Full-day highlights of event,”Corporate Governance in Investing: Theory vs Practice”, Pune 2019

Contributed By: Ria Agarwal

The Pune chapter of CFA Society India held its first marquee event in November 2019 on “Corporate Governance in Investing: Theory vs Practice”. Considering the recent fiasco’s in the financial services sector, Corporate Governance is re-gaining a lot of importance in investing.

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Here are some of the key takeaways from the conference-

Session One: Trends in Corporate Governance

Speaker: Chandrashekhar Bhave, Chairman, IIHS Board

Moderator: Bharat Pathak, Director, Wealth Managers (India) Pvt. Ltd

The session of, ‘Trends on corporate governance’, conducted by Chandrashekar B Bhave gave us in-depth knowledge on how and why there was a transformation of governance practices in India. He explained what governance is in his own words, i.e. ‘The ability to agree on a certain set of rules and follow the same to gain as a group.’ The speaker elaborated and said that although we have to keep our self-regulation policies strong, the need for external regulation by authorities is also growing due to the increasing complexity and cultural differences in our society today. Reforms are always messy & long process; we need the courage to deal with reforms. He also talked about the role of SEBI in some of the key changes happened in Indian Capital Markets. According to him, today, corporate governance is not just for the owners v/s minority interest, it’s about Owners/Managers V/s Environment/Sustainability. Companies should work to create an impact on society at large. There is a need for an awareness of interest and ensure a balance between competing interest. Merely appointing gate keepers are not enough, we need to address complex issues and find balance.

The speaker recommended a few practices to follow in the future that would help to increase better governance practices like

1) Company interest should not be just for themselves but for society at large

2) Those who are in power should always keep their doors open

3) Authorities should be open to criticism and

4) Individuals and companies should keep trust in the higher authority, i.e. regulators and the agencies.

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Session Two: The Tensions in Corporate Governance; And Why It’s Time for Transparency

Speaker: Andy Agathangelou, Founder, Transparency Task Force

Moderator: Arun Mantri, Founder & CEO, Mantri Capital

In the second session, Mr Andy Agathangelou talked about Transparency Task Force. A task force is usually a special unit just for a special task and increasing financial transparency is the special task which Andy is focusing on.  Andy said, ‘Transparency Task Force should be thought of as a movement to make the industry more transparent, truthful and trustworthy and these are the same principles that would lead to good corporate governance policies.

One of the most important pillars of good governance is having great transparency and this is exactly what the speaker focused on. He touched on two main questions that he proceeded to answer throughout his session.

  • Why we need to contextualise CG into the bigger picture?
  • What way the financial ecosystem needs to be changed.

Along with this, he mentioned a major problem that is prominent in the society, i.e. ‘The Trust Deficit’. Due to the increased normalisation of poor conduct of various companies in the industry, he said we as a society are becoming desensitized to it and are accepting malpractices as the norm. Unfortunately, one industry that is fundamentally dependent on trust comes in as one of the least trustworthy, that is – the banking and financial services industry. According to “The 2019 Edelman Trust Barometer”, Banking & Financial Services is the least trusted sector.

Andy mentioned four ways in which we can work to decrease the trust deficit.

  • Bring together the right people
  • Need to believe in the art of the possible
  • Cultivate a sense of purpose about the change that is needed.
  • Develop a plan

He said improvement for corporate governance requires a whole-system solution for a whole-system problem approach.

Just like the sustainable development goals of the United Nations, Andy has his own 12 Financial Development Goals that would help decrease governance failures significantly, but only if all of them are applied together.

Towards the end of the session, the speaker spoke about ways in which the members and students of CFA institute can affect change-

  • Identify some governance failures and understand the causes for it.
  • Identify if the structure of the company itself is the problem
  • Study the real separation of the management and governance of the company
  • Be suspicious if things are opaque
  • Don’t understand our collective power to affect change.

Overall Andy left us with a call for action to help in the betterment of an economy, industry and company by promoting better corporate governance as individuals and as a society.

The moderator of the session, Mr Arun Mantri also proposed the idea of incorporating a corporate governance index.

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Session Three: An Inside Perspective on Corporate Governance

Speakers:

M.S Unnikrishnan, MD & CEO, Thermax Limited

S.Sreenivasan, CFO, Bajaj Finserv Limited

Dr. Anand Deshpande, Founder Chairman & MD, Persistent Systems Limited

Moderator: Samit Vartak, Founder & CIO, SageOne Investment Advisors

The third session was conducted by Mr M.S. Unnikrishnan, Mr S. Shreenivasan and Dr. Anand Deshpande together. The session gave insights on Corporate Governance from the perspective of Family Businesses managed by professionals & family-driven businesses.

Mr Unnikrishnan spoke about how internal structures of companies play a critical role in good corporate governance practices. A few key points he mentioned were

  • How space is created for independent directors
  • Remuneration for independent directors should be assessed differently
  • There should not be an unhealthy tension on both sides (Promoters -Managers)
  • Good relations built over time can withstand healthy tensions
  • Companies should avoid delay in correction and taking necessary action to avoid governance issues
  • Ensure progressive practices in the organisation

The next speaker Mr. Sreenivasan spoke on the quality of management that needs to be prevalent in all industries along with some obstacles faced by many companies. Obstacles like the increasing cost of compliance, how the current laws are mostly for manufacturing companies and our need for newer more modern laws.

Broad evaluation, management awareness, pre-auditing techniques and active self-check on good and right governance are some ways that a company should follow. Another very important fact that was portrayed was that good governance and good profits do not have to be mutually exclusive, balanced growth is something most companies should strive for.

Next speaker for the session, Dr Anand Deshpande talked about how good corporate governance can be developed in family-driven businesses. He believes it is not just a company’s responsibility for short term profits, but it is (for a company and its employees) to maintain long term sustainability. This can be done only when companies can align their goals and objectives with the future direction.

He shared that companies should prioritise goals in the following order:

1) Value to customers

2) Invest in employees

3) Ethically support suppliers

4) Support and sustainably grow the community

5) Investigate the interests of the shareholders in the long term.

