PIC — The Satellite Investment Objectives
When individuals and families are able to satisfy their needs of:
- being able to cover for immediate-term contingencies — Preservation,
- having enough to survive through protracted tough times — Accumulation, and
- growing their wealth through the efforts of others — Growth
they look to do more with their money. Satisfaction of needs through Core Investment Objectives leads individuals and families to pursue their desires.
At Modulor Capital we have identified 3 significant satellite investing themes for individuals and families that are driven by ✓ the desire to grow faster than others or ★ Capital-appreciation, ✓ the desire to enjoy the fruits of their past labors or ★ Income-creation, and ✓ the desire to enjoy surpluses or ★ Profit-generation.
These satellite themes can easily be remembered as the PIC of Investing. Let us understand them in reverse order.
✓ The Desire to Grow Faster than Others
Studies show that happiness is relative. Humans are happier if they are better off than themselves since yesterday, or someone they know, or some standard accepted by society.
We feel happier when we make more money than we did last year, more money than our neighbors, or more money than others in the same profession. Comparisons are the key to happiness and drive us in our economic actions as well.
One of the key areas of comparison is wealth.
People are driven to make more wealth (even if it does not really improve their standard of living beyond a point) since it makes them feel better than others. They derive happiness from this fact.
This counts when making investment returns as well. Individuals and families seek more returns in order to keep appreciating their capital, faster than others.
The investment objective to take suitable risk in order to appreciate capital faster than others is Capital-appreciation.
Investing for Capital-appreciation
The quantamental investment objective of Capital-appreciation can be constructed by overlapping the fundamental investment objective of Funding and the quantitative investment objective of Fat-tailed and/or Exponential. Capital-appreciation is all about taking more risks in order to grow capital faster than others. It is a continuous activity to search for better avenues to generate returns faster (supposedly with the least amount of risks). In short,
Capital-appreciation = f(Funding) + q(Fat-tailed / Exponential)
Funding instruments that yield fat-tailed/exponential returns are equities. While passive equity investing serves the core investment objective of Growth, active equity investing is the tool for the satellite investment objective of Capital-appreciation.
Equity provides a spectrum of Fat-tailed to exponential returns starting from Largecap to Venture Capital. As the market cap for companies keeps shrinking, fewer and fewer winners (companies that grow in value over time) emerge, and the need to be more selective arises.
The below relationship always holds true for a successful investment strategy in equity (for any market cap):
(Average Size of Winner) * (Number of Winners) > (Average Size of Loser) * (Number of Losers)
For a fat-tailed distribution, the “Number of Winners” dominates on the LHS. For an exponential distribution, “Average Size of Winner” dominates (by having a few extremely large winners, that skew the average) to make the relationship hold true.
✓ The Desire to Enjoy the Fruits of Past Labor
Human beings know that at some point of time in their lives they may not be able to earn the desired amount of income required to sustain a healthy lifestyle. To counter this they work hard in the present and save some of today’s earnings to convert them into a cash-flow at a later date (as passive income).
Human life is structured for a rise and fall in our incomes. The fall in income can happen in the future (as retirement) or may even happen cyclically in the present (if the cash-flow is intermittent).
The investment objective to create passive income from accumulated capital is Income-creation.
Investing for Income-creation
The desired characteristic of income is that it should be regular. This means it should be periodic (consistent in terms of time) and uniform (consistent in terms of value).
From a fundamental perspective, income is required to be of a financing nature so that the same capital can yield returns over and over again. Quantitatively, the shape of the curve of returns matching this is compounding. In short,
Income-creation = f(Financing) + q(Compounding)
Corporate and government bonds are financing instruments of a compounding nature. While corporate bonds are risker than government bonds they also provide more returns.
Care should be taken while investing in Corporate Bonds. Bonds of smaller companies, poorly rated bonds, or venture debt are not suitable for Income-creation purposes (they behave more like Growth instruments and need continuous portfolio management and diversification to invest).
✓ The Desire to Enjoy Surpluses
Beyond enjoying the fruits of their past labor as income to meet their regular expenses, human beings desire to have surplus money to spend on things/ experiences they wish for. These wishes are of a personal nature (such as luxury, travel, etc.) and are not typically urgent expenses (they can be delayed for some time).
The nature of these wishes is not that of time-bound fulfillment. However, the price of these wishes keeps going up with time. Therefore, financing for these wishes needs to grow faster than the inflation rate. Thus arises the need for Profit-generation from the capital.
The investment objective to generate surpluses from accumulated capital in order to spend on non-essential things/experiences is called Profit-generation.
Investing for Profit-generation
Profit is irregular. This means it is aperiodic (inconsistent in terms of time) and variable (inconsistent in terms of value). This irregularity is a result of profit being linked to randomness. An investor cannot predict how much profit will come when. They can only estimate it on the basis of some models. However, the actual result may vary from very little to very much (depending on the volatility of the strategy).
Investment strategies that are very volatile can generate high profits and also result in high losses. These strategies are uncomfortable to bear for most unseasoned investors. The discomfort is the cost investors pay for high returns (keeping in mind that low-volatility strategies are comfortable but also yield low results).
The tool to tame high volatility strategies is profit booking. When profits are booked from time to time, the net volatility of a strategy decreases and loss of capital can be prevented. Over longer periods of time profit booking changes the shape of the returns curve from fat-tailed / Exponential to Compounding. However, the underlying instrument needs to be of a funding nature (in order to get the volatility in the first place). In short,
Profit-Generation = f(Funding) + q(Compounding)
The combination of funding and compounding makes Profit-generation a unique Investment objective. There are no instruments directly available that do both. Hence, active management strategies on equity are required to meet the investment objective.
Active equity investing/ trading strategies which target short-term movements of stocks or the market are suitable for Profit-Generation. Profits can be booked at the stock level (stock timing) or at the portfolio level (market timing). Such strategies can also be constructed using derivatives taking long-short positions.
The PIC of Investing
Our Approach to the PIC of Investing
At Modulor Capital we build portfolios that provide a specific solution to the desires of individuals and families. This is done by combining different approaches and providing tailor-made solutions as follows:
- Cubit, Palm & Digit portfolios meet the investment objective of Capital-appreciation using Growth, Value, and Sentiment strategies with Diversified-equity Portfolios. The Tornado portfolio uses a Focused-equity strategy to attain the same.
- The strategy uses a Diversified-equity strategy over the sentiment cycle for Profit-Generation while Waves Top250 used a Focused-equity strategy for the same investment objective. The Continental Tax strategy also generates profits along with saving tax under Section 80C using mutual funds.
- Finally, the Continental Income strategy is used for Income-creation using mutual funds portfolios.