Now that applies to the world of business, would it apply to investing?

A severe bear market may bring down the value of your portfolio. But if you have cash or if you have the opportunities to sell what is relatively expensive and go into a high quality business that has become ridiculously cheap and you act on it is where the advantage comes from being opportunistic. You're always looking for opportunities which are going to be missed by other people because they are sort of like a deer caught in a headlight, media encourages that by saying “oh, don't do anything” or the commentators and so-called experts say the outlook is not clear, sit on the cash. But that is exactly the wrong advice. You've got to buy things when they're cheap and let go of them when they're not…

But here again, is it a case that Berkshire could do it so efficiently because of the sheer size of the portfolio and the cash that they had, because an ordinary investor would not have access to that kind of capital that gives him comfort of doubling down on a stock by exiting an existing position?

You're right, but partly. I will answer it in two parts. One is the creation of Berkshire Hathaway itself, which is a fountain of cash-generating businesses, which are uncorrelated and regardless of economic environment, some part of the business will keep doing well. Second, they're very opportunistic and it's not just about Buffett and Munger -- it's become the DNA of the place. Berkshire today is probably the most anti fragile business out there, they're the ones who benefit from chaos. Not that they like chaos, but you know, they are the ones who will benefit from any kind of market-wide sort of chaos that happens and are willing to deploy capital when things are cheap. They can see through the noise and look for the signal. Again, this is a personal trait that they have been able to inculcate within Berkshire’s culture. In the absence of both Buffett and Munger, the next generation will, hopefully, follow through the principles that have been laid down. That's very important. So, it's become institutionalised.

To the other part of the question, if you don't have an operating business, which keeps generating money, and you only have a portfolio and dividend income, then how do you incorporate even a little bit of what I just said? I think you can and the way to do that is "don't think sell, think switch." Good businesses don't become cheap unless there is a market-wide macro event. If you have the cash, nothing like it, but you always have the portfolio which you can convert into cash. The moment you start anchoring yourself to cost: “Oh no, I paid Rs 100, now it is Rs 80. If I sell it, I'll make a loss,” you overlook the aspect that other things have become even cheaper, and that they are so much better and have more durability. Therefore, if you sell the existing position today and recognise an accounting loss, you will be economically still better off as you're replacing it with an asset which is superior in terms of quality, cheaper in terms of valuation and will produce more wealth going forward. So, don't think about accounting losses but think about the economic benefit that you will get by making that switch. The moment you frame it as a switch as opposed to selling, you start realising that you have a portfolio that is as good as cash. And if you were to ask yourself very tough questions like “If I had to recreate the portfolio today, if I had the cash equivalent instead, would I have this stock in my portfolio?” At times, the answer is no. Then comes the next more difficult question: “why is it there?” It's like debiasing yourself. The way to debias yourself from commitment bias or endowment effect, is to ask: “If I didn't own it, would I want to own it today?” Maybe there is something else you would want to own, then why are you not doing it? So, there are very important reasons why we don't want to do it, because we'll have a loss, there is inertia and so forth. But there are ways in which you can sort of try to at least get out of that inertia. That's what both Buffett and Munger have taught through their various methods.

Though the duo has often been referred to as value investors, they prefer to call themselves as buyers of business and not stock pickers. Now, can an ordinary investor have that kind of an approach by not getting swayed by the price but focus on the metric of the business?

Absolutely. Pulak Prasad wrote a book recently where he talked about it, and so has his colleague Anand Sridharan who has a marvelous blog, Buggy Human, where he talks about it. Essentially, they are articulating what Ben Graham has taught us. Although Graham’s book was called Security Analysis, what Munger and Buffett have taught us is that don't be a security analyst, become a business analyst. That is very different. When you wear a businessman's hat, you think differently. Even if you're buying 100 shares, you imagine that you bought the whole company. Would you want to own this company – why and why not? Would you want to own it at this valuation? Why and why not? Once you become a part-owner or a partner in a business instead of somebody who has a demat account with shares in a business, which can be flipped in one second at virtually zero transaction costs, it changes perspectives completely. That has been beautifully articulated by both Pulak and Sridharan. So, what we must learn from Munger and Buffett, rather that Munger weaned away Buffett from Graham, but he didn't wean him away by saying, “Look, you should pay up!” You only pay up if it makes sense. Basically, what Munger did was he never sought Buffett to abandon any of the three principles that Graham taught, and those three principles are underneath every stock and bond is a business. If the business prospers, the securities will do well. If the business goes down, it won't do well. So, think like a businessman.