If the above is followed by every company in every industry, then we can achieve a much stronger and better economy.

In conclusion, he said that we can achieve our goals if we move from a rule-based regulation to a principle-based regulation.

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Session Four: An Institutional Perspective on Corporate Governance

Speaker: JN Gupta, Founder & MD, Stakeholders Empowerment Services

Sampath Reddy, CIO, Bajaj Allianz Life Insurance

Moderator: Subrata Ray, Senior Group VP, ICRA Limited

Mr. JN Gupta said many are highly motivated by passion for their jobs and their businesses, but a lot of us are missing the passion towards good governance practices. Mr. JN Gupta showed us the mirror by his words. He focused on the hard-hitting facts regarding the failures of good governance practices from both sides of the coin, from companies and from the gatekeepers.

The speaker highlighted the problems in valuation reports like 1) they are less informative 2) if valuation report making is considered to be an art, then how are we getting identical reports from two independent sources. He also mentioned that we should have more discussion and analysis on the true independence of independent directors.

In the second half of the session, Mr. Sampath Reddy gave practical problems that one should probe. Below are a few aspects to check before investing in a company-

  • Adequate capital asset allocation
  • Should not have unrelated diversification
  • Depreciation policies
  • R&D expenditure
  • Related party transactions
  • Tax management
  • Should not have too many subsidiaries
  • Whistle-blower policies
  • Banking and asset allocation

Towards the end, both speakers agreed that every job will have some kind of risk & liability and today’s corporate culture is becoming more radical & bolder.

 

Session Five: Corporate Governance- Investors’ Dilemma

Speaker: Vikas Deshmukh, Former Founder, MD TATA Elxsi

Moderator: Jaideep Merchant, Fund Manager, Janak Merchant Securities Pvt. Ltd.

Mr Vikas Deshmukh conducted the last session of the day. Keeping in line with corporate governance he spoke about the investor’s dilemma. He elaborated on it by saying that due to unstoppable economic globalization and intense political localization, the gatekeeper ecosystem is failing. The gatekeepers are the regulators, credit rating agencies and auditors. A few measures that could probably help in increasing better ESG practices are

1) have better methods to detect insider trading and decrease opacity of organizations

2) establish the difference between material and non-material information

3) keep the incentives received by the independent investors independent and away from the CEO’s discretion

4) develop stricter rules for succession of positions in corporates.

Finally, in today’s world, there has been an increased focus on specific companies that are environmentally and socially responsible.

 

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Session on “Reminiscence: Indian Debt Market” by Mr. Santosh Kamath at First India Fixed Income Summit, Chennai 2019

Speaker: Santosh Kamath, MD and CIO Fixed Income, Franklin Templeton Asset Management

Moderated by: Sriram Mahadevan, CFA, Principal – Azim Premji Foundation

Contributed By: Deivanai Arunachalam

Fixed Income Summit

The Fixed Income Market doesn’t get the importance it deserves. It was in fact the first market worldwide. Why are FI markets so critical? Only if FI markets are efficient, do you get rates for equity valuation. The FI space answers a lot of questions including which discount rates to use when interest rates are negative.

An efficient market needs different players with different risk appetites, different horizons and perspectives.

Old days

Bond markets are valued completely on an appraisal basis. 15 years ago, when there was no way you could mark to market, how did funds manage?

The frequency of NAVs we had made it difficult to monitor funds on an everyday basis. It was natural for rating agencies to change their stance after a few months. Crisil was then given a mandate that their rating should be stable for a period of 5 years. We have often bought at the previous week’s NAV. Eventually we could see values for Monday, Wednesday and Friday. The momentum soon picked up and we had everyday NAVs. ETFs today Mark-to-market every second.

Similarly, we had only a 1-year certificate of deposit in those days. It soon paved way for the introduction of the 3-month CD and now we have even 1-month CDs.

The speaker also recall days when we’ve had nightmares about how to fund redemption. We’ve come a long way since then.

Compared to the times when share certificates were received in trucks to the dematerialised form in which we trade today, the equity market has seen a sea change. The fixed income market has been slower in its transformation. The Fixed Income market was opened to foreign investors as recently as 2000. There were many constraints and so markets were not fully efficient and even today we have a long way to go.

In the early days, the FI market was all about issuing low coupon bonds. The period from 1995 to 2000 saw several reforms culminating in the introduction of repo instruments in 2000. We have gradually moved to an anonymous trading platform.

Is it Fixed Income?

Due to its name, it has created an expectation that one should get a fixed return. This is especially true in India. A change in this mindset is necessary to help the market develop further. In 2008 a Korean liquid mutual fund gave a negative return for one day, when rates were very high. The fund had to shut down. When rates go up sharply, what does a fund manager do?

Mutual Funds are significant in size, scale and complexity. They are the most agile institutional investors. It was discussed that EPFOs should also be marked to market. Since there is no incentive for them to trade, they only buy. If they feel yields are going to increase, they should sell. This would increase market efficiency.

EPFOs and Fixed Deposits offer a fixed rate of return, say 8%. Regardless of the movement in market interest rates, the Indian investor expects the sacrosanct return of 8%. Unfortunately, in India we have a PSU bank culture – the investor believes that the bank will repay his money. The investor does not fear losing his investment. Assume that there were no PSU banks and there are only private/foreign banks. When one gets too comfortable with fixed return, one is clearly not comfortable with the mark-to-market impact.

Markets have tolerance for losses but not for noises. When equity funds give negative returns for a few days, we call it short term volatility. But if the same thing happens in the debt market, it is perceived as a problem. This is not a problem or an accident; it is the way the market is.

Sriram wondered if keeping sight of the scams we have seen historically and the bouts of volatility, (including the Harshad Mehta scam, or the Asian crisis which was a fixed income induced crisis), if it is time that we stopped calling it Fixed Income.

We should call it debt markets. It was called Fixed Income because of the fixed coupon attached to the instruments. SEBI has a regulation that if you have a credit fund, it should be called a credit risk fund.

