Returns Per Unit of Stress

Investment returns are typically measured in the form of returns per unit of risk.

“Risk” however does not mean the same thing to different people.

To most financial academics, risk is a measure of volatility, a proxy of which is the famous beta. At the other extreme is Warren Buffett who thinks of risk as “probability of permanent loss of capital” and who claims that beta has nothing to do with risk.

While the debate on the meaning of risk between academics/finance practitioners who follow CAPM (a model that equates beta with risk) and value investors who follow Buffett is not going to end anytime soon, I propose that one should also think about measurement of investment returns based on “return per unit of stress.”

For proprietary investors (and maybe for all investors), stress should figure in one’s investment strategy, much more than it does, perhaps, even more than financial risk, because stress is a killer and high stress situations – whether they carry high or low investment risk – will always carry a high risk to one’s health. In fact, one can now measure how many years of one’s life is cut short by being exposed to a high stress life.

In my view, its no co-incidence, that day traders (who have very stressful lives) and who look like this…

… will possibly not live very long, while spiritual, long term investors like John Templeton (who lived till he was 95) have calm and serene faces and look like this:

If one was to think about stressful way of investing vs. a relatively stress-free way of investing, what would the differences look like? The following table offers some suggestions.

High Stress

Low or No Stress

Investing in Highly Leveraged Companies Investing in Zero or Low Debt Companies
Borrowing to buy stocks Never borrowing for buying straight equities
High Frequency Trading & Day Trading Long Term Investing
Shorting Long Only Investing
Cigar Butts Moats
Business exposed to Negative Black Swans e.g. Banking and Commodity Trading Businesses not exposed to black swans
Corporate Governance Issues No Corporate Governance Issues
High P/E for Growth Stocks Low P/E for Growth Stocks
Cyclicals Stable businesses
Hostile Takeovers Passive Investing
Dealing in F&O Staying Away from F&O
Trading on Inside Information Avoiding inside information
Event Driven Investing Moats Driven Investing

Once you start incorporating return per unit of stress in your investment thinking, the trade-offs become obvious. You would start settling for investment situations which offer a satisfactory return per unit of risk and stress over those which offer high returns per unit of financial risk but low returns per unit of stress. You will slow down and start appreciating the slow process of long-term, stress-free compounding as opposed to nerve-wracking, adrenalin laden high frequency operations in the stock market.

My advice to those who ignore the stress part of the equation but focus only on returns per unit of risk: You cannot take it away with you, so what’s the point of all that stress, just for the money?

37 thoughts on “Returns Per Unit of Stress”

    1. Yes but only if you do care a lot about stress. If you ignore that, then investing in highly leveraged financial institutions, backing up the truck on them, and moreover buying them in the first place with borrowed money, if done at the right time, can make you a lot of money. it’s just that the money you make in that process will have a cost in the form of reduced number of years to spend with your family and friends. Will it be worth it? To some maybe. To others, maybe not.

      1. Would the same thing apply if one removes backing up the truck and buying with borrowed money out of the equation?

        If one invests in a bank as a diversified bet (say 3-4% of assets), after careful evaluation of gain/loss probabilities and expected payoffs in each case indicating substantial expected positive returns, would one still have reasons to be stressed out about an investment into a bank?

        I think that the twin weapons of a substantial margin of safety along with adequate diversification are potent enough to dispel away any stress. The individual investment can lead to a negative outcome (say the negative black swan hits) and one will still be OK on the group as a whole. Unless I’m missing something..

        1. You aren’t missing anything Taha. Banks are a type of business which one fine morning cease to exist because some proprietary trader blew away the equity in a gamble he had been hiding for months as happened in the case of Barings Bank. That is, banking is exposed to negative black swans. And yet, within the banking industry there are players who are extremely cautious in the way they approach risk in banking. They are the ones who have stressful lives fretting over recoverability of loans, exposures to sectors, geographies, business groups, interest rate risks, exchange rate risks, asset-liability mismatch risks, regulatory risk and a whole lot of other risks in banking. If you find such bankers and become partners of favorable terms, then you should be fine. But other things remaining the same, owning a bank is more stressful than owning a company which sells shaving cream.

