What I Learned About Investing from Darwin
Reading Notes Series
I have always wanted to write a reading reflection on "What I Learned About Investing from Darwin". To summarize in one sentence - "What I Learned About Investing from Darwin" is my favorite book this year. My general reading habit is to first read the summary and table of contents of the entire book, then choose interesting chapters to read the chapter summary if there is one, and then select interesting parts to read. For "What I Learned About Investing from Darwin", I followed this habit, and then I read the entire book without missing a word.
This is a very rare book that combines evolutionary theory and investment practice, drawing on billions of years of evolution history for inspirations in making investments. It is also a book with clear logic and beautiful arrangement. It has been an enlightening and enjoyable read. I had the privilege of communicating with Mr. Pulak Prasad, the author of "What I Learned About Investing from Darwin", this month. I have summarized my communication and reading gains as follows. I suggest you read the entire book first because no word is superfluous, and then read my summary and reflection below.
As always, please feel free to share your thoughts with me.
About Nalanda
We consider ourselves to be permanent (part) owners of high-quality publicly listed businesses run by exceptional people. We invest exclusively in small to mid-cap companies in India where we aim to be a large (typically the largest after the founding family), friendly (active, without being activist) and long-term (ideally, permanent) shareholder.
The above content comes from the Nalanda official website.
This straightforward investment process has led to the following outcome. One rupee (INR 1) invested in Nalanda’s first fund at its inception in June 2007 would have been worth INR 13.8 in September 2022. The same amount invested in India’s Sensex (the country’s large-cap index) would have been worth INR 3.9, and if invested in the Midcap Index would have been worth only INR 4. Over a little more than fifteen years, based on actual cash inflows and outflows, the annualized rupee return for this fund was 20.3 percent (after all our fees), and the fund beat both the Sensex and the Midcap Index by 10.9 percentage points.
The above content comes from "What I Learned About Investing from Darwin".
One last thing about Nalanda, they can hold a position for more than a decade.
Ecosystem Design
If we were to analyze Nalanda as a business, a key takeaway would be that a healthy ecosystem is composed of many interlocking mechanisms. The rarity of Nalanda's investment approach is due in part to both its investment strategy and the people/mindset behind it, as well as its fundraising strategy. The draw-down structure, similar to that of a private equity fund, and the longer lock-up periods are both essential pillars of Nalanda's success. Fundraising is not an easy task, but making the difficult yet correct choice that aligns with one's investment strategy can provide support for long-term success.
Avoid Big Risks
Most books talk about how to make money, but how to avoid losses is often overlooked.
There are two types of errors in nature:
Type 1, taking on too much risk where the downside is suffering losses or even death (mistaking bad companies for good ones);
Type 2, taking on too little risk where the downside is missing out on development opportunities (missing good companies, FOMO mindset). How to formulate your own strategy depends on your goals. If the goal is to survive, most animals and plants avoid taking risks to their life and well-being at the cost of giving up some potentially juicy opportunities.
Nalanda's strategy is:
Principle 1: choose easy-to-win games (investment universe with a high proportion of good investments)
Principle 2: focus on reducing your Type 1 errors, as it contributes more to success rate than reducing Type 2 (see below chart which is insightful)
Success rate under different Type 1 and Type 2 error Principle 3: never forget principle 1 and principle 2
When to Buy
The answer is in very few special circumstances:
Macro issues: Global financial crisis, European crisis - these are the easiest moments to act.
Industry issues: Upstream/downstream issues which are cyclical. For example, when commodity prices rise and margins trim.
Company issues: It depends on whether the issue is persistent or temporary, each case requires specific analysis.
For a great business built by great entrepreneurs, it is rare for all the stars (including price) to align perfectly for an investment. That's why patience is an indispensable quality for investors.
The act of purchasing at Nalanda is akin to the emergence of Pharaoh cicada from their cocoons, a phenomenon that occurs once every several years during a specific time period.
When to Sell
After investing, we ignore near-term fluctuations because the fundamental characteristics of stellar businesses remain stable over the long term. We never sell on valuation.
We have sold only when there had been egregiously bad capital allocation or irreparable damage to a business.
The above content comes from "What I Learned About Investing from Darwin".
Great Truths Hide in Simplicity
On the modeling level, Nalanda's strategy focuses on historical data spanning many years, without spending time predicting the future. They select the best-performing companies with stable historical performance and invest in them when there is a significant discount relative to historical prices. They do not use absolute valuation or relative company comparison, and one core element of the discount size is the stability of the company's historical performance.
On the investment timing level, they do not time the market, understanding that they can never buy at the lowest point. Instead, they buy within the reasonable price range when the price reaches their target price.
Understanding the Boundaries of One's Strategy
Mr. Pulak Prasad clearly tells readers the boundaries of their strategy. They actively avoid new companies and rapidly changing industries because their research focuses on a company's long-term history.
They are also particularly cautious about situations that have not occurred in history, such as turnarounds. In short, only patterns that have occurred multiple times in history provide them with confidence.
Common Sense in Disguise
Patience is a scarce ability for fundamental investors, but it is crucial for good investment returns.
Understanding and acknowledging one's ignorance in 99% of cases and avoiding it. Being candid and admitting that one cannot answer most questions.
As important as the investment strategy is 1-persistence, and 2-execution.
Finally, I would like to express my sincere gratitude to Mr. Pulak Prasad for sharing his insights on "What I Learned About Investing from Darwin". This book has been invaluable in shaping my way of thinking and investment style. I hope that this post will encourage more individuals to discover and learn from this exceptional book, thereby enriching their own investment journey.
As always, thanks for your reading and I hope you enjoy it. Stay safe and see you next time.