Being a Fund Manager

There are 2 key qualities needed to be a debt fund manager:

1. She should have a strong view

2. Should be open-minded to accept that she can be wrong.

It is noticed that many people don’t have an open mind. So, there is a high chance of failure.

Dynamics between regulators and market players

Regulators’ mindset is different from that of the market players. Market players would want a free hand, to generate extra alpha. Regulators would try to curtail risk given that we handle public money. There is a healthy balance in the dynamics between the regulators and the market players.

Too many restrictions make it tough for the fund manager.

There is always the question of doing the right thing versus doing what the investor wants.

The equity market has indices that are better followed. Public attention to debt markets is much lower. A luxury that we (at Franklin) have is that we have been here for 60-70 years. There is no pressure to please investors. Companies are now more investment driven than sales driven. Having been in the industry for so long, one has some wisdom. Sometimes there’s also a feeling that people cannot question you.

In developed countries, market forces and players brought about development in the market. The regulator just steps in to ensure that markets are orderly. However, in India, the regulator had to step in to develop the market too, noted Sriram. That happens when a country’s Per Capita Income is low, and infrastructure is not well developed.

Imagine a situation in which you are a coal miner, earning 10K per month. You put in money into a Provident Fund. It becomes unthinkable for the Government to tell him after 5 years, that his principal has come down, because the investor’s income is low. Over a period of time, it is possible for the Government to introduce improvements. For instance, the Government has introduced a Defined Contribution plan for new employees in the place of the existing Defined Benefit plan. So, we are slowly getting there.

It never crosses the investor’s mind that a PSU bank can fail. In 2002-03, when there was a lot of stress in the bank, Indian bank still managed to collect the highest amount of deposits.

Way ahead

The speaker strong believes that there is also a need for different types of products to ensure efficiency.  In this context, he is a supporter of Bond ETFs. It is a good initiative. But we’ll have to wait and watch if it succeeds.

Access to Indian sovereign bonds is institution-driven and not so much retail-driven.

Sriram observed that in the recent past, there were negative returns for 4 funds. He asked if we are seeing investors mature or if we are handcuffed volunteers.

Investors are becoming more sophisticated in their outlook. They realise that when they earn 5.5% to 6% in a liquid fund for a year, one day’s negative return is hardly anything compared to the service it provides.

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Session on “India Policy and Market Outlook 2020” by Dr. Anantha Nageswaran at First India Fixed Income Summit, Chennai 2019

Speaker : Dr. Anantha Nageswaran, Dean, IFMR Graduate School of Business at Krea University

Moderator: , Senior India Analyst at Observatory Group, LLC

Contributed By : Deivanai Arunachalam

Fixed Income Pic

Dr. Anantha Nageswaran, Dean, IFMR Graduate School of Business at Krea University spoke at the First India Fixed Income Summit. Here are the highlights of his presentation:

This is the first economic slowdown after social media entered our lives in a big way. We are in an era of impatience, hyper-ventilation and instant gratification. We expect policy change as soon as we publish a tweet. Policy implementation, however takes time; and time lags are indeterminate.

There is clearly an evidence of slowdown in private consumption. Even sales of consumer staples have slowed. The reason for the consumption slowdown is that the proportion of working population is reducing. It fell from 42% in 1993-‘94 to 35% in 2017-‘18. As a result income generation has taken a beating.

Trying to decipher the causes of slowdown for a country as large as India, operating within a democratic framework, we realise that long-term causes are not the only reasons. Despite these issues, India’s GDP had continued to increase from 3.5% to 5% and eventually to 6.5% and so forth. We need to identify the most proximate cause which is the collapse of the NBFC, precipitated by the collapse of IL&FS. There has been a sharp slowdown in credit, which is hampering capital formation. The corporate sector is trying to deleverage and get its balance sheet in shape as it did between 1998 and 2002. The 2003-2008 boom had been because the Indian corporate sector had worked its way to a very lean and mean balance sheet until 2003. Probably we are going through one such phase. This could be a bit longer as the extent of leverage is far bigger than before, so the adjustment is also taking time.

The gap between the lending rate and the repo rate is as high as it was during the taper tantrum in 2013 and 2016. The transmission isn’t happening in spite of the repo rate cuts by the RBI. Actual lending rate faced by borrowers isn’t going down as much as we’d like it to. Things have become slightly better in the third quarter.

Both lenders and borrowers are risk averse. Small savings interest rates are too high. So banks have to pay a higher cost to attract deposits – their lending charges are higher than they should be. Interest as a % of EBIT for BSE100 is very high. Interest expense is growing at the rate of between 10% and 20%. There is a clear burden on corporate balance sheets. So from their point of view, there is scope for further easing. In this context I would consider RBI’s decision to pause the interest rate cuts in December, (to put it mildly) an interesting one.

Andy Mukherjee, an erudite commentator, is of the belief that that the time might have come for India to have its Quantitative Easing program. This is a proposal for serious consideration, given that the transmission of rate cuts hasn’t had a sufficient impact to ease the situation. A limited duration QE can help bring down Government borrowing costs. A bulk of its fiscal deficit is contributed to by the interest cost that the Government bears.

Brazil and China might have turned the corner with regard to economic recovery. India is not alone in facing the slowdown. China doesn’t import as much as it should; it is a drag on global demand. It is a net exporter especially to ASEAN and other Asian countries. The US still remains a source of global demand. The growth rates in emerging countries have therefore fallen short of what was recorded pre-2008 and between 2009 and 2012.

We must separate the long-run (or structural) causes from the proximate (or cyclical) causes. Suppose you catch a flu, the intensity of the attack also depends on your long-run immunity and health. Structural factors do compound the cyclical slowdown. The debate about cyclical versus structural makes us forget that cyclical slowdowns can be an opportunity to address structural deficiencies. There’s a popular saying: Let’s fix the roof when the sun shines. But nobody does that. Neither individuals, nor institutions, nor governments. This is not a phenomenon prevalent only in emerging economies; this is the case all over the world.