  1. Great article professor

    I totally agree with you on this. But I think, if one make investment with extra care cigar butts and cyclicals need not be reason of stress but may result in substantial returns with minimum risk. For eg. currently majority of the brokers are trading around their book value and some like JRG Securities and Emkay Global are trading below their net working capital (net of debt). If one invest in such cyclicals at these level, the risk of permanent loss of capital will be much less.

    Thanks for all your articles and am quite happy that you have again started posting actively on your blog.

  2. Your post reminded me of when Buffett for the first time starts toying with the idea that in light of the drastic change in the levels of his personal wealth, he could afford to start categorizing ‘lines within the investment field’ other than purely in terms of the ones which ‘promise the greatest economic reward’. The ‘buy and hold forever’ mold that he has followed for the later part of his career is also nothing but a representation of the fact he was willing to sacrifice getting the highest possible investment returns for satisfying other personal preferences that he had begun to develop.

    The fact that you have chosen to leave out things like cigar butts, cyclicals, hostile takeovers and event driven investing is what leads to my inference about there being parallels in both cases.

    Here’s an excerpt from his 1967 partnership letter –

    “All-out effort makes progressively less sense. I would like to have an economic goal which allows for considerable non-economic activity. This may mean activity outside the field of investments or it simply may mean pursuing lines within the investment field that do not promise the greatest economic reward. An example of the latter might be the continued investment in a satisfactory (but far from spectacular) controlled business where I liked the people and the nature of the business even though alternative investments offered an expectable higher rate of return. More money would be made buying businesses at attractive prices, then reselling them. However, it may be more enjoyable (particularly when the personal value of incremental capital is less) to continue to own them…

    Thus, I am likely to limit myself to things which are reasonably easy, safe, profitable and pleasant.”

    1. I haven’t completely withdrawn from cigar butts, or cyclicals or event driven investing Taha. Its just that I have started focusing a bit more on being able to sleep a bit better than before (moving out of F&O and shorting was very useful there), not bite nails too much (reducing exposure of delistings where one doesn’t know if the book is built or not even until the last moment). I have also reduced activity greatly (my broker friends don’t like this which is understandable). I guess as one grows older, things like stress reduction come automatically…

  3. Dear Sanjay,

    I am newbee to structured investment.

    Question regarding investment in the banking stocks. I invest in the PSU Bank index when the P/BV is less than or equal to 1. I started recently when it hit the 2008 lows in Oct’2011. This index gave better return compared to Nifty Index or Nifty Junior index (the only other index funds available in India)

    As an individual investor i prefer index investing based on Price earnings, Price to book at the broad index levels as i dont need to spend lot of time analyzing the individual companies…

    Would you consider this as high stress because it involves Banking and financial services or the PSU Banks reduces exposure to Black swans ?

    Thanks in advance for your thoughts on this.


    1. Moving away from individual stocks and towards indices will obviously increase diversification, and reduce volatility. It may also reduce risk as defined by Mr. Buffett but not always e.g. a diversified portfolio of dot com shares at the peak of the dot com bubble wouldn’t have prevented the investor from permanent capital loss. In fact, that would be a good example of a lower volatility – high risk combination…

      Using aggregate P/E or P/B etc on indices is a good idea but you must be careful about P/B in banks because “B” is often fudged and what looks cheap when measured against reported P/B may not be so cheap when measured against Price/adjusted book where book value is adjusted for probable losses due to credit impairments. Of course if the degree of fudging in the “B” in reported “P/B” is unchanged, then it wouldn’t matter but that may not be the case now in banks. Just take a look at Bank exposure to infrastructure, power, and real estate sectors and their reluctance to properly account for NPAs. For some Indian banks, power sector exposure exceeds 90% of book value. With the power sector in disarray, I find the idea of being invested in “cheap banks” based on low reported P/B ratios, stressful.

