Why Samir Arora’s Helios Capital follows an EI, not AI approach to investing

When it comes to investing, what to do comes only after knowing what not to do. That forms the foundation of the investment approach at Helios Capital, founded by Samir Arora. The firm, which is all set to launch the country’s first equity mutual fund on October 23 unveiled its investor guide articulating its philosophy and the firm’s guiding principles earlier this week.

Also read: India’s weightage in MSCI Index based on free-float factor is flawed: Helios Capital

Called Elimination Investing, Helios’ unique EI framework involves weeding out the bad as the first step. “It is easier to know what is bad than what is good. Rejecting bad companies increases the chances of arriving at the good companies, reduces errors and reduces the cost of errors,” the guide says.

It suggests that it is better to “look at stocks with a 1-3 year rolling view” as over one to three years, the probability of getting stocks on the outperforming side is much higher and an investor can also use this period to assess various metrics of the company. The guide adds, “Not only are the long-term outperformers very few but it is also difficult to assess long-term potential of companies and managements as No one knows everything, and it is impossible to know anything for certain beyond a point.”

Key highlights of the process

Over a one- to three-year period, the guide explains that approximately 40-odd percent of the stocks in the index do better than the index and even compared to the market, approximately one-third of the stocks do really well and another third do not. What this means is that in most cases, even owning the last stock from the top third list would add to an investor’s returns.

Also read: Why Samir Arora went against his investment philosophy for this company

The first important but difficult step/goal, the guide says, is to have as much of the portfolio in the outperforming part of the market over a one- to three-year time horizon. And since one-third of the stocks do badly, the easiest first step is to try and cut the number of such stocks in the portfolio.

But this can be challenging as it requires a proven process, considerable market experience and deep fundamental work. Additionally, it is easier to know what is bad than to know what is good as a single factor could make a stock “bad” on the one hand but on the other, a host of positive factors may not be enough to declare a stock “good”.

Understanding this challenge, the guide lists eight factors most likely to lead to the underperformance of any stock over the next one to three years. While this does not necessarily mean that the stock will always perform badly, the Helios analysts also believe that it pays to “avoid such companies”. The factors are further divided into permanent rejection and temporary rejection factors. Permanent factors include ‘Limited Size of Opportunity’, ‘Unfavourable Industry Dynamics’, ‘Potential for Disruption’, ‘Low Quality of Accounting’, ‘Weakness in Management/Background/Strategy’, ‘Poor Corporate Governance’ and ‘Low Quality Governance’. Temporary factors include ‘Negative Medium-term Triggers’ and ‘Unreasonably High Valuations’. The team further classifies a company as good and bad on each of these factors.

This process, Helios Capital says, gives them a template to eliminate weaker stocks. “Knowing that a large number of stocks do better than the market, we can be liberal in eliminating stocks. For example, if a company is good but expensive, we will eliminate it for being expensive, and if it has poor management but cheap valuation we will eliminate it for its management quality,” the guide says. It adds that they do not believe in trade-offs between factors, hence even a single bad factor is enough to veto the stock.

While starting the investment process by eliminating stocks makes the final investment pool good to start with, the guide says that the market does not always offer black-and-white choices and, therefore, decision-making is also backed by the “collective experience of their team”.

Lastly, the guide says that they believe there is a lot of value in differentiating between good and bad stocks but not so much value in differentiating between two good stocks, “particularly if they are in different sectors and therefore are driven by different dynamics and cannot be compared directly”.

The endeavour, the guide explains, is to at the end of the day have a portfolio in which the number of stocks that do well can be increased and the number of stocks that do badly can be reduced. “If we can end up with a portfolio which has more ‘good’ stocks or at the very minimum fewer ‘bad’ stocks than the market, a large part of our job (of trying to outperform the market) is done,” they say.

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