A checklist to manage risk

Jun 12, 2013

In this issue:
» Does RBI need to be stricter with these banks?
» The link between Rupee's fall and interest rate cuts is...
» Can India's growth exceed 6% in FY14?
» Developed nation falling to emerging market category?
» and more....

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In recent times there have been quite a few news articles on hedge fund losses. Some of these losses were related to the announcement by US Fed on pulling the brakes on its stimulus program. As per the Financial Times some of the world's biggest quant hedge funds have suffered steep losses in the recent past. Given that these funds use complicated models and strategies one would not expect them to be at the losing end. But we suppose the thing that worked against them was not their intelligence but the risks that they were undertaking. In fact we feel it is their intelligence that made them take the risks which eventually led to the losses that they suffered.

And this is why we could not help but remember Charlie Munger's quote on how Berkshire Hathaway has been able to create its long term advantage. He had once said that "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent." In our opinion this is one of the most important learning for any investor. All it takes to be successful in investing is to continually avoid doing stupid things in order to minimize your losses. For this it is necessary to have a strong risk aversion. We have seen how taking too much risk has helped the hedge funds!

But how do you avoid risk? A good way to minimize your risk in investing is to do your own homework before investing in a stock. To do this you have to keep in mind several points. You need to study the company's financials; factors influencing its fundamentals both internally as well as externally; its management's track record; its valuations. The list is long and it is but natural that a slip up is possible. This is why it is important to maintain a checklist. A matrix that lists out all the key variables that influence all stocks. This includes the company's financial performance, key factors related to the industry in which it operates. The company's management quality and its balance sheet strength must get utmost importance. This checklist can be used as a reference point for analyzing any stock. This is why we at Equitymaster try to even measure the comparative risks for different business more objectively with the help of 'Equitymaster Risk Matrix'.

We believe that if investors are able to form and follow such a checklist then they increase their chances of investing successfully. We again reiterate that investing is all about being less stupid and not more intelligent. Thus, it pays to have some sort of checklist or risk matrix so that you can go through it every time you analyze a stock.

Do you think it pays to have a checklist for analyzing a stock? Please share your comments or post them on our Facebook page / Google+ page

 Chart of the day
Back in 2007, the BRICS were the apple of global investors. The blistering pace at which these countries were growing, it was little wonder that everyone wanted to invest in them. But in recent times things have changed. The countries have slowed down. Inflation has shot up and the current account situation in nearly all of the countries has worsened from what it was in 2007. But even when all BRICS are doing badly, India seems to be faring even worse. Especially when it comes to budget deficits which is nothing but the excess of government's spending over what it earns. As per The Mint, India's budget deficit stood at 4.9% of GDP in 2013. This makes it the worst on the BRICS list. In fact India has fared badly even on other economic parameters. Inflation is high, its current account gap is increasing, growth has slowed down drastically and the fiscal mess is getting worse. This is a poor reflection on the country's government. We have been writing about how the government needs to pull up its socks and fast track reforms. Though it has gone ahead with some reforms in the recent past, however, there is still a lot of work that needs to be done.

Source: The Mint

The Reserve Bank of India (RBI) is perceived to be a strict and prudent regulator. Not sure what is it then that is forcing the regulator to act differently this time. What is stopping it from taking a firm stance on the money laundering accusations against the top 3 private sector banks in India? Axis Bank, HDFC Bank and ICICI Bank have been fined Rs 50 m, Rs 45 m and Rs 10 m respectively. The allegation by Cobrapost that the banks violated KYC norms and failed to report cash transactions were independently audited by the RBI and banks themselves. For lack of evidence it seems that RBI has chosen to impose a token penalty. For the amounts are just about 0.1% if the banks' profits in FY13. However, what stumps us is the differential penalty on the three banks. Instead of ensuring that it shows non-tolerance towards poor compliance, the RBI seems to looking at granular details. The extent of the banks' involvement in the unreported cash transactions seems to be the basis of the penalty. Going by this we would not be surprised if banks get encouraged rather than discouraged to chase profits at the cost of compliance. And the sector would not be far from the days when non compliance with KYC guidelines becomes a systemic risk. Something that the RBI chooses to deny!

