Pulak Prasad, founder of Nalanda Capital, is one of the giants of public market investing. Based out of Singapore, Pulak Prasad has built Nalanda into one of the most respected public market investors operating in India, presently overseeing around $5b in assets under management. Now, Pulak is known as much for being super-reclusive as for his track record. So ever since the book was announced, it was keenly awaited by the public investment community.
Pulak is a student of evolutionary biology and in his first book, he uses readings and findings from Ecology and Evolutionary Biology to illustrate key investment principles. It is an interesting read, though some evolutionary principles seem to translate better to the world of investing, while some seem forced. Nonetheless, it is a fun, easy read. Those who like to read books on public market investing will find it the most useful. As a private market investor, and one who operates in a field and style far removed from Pulak’s, I still found it useful and interesting.
In this essay, I will first layout out the broad thrust of Pulak’s book, distilling his key ideas. In the next section, I will look at how they contrast and compare with venture investing, the field where I work.
Distilling the book
A bit about Nalanda before we start. Nalanda is known for its disciplined investing style, selecting high quality businesses after considerable research, and buying into them when they become available at discounts during market crises. They typically buy deep when they enter a company and are almost always the largest institutional shareholder. ₹1 invested in Nalanda’s first fund in June ’07 would have been worth ₹13.8 in September ’22. The same amount invested in the Sensex would have been worth ₹3.9. At 20.3% annual rupee returns net of fees, these are incredible results. Now to the book.
Pulak starts the book by laying out Nalanda’s investing principles. These are
- Avoid big risks.
- Buy high quality businesses at a fair price.
- Be very lazy (in buying and selling).
The book is also structured around these principles, with a section and chapter set, for each of the principles.
The bedrock of their philosophy is that there are very few good investments in the market. Given this, it is better to reduce errors of commission or Type I errors (investing in bad companies) than errors of omission or Type II errors (missing out on good companies) – because the errors of commission cover a much larger number of outcomes. In pages 20-22, he illustrates this with examples and shows how reducing Type I errors or errors of commission dramatically improve investment outcomes, but reducing Type II errors or errors of omission doesn’t help as much, because there are far more bad companies vs good ones (typically, there are about 25% ‘good’ companies in any listed universe he says). The best investor has to be the best rejector, he says.
How do they reject? They first avoid risky businesses. These are businesses with poor corporate governance, businesses in turnaround situations (as typically these don’t work out), highly leveraged businesses, those who keep growing through inorganic means, and finally those with unaligned owners (govt-owned businesses, subsidiaries of foreign businesses etc).
Their investable universe is ~800 Indian businesses (with market cap of >$150m). They reject ~350 businesses for reasons shared in the earlier chapter (governance, leverage, turnaround, excessive M&A, non-aligned owners etc). Of the remaining 450, they use historical ROCE (Return on Capital Employed) to bring it down to ~150.
In nature, selecting for just one trait can influence many other behavioural and physical qualities of an organism, like the example he gives of selecting for tameness in Siberian Foxes which turned them into doglike beings with curly tales, spotted coats etc. Per him, ROCE is the equivalent of tameness on the business end, in turn correlated with a high quality management team, competitive advantage, good capital allocation etc.
They then use some more additional criteria to create a final list of 75-80 firms they can invest in. These additional criteria include robustness, high predictability (not a fast changing business), favourable business templates and finally the presence of costly signals. Let us quickly unpack these.
- A robust business has made consistent operating profits over a long period, has a fragmented customer base (or no concentration in customer base), has no debt, excess cash, has moats (strong brand, industry with high entry barriers), has a fragmented supplier base, stable management team, and is in a slow changing industry.
- They prefer slow stable businesses (electric fans over electric vehicles, he says) which don’t change fast (like Nokia).
- Favourable business templates are those like job boards and yellow pages which see high profitability for the market leader (as opposed to airlines which are unprofitable mostly everywhere).
- Costly signals are those which take time to reproduce like operating profits and hence honest signals versus signals such as PR announcements
Thus, they have a final list of 75-80 companies they can invest in, and this constitutes their strike zone. They do not go outside these 75-80 companies ever. This is how they avoid big risks and identify high quality companies.
They wait for market crises (global financial crisis, COVID etc.) for price drops in these companies and they then buy large chunks of these companies. Almost half of their capital deployment of nearly $2b was done across three periods when the Indian stockmarket crashed (2008-09, 2011 and recently in 2020). 22% of the capital was deployed across three months of March to May 2020 he says, when high quality companies went on sale, and are available at fair prices. This waiting to strike is a feature of great investors. Bruce Karsh, cofounder of Oaktree Capital, alongside Howard Marks, similarly describes in How to Invest by David Rubenstein, how they invested large amounts to take advantage of favourable conditions for distressed debt investing in 2008-09 during the Global Financial Crisis, and in March-April 2020 as COVID derailed the financial markets.