So let’s not expect more from our governments when we don’t do enough ourselves. There are structural issues that have placed a cap on India’s potential:

1. Women’s employment in India is only 17% whereas it is about 37% internationally.

2. % of GDP spent on healthcare and health expenditure as % of overall government expenditure are very low. Out of pocket expenditure in India is as high as 60% only matched by Nigeria; China and Brazil have much lower rates. High out of pocket expenditure can tip a family back to poverty.

Education, health, women’s participation in the labour force are some of the structural factors that need to be addressed.

Let’s consider some economic indicators from the recent OECD economic survey:

1. Vacant housing as a % of total dwelling units: India has a fairly high vacancy rate at 12% compared to some developing and many developed countries. The best way to reduce excess supply is to bring down prices. The floor space index is way too low. Singapore, Hong Kong etc. are at much higher levels. It is a state-level subject – Tamil Nadu increased it somewhat modestly, but we have a long way to go.

2. Affordability – India’s real GDP per capita growth in the last 6 years has trailed the growth in real home prices. This is due to the artificial sense of excess demand. In many countries such as China, Turkey, Mexico and Indonesia real GDP per capita growth has outpaced growth in real home prices. The best economic stimulus is to lower prices.

Agricultural statistics at a glance 2018:

Marginal land holdings (less than 1 hectare) constitute nearly 2/3rds of overall land holdings. The average size of land holdings in India was 1.23 hectares in 2005-06; it dropped further to 1.08 in 2015-16.

An 8% growth rate in India is difficult to sustain because we have never recording such a rate for even half a decade without causing the economy to overheat. It has not been possible to achieve an 8% growth rate continuously without high inflation, a high current account deficit or an overvalued rupee. The main reason for this is that we are fragmented and do not have scale efficiencies.  We are well below the optimal farm size; similar is the case with factories.

Fragmentation is evident even in the corporate sector – there is a bulk of companies with paid up capital less than INR 50,00,000. Less than 300 companies have a PBT more than 500 cr. Almost 300,000 companies don’t pay any tax whatsoever. We have a large number of small entities.  To lift people sustainably out of poverty we need to achieve scale efficiencies. Not by resorting to capital misallocation like China has done. But by moving towards the median figure.

Some of the obstacles that lie on this path are:

1. Export performance of textiles: National textiles exports share as a % of world textile exports is below 4% for India. India has stagnated while Vietnam has been able to achieve substantially on this front (6%). Bangladesh has been able to catch up as well.

Why textiles? It is one of the items that require relatively less literacy/skill levels, before the country scales the economic ascent to more value-added products. If we can’t crack this, then it is difficult to crack sophisticated, value-added exports.

Do we have the credit and the savings mechanisms required to achieve this scale (to attain middle-income or higher-income status)? The answer is an emphatic no, because:

1. Banking sector assets as % of GDP is well below S East Asian / North East Asian countries

2. M2 money supply as % of GDP is also low

3. Our credit markets are relatively shallow

4. Banking system needs to become bigger to cater to our infrastructure and investment needs

5. Households savings rate – the Gross Financial Savings of households was 10.9% in 2017-‘18. Net of liabilities it is 6.6%. The E Asian countries had a rate in excess of 20%.

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Person of the year 2019

Navneet-Munot

Contributed By : Navneet Munot, CFA , CIO, SBI Funds Management Pvt Ltd and Chairman, CFA Society India

Person of the year 2019

Like every year, there were several contenders.
The planet recorded its highest ever temperature and the highest decibels on climate change. Greta Thunberg, the young Rebellion against mankind’s Extinction was a strong candidate. How Dare We let the Amazon burn, Venetian alleys flood, Australian bushfires rage and Delhi choke? Odds of a catastrophe may not be Evened by retiring cars, moving the COP 25 from Chile to Madrid or by changing capitals (Jakarta to Kalimantan).

There are a few good signs – EU’s push for a circular economy, democratic candidates’ green new deal, the rise of green parties and innovations funded by the likes of Bill Gates. Christine Lagarde gets full marks for joining Mark Carney in making green finance a central agenda for central banks. For lasting change, we must stop flying private jets to inconclusive Climate conferences. As Yoda says, Do or Do not, there is no try. ‘Chernobyl’ was the highest rated TV show, hope the climate story doesn’t end like that.

Carrie Lam must be lamenting the cost of extradition bill. Hong Kongers are honking loudly, tear gas can’t tear apart their Victorian determination. Dealing with these bulls in China shop may put Jinping in a soup. Events in Hongkong will have repercussion on Taiwan, Tibet and the mainland. China is dealing with a slowing economy, ageing population, leveraged system, tariff troubles and deteriorating international relations. But, make no mistake, China is an 800-pound gritty Gorilla as nimble as a Gazelle with ambitions taller than its Great wall.

Ukraine chose a young comedian as President. Nancy Pelosi pelted Trump for biding with him to stall Joe Biden’s bid. President got a Hunter of impeachment. Trump’s tweets kept markets on tenterhooks. Mocking the Canadian president or UK Ambassador, leaving Syrian Kurds or the Paris agreement, picking a fight with Jerome Powell or Jeff Bezos, dealing with Government shutdown or China, he may look like playing Birdbox challenge, but Don has his dongles dialed to the 2020 elections. Democratic Avengers are searching for their Captain America.

Tiger Woods’ resurrection was as ‘breathtaking’ as Keanu Reeve’s Renaissance. Rafael and Djokovic aced the court. Messi dribbled with Balls of fame. I loved Megan Rapinoe’s roaring calls for equality and Ashleigh Barty’s play on Parisian clay.

Paris saw fumes from Notre-Dame on one side and yellow vests (Gilets Jaunes) coming out on streets. Despite his falling popularity, my macro bet is still on Macron. His manual seems right for Europe. US Scientists revived brain cells of a dead Pig, he can do that with NATO. Multilateralism has been on the wane, we need leaders who are sane.