The Indian Rupee is currently witnessing a free fall. It has lost about 7.7% against the US dollar since 01 May 2013. And this is likely to make Reserve Bank of India (RBI) circumspect for further cut in interest rates. It may be noted that RBI adopted a dovish stance since April 2012 after growth started faltering. But weakening rupee may force RBI to reconsider its decision. Weaker rupee means that imports will turn expensive. This is likely to fuel inflation. In other words, India will be importing inflation because of weaker currency. And with imports majorly comprising of oil and gold; inflation is likely to sink deep into the financial system. As such, the RBI may turn wary to cut rates from here on.

In order to avoid further depreciation, the RBI has intervened in the forex markets by selling dollars and buying rupee. While this may support rupee for the time being, India's forex reserves might get depleted to some extent. We feel that in order to support rupee such short term measures will do no good. The government will have to come out with conducive policies that are favorable for foreign investments. Inflows of long term foreign capital will provide much needed support to the rupee.

An economy just entered the club of emerging markets. The term 'emerging' brings to mind a fast growing developing economy, right? But this is not the case with the economy under consideration.

The country we are referring to is none other than the crisis-struck economy of Greece. As per Bloomberg, Greece has been downgraded to emerging-market status by index provider MSCI Inc. This is the first time ever that a developed nation has been downgraded to a lower status. Just to recall, Greece had been elevated to the developed-market status in 2001 by MSCI. But the sovereign debt crisis that engulfed the nation in the last decade crippled the country's economy. The benchmark ASE index has plunged 83% since October 2007.

The downgrade is likely to make matters worse for Greece. It could further lead investors to dump the country's stocks. Greece's condition is a clear proof of the status of progress in the Eurozone. The crisis is still far from over.

FY13 was a forgettable year for the Indian economy as it recorded its lowest GDP growth rate in a decade. Consumer price inflation was high, demand was subdued. Industrial production was sluggish and monsoons failed to take off. Fiscal deficit kept increasing as did the bickering between various political parties. The latter especially led to the government not doing much on the reform front for the larger part of the fiscal. In such a scenario, how is FY14 likely to shape up? The Prime Minister's Economic Advisory Council (PMEAC) chairman, Mr C Rangarajan opines that India's GDP will grow by at least 6% in FY14. This is on the back of efforts being taken by the government to get the reforms process going. This includes among others trying to reduce fiscal deficit and cutting back on subsidies. Removal of obstacles and clearance of large projects also appears to be on the agenda. Although not much is likely to happen in the first half of the fiscal, Mr Rangarajan expects things to pick up in the second half. We certainly hope so. There is no doubt that the government has become more aware of the importance of reforms. But so far on the implementation front a lot still leaves to be desired. So once that gets going there is no reason why the economy should no grow above 6% either.

In the meanwhile after opening the day on a negative note, Indian equity marketscontinued to trade below the dotted line. At the time of writing, the Sensex was down by about 87 points (0.5%). The other major Asian markets have closed the day on a negative note as well with China and Indonesia leading the pack of losers in the region.

 Today's investing mantra
"We don't have to be smarter than the rest. We have to be more disciplined than the rest." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "A checklist to manage risk". Click here!

    2 Responses to "A checklist to manage risk"


    Dec 16, 2015

    I completely agree that a checklist is paramount before making an investing decision. As a EQM secrets subscriber I would like to take the privelege (if I could) to know whats on your in-house research teams checklist while they study an equity stock.


    sn malhotra

    Jun 12, 2013

    The best innovation of the Japanese probably has been The Checklist. It is the backbone of a number of their quality assurance processes and it WORKS.
    Having said that, the design of the checklist is very important. KISS has to be the governing principle - not more than 5 or 6 parameters, which can be quantified and integrated into one single score on a weighted average basis, to make decision making simple yet decisive.

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