Irrational exuberance and then risk aversion in 2003

by Ashik Shah on 7 February 2003

Kurm has now finished its first five years of business. The company has focused on Value investing, and remained in this area all the while. Since the company commenced in business, the investment business and world financial markets have witnessed a great deal.

When Kurm began investing in the US Markets, many already believed that they were overvalued.  However, over the following two to three years, the markets rose at an unprecedented rate. This was really driven by the “Tech” boom, which turned out to be a bubble, which went bust. There was the rise of “irrational exuberance” and a belief that companies dealing in everyday products making ordinary profits were not worth much, while companies with little business, no profit, indeed negative profit, and some revenue, were given astronomical values. Some kind of rationality has now returned to the markets. Many of the public, and – worse! – professional investors, were caught up in this mania, and most are nursing their wounds.

In the meantime, in India, there was another scandal in stock manipulation or “ramping” where thousands of small savers and investors lost out. In Kenya, there was a crisis amongst the small banks, often known as Duka banks, where, lured by the prospect of high yields on their deposits, many invested, without wondering where a bank borrowing at rates above 20% would safely lend money to turn a profit. The result was bankruptcy, some fraud, and much pain for many innocent depositors.

As stock prices began to falter and business growth in the New Economy failed to appear, many managements turned to cooking the books. There have been several corporate scandals, based on fraud, misleading financial statements, which have resulted in the collapse of once great enterprises such as Enron, WorldCom, and even Arthur Andersen. Even the Investment Banks have been caught out and many forced to pay huge fines for the unethical guidance from their analysts.

As if this was not enough, on September 11th, 2001, we had the World Trade Centre events. This shocked the world, disturbed stock markets, and ruined the balance sheets of many an insurance company. Indeed many general and life insurance companies are also suffering because of their major exposure to equities. Again, many thousands of small investors, in the UK for example, have lost out as their bonuses have been cancelled, their insurance bonds have fallen in value, and what they thought of as “guarantees” have melted away with “market value” adjustments, especially if gearing was involved.

In all of this, we cannot say that everyone has lost, nor can we say that everyone was cheated. Many investments were conservatively and carefully made, and many were exited luckily. For example, someone who managed to exit from technology investments at the “top” of the market would have done very well, but very few ever did. However, when investment decisions are driven by fear and greed, much rationality is ignored. Investors fear that they will “miss out” or they become greedy of the returns that they hear others are making. Of course, very few investors ever speak of their losses, while they often speak of their successes.

Indeed, in the last few years, those investors who stayed focused and kept their approach very simple have done better than most. In fact, many with bonds and cash have done very well indeed, as have those with certain types of property. Of course, even in property, there has been a bubble with the buy-to-let phenomenon in the United Kingdom now beginning to cause pain where it once brought profits.

Kurm Investments has cautiously invested the capital of its shareholders using a conservative approach, based on buying at a discount to intrinsic business values. There has been success in preserving capital, while the returns have been modest. However, Kurm has managed to avoid the major mistakes of the last few years, and also managed to avoid suffering from a great deal of volatility.

The investments have been focused in the areas of investment and financial services. There is some exposure to other simple businesses, but insurance and consumer finance are the most important sectors. However, each of the businesses is conservatively managed, with a strong balance sheet.

This has meant that the companies in which we have invested have not suffered so much from the volatility in the stock markets, or from the downturn in the economy, as much as their competitors have.

Indeed, as many others suffer, the capital strength of our investee companies has meant that they have been able to take advantage of the weakness of others. For example, we have recently taken an indirect exposure to the Telecom Sector, resulting from an opportunity to buy cheaply arising from the bankruptcy of a large Telecom Company, and this was only possible because our investee had the financial ability and reputation to make the purchase.

Most business people are acutely aware of the tremendous rise in the cost of insurance. This is a direct result of the loss of capacity in insurance and re-insurance after September 11th. As world equity markets have fallen, insurance companies struggle to meet solvency or regulatory capital requirements. This means that many have struggled to write new business and so missed out on the profitable and less-risky-because-better-priced business out there, our investees, on the other hand have benefited enormously from this.

Apart from investing in conservatively managed companies, Kurm has always looked at companies with a sustainable competitive advantage and high returns on capital. More importantly, it is important to be with an honest management, which thinks like owners, and has the majority of its own wealth in the shares of the company, so that they benefit as we benefit, and lose as we lose. Also, investing with price discipline, with a “margin of safety,” helps with the goal of capital preservation, and to avoid speculation.

While the world is braced for war, it is a terrible time for those who love peace. At the same time, peace is required for capitalism to function properly. A short war is not expected to damage the US economy much, unless terrorists target more assets. However, a prolonged war will have a severe impact. More importantly many lives will suffer. In investment terms, conservatively financed, conservatively run, simple businesses with strong competitive advantages will survive the uncertain times ahead and then thrive.

Kurm is continuing its existence, but in a different form going forward, about which you will hear more shortly. In the meantime, we would like to thank you for your support and interest over the last five years.

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The views expressed and comments made on this website are not personal advice based on your circumstances. The purpose of this website is to provide information and analysis to help you make your own informed investment decisions. If you are not confident making your own investment decisions you should contact a firm which is authorised and regulated by the Financial Conduct Authority (such as Ashik Shah & Co. Ltd.) so that a qualified financial adviser, after considering your personal circumstances and investment objectives, can make personal recommendations of investments which are suitable for you. Whether you make your own investment decisions or prefer to follow the recommendations of a financial adviser you should always remember that your capital will be at risk and that investments can go down in value as well as up.

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