Boris bore the brunt of judges for bypassing Westminster and boxing his way into a no-bargain Brexit. Now, he is back with a bang in Downing Street, Labor is broken under Corbyn’s feet. UK has entrusted this hairy Tory but negotiation with EU and SNP may not be so hunky dory. Baby Archie brought Pounds of luck, Britain won cricket world cup.

Robert Mugabe, liberator turned dictator, has left an interesting tale. Abiy Ahmed deserves it for infusing a new hope in Ethiopia. Africa needs leaders like him. Jokowi is back in Jakarta while Rajapaskas Dynasty will run the Ceylon tea party.

Despite hazy clouds, equity markets kept dancing like BTS and indices rose like their followers. Commodities are entering the party. Greece and Italy issued bills at negative yields. Forget bulls and bears, even PIIGS made money. Lenders paying bond issuer, what a bonding orchestrated by central banks. Inverted yield curve subverted Fed’s agenda. Japanification of developed world can create risks for pension funds. Hangover of excessive debt is being treated by more monetary alcohol. In a savings glut world, fiscal policy (promoting capex) must take the reins. Building a sustainable economy with new Infrastructure can cure several social and economic ills. I wish Keynes was around.

I thought of John Bogle, the Ironman of capital markets, for being at the Vanguard of democratizing equity ownership. Paul Volcker, the crusader at US Fed and the paragon of public service will always “rule” American hearts.

Ranting investors demitted founder Neumann from Wework’s ofice. Softbanks had a hard time while Uber and Lyft had a tough ride on bourses. Bolsonara’s bytes bite hard, but his reforms have brought a bull market in Brazil’s Bovespa.

Satya Nadella reached Cloud nine with Microsoft making a trillion-dollar Power-point while Tim has Cooked an equally large Apple pie. Google founders had their best moonshot in Sundar Pichai. Can he Doodle the next trillion dollar Alphabet. You bet. Libra didn’t find currency with regulators. Mark my words, public wrath on data privacy issues will continue. Coordination among scientists brought first images of black holes. Tides of de-globalization and cyber risks are dark matters. Ask Jack Dorsey.

Boeing facing turbulent weather deplaned its CEO. United Technologies is uniting with Raytheon. BMS-Celgene and AbbvieAllergen will create new bio-concoctions. Philip Morris’s proposed marriage with Altria went in smoke while LVMH ringed Tiffany. What a Juul!.

MBS & Co saw Yemenis drones hitting their wells and ESG-infected investors not taking Aramco well. Oil apart, Middle east remains one of the boiling flashpoints. Will Smith sings rightly in Aladdin – Arabian nights like Arabian days are hotter than hot.

Texas – a promising oil-field was chosen by Howdy Modi to drill a well of partnership. Rafale jets backfired on Rahul in election WAR as BHARAT voted with Josh – Phir Ek Baar, Chowkidaar. India lost stalwarts like Jaitley and Sushma. Netflix bid adieu to Game of thrones. The ultimate Power (Pawar) game was played in Maharashtra. Legislators shuttled like PV Sindhu. Let’s do 370 prayers and work with an Inner-net to build a peaceful, pragmatic and prosperous India.

The economy needs the boldness and precision of a surgical strike. Rate cuts, liquidity and now operation Twist, RBI is showing its fist to take the economy out of mist. My wish for financial system – May the Shakti be with you. A lot that others need to do what Das Kan’t do. Corporate tax cut makes the cut. RCEP or no-RCEP, Indian businesses should build biceps of innovation and efficiency to be future-ready. With the might of millions of Gully boys, $ 5 trillion could be in sight. I am sure, Apna time ayega.

Nifty axed 12000 walls of worries. Those holding mid and small caps lost their caps. Its’ time for bottom fishing. Telecom’s trunk call got attended. Time will reveal whether Essar deal was a steal for Arcelor. A big leap for bankruptcy process for sure. Yes, stressed financial entities need faster resolution. Naresh Goyal lost a Jet privilege. I sympathize with lenders, crew and flyers. Corporate Dewans need to perk up their CG power (Corporate Governance). Azim Premji’s bequest touched $ 21 billion, I salute his Aseem Prem for society.

I wish the barbarous mindset that wounded us in Pulwama, Khartoum, New Zealand’s Christ Church, Colombo and Congo learns the message of universal brotherhood from sages like Guru Nanak and Gandhi. In a polarized world, bereft of many true leaders, Gandhi remains the glowing lighthouse. His advice on seven sins are as relevant for business leaders, especially against “commerce without morality”. He remains relevant in his 150th anniversary, hence a strong contender.

It has been 30 winters since Capitalism celebrated the fall of the Berlin Wall. Many invisible walls continue to grow taller. Listen to the loud chorus in protests in Hong Kong, Gilets Jaunes, Chile or Extinction Rebellion. Before we criticize our premiers, what about the wall between those corporate moguls who can prevent climate change and the other earthlings who bear the consequences. Would it be long before the protests are at their gates? Millennials and Gen-Z are wired differently. While buying, they care as much about the planet and the people as about the price and product. Marketers, rework your 4 Ps. Thankfully, in 2019, the influential US CEO roundtable turned the tables. Their new bottom line is – it’s not the bottom line alone that matters. Be as particular about the Planet and People as about Profits. Abhijit and Esther’s “Poor Economics” may help companies do as much for sustainable value creation as review of “Project Economics”. Investors are future proofing their portfolios with ESG (Environmental, Social & Governance) screeners. Sustainable investing crossed $30 trillion and counting. Gen-Z will hasten this transition. What their money does is as important to them as what it earns. Investing bulls of tomorrow will charge at GreenBonding, Community-Binding and Values-Abiding businesses.

The glowing story of human prosperity has been written with the invigorating ink of capitalism; communism and socialism were too dull for that. Challenges like rising inequality and pompous populism are testing the tenacity of capitalism. Businesses need societal permit to operate, hence, sense of Purpose will be pivotal to earn profits in perpetuity.

Business as usual will no longer be usual. ‘Capitalism with Conscience’ is my Person of the Year. Standing ovation!

