QED Capital Advisors LLP AlphaBets – October 2018

If you can keep your head when all about you are losing theirs;
If you can wait and not be tired by waiting;
And yet don’t look too good, nor talk too wise;
If you can meet with Triumph and Disaster
And treat those two imposters just the same;
‘IF’ by Rudyard Kipling

We have completed 2 and half years since inception of the AlphaBets investing program. I have written
about our process in our earlier letters and today I will write in some detail about a key insight which
has helped make our investing process robust and simpler.

But before that the performance from inception till 30 Sep 2018 is given below. As you can see we
have managed to outperform both the Nifty 50 and Nifty Midcap Index in absolute as well as risk
adjusted terms.

Return1 Max Drawdown

AlphaBets 13.4% p.a. 6.5%

Nifty 50 12.7% p.a. 9.9%
Nifty Midcap 12.5% p.a. 18.1%

Returns Alpha-Bets Nifty

150

140

130

120

110

100

90
08-Jul-16

08-Jul-17

08-Jul-18
08-Mar-17

08-Mar-18
08-May-17

08-May-18
08-Nov-16

08-Nov-17
08-Sep-16

08-Sep-17

08-Sep-18
08-Jan-17

08-Jan-18

Two and half years is a short time, but we have navigated events like Brexit, US Elections,
Demonetization, NPA crisis, GST implementation, SEBI Mutual Fund re-classification impact etc. to
name a few. Currently we are amid some serious liquidity issues in the Indian bond markets which are
impacting NBFCs, Banks and Housing Finance Companies. The macro back drop is also deteriorating
with rupee depreciation, crude prices shooting up and the Current Account Deficit widening.

1 Annualised return for live client account post fees and expenses since inception i.e. July 2016 to September 2018
QED Capital Advisors LLP AlphaBets – October 2018

0.0% Drawdown NIFTY ALPHABETS

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%
08-Mar-17

08-Mar-18
08-Nov-16
08-Dec-16

08-Apr-17
08-May-17

08-Nov-17
08-Dec-17

08-Apr-18
08-May-18
08-Jul-16

08-Jul-17

08-Jul-18
08-Oct-16

08-Oct-17
08-Jun-17

08-Jun-18
08-Aug-16
08-Sep-16

08-Jan-17
08-Feb-17

08-Aug-17
08-Sep-17

08-Jan-18
08-Feb-18

08-Aug-18
08-Sep-18
“An original sound premise becomes distorted as time passes and people forget the original sound
premise. So, after a while, the sound premise, becomes the sort of impetus for later turns out to be a
bubble and the price action takes over.” - Warren Buffett (testimony to the Financial Crisis Inquiry
Committee – 2010)

In my January 2018 letter I had quoted WB, “A pin lies in wait for every bubble. And when the two
eventually meet, some new investors learn some very old lessons.”

The pin has met the mid cap and small cap stocks/portfolios well and truly this year. Investors are
losing money in 123 out of 147 actively managed equity schemes, as per data from Value Research.
Small-cap funds have seen the highest fall followed by midcap funds and multi-cap funds.2

Scheme name Category 1 year (%)

Sundaram Small Cap SmallCap -34.10
HSBC Small Cap SmallCap -28.39
ICICI Prudential Smallcap SmallCap -26.63
Aditya Birla Sun Life Small Cap SmallCap -24.74
Aditya Birla Sun Life Pure Value Value Oriented -23.73

In the same period (Sep 2017 - Sep 2018) our investing program AlphaBets is up 11.7%3. To be fair
we are a multi-cap investing program. But then, even most multi-caps have not been spared even
though the category as an average has returned about 2.1% over the year ended Sep 2018.

Amid such a noisy environment, “the single greatest edge an investor can have is long term
orientation. In a world where performance comparisons are made not only annually and quarterly but
even monthly and daily, it is more crucial than ever to take the long view. In order to avoid a mismatch
between the time horizon of the investments and that of the investors, one’s clients must share this
orientation” – Seth Klarman. We are glad that our investors share this orientation with us. You, the
investors, have helped us do our job by placing your faith in us.

2 Source: Economic Times 26th September 2018

3
Return for live client account post fees and expenses between Sep 2017-2018
QED Capital Advisors LLP AlphaBets – October 2018

Barry Ritholtz says that his greatest lesson is that “we are all still monkeys. It all comes down to that.
You are a slightly clever, pants-wearing primate. If you forget that you’re nothing more than a monkey
who has been fashioned by eons on the plains, being chased by tigers, you shouldn’t invest.” And it is
to prevent my monkey brain from making decisions amidst daily noise, period euphoria and panic
situations, we have put in place a systematic process of filtering, sizing, buying and having approximate
exit points. However, they don’t mean much if we don’t execute. So far so good.