The second lesson is that markets can go crazy. It can be absolutely detached from underlying reality. Valuations could become insanely high or insanely low, and nobody can tell when this party will end or when this mayhem will end. But it happens. It happens recurrently and, therefore, you must be independent minded. Don't let the market dictate what's right or wrong. This is exactly opposite of what we are taught in academia. In academia, we are taught value and price are the same. The market's always right. You know, even accounting bodies would force you to do mark-to-market accounting. So, basically detach yourself from the market.

The third lesson is that there must be a margin of safety. Now, the margin of safety in Graham's approach came from cheap valuation, and diversification. The same principle of margin of safety has been applied very differently by people such as Philip Fisher, Buffett, Munger and so many others, where the primary source of margin of safety came from the quality of the business model, the ability to own high returns on capital, the durability of capital which allows them to continue to earn higher returns on capital and so forth. So, the essential principles are the same, but the way they were applied have changed and that's exactly how Munger effectively weaned Buffett away from the Graham style of investing.

So, can we also attribute Munger's strengths to his multidisciplinary approach and his ability to incorporate elementary world wisdom, which may not be easy?

Munger’s talks on elementary were life changing for me and for at least the thousands who would have read through them and tried to incorporate what was written in those essays by Munger. To your question, how easy is it? Why should it be so easy? It must be difficult because the rewards are so amazing. There must be an effort involved in understanding it. There must be an additional effort involved in incorporating it routinely in your repertoire and that takes a lot of training. You don't become good at any game or any game of skill without a lot of deliberate practice. It’s almost like breathing. To have the ability to synthesise those ideas, whether they are from mathematics or physics or psychology or economics, is not going to be easy. And, of course, as Mr. Munger has pointed out so many times, academia doesn't make it easy for us as well, because they have their own territorial sort of turfs, and they live in silos. Munger believed that one needn’t have very high IQ, but what is needed is a broader mindset, to start thinking across boundaries and become a better thinker. I've seen that happen a lot. I think that itself is a good reason for you to completely accept Buffett's view of being a broad-based thinker and try not to think in terms of silos. So that part has really paid me very well, both intellectually and financially. It has done the same thing for, in my view, to millions of other people out there.

How does one go about it?

It's not going to be easy. The framework is multidisciplinary. Therefore, you need to have the ability to grab some of the best ideas from different disciplines. It could be evolutionary biology, which is a very fascinating discipline. There’re so many parallels between the world of evolutionary biology, the world of business and the world of investing. You can learn a lot by just reading a few books. You don't need a PhD in that subject. Pick up two or three books and grab those ideas. The important part is not in recognising the ideas, but about synthesising those ideas into a different domain that you work in. That's the fun part and that's the learning that comes in. It’s not taught anywhere. It's not taught in textbooks for sure.

How did you synthesise the learnings? Can you share some anecdotes?

It happens all the time. Look what happened during Covid. I've been teaching evolutionary biology for a long time and Pulak wrote this marvellous book and I ended up giving a talk about evolutionary biology to CFA students. But anybody who has picked up even rudimentary evolutionary biology, such as Selfish Gene by Richard Dawkins or The Blind Watchmaker or a few other books out there, you would be able to grasp several similarities. One of them is the idea of mutation -- that things get better -- survival of the fittest. There are mutations which are random, but some turn out to be improvements. And if they are better fit for the environment, that mutated gene will spread to the gene pool. Now that trait will spread and, therefore, to imagine that evolutionary biology can be completely ignored in a world that we live in is wrong because there are so many parallels out there.

