I came across a very interesting take on risk in The Mint from a piece written by Naseem Taleb, bestselling author of The Black Swan. Taleb cites a fire-fighter who apparently wrote an email to him asking, when as fire-fighter he could easily understand Taleb’s ideas on risk properly, why can’t risk gurus, academics, and financial modellers? The answer as Taleb points out - is simple skin in the game.
My first experience of the concept of ‘skin in the game’ came very early in life, when I was a novice investor in the Harshad Mehta boom time. Anybody and everybody started punting in the stock market. Like most of them, being in Mumbai and working in financial services, I also thought it was my birthright to make money in the stock market. It took me a long time to realise that, making money is very difficult and to successfully make money in the market you should understand the concept of risk; especially Value at Risk. Because when the market moves against you, the difference in the net worth and not worth is just a simple letter ‘e.’
Those days – tips was lingua franca in stock market community, unlike now where word tips is domain of hotels and other such service providers. In my early days, like all the other novice and young first time investors I used to hunt around for tips.
Thanks to financial literacy and regulatory zeal, people have, to some extent, stopped asking each other for tips. Most people would exchange tips and in every organization used to have people who would be looked upon as the ‘masters of the stock market.’ Their stock market successes were topic of canteen and smoking session discussions. They had steady followers and people would besiege them for this. Needless to say, they were very popular and their land lines were always busy. Those days cell phones and emails were not really heard of.
Slowly and steadily, with the passage of time and reduction of hair line, I understood that relying on tips was the easiest way to lose money. The only way to make money in the market was by discipline of long term investing.
I also had the privilege of working with one of the ‘masters of the market’ who taught me how to invest and how not to confuse luck for skill. Instead of asking for tips, he used to ask the correct question, “What stocks have you bought recently”? It was his way of measuring how much ‘skin in the game’. Ideas anybody can give, but to back the idea by writing a cheque is a reflection of your conviction.
Over the last decade, I have met so many people including rated and great analysts who have pontificated and written tons of pages on stocks. But when you ask them “have you bought the stock” they will give a polite smile and say “No” and blame compliance department. You may be surprised to know that there are many equity analysts who do not put money in the stock market. Instead they park their money in fixed deposits, FMP and debt. No wonder debt schemes have seen a significant increase in AUM. Very few fund managers, without taking names, put money in their own schemes. A certain gentlemen, who runs one of the largest equity funds, is one of the very few people I know who has put a significant amount of his own money in the fund he manages. This shows how much ‘skin in the game’ he has and why his funds continue to do very well.