A few days ago, out of sheer curiosity, I read a few verses from the Bhagwat Gita. One of them caught my attention (Chapter 3, verse 38). The verse broadly tells us what Shri Hari says about the three types of desires one can have: Tamasik, Rajasik, and Sattvik. The point is that a Sattvik desire is the easiest to remove; Rajasik takes time and effort, and Tamasik is the toughest to detach from. It lit something inside me, and I am not able to express what it was, but I discussed my thoughts with someone knowledgeable in this field. The discussion led me to think deeper about every desire I have. But this doubt about what the actual meaning of Tamas, Rajas, and Sattva is - the properties that lead to the respective desires - kept me awake (not literally). Little did I know about Chapter 14, where Keshav and Arjun discuss those very properties. More about them in some time.
In Finance, we have a concept called the cost of capital. I will try to explain in the simplest of terms what it means. For any entity (firm), there is a fixed cost of debt. Looking at the balance sheet and related notes, we can, with 100% accuracy, tell what the cost of debt is (interest rates on loans). Similar to lenders, there are investors who expect returns from that company. Think of it like you own a garage; you do expect some returns on your investments, so your return expectation becomes the cost of equity (shareholders' money) for the company. Now, when you take the weighted average of those costs, you get the cost of capital. In finance, professors try to equip us with statistical tools that can help us arrive at that number. It gets quite complicated sometimes, and we know statistics can hide certain realities. The tools are based on broader market sentiment and not on the business and its nature.
Now here is the caveat: for fund managers, it might make some sense because they must have invested in numerous businesses, and for them, the risk is the price of securities. They have the liberty to operate in ways where they can enter and exit investments quite easily. Sometimes they get so involved in this statistical process that while analysing risks of investing in a private company (one that doesn't have publicly listed shares), they take statistical references from some other similar company that is publicly listed. But for a CEO or a business manager, this liberty isn't there. Business managers don't trade in and out of their own company; for them, most of their capital decisions have to go towards expanding the business or returning money to their shareholders. For example, a logistics company isn't going to make capital decisions based on stock prices. They are required to assess opportunities available in different segments of the logistical sector and see what profits can be generated over very long periods. Discount those series of cash flows at a reasonable discount rate and see if the investment makes sense or not. Usually, that discount rate is the cost of capital. Some managers say publicly what the number is for management, and this number is always more than the cost of debt for that company. For some, we need to figure it out.
Here came my dilemma of how to approach this problem. I have listened to so many people, some like Buffett-Munger, who don't really give that much attention to what the cost of capital is. Obviously, an asset must provide a decent return on the invested capital, and they have said multiple times that they assess other opportunities and try to figure out what the business is going to do over the next few years. They have some number in their minds that they use to discount the expected cash flows. This is extremely difficult on multiple fronts: one, to understand a business itself is very difficult. They think about it from multiple dimensions: is there a moat, is there something special about this business, do they have brand loyalty, do they have pricing power, and so on and so forth. Every question is very difficult to answer. Also, no one has accurate answers to such questions. But broadly, they try to gain knowledge about the business rather than tinkering around with statistics. They have this thought process because they want to hold businesses for a very long duration. Yes, even though they make mistakes and sometimes exit investments within a few years, their mindset when entering an investment is very different from that of a typical fund manager. Even after listening to numerous talks given by them, I couldn't figure out the discount rate they use to assess.
I emailed one of their disciples, Mohnish Pabrai, about the discount rate they use to discount cash flows and which discount rates the businesses in their portfolios consider when making capital decisions. I haven't yet heard back from him. Then I thought, let's look into the Gita. The Gita is not a capital management or allocation handbook, but it certainly helps in shaping the right thought process. You could figure out from the previous paragraph that I was focusing on exactly the wrong thing. I was looking into what discount rates Warren and Charlie used for all their capital decisions. Rather, I should have given more attention to their ability to understand different types of businesses and securities.
Now, having surrendered to Muralidhar, I opened the index page of the Bhagwat Gita and looked for a chapter related to the properties: Tamas, Rajas, and Sattva. In finance, greed and fear come under the umbrella of Tamas, so I thought that even Arjun must have had some questions related to these Gunas, and there may be something that can tell me what the Sattva is in my domain. I found Chapter 14. Now, to be clear, the Gita is meant for a spiritual purpose, but when you can't find anything in the library or on the internet that can satisfy your thirst for knowing the right path, the feet of Jagannath are the best place to be. As the Indian Foreign Minister Dr S. Jaishankar points out, in the entire human history, there were only two truly great diplomats: Bhagwan Hanuman and Shri Krishna. If he can learn about diplomacy from ancient Dharmic scriptures, why can't I learn about the right mental model that can enhance my knowledge in my field? And this is how Kanha explains the Gunas.
(14.6) Sattva is stainless, luminous, free from evil, and bound by attachment to knowledge. (14.7) Rajas is like having passion for something; it has an attachment to action. (14.8) Tamas is born out of ignorance; it is bound by miscomprehension, delusion, darkness, and irrationality. We can figure out very easily who is full of Tamas in the field of finance: one who invests or trades based on somebody else's advice without fully understanding the underlying risks, the process, and the mindset required. In my observation, they are always the trend followers and have a FOMO mentality. In (14.18), Keshav says that people with a Tamasik mindset go downwards. Globally, many people lose a lot of wealth based on advice given by someone else. No risk assessment and no understanding of how the underlying frameworks work. They react in accordance with two emotions: greed and fear. Either they will be too greedy to see the entire picture and do rightful risk-reward analysis, or too fearful to try and take a step towards attaining knowledge.
Rajasik are the ones who are attached to their actions. I think, from my current observations, Rajasik people in the financial field are the ones involved too much in mathematical or statistical tools. For instance, if your derivation of the cost of capital comes from certain data points available in the market, don't you think everyone has the same number? After all, you have reduced those data points to a mathematical equation, which everyone has. I have seen that they apply numerous methods to get it "right" if it has certain systemic errors. The greed of getting the math right is a Rajasik phenomenon. In (14.16), it is said that Rajas yields the fruit of pain. Obviously, as there is an attachment to action, and when it doesn't yield good results, pain follows. Now, I don't think one should ignore statistics; use them as side tools.
Sattva, the purest among all the properties. Here, there is detachment from action and its consequences. The person with Sattva as the dominant character is attached to knowledge. The very questions that Buffett and Munger ask themselves. Sattva is about analysing the numbers and the characteristics of an entity, whereas Rajas is about analysing numbers alone. The focus on continuous learning is what makes the journey interesting; a journey that is free from greed and fear, and has no attachment to the end results.
These are my views, and the more I read Chapter 14, the more perspectives I get about other things that we go through in our respective lives. It will definitely take a lot of time for me to realise whether my thought process is correct or not. I may be right or wrong; only time will tell. But as I have said in my previous blogs, I think I am blessed enough that Dwarkadhish will guide me towards the right path. So even if I am wrong right now, there is nothing to worry about.
Thank you
Rutvik
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