      One more point. You are comparing returns on banks (which are highly leveraged institutions) with those of Nifty, where leverage is much lower. When this comparison is made from troughs to peaks in markets, leverage will work in your favor. See when happens to returns when you measure them from peaks to troughs in past market cycles. You will find that banks perform relatively well during bull runs because of leverage and perform relatively poorly during bear markets. Leverage is a double edged sword – both at the corporate level and at the investor level…

  4. Dear Sanjay Sir,
    You have mentioned about Wokhardt turnaround in your presentation. You have also mentioned about Kingfisher as scrap business(scarp industry).
    There is one more high debt leader in cyclic sector i.e. Shree Renuka Sugars. Positive point about this cos is they have valuable noncore assets which they can sell to reduce debt substantially. And, relatively there is less impact of Indian Goverment policies on this cos as it derives substabtial revenue outside India.Are u tracking this cos.
    Another one being Suzlon but again historically not good business.

    1. Sameer, I like highly leveraged situations after the borrowers have entered into a formal debt-restructurng process. There are many companies which are distressed but have yet to get to that stage. Its just matter of time. So, yes, this space will get quite interesting over the next few years. I won’t want to comment on specific companies here. Thanks.

  5. BIll Ackman once gave a talk along the similar lines and coined a term too ROIBD(return on invested brain damage )…
    I think the lesson for younger investors out there is to cultivate the right philosophy from the beginning.

  6. Prof. Bakshi,

    Could you elaborate on the “Businesses not exposed to black swans” under the “Low or no stress” category for a retail investor? To my mind, there is no business that is not exposed to catastrophic risk. The question is timing and probability. Even a regulated utility company like Enron posed a huge portfolio risk because some joker in the CEO’s office was cooking the books!

    1. Abhishek, some businesses are what I call “accidents waiting to happen.” Others can get killed by accidents but by design they are not fragile. My thoughts here are similar to the ones described by Nassim Taleb as fragile vs. anti fragile (check out his new book due soon – he has been posting chapters on his FB page).

    1. Good point Vishnu. The table was illustrative and will probably expand over time. Clearly position sizing has a lot to do with stress. The hypocrisy of an investor comes from the asymmetry of two responses when the stock he bought goes up a lot or crashes. When it soars, he regrets not having bought more. When it crashes, he regrets having bought too much 😃

      I think there is wisdom in the advice given to a fellow who is worried about the size of a position he has in his portfolio and is therefore unable to sleep. The advice is “sell it down to the sleeping point.”

  7. I’ve been coming to the site quite often to see if there are new posts and I was quite excited to see new and more frequent posts. Thanks a lot and please do continue the posts…

    The basic idea is quite intuitive once told and well put. But I think though not sure that Templeton may not be a good example.

    I was not able to find much on Templeton but an economist link says, “…In September 1939, when the war-spooked world was selling, he borrowed $10,000 to buy 100 shares in everything that was trading for less than a dollar a share on the New York Stock Exchange…”. It should be like borrowing more than $150000 today. After 50 or so, he changed his citizenship which avoided him a lot of money in taxes. In an interview when he was 90 or so he said, “…But all during that time, over 50 years, I felt that my benefit to people was not as great as if I were trying to help them get spiritual wealth….”. One can speculate that if a person changes his place in an age where people go back to their homes, he might feel lost, which would be stressful of a different magnitude altogether, and find sanctuary in spirituality. He also answered for something else like, “And just within the last week, I made what is called a “straddle” – I sold short $25 million worth of Japanese money and bought long $25 million worth of South Korean money….” It looks like he’s been living in high stress all the while. Wouldn’t going global those days have been high stress? And Mobius is compounding that by going global and investing in emerging markets! Even if we do speculate on why Templeton went to the Bahamas am not sure why Mobius had to do the same. Either there’s a reason or Templeton’s charisma’s making him follow suit.