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Session on “Fixed Income Markets-Global Perspective” by Dr. Arvind Rajan, CFA at 1st India Fixed Income Summit, Chennai-2019

Speaker- Dr. Arvind Rajan, CFA, Managing Director, PGIM Fixed Income, USA

Contributed By: Deivanai Arunachalam

Fixed Income Summit3

Arvind Rajan, CFA, Managing Director, PGIM Fixed Income, presented themes from both global and emerging markets. His two main conclusions were:

1. The Global Economy will expand. Growth, although positive, will be anaemic.

2. Interest rates will continue to bounce along the lower range.

Even though rates are low, it will not be an easy ride as markets will be skittish.

Below – excerpts from the speech

Growth and debt outlook

Preservation of low interest rates is crucial to preserve macroeconomic order. Global growth has dropped dismally. PMI (both manufacturing and services) fall is bottoming out. Services have been less weak than manufacturing over the last several months. It is likely that the global economy will bounce back in the next quarter or two.

There has been an increase in global government debt. As a country gets richer, non-financial debt increases. As more countries grow, we should expect to see even more debt.

The trade war has increased stock market volatility. The Fed has been injecting liquidity, though not through explicit QE. The ECB may use firepower to buy assets. Emerging market central banks are expected to buy assets too.

The US is at almost full-employment. Employment levels in Asia are reasonable. And most of Europe’s problems are internal. In my opinion, the global situation has improved. The issue now is the situation of low interest rates, which monetary policy cannot resolve. Without QE, things would have been far worse. Fiscal easing should be the next step. India too will witness fiscal easing.

The turn in demographics also presents a concern. Working age population as a proportion of total population has dropped. And China is fast experiencing this trend. Japan was the first country to witness this trend. As a result the country faces lower growth and lower inflation. An ageing population has fewer propensities to spend; prices are kept under check; workers cannot demand higher wages. Automation augments these trends. Working age population is positive correlated to both inflation and interest rates.

China outlook

China has maintained an accommodative stance. Add to that the loose fiscal policy in Europe. With the natural bottoming of sentiment, economic growth will pick up.

Which factor led to anaemic global growth over the last decade? Export growth from China to Europe which was 5-10% between 2000 and 2010 has fallen to 2-3% in the last few years. While Europe had a major crisis, post the crisis of 2008-09, China has been gradually fading, thanks to extensive protectionism. Overall trade has shrunk and attention is moving towards domestic consumption in China.

There are growth risks in China. Global manufacturing recession may have a contagion to services. There is a possibility of escalation of tensions in Hong Kong/Middle East.

China has engaged in rebalancing for many years – be it from manufacturing to services, from export led growth to domestic demand, resource intensive production to greener means, from being high on leverage to toning it down, moving the focus from investment to consumption and from a Public State Owned-Enterprise system to one with greater private participation. Debt to GDP ratio is at 300% and is increasing. This is likely to exert downward pressure on interest rates.

China’s pains may be India’s gain. Donald Trump views China as a strategic competitor to the USA. A trade agreement between India and the USA can improve the situation for both countries. I see a 70% chance of a trade dealing in the next 2-3 months.

Emerging markets

I expect emerging markets to grow at faster rates than developed countries. Emerging markets will maintain moderate policy rates accompanied by moderate inflation. EM hard currency debt is the second best performing asset class after US equities. Since EM debt is just moderately correlated with other asset classes, it will prove to be a good diversifier. EM spread is still attractive, given the level of credit risk.

EM local bonds have outperformed those of developed countries. Specifically, the duration of Indian bonds looks good.

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2nd Financial Talent Summit – Bengaluru 2019

FTS BLR

Contributed by: Sachin Chopra, CFA

On 14th September 2019, Bengaluru chapter of the CFA Society India was honoured and privileged to host the 2nd edition of the Financial Talent Summit at The Leela hotel. It was a full day event with an impressive array of speakers and moderators which came together to provide insights into important questions facing Finance career professionals especially the ones who are fairly young in their careers.

The key theme and buzzwords for the event were how to make yourself future ready and stand out in this highly competitive environment along with identifying the key opportunities shaping up the financial services industry.

The event began with a presentation from CFA Institute senior leaders on the vast variety of career tools available on the CFA Institute website which support and aide a member’s professional development at various stages of his / her career. This was followed by a 1 hour talk on a very interesting and eagerly anticipated session – Small Actions, Subtle Thinking – Creating Big Impact to Your Career & Life by Eric Sim, CFA (Founder, Institute of Life) who was the key note speaker at the 2nd FTS. There were several points worth pondering over in Eric’s talk. Some of the key takeaways from the session were focusing on developing signature skills for oneself which could help an individual differentiate himself or herself from the crowd. Also, thoughts around personal branding and the qualities which can build our brand – being trustworthy, competent and interesting were very inspiring.

Other speaker sessions focused on themes including building a career in Financial Services industry delivered by Saket Jain (Managing Partner, Vito India Advisors). Saket laid out the facts and data very methodically in his presentation with some fantastic visuals such as the heatmap on the 2018 hiring segments within financial services industry. Also, his ideas around the employment trends and outlook in sectors such as wealth management, insurance, and Fintech were very well received by the members and candidates present in the audience.

Binod Shankar, CFA who is a guest on CNBC gave an inspiring talk on closing the skills gap : how to transform yourself into a work ready professional. He shared many pearls of wisdom on career and life. Some of the notables ones were your past doesn’t determine your future, unless passion is defined and pursued, it’s mostly a soundbite and a very cliched one, soft skills feel soft only on paper … in real life, they are probably the hardest to learn and comes only with time and experience, people hire people and not degrees or CVs or artificial intelligence.

Kashyap Compella, CFA (CEO, rpa2ai) presented an excellent insight into the impact of technology on finance and the future of work. This is an area which has gained significant prominence in the last few years and is something which keeps all of us on a constant endeavour to consistently learn and break new grounds.

To conclude, the 2nd edition of FTS was a grand success and provided everyone with insights and fresh ideas on the changing landscape of careers in Financial Services industry and how to be constantly learning and developing in this age of constant change and churn.

