Discovered And Undiscovered Asset Classes

In the USA, where basketball is one of the most popular sports, there’s a saying: “You can’t coach height,” meaning that no amount of coaching will make a player taller, and being tall is an important aspect of success in this game.

Similarly, to become a better investor and achieve superior returns, one of the key ingredients of success is having insight.

And it is almost as hard to teach insight in investing as it is to coach height in basketball.

But unlike increasing one’s height, one can try to acquire investing wisdom either through personal experience or by learning from the experience of others.

Sharing one of the insights I’ve gained from my own experience, which has become too obvious to me over my long journey of investing.

This insight pertains to types of asset classes. From my experience, to achieve better returns, one needs to be able to differentiate between different assets with respect to second-level thinking.

As far as I am concerned, to generate an initial understanding of an asset, I have started categorizing all investable assets into two categories: discovered and undiscovered.

Type 1: Discovered

If your behavior is conventional, you’re likely to get conventional results—either good or bad.

These are assets that are known to everyone, are mature (i.e., in the market for a long time), and generally multiply 2-3x in cycles, followed by long periods of stagnation.

For example, stocks of big companies (Nestlé, Reliance, Asian Paints, etc.), real estate in already established areas of a town, or gold.

The prices of these assets tend to jump 2x or 3x every 10-12 years, and then stagnate for the next 10-12 years.

Future growth or changes are well-discounted in prices well in advance, as these are visible to everyone. All rush in at the same time, and prices peak too quickly. But later, when all the buyers are in, the prices stagnate, and these asset classes wait for the next wave of buyers.

Generally speaking, in the Indian context, the long-term (over a 10-15 year period) annual return for these types of assets (mature and known) is anywhere between 10-15% (i.e., inflation + 5-6%).

Investing in Type 1 assets requires some discipline—knowing when the next cycle of upturn is about to start and when to exit, once everyone else is on board.

Howard Marks describes this beautifully in his book The Most Important Thing:

Rule 1: Most things will prove to be cyclical.

Rule 2: Some of the greatest opportunities for gain and loss come when other people forget Rule #1. Very few things move in a straight line. There’s progress, and then there’s deterioration. Things go well for a while, and then poorly. Progress may be swift, and then slow down. Deterioration may creep up gradually and then turn climactic. But the underlying principle is that things will wax and wane, grow and decline. The same is true for economies, markets, and companies: they rise and fall.

Type 2: Undiscovered

Higher returns are made in undiscovered or freshly discovered assets, or those in sectors where new ideas are being implemented.

Examples include new-age companies in emerging sectors (Nvidia, Google, Amazon, Ceinsys, Lal Path Labs, ZenTech, Waree Tech), start-ups, real estate outside established towns or in emerging areas, or fresh assets like Bitcoin.

Real alpha lies in this type of asset class. Here, your money grows in multiples (not percentages).

The prices of these assets can grow 10x-20x, and this growth can continue for a long period of time.

However, most people miss this kind of ride due to one of the following reasons:

A) You’re not a gold-digger:

Majority is either unaware of undiscovered ideas (as they don’t spend time searching for new opportunities and are happy with whatever is on the surface). Majority tends to be trend-followers, going where most people are already invested or planning to enter.

B) Exiting too early:
Even if they happen to enter these Type 2 assets, they often cash out too early.

This happens because they are used to mature (Type 1) assets and tend to sell out of freshly discovered ideas too soon. They feel happy when they make 2-3x on an undiscovered or freshly discovered idea, but fail to gauge the long runway of growth.

C) You’re too late:
Many people enter Type 2 assets too late, when the future potential has already been priced in. As the saying goes: “What the wise man does in the beginning, the fool does in the end.”

D) You’re too early:
Alternatively, many invest in immature ideas too early—well ahead of their time. Being too far ahead of your time is indistinguishable from being wrong.

Of course, there is risk involved in Type 2 asset classes because these are untested ideas, and it is difficult to judge their level of acceptance in the long run.

That’s why people who invest in these types of assets are generally well-diversified. They tend to invest in multiple new ideas, knowing full well that some may not succeed. They understand that there can be a big difference between probability and outcome.

Conclusion

In conclusion, to make superior returns, one needs to be a second-level thinker. Whenever a fresh investment opportunity arises, the first test should always be the same: “And who does not know that?”

The quest for superior returns is essentially a journey of discovering the undiscovered or less-discovered ideas.