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Unleashing Antifragile Powers: Power of Experimentation
Pathway to building Antifragile Portfolio
In my previous posts in the fragility series which can be found here Fragility Series, we explore building an Antifragile Portfolio, focusing on vital aspects of investment fragility. By following these guidelines, investors can safeguard their equity portfolios from negative impacts and maximize gains from positive news. The series covers four key fragility pillars for eliminating fragility and reducing downside risk. The goal is to create a portfolio that not only withstands adverse events but also leverages positive events for unlimited growth. Antifragility involves capitalizing on both negative and positive events, achieved by removing fragility through the discussed pillars. This approach unlocks a few "Antifragile Powers" that when utilized amplify positive impacts on returns.
I discussed two such Antifragile Powers - Power of Population Explosion & Power of Saying No in my previous posts. In this post, we will delve into another such Antifragile power - Power of Experimentation.
One of the ways of achieving upside potential is through “Experimentation”. Experimentation is the act of exploring new ideas, approaches, and methods in order to achieve a desired goal. It involves stepping out of one's comfort zone, taking calculated risks, and venturing into uncharted territory. This approach stands in stark contrast to conventional thinking, which often discourages deviation from tried-and-true methods.
Incorporating experimentation into one's pursuits opens the door to a multitude of possibilities. It encourages individuals and organizations to break free from the constraints of routine and to push boundaries in search of novel solutions.
Experimentation like other Antifragile Powers, unlocks upside potential.
Companies can experiment by way of launching new products, acquisition, capacity expansion, R&D, etc.
An investor can experiment by finding new companies to invest in.
However, experimentation is like the act of launching arrows into the darkness – outcome can be either success or failure. Whether we hit our target (keep aside bullseye) is uncertain.
Risk of Ruin
The maxim "Failure is the stepping stone to success" underscores the necessity of continually releasing arrows into the darkness, hopeful that we will eventually find its mark. Each miss (failure to hit the target) serves as a lesson that the target lies elsewhere.
We can also endup in total failure by exhausting all our arrows in our arsenal and not being able to hit the target. This is called risk of ruin. We should avoid the risk of ruin at all costs.
How can we navigate experimentation without succumbing to risk of ruin? Three core principles can guide us in avoiding the risk of ruin while embracing experimentation.
Maintaining a Sufficient Arsenal of Arrows: Engaging in experimentation necessitates a stockpile of arrows in our arsenal. Fragile companies often grapple with constrained cash flows, rendering experimentation unfeasible – effectively depleting their arsenal of arrows. Notably, such fragile companies can fall even without engaging in experimentation, due to the weight of their mounting debt.
Prudent Allocation of Arrows: Unlike a single massive launch of all arrows at once, which can render even a robust company fragile, it's wiser to release smaller, targeted new bets in proportion to the size of the portfolio and future SIPs. This approach safeguards against the risk of ruin, offering a buffer against substantial losses.
Continual Pursuit of Experimentation: To sidestep stagnation, one must consistently unleash arrows into the dark, symbolizing a commitment to ongoing experimentation. This practice is far more advantageous than hoarding arrows in the arsenal. Exploring uncharted territories and embracing calculated risks fuels growth.
Maintaining a Sufficient Arsenal of Arrows
We can throw arrows into the dark (experiment) only if we have arrows in our arsenal. Fragile companies have limited cash flows to afford Experimentation. In other words they do not have arrows in their arsenal. Further, fragile companies can fail even without experimentation to begin with.
Some of the large Indian fragile companies which failed are:
Bhushan Power and Steel: This was a steel manufacturing company that was one of the 12 large defaulters identified by the Reserve Bank of India in 2017. It had a debt of US$6.9 billion and was admitted to insolvency in July 2017.
Essar Steel: This was another steel manufacturing company that was also among the 12 large defaulters identified by the RBI in 2017. It had a debt of US$6.9 billion and was admitted to insolvency in June 2017.
Lanco Infra: This was an infrastructure development company that had interests in power, roads, railways, and mining. It had a debt of US$6.3 billion and was admitted to insolvency in August 2017.
Bhushan Steel: This was yet another steel manufacturing company that was also among the 12 large defaulters identified by the RBI in 2017. It had a debt of US$6.2 billion and was admitted to insolvency in July 2017.
Reliance Communications: This was a telecommunications company that was part of the Reliance Anil Dhirubhai Ambani Group. It had a debt of US$4.6 billion and was admitted to insolvency in May 2018.
Alok Industries: This was a textile manufacturing company that had a debt of US$4.1 billion and was admitted to insolvency in July 2017.
Jet Airways: This was an airline company that had a debt of US$2 billion and was admitted to insolvency in June 2019.
These companies before getting admitted to insolvency had limited cash flows to experiment. They were fragile and succumbed due to their mounting debt.
For investors, future SIPs act as a tool to keep replenishing arrows in our arsenal. We can experiment with future SIPs i.e. we can always invest in new companies from future SIPs instead of existing companies in our portfolio. Alternatively, we can also replenish arrows in our arsenal whenever there is Population Explosion in our portfolio. We can partially exit stocks which experience Population Explosion and invest such money in new companies.
Prudent Allocation of Arrows
A robust company can become fragile by taking one large leveraged bet (launching all arrows including borrowed arrows at once). This can lead to Risk of Ruin. It should avoid throwing all arrows at once. One such classic example is Tata Steel acquiring Corus which is explained in following articles:
Tata Steel in 2007 acquired Corus which is 4 times its size through debt (it threw all arrows and once, it even borrowed few of the arrows).
Look at its share price after that. It never reached its peak of Rs 88 per share in 2008 up until 2021. It could remain afloat only because of its strong Tata Parentage.
For investors, we should avoid allocating entire money in one single company. We should also avoid taking debt to invest. This should not be confused with Power of Population Explosion. While we should encourage our investments to explode after we invest in them, we at the same time should avoid taking large bets when we invest to begin with.
We should experiment within our means or limits.
Continual Pursuit of Experimentation
Robust companies keep generating surplus cash flows every year from existing businesses. They keep replenishing their arsenal with arrows. They can choose not to experiment by either building cash reserves from these surplus cash flows or sharing these cash flows as dividends or share buyback to investors. Such companies are not utilizing their Antifragile Power i.e. Power of Experimentation. However, these companies can become antifragile by using surplus cash flows to experiment i.e. by way of launching new products, acquisition, capacity expansion, R&D, etc.They need to keep taking multiple small bets instead of one large bet. They also need to avoid taking debt while taking new bets. Who knows, they might end up hitting bullseye like Infoedge’s investment in Zomato which led to windfall gains at the time of Zomato’s IPO or Eicher’s experiment with 2 wheelers which led to its dominance in the premium segment.
As investors too, we need to remain invested in the market through experimentation instead of keeping our savings in the form of Cash and trying to time the market.
In conclusion, the Antifragile Power of Experimentation offers a pathway to unlocking upside potential, reliant on a balance of resources, prudent allocation, and sustained commitment to venturing into the unknown. By wielding this power, we empower ourselves to navigate the realm of uncertainty, bolstering our portfolios against fragility and embracing the promise of unlimited upside potential.
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