It is not that we could predict the timing of the correction in mid and small caps, but our process
guided us to be cautious from the start of 2018 and stay away from midcaps.

However, we were not fully in cash or avoided stocks altogether. Guided by our sector ranking process
we started building positions in IT, Pharma and few consumer names last year but mainly in the large
cap space.

Howard Marks says, ‘the most important thing is to know where you are in the cycle’. Its only our
view (and we are wrong many times) that we are in the late stage of a very long global bull market.
The longevity of this bull market has been astounding to say the least. Soros’ reflexivity principle
would perhaps state that this was expected given the severity of the 2008 meltdown. But now we
are in the 10th year and there are many participants in this market who have only read about 2008.
And while this ten-year cycle hasn’t been free of corrections, the length of those corrections hasn’t
been long enough to test the participants who have come post 2008.

Our process emphasizes limiting losses in falls over maximizing gains in upswings. It ensures longevity
and helps us to grind out slow and steady returns over the cycle. We are ok waiting for the fat pitch
and we are able to do it because you, our investors are not calling us and saying – “Swing, you bum.”
You allow us to wait for the fat pitch.

Regards

QED Capital
4th October 2018
QED Capital Advisors LLP AlphaBets – October 2018

PARETO PRINCIPLE

OVER 80% OF STOCKS HAVE A LIFE TIME RETURN OF ZERO

In 2016, I was reading this paper titled, “The Capitalism Distribution” by Longboard Asset
Management. It stated over a period of 20 years, the 2000 (25% of all) best performing stocks
accounted for all the gains in the stock market. This was very intriguing.

And we got down to the job of confirming if the same was true for Indian stocks. We looked at about
1400 stocks listed on the NSE and got down to crunching the numbers. And it turned out to be true
for Indian stocks too. Infact it was even lower. Only 17% of stocks accounted for all the gains in the
market between 2006-2016. This was astounding even to me. And it was an epiphany for me. Should
I be doing something in which I have 1/5th odds of winning or focusing on something in which I have
4/5th odds of succeeding.

The best performing 200 (17% of all) stocks

accounted for all the gains

The worst performing 1088 (83% of all)

stocks collectively had a total return of 0%

(Source: AceEquity)

This then led me to the ‘Anna Karenina principle’ which states that a deficiency in any one of a number
of factors dooms an endeavour to failure. Consequently, a successful endeavour is one where every
possible deficiency has been avoided. Its not a truism but a fairly accurate guide.

The name of the principle derives from Leo Tolstoy's book Anna Karenina, which begins:

“All happy families are alike; each unhappy family is unhappy in its own way.”

In other words: in order to be happy, a family must be successful on each and every one of a range of
criteria e.g. compatibility, money, parenting, religion, in-laws. Failure on only one of these counts leads
to unhappiness. Thus, there are more ways for a family to be unhappy than happy.

I have observed over my two decades in the market that every stock successful over the long term
was alike, but every dud had its own story. The common factors were that the long term
compounders/multi-baggers have efficient capital allocation, strategy execution, consistent ROE,
consistent robust earnings growth and management which walked the talk. You fail on any one of
these and it’s a recipe for a dud.

Putting that and Munger’s words – “Invert always invert” it hit me that I was focusing too much on
the picking the winners and not as much on avoiding the losers. My gut finally understood what it
meant when Munger said “Let me know where I am going to die, and I will never go there.”
QED Capital Advisors LLP AlphaBets – October 2018

So, we have a set of criteria which came from our study of successful companies and stocks. We added
certain criteria to our checklist and filtering process based on this insight. We also added certain
quantitative trend criteria to our position sizing and risk management process. This has helped us
greatly in either avoiding or exiting early some of the losers.

This kept us out of stocks like Vakrangee and DHFL even though they made it past a couple of our
filters. The other stocks in the list below (of stocks that have corrected recently) did not make it past
even the initial list. The list below is only a representative list.
Stock Sep-17 Sep-18 1 year (%)
Vakrangee ₹ 247.00 ₹ 28.35 -89%
PC Jewellers ₹ 331.00 ₹ 62.35 -81%
Manpasand ₹ 467.00 ₹ 102.00 -78%
Infibeam ₹ 128.00 ₹ 58.54 -54%
DHFL ₹ 549.00 ₹ 274.00 -50%

That is not to say we haven’t made errors of omission or commission. We have, and we will make
those. But I am confident that through the cycle we will have done well despite those. If we continue
to execute as we have been doing so far, we should be ok. Our selection and position sizing process
protects the portfolio from losing too much even if we encounter the occasional individual black swan.
This is not to say that all companies that ex-ante have all the characteristics of a good business turn
out to be profitable investments. They also must be bought correctly. (My next letter will perhaps
cover this)

With regards

Anish Teli

4th October 2018