For example, during COVID there was this perception that people are going to be so scared of what happened to their loved ones or would ever want to go into a gym. So, the shares of Peloton (which makes exercise bikes started going up), businesses such as Netflix started thriving very well whereas stocks of restaurants, airlines, and hotels were decimated. But anybody who is aware of human nature would have realised that we are basically social beings and like being in the company of each other. There was a perception that who would want to go into an office anymore. You can work from home; the technology exists to work from home. Hence, commercial real estate is going to go down. But all these were perceptions. Anyone who understands basic human nature would have realised that's hardwired in us, the desire to be around other social beings. We go to a restaurant, not just to eat the food. We also go there to mingle with people whom we have never met before. We want to see what they're eating. We want to see what they're gossiping about. We want to see what they're wearing. Who likes to go to a restaurant where there's nobody else out there? That part of human nature has been with us for a very good reason. Evolution gave it to us, right? Even if you had a rudimentary understanding of evolution and how that plays out, you would have said, well, this is not going to last. But we don't know when. But then these businesses were being thrown out for no reason. We've seen, subsequently, what happened -- revenge shopping manifested, people went back to retail stores and bought stuff and now they're going for holidays. Exercise bikes are out, and gymnasiums are in. Basically, the point is that markets tend to overreact to something that seems very monumental, but it was a ripple in a pond. When you throw a rock in a very silent pond, there is a ripple, but if you look at the same pond after five minutes, there is nothing. Covid was a ripple in a pond called the World Economy. If you normalise the data, you will find that you have excess spending right now, and no spending back then. If you look at it over a longer term, it's almost like nothing happened. That perspective comes by looking at so many worlds out there, the idea of mean reversion in statistics, the idea of social proof and us being social beings from evolution. So, there are a whole lot of ways in which you can see that the world is betting on one thing. Directionally they are doing something but they're wrong. Therefore, that gives you insight and conviction that this is not going to last forever. Those insights will come only by having a broad-based understanding of human nature, which comes from studying not just evolutionary biology and other similar subjects, but also history and the world of business -- things that worked, and things that did not. Hence, you learn a lot from human nature and how things work out in the long run.

Coming to durable competitive advantage, how does one assess, for instance, the impact of high interest rates after several decades of zero interest rates? Wouldn’t that distort the advantages that a traditional company would have?

The question on interest rate is something which Buffett and Munger have been asked about a lot, but, honestly, they didn’t care about it. Anybody who understands DCFs will know that higher the interest rate, other things remaining the same, the value of the asset goes up. But other things are never the same because you live in a parimutuel world. You're living in a world where businesses are competing with other businesses. So, if a high interest rate is bad news for you, it may be terrible news for your competitors. So, is that really bad news for you? Hence, if you think about it in second-order effect, you realise that it's not as easy as it sounds. Other things are not the same and they do change. If you're sitting on a lot of cash -- which is what Berkshire has done for the longest time — even Munger did in Daily Journal. If you're sitting on a lot of liquidity, which is not earning much and if rates go up, then that money can be deployed in higher income producing assets immediately and that's a competitive advantage because you had the money and others didn't. The third big advantage is that if you have the money which others don't, and if high rates are going to produce lower asset prices, then the attractive assets could become even more attractive and you have the money to buy them. The big part of the reason why they're becoming very attractive is because people are running out of cash, they're over-levered and interest rates are going up and they don't have the ability to buy things. In fact, they become net sellers. So, you are a buyer in a market of sellers, and we saw that during the Global Financial crisis how opportunistic Berkshire was. They are the last provider of liquidity. But to become the last provider of liquidity on terms which are very remunerative, you must be prepared. That preparation is all that Buffett and Munger have created. To be able to sit on your ass with billions of dollars of cash, which basically earned nothing and to have shareholders who will accept that, and then be very opportunistic and act on them, which is why the option value of cash in those situations is extraordinarily high. Munger and Buffett understood that completely and that gave them a competitive advantage because others are not willing to sacrifice their early numbers and sit on billions of dollars of liquidity with 0.2% rate of interest. When others won't have the money and when you will have it, that itself is a sign of strength. In that sense, interest rates by itself don't really mean anything. Buffett and Munger were able to figure out a way to make money in any kind of interest rate environment.

Is that also the reason that Berkshire consciously avoided leverage because its fortunes would have been very different if they had used leverage. Did the duo envisage today’s scenario [of high interest rates]?

I have a very different take on this. I have done a series of lectures on the concept of float. So, if you study deeply, Berkshire is highly levered. It's just that they don't have the wrong kind of leverage. What is leverage? Leverage means the use of other people's money, right? So, what are the three things that make other people's money onerous? One, you must give it back. Two, you must put a collateral, which can be taken away from you if you're not able to give it back and, three, you must pay interest on that money. But what if all three things could be taken away? What if your insurance float amount keeps rising, which is interest-free money. So, you don't have to return it. If you return it, the others will give you more money. So, the balance of the float account only keeps growing.

What are deferred taxes? They are float. If you look at insurance float, you look at deferred taxes, or look at Blue Chip Stamps, you know, basically Buffett thrived on the creation of float, which is the use of other people's money, on which they don't pay any interest. They don't put up any collateral and don't have to return it. They don't have to pay any interest on it. If you take away all these three onerous conditions about other people's money, then it is the best quality leverage. [Buffett used Blue Chip’s float to buy See’s Candies for $25 million in 1972] If you didn't have that money, and have assets funded with that money and if that funding is taken away, you replace it with other forms of onerous financing – either equity or debt. Replacing float with debt, means a large interest expense will appear on your P&L. Then you put collateral, and you must create a cash flow for returning the money also. But that would bring down the earnings per share because you have a large interest expense. Instead of debt if you issue equity shares, higher outstanding shares will bring down the earnings per share significantly. So, if you take away those three onerous conditions, then you have got the best form of financing -- which is other people's money [that is float].

