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 Corporations are built on the assumption of continuity, and their focus

Index investing was also, in a sense, copying that crowd behavior. There

Index Investing

rules, information and analysis are ignored in the name of vision. The

This argument also did not go down well with him, and I left it at that

do some value investing by spending time and energy identifying the

by rational decision-making: the codification of what worked in the

conveyed the message that lower fees added to the overall returns to the

losing. As long as they had

research on index investing.

a representative of the markets.

The other trait that worked was the psychological solace that one was

discontinuity, and their focus is on creation and destruction. The market

corporations, and helping the new ones to take their place. It was to be

itself. This leads to the company’s decline.

the next 5 to 10 years it would make a big difference to his portfolio.

from two distinct human behavioral traits.

done well, especially if you were lucky enough to get the money in

with the crowd. If the markets went up, one would gain, and if they

with spectacular returns. I will not

company they were comfortable.

fees.

investing. They believe that the best way to beat individual active

of the new. They help creative disruption to happen.

is good, but because it

capitalization.

mind losing if everybody was

wisdom, which says that index investing will beat individual stockpicking for the following reason.

is on operations. Capital markets are built on the assumption of

seasoned investors in the

Was “The Law of the Farm”

A company gets into\

investing is to put money in index stocks. There is this conventional

being vindicated? Can such

They do not experience the bursts of desperation, depression, denial

right long-term stocks, and there you have a very passive form of investing

Individual stocks have their life cycles. In the initial phase, the

stocks? Being a firm believer in behavioral finance, it is my strong belief

It was based on this hypothesis that indices were formed. It was to

underperformance.

2003 as we did. I will take the credit for having invested his money in

We had beaten the Sensex by around 2% and the Nifty by around 1%,

exceedingly well on his portfolio,

markets.

and the rigmarole of choosing individual stocks and, thus, shun active

exceedingly well in the

10.1 INTRODUCTION

the last four years. We had done

encourages rapid and extensive creation and, hence, greater wealthbuilding. It is less tolerant than the corporation is of long-term

while ensuring that the downside was protected. The client, though

investor? This called for some real soul-searching and, thus, started the

was nothing contrarian about it. If it was that simple, can it benefit the

the index not because it

works so well? My immediate answer to him was that beating the index

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successful Vanguard Funds, which had pioneered the concept of Index

by 2% was not a small feat and if one were to compound the same for

that gives you nearly the same returns.

investor. Moreover, investors were quite dismayed by the fees that asset

10.2 THE ESSENCE OF CONTINUITY AND DISCONTINUITY

made by them.

One was the offer of lower fees as compared to the more activelymanaged funds. Psychologically, it was a big positive, as it indirectly

Investing is a difficult game

the Index. Why was he going through all this when passive investing

and hope that the corporations face. They have no institutional

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Why do people prefer passive investing like the index or the index

passive investing score over the efforts of identifying value and mispriced

be no regret-aversion in case of

believed that he would have also been better off had he just invested in

facilitate continuity by aiding the discontinuity of individual

The other day, I was with a client

entrepreneur is filled with passion and works on intuition. When passion

memories, nor do they have any mental models. The markets allow

Value Investing and Behavioral Finance

went down, one would lose. There being no benchmark to the Index

past. This causes a cultural lock-in and the company is unable to reinvent

take any credit for the returns, as everyone in the Indian markets has

that the majority of market participants display crowd behavior that

leads to irrational choices. This gives rise to mispriced opportunities.

the right wealth-enhancing assets and walked our talk of having a longterm investing strategy. Our churn rate on the portfolio was negligible.

and there are a very few

management companies charged, irrespective of the profits or losses

Funds? On more introspection I concluded that their popularity soared

up. The company does well, and passions cool down and are replaced

world who have done

weaker companies to be put up for sale or to exit and pave way for entry

fairing poorly. People wouldn’t

However, markets are very different. They lack culture and leadership.

However, this got me thinking. Here we were making all efforts to

Who was I to argue when there was a track record of the most

company keeps on growing and, over time, bureaucracy starts building

funds? Most investors prefer to avoid the ups and downs of the markets

as I thought that this could be his way of bargaining to bring down the

pleased with the performance did not show any enthusiasm, as he

whose money we were managing for

has a high market

but the index itself, there would