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  • JUNE 8, 2016

An Enterprising Zebra in Lion Country...

Today's thought experiment was inspired by the works of Ralph Wanger, a small-cap fund manager.

Let's begin.

Imagine portfolio managers as zebras and Mr Market (aka Volatility) as a roaring, ferocious lion.

Fund managers and zebras have a few similarities. While the manager strives for above-average performance, the zebra wants fresh grass. Both dislike risk. Managers can be fired. Zebras can be eaten by lions.

Furthermore, zebras and fund managers both think and move in herds. Zebras look alike, think alike, and stick close together. Just like fund managers.

For a zebra, a key decision is where to stand in relation to the rest of the herd. When things are safe, the outside of the herd is the best. That's where the fresh grass is. Meanwhile, those in the middle eat grass trampled upon (and worse) by the other zebras.

The enterprising zebras on the outside eat better. However, there will come a time when a lion approaches. The outside zebras will be the lion's lunch. The skinny zebras in the middle of the pack may eat a bit less, but they are still alive.

  • A Lion does not ask permission before he eats a zebra. Lions cannot talk and zebras will not listen. - House of Cards

Think about it...

Mutual fund managers cannot afford to be an outside zebra. For them, the best strategy is simple: Stay in the centre of the herd at all times.

As long as they continue to buy popular stocks, they cannot be faulted. Look at an index heavy weight, Reliance Industries.

Now, Reliance Industries had a market capitalisation of more than Rs 3.5 lakh crore in 2010. Its market cap in 2016 is slightly less than 3.10 lakh crore. So if you bought Reliance in the past six or seven years, you did not make a dime. In fact, you lost money.

But even more surprising is that all the major fund houses continue to hold a huge chunk of Reliance in their portfolios. Why?

Is it because they believe in the company's long-term performance. Well, how long is 'long term'? As John Maynard Keynes says, in the long run, we're all are dead.

These fund managers are not questioned or grilled on their stock pick because for mutual fund managers, it is better to fail conventionally than try to succeed unconventionally.

We can imagine these managers boasting to each other at a party about how they would rather buy a big known company than try to look for some untested company fearing failure. They failed anyways...

Our pledge at Equitymaster is to be an enterprising zebra. We look out for opportunities that will help our investors earn above-average returns while taking below-average risk. In our drive to eat the fresh grass, we have earned our share of scars from the lion (Mr Market). We flaunt them openly and proudly. You will always find us willing to succeed unconventionally.

"It is okay to look stupid as long as you aren't."

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