They then seek to hold these companies forever (this is the lazy part). The final section of the book dwells into why they like to hold forever – because the best companies tend to persist, and compounding needs to be played out over a long period.
This is broadly how the book is structured. Each chapter has a principle or lesson from evolutionary biology, and tries to draw parallels to the investing world.
How Pulak’s principles compare and contrast with venture investing
It is interesting to contrast Pulak’s principle of eschewing Type I errors or errors of commission with venture, where errors of omission often matter more, because a large majority of the investment returns come from a few companies (‘The Power Law’). Errors of omission can be very costly here. Errors of commission are less costly in venture as one winner can cover losses from a multitude of bad bets. That said, I do wonder if the power law phenomenon applies to the Indian venture market entirely. My sense is that the Indian venture market exhibits a weak power law. The winners here aren’t necessarily as big as they are in the west.
My colleague Karthik Reddy, who cofounded Blume, likes to think of venture investing process as a two-stage process – the first where you ensure you avoid false negatives – that is, you ensure that there are no errors of omission, where you unwittingly pass on meeting a potential winner. The second stage is where you avoid a false positive or errors of commission, that is, picking the wrong company. A great venture investor tries to eschew both these risks and sets his or her investing process and style to eliminate these risks. I thought this framework was an interesting parallel to Pulak’s Type I and Type II errors framework.
A direct contrast of public market investing with venture investing can be misleading though. A big learning for me from my last few years in venture is that there is a two-tier market in venture, a lower-tier, less or non-venture-fluent founder market (almost always a first time founder, though some first-time founders are venture-fluent) and an upper-tier venture-fluent founder market (a lot of whom are second-time founders). In the lower tiers, the VC ‘picks’ the investment; it is effectively a buy-side business. In the upper tier venture market, the founder picks the VC or capital he wants to buy with his equity. It is sell-side effectively, and the VC is trying to make his or her brand of capital acceptable and attractive to the founder.
Interestingly, Alex Bangash of Transpose, a fund of funds platform, calls VC (essentially the upper tier venture market) an access class business, not an asset class business, given it is fundamentally around getting access to top-tier founders. He also refers to VC as the only asset class where the asset picks the manager and not the other way around. Thus, in my opinion, if we recognize the two-tier structure of venture as well as the access class theory, then a lot of the frameworks that inform public-market investing, and thereby Pulak’s frameworks thus cannot be directly employed in the upper-tier venture business, or at least there is no easy contrast.
For instance, take Nalanda’s reluctance to invest in fast-changing businesses. Venture is the opposite of this, in the sense that we like to skate to where the puck is, and our investors demand us to invest in fast-changing businesses. This principle along with how they prioritise risk of commission over omission, was I thought the biggest difference of Pulak’s principles with venture investing.
But there are also similarities in some areas. For instance, Nalanda’s reluctance to sell, which I found very impressive. In venture too, we are very reluctant to sell – lack of liquidity is one factor, but there is also the fact that given our business has a power law (even if weaker than in the west), the vast majority of returns comes from a few investments, and you don’t want to sell those too early.
One point I found amusing was that Nalanda’s returns despite being focused on high quality stocks, exhibited some signs of a power law (of course far weaker than in venture). Pgs 254-55 cover how some of their holdings have performed, and I thought it was interesting how a few of their investments account for disproportionate returns. While it isn’t a true power law like in venture, there are some resemblances. Page Apparels is their big winner; it has risen 82x over the near 14 years of their holding, while Berger for instance has only risen 32x in a similar time frame. Most of the other winners are in the 10-15x over 10-12 yrs range. There are seven stocks that have underperformed.
Finally, I thought it would be interesting to look at two areas that Pulak stresses to filter for high quality companies and see what the equivalents for venture are.
- The first is ROCE in public companies. Wondering what it could be for venture investments. Could it be say being CM2 Positive on Capital Deployed (though this doesn’t factor in growth which is important)? Or is it NRR? Or perhaps it is not a business metric, but something like a second-time founder or someone who is venture-fluent?
- The second is signalling. What is honest and costly signalling? Clearly one could be opportunity cost foregone (like giving up a high-paying job); the others could be a very high ESOP pool to attract talent.
Am sure there are more examples here.
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To sum up, Pulak’s book was extremely interesting and enlightening. To me what I took away is the importance of reducing errors of commission, limiting your strike zone to 75-80 companies, using ROCE and predictability (lack of change) as filtering mechanisms, concentrating buying in periods of market crises, and finally not selling ever.
Pulak is not well-known unlike say a Rakesh Jhunjhunwala or Shankar Sharma or a Porinju Veliyath. Hopefully this book will popularize his investment style, one of the most successful ones in the Indian public market investment space.