    May be I’m missing a source which tells about just his investments per se without the spirituality coming in. If anyone knows such a source, please do give a link.

    I have a doubt if Templeton didn’t stop to ask the question you ask at the end of your post…

    1. That’s the only time Templeton borrowed, that too when he was very young. His philosophy on debt changed in his later years. You can learn more about what exactly happened in those trades, and also about Templeton’s philosophy on debt and luck from:


  8. Respected Proff.

    On the subject of moats, I have a question. I attended your SABV lectures, one of them was on Moats where you exemplified how IGL has a moat on the advance cash deposits, the hassle of switching back to cylinder and the use of gas as a low cost fuel option. But I am hearing that the recent regulatory order to refund the money earned on the account of high IGL network rates and compression rates will wipe out all their gains. What are the implications of such external forces on Moat ? Does the Moat still exist ? Is it not wiped off by the refund they have to pay (subject to court hearing ) ? Will they continue to make profits in future on account of low network and compression rates ? Would love to hear your thoughts on this subject.

    warm regards

    1. By the time I got around to replying to your comment, the PNGRB order has been set aside by Delhi High Court, as you probably know. So the moat exists, but it’s still under attack. The case will probably end up in the Supreme Court and even if Supreme Court refuses to intervene, PNGRB can request the government to approach the Parliament to “repair” the Act. So it’s going to be a long-drawn process I think. In the meantime, there are other fundamental developments. Petrol prices have gone up, and diesel prices might also go up, making CNG attractive again for voluntary customers. Also, US natural gas prices have crashed and as the fracking technology spreads, this should also result in a pressure on Asian natural gas prices. If that happens, it would be good news for pipeline owners and city gas distribution companies. Lastly, the low administered price enjoyed by IGL may be revised upwards. So, as you can see, there are many moving parts here and you have to analyze them to evaluate the investment potential of this stock at its current price.


  9. nice article… and the way you pointed out the difference between ‘high stress’ and ‘low stress’ investing was very good…

    the problem with most high stress investors is probably that they set their targets to the likes of Warren Buffets… thus, for most investors, probably, the distance to cover is too much and the speed from low stress investments is too slow… most loose patience…
    thus, probably, while making investment decisions, they become biased towards high rewards and hence, underestimate the associated risks…

    and most importantly, the loss due to stress is not directly observable… it cant be measured like many others subjective factors which are important but ignored…

  10. Dear Sir,

    I’m a great admirer of you and your article on Piramal made me to start researching and buy Piramal Healthcare.

    What you say is more applicable for overseas banks. In India, trading with capital is not possible and of course there are NPAs due to lack of prudence or malefic intent.

    There are good banks as well. Have you looked in to City Union Bank or Karur Vysya Bank?

    Disclosure: I’m a share holder of CUB.


  11. Is FMCG companies low in stress while UU investing high stress?
    Does UU investing compensate for per unit of stress?


  12. Dear Sanjay,

    I am a regular reader of your blog. Seems like it has not been updated in the last 2-3 months. Look forward to reading a new post soon. 🙂


  13. Dear Sanjay:

    As a practicing value investor in the USA for over a decade, I just stumbled across your Blog. I must say, it is very well thought out and written, with a lot of supporting references. It is like a breath of fresh air

    Your students must be very lucky to have you!! :). Thanks for taking the time to write consistently.

  14. Dear Sir

    Over the last few months I am struggling to understand your lectures and presentations on buying quality business [your lectures & presentations are very clear, but I am deep rooted in buying only CHEAP stocks and as they say OLD HABITS DIE HARD]. But after re-reading your post on return per unit of stress combined with what you said in another comment about having investment time frame of decades and not years, I think I am better able to appreciate your stress on quality stocks…

    I know it will take a lot more time for me to truly understand your presentations on quality stocks…. But thanks a lot.

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