Video Links:

Building a career in Financial Services | Saket Jain, Vito India Advisors : https://www.youtube.com/watch?v=1_i5YI3WYX0

Impact of Technology on Finance: Future of jobs | Kashyap Kompella, CFA: https://www.youtube.com/watch?v=cYdR8R50DVQ

Closing the skills gap: How to transform yourself into a work ready professional? | Binod Shankar: https://www.youtube.com/watch?v=t7OF7HNRUiE

 

 

 

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Full Day Highlights of Value Investing Pioneers Summit(VIPS), New Delhi-2019

Contributed By: Dr. Udai Cheema

Star-studded event with a high impact factor!

Last year, I had attended the 2nd Value Investing Pioneers Summit, highlights of which I had shared in the blog post [Here]. That event was quite a learning experience for me, so when the opportunity presented itself again this November, I was there. After all, who can resist this line up of speakers, take a look;

6

We are talking about 100+ years of cumulative market experience along with assets under management worth billions of dollars. So, not wanting to miss out on such a golden opportunity, hundreds of participants thronged the halls of Hotel Pullman, Delhi Aerocity on the 8th of  November 2019 for the 3rd Value Investing Pioneers Summit.

Here are some of  the key takeaways from the conference;

 

  • Regardless of many gloom and doom scenarios locally or globally over the last four decades, India has maintained a nearly constant nominal GDP growth. He gave a great analogy to explain the importance of that fact;

We are sitting in a boat that is in a river flowing at a steady speed and if we don’t mess up then the river itself will create significant wealth for us.

 

  • First time in the history of India, the inflation rates have stayed at the level of 4-5% over a prolonged period of nearly 5 years. If this is an indicator of things to come then we might have to lower our expectations of market returns going ahead.

 

  • Most of the economic parameters are currently in India’s favor such as inflation, current account deficit, foreign exchange reserves, interest rates but ironically the growth has slowed down sharply due to lower discretionary consumption.

  • The main reason for the consumption slowdown in his opinion is that the white-collar wages in India have de-grown in real terms and over the years there has been a convergence in the average wage of white-collar and blue-collar jobs in India. As a result, the financial savings rate in India has also fallen for the first time in the last ten years. A big chunk of the consumption that has happened in the last couple of years has actually been debt-fueled consumption on the back of EMIs. There is a limit to how much borrowing a society can do, that limit might have been reached in India causing the overall slowdown in the economy.

 

  • In fact, in the 80s India’s per capita income was higher than China but now it is 5 times more than ours. Same is true for wages, wages in China are much higher than those in India. On the other hand, this along with factors such as US-China trade wars and environmental concerns in China have also led to the shifting of global manufacturing base from China to other Southeast Asian countries such as Vietnam, Thailand, Indonesia whereas India was missing out due to higher corporate tax rates but going forward that is no longer a worry as the government has cut corporate tax rates bringing them at par with global averages. A massive domestic market and ample workforce give India an added advantage over these countries.

 

  • In his view, the next capex cycle in India will not be led by the local companies rather it’ll be the global companies that will start the next capex cycle in India. Considering they will enjoy further concessions on corporate tax rate if they commence operations in the next 3 years, it is highly likely that revival in capex is not far. This will lead to the growth rates in India coming back over time.

 

  • India’s market cap to GDP ratio indicates that there is good value in the market at present. When earning yields converge with bond yields, it means one is paying very little for growth which is the present scenario. With the cost of capital/interest rates moving lower, it will have a positive impact on the earnings going ahead improving yields.

 

  • Simply if we remove some of the consumption-oriented stocks from the equation, there is a lot of value in the markets currently. The forward PE of the index which is roughly 15 times can fall anywhere between 20-30% if we are to remove these names. Consumer staples being traded at 50-100 times is unheard of and more so abroad. Even though the markets continue to defy the logic of value but in the past, all excesses, be it 1992, 2000, 2008 or 2017 were curtailed eventually. Also, remember that whenever the markets are overfocused on one area it creates lots of opportunities (value) in other areas, it’s just that long term thinking is required along with patience.

Keep things simple, one doesn’t always have to write a 100-page report to come to a conclusion. Simply apply the right logic and if you find no flaw in your logic then just stay put till the market eventually corrects itself.

 

  • Instant gratification and desire to avoid pain are the two factors that contribute to the emergence of value buying opportunities in the markets. To illustrate this he used the famous example of the Marshmellow test. Here is [Link 1] & [Link 2] to the videos that illustrate the test.

 

  • Momentum is easy to participate in and difficult to stay away from because if one doesn’t then people appear to be earning today whereas you might not be which can be painful. Another tendency that supports momentum is that people simply extrapolate the present into the future which might not be the case. Instead one needs to understand why the business is doing well or badly over the last couple of years and where the business is headed from here on in.  So, buy cheap, increase your understanding of the business over time, keep modifying your views and in the long run, markets are likely to agree with you as they are quite efficient in the long term.

 

  • An interesting hack he mentioned to understand where the exuberance and pessimism stand at the moment is to look at the long term charts of the sectoral indices. On a yearly basis, they will clearly tell you which are the most loved and hated segments of the market. Understand that one cant simply extrapolate the peak earnings of a sector into the future, more so when the earnings have had a boost in recent times due to external ‘one-time’ factors.

Mean reversion is true in life and in the markets. Both good and bad times shall pass.

 

  • The discount of PSUs to the market as a whole has deepened quite sharply in recent times as there are some preconceived notions in the market for these public companies. PSUs are very predictable businesses and fairly easy to understand. PSUs are run under strict guidelines and investments in unrelated areas are quite infrequent. The mortality in the PSU space is much lower than in the private sector. In fact, PSUs in their particular sector are quite dominant franchises.

Not all public sector is bad and not all private sector is good

  • In fact, PSUs are a better paymaster than the private sector as on date which might not have been the case 15 years back.

