Moats Versus Boats - Part 7

Having a lot of capital to deploy is both a blessing and a curse, more so from an institutional perspective. During my time at Morgan Stanley, GIC or Temasek and even today when we deploy capital, it is a reasonably large amount per position. Hence for us, moat investing is not the only way to invest. It is obviously one very successful route but by no means the only one. George Soros and Seth Klarman are not classic moat investors yet have an extremely illustrious track record.

Second, for institutional investors in India, it is really difficult to use only the moat approach. True moats i.e. businesses with real pricing power (which is how I define a moat) are actually very few in India. If you have true pricing power you control profitability as you can price independent of the environment and inflation. I have seen very few companies actually do that. And those are very expensive. Hence it is hard to deploy $500 million or $1 billion if the expected return is unattractive. Also, when you are running institutional money, you can't sit on 50% cash for six months. Capital will simply bolt off.

The fact also remains that, India with its high local investor base, is a fairly efficient market unlike Philippines or Thailand which are foreign investor driven. I would actually argue that the local investor in India is smarter in most cases than foreign investors. So, the probability of figuring out a moat in India of which only you know of is very low. I think that is unlikely to happen in a market with a very long history of investing. There is a pretty high probability that the moat is well recognised and priced as such.

How do you then make money buying the stuff? You will not make a different return unless you have a non-consensus view. Well, what is the chance that your estimate of earnings over the next 15-20 years is dramatically higher than what the market has estimated? It can happen but it is highly unlikely. Sure, you can presume that there might be a rerating. But given that P/E multiples are cyclical, that presumption can’t give you an edge. The reality is that when you bet on a richly valued moat business, you are betting on the longevity of the moat. You are assuming that the competitive advantage will last longer than what the market thinks.

You could be right or wrong about the durability of the moat but the point that I am trying to make is that we find it difficult to make that judgement. It could be 15 or 25 years, we have no idea. Partly, it is because of the company and partly, because of technology. I will give you an example. In the case of FMCG companies, the competitive advantage was a function of the brand and distribution reach. Guess what? Now that moat has reduced dramatically as ecommerce has shrunk the distribution advantage. So, I would argue that to make a long bet, you have to know the moat really well. You have to have a sense of technology and how things are changing. You have to find them at a price where you can justify the valuation and make a decent excessive return.

This is the first of a three-part series. You can read the second part here and the final part here