 25,000 core kind of combined IPO, roughly next to each other.

Deepak: There was the 2008 debacle that I talked about, the 2006 debacle that I talked about. If a large set of IPOs comes during that during a very concentrated phase of these IPOs. We are going to see tough returns for the next, say, [01:08:00] one year or two years is a call that may be useful to take at that time.

Deepak: So if that, if anything, I would look today at that as an indicator. So whenever those IPOs start to hit the market is when you should perhaps in advance generate cash. And that's the only thing I can think of beyond the quantitative framework of wait till the market falls 10%. And before I, you know, before I go in here.

Deepak: The toughest thing called to take in a market is when to get in cash. Maybe there is a saying that I want to bring in. This is a book by a guy called Edwin Lefever called Reminiscences of a Stock Operator. There was, there is a story of this famous trader called Jesse Livermore. And Jesse Livermore was, was, was, you trade both long and short.

Deepak: So he goes to this big investor and says you know, the, you, I know you own this stock. It's going to fall. Why don't you sell it? And then you can buy it back on the way down. So the [01:09:00] guy says, okay. And then two days later he says, you haven't sold your stock. I told you it's going to fall. And you know, then you'll, you can buy it back on the way, you know, when it's down.

Deepak: He says, okay. He doesn't sell. Three days later he comes and says, I told you the stock was going to fall. Why aren't you selling it? He said son, it's a bull market. What do you mean by it's a bull market? Well, in a bull market, you, if you, if I sell something, I lose my position. I take cash as my position.

Deepak: My new position is cash. If I sold the stock, I won't have my position. What he actually telling you is, it's going to be difficult for me to buy back when the market starts going up because the market's a bull market, markets will eventually start going back up. I would rather keep my position than move my position to cash.

Deepak: So I think the answer to it's this perhaps today is it's a bull market and maybe it's not the right time to lose your position. [01:10:00]

Shray: Well, that's our show. Thanks everyone for listening and watching this. If you'd like to read more about how we think about markets, then do visit capitalmind.in. If you'd like to look at our podcast, then visit capitalmind.in/podcast, and just to subscribe to this YouTube channel to see more about how we think about markets.

Shray: Happy investing.