Sanjoy Bhattacharyya: The Difficulty of Being Good - Part 2

Sanjoy Bhattacharyya is a seasoned investor and one of India's most respected value investors. He has over three decades of experience in the financial markets and is known for his deep understanding of value investing principles. Bhattacharyya has a strong academic background, with a PGDM from the Indian Institute of Management (IIM) Ahmedabad.

He has held significant positions in the financial industry, such as the Chief Investment Officer of HDFC Asset Management Company. Bhattacharyya is also a founding partner of Fortuna Capital, where he continues to apply his value investing philosophy. His investment approach emphasizes long-term wealth creation through careful analysis of business fundamentals, focusing on companies with strong balance sheets, sustainable competitive advantages, and prudent management.

Bhattacharyya is also known for his educational contributions to the investing community through his writings and speaking engagements, where he shares his insights on market behaviour and investment strategies. Through one such speech, ‘The Difficulty of Being Good’, he tells us why investors fail to behave in a manner that makes them good investors. This article is divided into two parts. The first part discusses the element of uncertainty in investing while the second part discusses market wisdom and the behaviour of investors.

Let’s dive into Part Two!

Data, Information, Knowledge and Wisdom

The key distinction between data and information is that data consists of raw, unorganized facts, while information is data that has been processed and contextualized. Knowledge arises when experience and expertise are applied to this information, but wisdom—arguably the most important element—depends on judgment, particularly understanding the limitations of knowledge. Investing, as a profession, is complicated by slow and incomplete feedback loops, which make the process multifaceted. Unlike a chess player, who can use knowledge and memory to predict optimal outcomes based on the position of the pieces, or an orthopaedic surgeon who understands the healing process of fractures, investing involves too many variables to rely solely on historical patterns. The ability to judge whether a situation is similar to or distinct from past events is crucial.

Wisdom imparts several valuable lessons. First, timing the markets is a futile endeavour, and its importance diminishes as the investment horizon lengthens. Second, investors must stress-test their portfolios to assess how adverse events might impact them. While one cannot be blamed for failing to predict a tsunami, one can be held accountable for not preparing for such a scenario. Third, avoiding unnecessary churn, and fourth, steering clear of leverage, are both essential practices. Ultimately, wisdom lies in recognizing our limitations as investors.

The Trend is Not Your Friend 

Spotting trends early is difficult, in part due to the challenge of understanding exponential growth. Additionally, established trends can shift quickly as new competitors and innovators emerge to disrupt the market. Even after navigating these challenges, an investor must not only identify the winning trend but also figure out how to profit from it. For instance, Uber's first ride took place on July 5, 2012, and its billionth ride occurred just three and a half years later. However, despite this rapid growth, Uber only became profitable in 2023, after enduring billions in losses over the years. This demonstrates that even if a trend is accurately predicted, it is still difficult to invest profitably in such trends.

Successfully profiting from trends usually cannot be achieved by betting on individual stocks alone. Instead, investors can benefit from trends by diversifying their portfolio or purchasing specialized funds that focus on emerging sectors or industries.

Skill and Luck

Certain professions reward skill, while others are more dependent on luck. Chess and tennis, for instance, are games where skill plays a dominant role, but investing is a profession where luck often takes precedence. The average return of stocks is typically higher than the median return, meaning that most stocks underperform. A small number of stocks are responsible for creating the bulk of wealth, and successfully identifying and holding these stocks over long periods relies more on luck than skill.

Between 1926 and 2016, out of a universe of 25,000 U.S. stocks, the average return was 14.74%, while the median return was only 5.23%. More than half of the stocks delivered negative returns during this time. In fact, just five stocks—IBM, GE, Microsoft, Apple, and Exxon—accounted for 10% of the wealth created over those 90 years, and only 100 stocks were responsible for all the wealth creation.

That said, it is possible to outperform the market through diversification and maintaining a high active share. Diversification spreads the risk across a wide range of stocks, increasing the chances of owning a wealth creator. Active share measures the difference between a portfolio's holdings and its benchmark index. Since one cannot outperform the index by simply mimicking it, maintaining a high active share can enable an investor to achieve superior returns.

What it Means to Be Good

As investors, we seek certainty in an uncertain world and are at the mercy of greed and fear. However, good behaviour, overriding our emotions and controlling our baser instincts, is possible by practicing the right activities.

To achieve lasting success in investing, it's essential to follow key best practices that prioritize discipline and long-term thinking. First, choose lethargy over activity, avoiding overtrading—much like the proverbial "dead investors," whose inability to trade protects their holdings from rash decisions. Simplicity should be prioritized over complexity by steering clear of derivatives or other instruments that are difficult to value. A clear investment policy statement is vital; it defines one's goals, asset allocation, and rebalancing framework. Building a margin of safety into a portfolio helps mitigate risks, and focusing on the long-term prevents short-term volatility from derailing one's plans. Checking the portfolio infrequently also reduces the urge to make emotional decisions based on daily fluctuations. For those tempted by speculation, setting up a separate, limited account for risky ventures ensures that any value-destructive behaviour is contained. Finally, choosing the right advisor is crucial—not for picking the next hot stock, but for fostering discipline and encouraging sound investment behaviour over time.

In financial markets, uncertainty is a constant reality. While investors may attempt to manage or reduce uncertainty in various ways, it will always persist, as the future is inherently unknowable and not everything that should be known can be known. As a result, investors should focus on what they can control—their behaviour. In a field that often relies more on luck than skill, ensuring the opportunity to benefit from luck requires disciplined behaviour. This can be achieved by maintaining a healthy focus on diversification, minimizing costs, and controlling speculative activities, all of which increase the likelihood of long-term success.

Click here to dive into Part 1 and explore more of Sanjoy Bhattacharyya’s investing insights!