INVESTOR NEWSLETTER
QUARTER ENDED MARCH 2023
What a quarter it has been! A 3% down Sensex does not capture the emotions and turmoil experienced by the market through this quarter. We witnessed financial stability risks in the west with large banks disappearing for the first time since the Global Financial Crisis in 2008, and allegations of fraud in the Adani Group causing one of India’s largest conglomerates to crash. Despite the turbulent market environment, the domestic equity flows have remained strong, especially the SIP market, and this is probably the reason the markets didn’t fall further.
We were able to stay nearly flat (down 0.3%) and squeeze out some alpha relative to the market. Most of this came from our stock selection. This quarter we used some of our cash pile to buy into the weakness, and initiated new positions in the Life Insurance sector, which corrected sharply post the budget announcements relating to the sector.
The other important aspect to talk about this quarter is the collapse of “decoupling” thoughts which we referred to in our earlier newsletters. Through 2022 many market commentators talked about how India’s markets were decoupling with western markets in terms of valuations and that a much higher than average valuation for the Indian markets was warranted due to higher growth outlook relative to the western markets facing inflation and consequent interest rate driven growth risks. We did not agree with this view. This quarter the S&P 500 went up 7% while the Sensex fell 3%. Despite this, Indian markets remain at higher than their average P/E levels, creating an environment for lower equity market returns than the average historical returns of 10-12%. One way to look at it is that the market’s returns in 2020 and 2021 borrowed returns from the future!
We have received 2 questions from investors on performance regularly:
- A lot of funds did well during the Covid period (2020-21), will you be able to follow this up in a more normal environment
Answer: Our performance of Fy Mar-23, a more normal year, has been meaningfully better than both the market and our peers. We returned 14% in Fy Mar-23, Sensex returned nearly nil (0.7%) while most of our peers struggled to be positive.
- Is your performance replicable as your size grows?
Answer: We strongly believe that we would be able to generate these returns on much larger AUMs. The investment style has been designed to be able to absorb billions of dollars in AUM by limiting exposure to small caps both in aggregate and on a single name basis. We have never had more than 40% in small caps, and this has averaged around 23% of our Portfolio over time. Even within small caps, we have tended to buy larger small caps. The average market cap of our small cap names is ~$900m, and the minimum market capitalization is ~$200 million (for all but one name). We think we could replicate our Portfolio for $1 billion AUM fund in a few days of buying.
Benchmarking our performance
Most Popular Funds
Leading Funds With 10+ Years Existence
Leading Funds With 5+ Years Existence
Leading Funds With 3+ Years Existence
- Performance details for Guardian Capital are before expenses and tax to make it comparable to Sensex
- AIF license received in Q3 C21. Assets have been transferred into AIF as of 01/11/2021. Returns from Nov-21 onwards are for assets in the AIF
- Before Nov-11 returns are for capital invested through the Sponsors’ personal account, with HDFC Bank as Custodian providing performance statements
Key reasons for outperformance in Fy Mar-23
- Given our investment strategy (see section labelled “Our Strategy in Action”) we had almost 80% in cash at the beginning of 2022 which allowed us to take advantage of cheaper valuations in the middle of 2022 when the markets corrected.
- We have been overweight Financials through the last year given their low valuations, solid growth in loans, benign credit cost environment and improving RoE profiles. This is the single largest contributor to Fy Mar-23 returns.
- We took a contrarian view on commodity prices, expressed by being invested in commodity consumers (FMCG companies, oil marketing companies and gas distribution companies). This has partly played out and provided returns especially in months when the market was weak, reducing the overall risk levels in our Portfolio.
Changes to the Portfolio in the last quarter
Portfolio Characteristics
Top 10 Positions:
Notes:
Market Cap Definitions: Large = largest 100 market cap companies, Mid = Between 101 and 250, Small = 251 st and smaller. The average market cap of the small caps in the Portfolio is ~$900 mn
Detailed performance charts
Returns attribution
Outperformance For Last Year: +13.3%
Outperformance For Last Quarter: +2.7%
Outperformance For Last Year: +13.3%
Outperformance For Last Quarter: +2.7%
- Performance details for the Portfolio are before expenses and tax to make it comparable to Sensex
- AIF license received in Q3 C21. Assets have been transferred into AIF as of 01/11/2021. Returns from Nov-21 onwards are for assets in the AIF
- Before Nov-11 returns are for capital invested through the Sponsors’ personal account, with HDFC Bank as Custodian providing performance statements
Our strategy in action
Our strategy is to buy good companies if they are cheap, and ONLY if they are cheap. If they are not cheap we stay on the side-lines in cash for periods. Especially for large cap companies we buy them when they trade at discounts to their long term average valuations and exit them when they start trading above long term average valuations without waiting for peak valuations.
This allows us to capture up market moves (High Up Capture Ratio), reduce our risk positions when markets are expensive, and wait in cash for opportunities when markets become cheap. We have been able to remain in cash for 2 down markets because of this strategy: i) before Covid, and ii) From Oct-21 onwards. And this ensures that in down market moves our Portfolio falls less than the market (Low Down Capture Ratio). A high Up Capture Ratio and a low Down Capture Ratio combine to provide our Portfolio with meaningfully higher returns than the market and a high Sharpe Ratio.
While the Sensex has remained flat to slightly negative in the last 18 months, the earnings of the underlying companies continue to go up, and the P/E ratio is normalizing towards its long term average of 17-18x. However, it is still above average at 19.3x.
Some of the macroeconomic headwinds remain:
- The debate on US peak rates, near-term US inflation outlook, and near-term recession outlook continues to create a volatile environment for global equities. The emergence of full scale financial instability due to the higher interest rates was on display this last quarter, and we remain watchful for further financial instability risks.
- War in Ukraine continues, and though some of its inflationary impact on commodities have been absorbed, the outlook for inflation could be impacted further yet.
The good news here is that the normalizing of market valuations towards mean has thrown up even more sectors that are now becoming cheap relative to their own history. This is keeping our team extremely busy, and we see an opportunity in the near term to be fully deployed again.
Portfolio positioning
- Continue to be long Big Banks and select NBFCs: Despite strong returns in the last year we think there is a long way to go on many Financials. You will see below that the credit cost environment in the near term is benign, keeping risks low in the sector. And given our investment style of investing in names trading at discounts to their long term valuations, we believe that the risk adjusted return profile of our Financials names is very attractive still.
- Recent entry into Life Insurance: As discussed earlier, you will in the charts below that valuations have crashed, even though long term profitability is intact. There is likely to be 1-2 years of slightly lower growth in premiums but that is more than priced in.
- Continue to be long commodity consumers: While commodities have corrected across the board, there is further room for this to normalize. Additionally, the passthrough to the ultimate consumers takes many quarters and we believe the equity markets will reward these companies when they see this come through the numbers over the next few quarters. It is worth mentioning that our positions in FMCG companies have not worked yet, as the benefit of commodity price reductions have been passed on to consumers through lower price increases in order to stimulate demand, which has been weak especially in rural India.
- We are deep in research mode in the Pharma sector: Valuations are now below long term averages for some of the players and growth prospects remain robust over the foreseeable future.
- We are beginning our work on IT Services: We think that the recessionary environment in the Western markets could lead to a meaningful further correction in IT Services, making it attractive to us in the later stages of this year. IT Services company have corrected but further corrections are warranted.
- We are also beginning our work on the Auto sector: Cheapness has recently emerged, and we are sharpening our pencils.