It's just that it's very hard for people like you and me to create other people's money. But that's what Berkshire has done. They have offered the world an anti-fragile, cash-generating machine, which has got billions of dollars of float sitting on it. The number keeps growing year after year after year. It's like a perpetual zero-coupon bond with no collateral, that's the best form of financing. Buffett and Munger are not anti-leverage, they are just against the idea of onerous leverage, because it takes away freedom. If you are a levered stockholder and you borrow money to buy shares or indulge in derivatives -- again another form of leverage -- and if the markets go against you, then you must put up mark-to-market margin. Where you'll get that from, and you could be right in the long run if the markets are wrong in the short term, but you could end up being sold out. In fact, if you look at another form of leverage it is derivatives, Buffett has written many options on which he collected premiums, but those were not on exchange traded options. There was no collateral or mark-to-market margin. In the order of higher-level thinking, you'll find the leverage is all over Berkshire, but it’s just that it is the right kind of leverage and not the kind that can take you down.

Replace leverage with float, and that completely changes the game…

That is what it is. Look at what Archimedes told us, “Give me a lever long enough and a place to stand and I will move the earth. It is basically a small effort and a big move. Which is what leverage does, right? It is other people's money. So, you must think broadly. We think of leverage as basically financial leverage, but it's not just that. There are many other forms, like operating leverage and float, among others.

At the cost of sounding repetitive, how easy is it to imbibe Munger’s advocacy of mental models, especially inversion?

Once you understand a few things, it's a lot of fun to do. So, I'll give you a few examples about how to apply the “invert, always invert” principle. The idea comes from algebra. If we must solve an equation, at times we take things from the right-hand side of the equation to the left to make it easier, or we use concepts such as proof by contradiction, which is again, an inversion. We assume that a proposition is correct, and we show that if it was correct, it will lead to an absurd outcome and, therefore, it can't be correct. These are taught in school. This is exactly what I think Munger has taught us that worldly wisdom is very academic. These academic ideas are taught to us in school, but we never learnt how to apply them in our daily routine. This is what Munger has done. He basically took up ideas taught to us in school and college that we forgot and applied them routinely. So, I'll give you some illustrations here of inversion. One way to think about inversion is to basically, say, focus on failures and just don't do those things which cause failure. If you really think about it, there are a million ways of making money but only a few ways of going broke. In terms of how to make money, there are all sorts of crazy innovations, which you don't know whether they'll work or not. There's a lot of variability over there. There's a lot of uncertainty over there but in terms of standard causes of dying financially, there are just a few usual suspects -- overoptimism, leverage, overconfidence, and aggression. WeWork is a classic example. There’s a wonderful documentary that came on this company called, “We Crashed”. It tells you what hubris can do. Business that doesn't generate cash was at one point of time valued at more than $50 billion. It's gone to zero. You learn a lot by focusing on what does not work or what is destined to fail; to look for causal factors and avoid those things. Don't chase success. Don't try to be extra smart, just try to not do foolish things as not being foolish is easier than trying to be very smart. And that's a big lesson from Charlie's life. You don't need a high IQ, just don't do stupid things. Munger had a wonderful way of teaching this. He said, “You don't have to pee on an electric fence to learn not to do it. You can just watch other people do it.” Figuratively speaking, we see a lot of people peeing on electric fences; companies have lost reputation by doing something dumb and paid the price for it. Therefore, why do you have to pay the tuition fees for making that mistake? Let other people make those mistakes. Studying failure by itself is such a great way of learning. People end up studying success, but success could be caused by luck. To be sure failures can also be caused by luck but the causal factors for failure are so few as compared to causal factors for success that you can figure out patterns of failure and, thus, avoid those patterns. Whether you are a business analyst or you're an investor, it doesn't matter.

But when you concentrate on what can go wrong, won’t you run the risk of becoming risk-averse?

