Pulak Prasad: What I Learned About Investing From Darwin
Pulak Prasad is a co-Founder of Nalanda Capital, a Singapore-based investment manager which has built an exceptional track record investing in Indian public equities since its inception in 2007. Pulak prefers to fly below the radar but recently published “What I Learned About Investing From Darwin” to share how his intense interest in evolutionary biology helped him derive the core principles of long-term and patient investing.
On the surface, these disciplines have little in common. But as Pulak says, “Almost every topic I studied in evolutionary biology has parallels to investing in general and to the Nalanda way of investing in particular. The more I studied Darwinian evolution, a new hobby, the more I learned about investing, an old passion.”
What is the Nalanda way of investing, then? Simple: to be permanent owners of high-quality businesses. Achieving this requires a three-step process: 1) avoid big risks; 2) buy quality at a fair price; and 3) don’t be lazy - be very lazy. Each step is explored in its own section of the book, with insights drawn from evolutionary biology used to illustrate their rationale and application.
For example, the overarching goal of all living things is to survive. Animals instinctively understand risk management because to be careless is to risk a swift and brutal death. The thirsty antelope will not take a chance drinking from a predator-infested watering hole, hoping to get away with it this time. Instead, it will cautiously wait for the sure thing and live another day.
Likewise, Pulak and his colleagues pride themselves on firmly saying “no” to the overwhelming majority of potential investments: “We at Nalanda love stable, predictable, boring industries. Give us electric fans over electric vehicles, boilers over biotech, sanitaryware over semiconductors, and enzymes over e-commerce. We like industries in which the winners and losers have been largely sorted out, and the rules of the game are apparent to everyone. For everything else, thanks, but no thanks.”
In scientific parlance, both Nalanda and the thirsty antelope seek to minimise Type 1 errors (false positives, mistakes of commission), even at the expense of increasing Type 2 errors (false negatives, mistakes of omission). Charles Ellis would call this ‘winning the loser’s game’. In contrast, driven by a fear of missing out, most investors do the opposite and speculate on moonshots, i.e. they hope to minimise Type 2 errors even at the expense of increasing Type 1 errors.
Perhaps my favourite of the book’s many illustrations is the tale of the wild Siberian silver foxes, which researchers selectively bred over decades based on a single factor: their tameness - that is, their interest in humans and need for affection. After just several generations, the silver foxes began to take on the physiological characteristics common across all domestic animals: their ears turned floppy, their snouts shortened, their tails became curly, and their skin became piebald. In a word, they became cute! For reasons I’ll save for the book, the researchers proved that the animals’ behaviour and physiology were intimately connected.
Pulak draws a parallel between this experiment and the way he and his colleagues screen for potential investments. They have found that by focusing on a single factor - high historic returns on capital employed - they can quickly identify businesses with the traits they seek. Like the tame foxes which became cute, businesses with high historic returns on capital employed are more likely to be run by excellent management teams, possess strong competitive advantages, allocate capital well and have the capacity to take business risks without taking financial risks.
Above all, I sense that Pulak has grown comfortable in his skin. He writes, “My circle of ignorance has expanded in lockstep with my age. As a young McKinsey consultant, I thought I had all the answers. As an older investor, I have only questions. I wish I had ready solutions for them, but I don’t. So my only option is to internalize and implement a process that can simplify the world’s complexity in a way that my intellect can’t. If we are surviving and outperforming the market many years from now, it will not be because we know a lot. Instead, it will be because we know that we don’t.”
There are no silver bullets in this book, and you won’t find tips on the next Indian hundred-bagger. Pulak offers instead a mindset and a repeatable process for investment success. For that process to work, however, you must be comfortable that you are unlikely to catch the next Netflix or Tesla. But on average, over a long enough time, you will do very well.
As a practitioner, I have a few questions I would love to ask. Does Pulak focus his search on small companies? What role is there for managing risk at the portfolio level? Would he still try to own businesses forever if he didn’t have longstanding client commitments for fresh capital? Is it fair to measure investment returns from when capital is deployed rather than when capital is committed (i.e. the private equity method versus the public equity method)?
And does he think about the ecosystem in which his companies exist? Does it matter, for example, who is Prime Minister or which party is in power? Would his strategy have been possible anywhere but India, which has enjoyed a high rate of GDP growth over many decades despite the scarcity of capital which has allowed many businesses to enjoy high rates of return on their own capital?
I was recommended this book by my friend Andrew Burns, founder of Conover Investment Advisory, and read it on the long flight home from Omaha. Given the ambitious subject matter, it is well-written and perhaps deceptively easy to read. I think it will go down as an investment classic.
chapter summaries
At the end of each chapter, Pulak helpfully summarises what has worked for him:
Learn to prioritise survival above all else
Select a single business trait (ROCE) that brings with it many favourable business qualities
Own only robust businesses that are resilient to internal and external shocks, while continuing to evolve and grow
Ignore proximate causes of stock price movements while focusing on ultimate explanations of business success
Study and understand the history of a business and industry instead of constantly obsessing over the future
Internalise the recurring patterns of success and failure in the business world
Differentiate between the honest and dishonest signals of businesses
Embrace the tenet that the long-term character of high-quality businesses remains unaffected by short-term fluctuations in the economy, the industry, and even the business
Accept the pervasiveness of business stasis. In other words, great businesses generally remain great, and bad businesses generally remain bad.
Be very patient and don’t sell an outstanding business at almost any price
Execute a simple and repeatable investment process.