Embracing uncertainty

I recently read that if we could embrace uncertainty in all aspects of our lives, we'd also be a different species. We humans are programmed to try to dispel doubt and uncertainty, to seek the comforting bedrock of certitude.

But it is impossible to banish uncertainty; life is about finding a different and healthier relationship with uncertainty.

In the investing world also, one sees investors flipping one YouTube or TV channel to another, listening to one expert after another, identifying the best product and yet another that will better the best, all in the quest for right answers and to find the right prediction, the right forecast and ultimately, aiming to attain certainty of outcomes. Certainty is elusive - there is only one certainty - that we will have uncertainty.

So the investing equivalent of finding a 'different and healthier relationship with uncertainty' is to stick to investing with funds that do a relative assessment of asset class attractiveness (for hybrid or asset allocation funds) or sectors' and stocks' attractiveness (for equity funds) and then rebalance allocations to those asset classes or sectors and stocks in a largely unfettered but not totally unbounded range; thereby ensuring as narrow a range of returns outcomes for a given level of risk tolerance.

But if it is so, why do we fail? Why can't we practice asset allocation across asset classes and diversification within our equity portfolios? Why do 40 per cent of net new inflows go into sectoral and thematic funds, or 60-70 per cent go into sectoral and thematic funds plus small-cap and mid-cap funds? All of this, despite the largest part of the market being large cap, despite our market construct itself being flexi cap (if you take our total market capitalisation, it is more representative of a flexi-cap fund kind of construct i.e. about 60-70 per cent large, 15-20 per cent mid cap and 10-20 per cent small cap). And yet, the largest single category of actively managed equity mutual fund schemes - bigger than large-cap or flexi-cap or anything else is 'sectoral and thematic funds'. The next few top categories are not large caps or such; they are all small, mid or mixed market caps, leaning materially on small and mid caps.

Why is allocation to fixed income instruments and bank deposits on the decline and why is gold remembered only after it goes up 40 per cent?

If for a large section of investor population, the allocations are skewed towards sectoral/thematic/small-cap and mid-cap funds even as 60-70 per cent of our market construct is largecap; if the most allocated themes are narrow ones like defence, energy, transportation and logistics, conglomerates, PSU, auto etc., instead of large ones like banking and financial services, consumer, information technology and healthcare; it only goes to show that we are trying to maximise outcomes, rooting for the underdog to win making us rich, fast! Instead of consuming rice like it is rice, we are consuming rice like it is pickle and consuming pickle like it is rice. We are eating for taste and not for nutrition.

This is because investors have been trying to overcome uncertainty for far too long instead of embracing it, accepting it and working with it. Which asset class will outperform others next year? Which is the hottest sector within equity that will grow my money the fastest? Why should we buy gold if it doesn't produce any cash flows and the price hasn't moved in the last three years was the thinking till a year back. But now that gold has gone up 40 per cent in one year, it's obvious that the world is in a mess, gold will go up further!

Why are we so often seduced by fast, easy, deterministic 'answers' to the most significant investing questions? Why do we seek complete clarity and sure-shot answers when we know none exist? Why are we making deterministic bets chasing definite outcomes in an ever-changing landscape where a myriad set of developments cause shifting sands? Psychologists have named our tendency to want to resolve uncertainty instead of accepting it 'the need for closure'. Our instincts to reduce uncertainty don't always serve us well. Instead, the obsession with betting on what's purportedly ostensibly 'known' can make us vulnerable to easy answers with undesirable results. We are investing to maximise, not to optimise.

Accepting uncertainty and working with it instead of around it requires patience and openness to possibilities, the experience of continuous adaptation of investment stance to optimise outcomes given the circumstances, rather than a fixed, deterministic or premeditated stance chasing a preconceived outcome.

The best soccer teams have a goalkeeper, defenders, midfielders and strikers. The proportions may change depending on circumstances, but you will not see any elements being knocked off. The formation is devised to win amidst uncertainty and unknown strategies and forms of the opponent. In a typical soccer match, for 70-80 minutes of the 90-minute duration, the ball is passed around midfield and possession is fought for. Good soccer matches are never played 75-80 minutes in penalty areas with all players of a side breaking formation and rampaging for a goal. If you persistently attack the opponent's penalty area, the moment you lose ball possession, they will turn around and score a goal against you.

A typical T20 team will have six batters, 2-3 all-rounders and at least 3-4 specialist bowlers. The wicket-keeper must be a good batter. The proportions may change, but you will never see nine batters and two bowlers in anticipation of winning the toss on a Wankhede-esque pitch and score 500 runs batting first. Good teams are structured to negotiate all possibilities and win under myriad set of circumstances - toss can be won or lost, they may need to bat or field first, Mohali may behave like Eden Gardens, there may be dew under the lights, opening batters may fail, catches may be dropped or some magical ones caught. Bowlers may have a good or a bad day.

Your favourite soccer team plays a 4-4-2 formation; your favourite T20 team is never made only with batters; then how is it that you land up on the investment field with only equity funds and no asset allocation? And within equity also, why chiefly only sectoral, thematic, small-cap or mid-cap funds?

Where is the balance to negotiate uncertainty? Or are you certain that uncertainty won't play truant with your plans, that you will win the toss and bat your way to glory to win the investment game?

Aashish P Somaiyaa spearheads WhiteOak Capital Asset Management Limited as their CEO.