You must look both at the downside and the upside. You cannot say that if I take care of the downside, the upside will take care of itself. You're looking for asymmetries. You're looking for a situation where the downside risk is low, but the upside could be significant and, in some cases, very significant. So, when we say study failure, you're trying to look at the risk part, the return part comes from the upside. A lot of people focus on the return part but don't look at the risk part. That's the important aspect that comes to mind. There's another sort of application of the idea of inversion, which is one of my favourites: which is basically that the price of a stock is very high. Let's say a stock is selling at 150x PE multiple or some such crazy number. For a moment, imagine that the market is correct. Imagine that this is the correct value of the business. Think like a businessman that you're buying the business. Then you say, well, interest rates are 8%, if I get 12% return per annum, I'm fine. Then, figure out how much the business needs to earn. If you buy the business for example for Rs 1,000 crore, the next year it must make Rs 120 crore. But it's not going to earn that and that is okay. But it must earn more the next year or the year after in terms of compensation for time value of money. Therefore, you can figure out what the business needs to earn 5, 10, 15 years from now to be able to justify the valuation today. Then you can move up the P&L to figure out what kind of business volumes need to be generated. Because if you know the earnings, you can estimate the revenues. If you know the relationship between revenues and profits, you can figure out what the revenues must be. Then you can figure out from revenues, what should be the total volume of business that you need to generate? If you know anything about prices and volumes, you will be able to figure out how to justify this valuation -- 10 years from now – the business should sell so many tonnes of whatever it makes. Then you realize that there isn't going to be enough demand to be able to do that. Therefore, you have been able to use the basic idea taught to us in school -- by contradiction assume a proposition to be true and then show that if it was true, it would lead to some absurd outcome. That's a very important part of what Charlie taught us -- inversion combined with reductionism, reducing a problem to a more fundamental discipline. Because if you reduce it to a discipline such as physics or mathematics, then you know that there's something wrong and, hence, this can't last. They [Munger and Buffett] just know that this can't last forever and will not end well. Munger never said Valeant Pharmaceuticals will go down in the next 12, 14 or 15 months.

They just knew something was not right…

It’s not something. There are a lot of things which are combining to say that this is not going to end well. But Munger never said it's going to go down tomorrow. They were never short stocks and so on. But it's important to have that mindset to be able to use these tricks taught to us. Therefore, studying Munger is so important because it reminds us of things that we learnt in high school and to start applying them in important decisions that we make in the world of business or investing and, of course, in life as well.

Munger’s body of work is humungous, but if you synthesise and crystallise some very key aspects of Munger’s learnings, which are close to you, what would they be?

Some of the personal favourites that I've learnt from Munger are: first, be extremely discriminating between choosing what you should do and what you shouldn't. Be very careful and focus a lot on quality. Quality is much more important than quantity. So, whatever filters you use, they should be a very important filtering process that will lead you to what you think is high quality. Have that ability to be extremely discriminating. It's a skill. It's not easy to do, but it's a habit worth imbibing.

Second, be extremely independent. The whole world can be wrong, and you could be right. So, have the courage to know that the world is wrong for various important reasons, which are backed with evidence. Going back hundreds of years in history, people can go wrong, markets can go wrong or there's a confluence of events and circumstances that tell you that this will not end well. But now, everybody thinks this is going to be the best thing that is going around in the world. That happens repeatedly. Have that extreme independence.

Third, be extremely opportunistic. Once you know that you are right and others are wrong, that's not good enough. You need to have the courage and conviction to act on that. You must be prepared that I'm going to do something which is totally out of sync with what other people think is the right thing to do. Being able to think, as Jeff Bezos says, being willing to be misunderstood for a long period of time. That requires a lot of mental courage. Try to be extremely opportunistic and be decisive and be able to act on your conviction.

Fourth, be humbler. Learn from mistakes -- your own mistakes and, hopefully, from the mistakes of others. Recognise that you're not perfect and there is no such thing as perfection. You're just trying to be a little better every year. Don't try to compare yourself with others. Try to compare yourself with an earlier version of you. That takes out the envy completely. That makes you more focused. Look inwards and try to become better at your own game. That's exactly what we should all be doing.

Will Munger’s absence create a void? Even the AGMs of Berkshire may no longer be the same. So, is this the end of a Golden Era in investing?

No, not at all. We will all miss Mr. Munger and there’s no question about it. But he left us with a legacy of knowledge and wisdom out there, which can last more than a few lifetimes. He has been instrumental in shaping an organisation that has become a vast learning machine, led by a younger generation deeply influenced and mentored by these two great teachers. Conscious of their own mortality, they aimed to build an enduring organisation destined to last for many years to come. If you were to think about businesses that will be here 50 years from now, it won't be a long list. But what you could say with conviction is that Berkshire will surely figure on that list.

Prof. Sanjay Bakshi

Munger taught us how to think: Prof. Bakshi