During Covid there was a joke about a US Pharma company that used to buy $2 worth of API (Active Pharmaceutical Ingredient) from China and sell the drug for $100 a piece. And they refused to buy the same API from India because it costs them $2.50 and going all-in in China made economical sense. But when Covid came and China was under lockdown, that pharma company could no longer sell the $100 drug because … it wanted to save $0.5!

Another management concept that I and a lot of my generation of MBAs took as the gospel was Just-in-time. That is supply chains are tightly run such that there is minimal slack in the system and minimal slack means products are delivered on time at a cheaper price. This concept worked fine for 99% of the time, except when Covid and other disruptions came about, the system broke down.

I heard this anecdote in an interview that countries like Germany had stopped producing basic drugs like Paracetamol and were importing them from say China. You know what happened next – when China went into a lockdown during Covid, even Paracetamol wasn’t available. (In 2020, I overdosed on Thomas Sowell and I thought Indian government was silly trying to manufacture in India when they should let China do all the manufacturing … I was wrong.)

Critical parts, systems, drugs are like parachutes. Do you want a parachute that works 99% of the time or an expensive one that works 100%?

Believe me … I had been so brainwashed in concepts such as “Just in time”, “efficiency” and all other jargons and so it took me a long time to appreciate redundancy or slack. Concepts like black swan, fragility, anti fragility, survival need to be taught more.

You can’t choose to thrive now and survive later. It doesn’t work that way 🙂

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Data centers that promise very high availability have slack built into them. Our cars have a spare tire – that costs us in terms of space and weight but we need it for that rare day when we have a flat tire. Yet, slack or redundancy has been taught as if it is a bad word in management.

Suppose you were running a company – would you borrow money and then let some of that money idle? Think carefully. And the answer, in my opinion is, it depends.

Here are some examples.

Example 1: Bajaj Finance

In 2013, because of Taper Tantrum, the short term credit markets froze. Bajaj Finance faced a mini crisis. A learning that they took was 1> diversify their funding sources by borrowing from public and 2> to park 4% of their money in the bank.

Both of these cost Bajaj Finance. Public deposits increases costs but will not go away at times of crisis. Letting 4% of your money “idle” (slack) means that money is a cost center and not a profit center. But, but, but… it is a life saver during times of crises.

Bajaj Finance enjoys a AAA rating. That means, it is among the safest borrowers. It is among the hidden strengths of this company and allows it to borrow at rates cheaper than others. Imagine a scenario where Bajaj Finance defaults on it’s loans just once … that rating would quickly go from AAA to D. So the above actions are protecting those strengths.

This survival strategy helped Bajaj Finance thrive in subsequent Black Swan events such as the 2018 IL&FS crisis and 2020 Covid.

Example 2: Warren Buffett and the slow moving elephants

Warren Buffett had at one time in the 80s I think, borrowed money and was paying 6% on it. He was keeping that money aside to acquire companies. He called it keeping the gun ready to shoot rare, slow moving elephants. So that money gave him options. Raising money just in time to acquire may not be possible – either the money may not be available or the cost may be very high.

Example 3: Companies “sitting” on cash

Some businesses like RateGain have in the recent past raised money for acquisitions by diluting equity. And that money is parked. Investors get anxious and jittery because they think money has to be put to work 100% of the time. No! There are times when you need to be defensive and there are times when you have to be aggressive and invest. And therefore letting money idle for some of the time is not a bad strategy. (I smile to myself every time “jittery” PPFAS unitholders ask Rajeev Thakkar why he is holding onto so much cash).

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Here is an unpopular thing to say: Investment managers like me, should sacrifice some performance points and build in some slack into their thinking.

What is this slack in thinking?

I am asking you to build some defensive thinking. Yes, yes, yes – I have no doubt you may be the next Buffett or the next RJ, but you also need to survive some of the down turns. And therefore:

• Like Bajaj Finance, having cash at all times is important because you never know when you are going to need it.
• I have no doubt that your portfolio is the best performing asset that you have. But don’t overload all your net worth into it. If you are tempted to, think of the supply chain managers who may have visited China and found great infrastructure, great economies of scale and great manufacturers etc. Putting all their eggs in the China basket would have seemed the rational thing to do. And you know what happened. Therefore, having assets outside your portfolio is key to survival. (Do you want to be the guy or gal who lost $100 while trying to save $0.5?)

To me, slack is like margin of safety. Just as we don’t drive bumper to bumper at 60 Kmph … instead we make allowance for unexpected things. It’s what makes driving fun. Similarly, investing can be a lot of fun. But investing is filled with unexpected surprises and therefore sacrificing some speed and carrying a spare tire can make for some fun drives.

On the other hand, Fast and Furious is no fun way to drive, invest or live.

Lastly:

• The 4 most dangerous words in investing: This time is different.
• The 3 most important words in investing: Margin of safety
• The 2 most important words in investing: Shit Happens

Slack, is the good bad word.