A major flaw in our thinking is that we tend to generalize by exceptions

  • The media always highlights the outliers and not the averages. Rather than looking at the average salary of Virat Kohli, one should try to find out the average salary of an average cricketer for the purpose of generalization. The more people start working with averages, they are more likely to reach the right conclusions.

 

  • Amongst the PSUs, service-based companies like the ones in the telecom sector or the airlines’ sector are at a significant disadvantage but the resource-based, asset-based, trust-based companies have significant advantages and value. Simply the dividends in some of these companies are at par or even two times the bond yields at present. Also, the announcement of strategic divestments bodes well for this segment of companies.

 

  • Efforts must be made to try and seek out people who have contrary views on a particular idea. It helps challenge the confirmation bias. Documentation, presenting ideas to peers is a great exercise for building a strong investment thesis. One must listen to everyone, evaluate the merits of each argument but in the end make your own decisions as your money is your responsibility.

 

  • Information overload is a problem in modern times. Sifting through all that to reach the info/data that truly adds value has become increasingly difficult. So, work only on your high conviction ideas which according to you have the best chance of delivering superior returns rather than looking at everything.

 

  • Investing at an institutional level can never become fully process driven because in the same institution there will always be a duality of opinion that should be encouraged.

Processes can lead to average outcomes with more certainty but great outcomes in this industry won’t be possible without great individuals.

 

  • One doesn’t always have to be a contrarian while investing. It is all about understanding the business well, figuring out its fair value and how it will move i.e the key drivers and the risks associated with the business. If you prudently invest after figuring out all of that and it happens to be a contrarian call then so be it.

There is a thin line between being early and being wrong.

  • In such a scenario, simply go back and see why things have not played out the way you had anticipated. If you find a flaw in your assumptions/thesis then exit regardless of the price but if you still believe that buying the stock was the right call then have patience and simply wait it out before the market realizes its true value.

If your conclusions are right then it has been frequently observed that the longer the pain period, higher are the rewards.

 

  • There are very few companies that are exceptional in perpetuity. The companies’ termed as exceptional today weren’t viewed the same way 20-30 years back. So there should be a threshold below which investors must not go but one cant stay restricted to buying only exceptional companies. So one must take an objective and pragmatic view on quality and price.

We are in the business of investment and not in the business of buying the best companies, we should aim to make good returns on our capital.

 

  • How to identify a bubble;

1.When everyone wants to buy the same stock. Consensus trades after a while tend to become a bubble both on the upside and downside but sometimes on the downside, they can turn into value bets.

2.Strong divergence from the past.

3. Think about what has led to the current situation.

For example, in the consumption stocks, the earnings growth has not been superior compared to the past. The growth stands out because other sectors have hardly shown growth in comparison but on a standalone basis these consumption names have not grown earnings much but the margins have grown sharply. Most of these companies are sitting at lifetime high margins. So, if one was to break up the returns from topline growth and margin expansion, one will get the answer to the future as the margins can only grow so much and what are we paying at present for that.

Simply try and understand what brought us here and is it sustainable.

  • On the Auto Sector – not sure if the growth is coming back because cars face a challenge of affordability and the two-wheelers market in India has matured. Great value in the sector is not apparent.

 

  • High-interest rates are not the reason for the slowdown in growth. The mortgage rates today are much lower than what they were earlier, so the EMIs have dropped 20-30% but home sales and car sales which should have gone up aren’t doing so. This clearly suggests the issue of affordability as the gap between rental yields and mortgage yields is high in India making the EMI outgo much higher than the collectible rent. As there is a de-growth in the white-collar wages, the real estate has become unaffordable for many which has put the entire real estate sector in jeopardy.

 

Megatrends and Leadership

 

  • Megatrends and Leadership are the two most under-appreciated yet the most important drivers of value and wealth creation in the markets. These are usually overlooked because they aren’t too obvious.

 

  • There are some sectors like private banks that have consistently outperformed the broader indices over the long-term due to some structural (none mean-reverting) changes which we call the ‘Megatrends’ and within these sectors, the top three players have taken up 70% of the market cap of the whole sector establishing their ‘Leadership’. This implies that not only were they large in market cap a decade ago but they have incrementally gained market cap over the proceeding ten years.

The leaders within the megatrend create most value across sectors over many cycles.

  • Megatrends;

– Structural shifts that are long term (30-40 years) and have irreversible consequences for the world around us.

– Picking them requires a broad perspective and narrow focus. One needs to see the big picture but a narrow focus as there are very few true megatrends.

– They reset the rules, throw up opportunities and threats along with new winners and losers.

– They transcend geographies, generations, and governments.

Some of the Megatrends include

  1. IT Revolution
  2. Urbanization
  3. Demographic evolution
  4. Consumption boom
  5. Women in the workforce
  6. Financial deepening
  7. Digital transformation
  8. Unorganized to organized shift
  9. Culling of ‘Dwarfs’ i.e the companies that have not grown due to ‘n’ number of factors despite being in business for the last ten years or more.
  • IT  Megatrend – A case Study : 

– The IT megatrend had a confluence of factors driving opportunity size and longevity such as benign supply-side conditions, fall in the data storage and transit cost, changing demand dynamics with more focus of the west on outsourcing and evolution of innovative business models like global delivery models, offshore dedicated centers, master service agreements, infrastructure management service, etc. This evolution of the business model was necessary to sustain the megatrend. All the three components were necessary to have an IT megatrend in India.

– Once the megatrend is in place, two things are needed to sustain it;

  1. Scalability
  2. Granularity – Eg: Addition of more and more verticals in the IT services offered by top Indian companies. It gives the businesses inherent strength to develop different revenue streams which reduce client dependence and helps in de-risking the business.

– The Concept of Displacement – for any megatrend to reach it’s potential, a lot of displacement is needed. For example, in the early 90s, the IT outsourcing spend by global IT companies was almost zero but now it is consistently 30% of their global spend. It is this displacement from 0 to 30% that has created this opportunity. Within the outsourcing, it’s the offshoring that has driven the profits higher.

– For megatrends to sustain, the sector also needs to show resilience. The IT megatrend persisted through the dotcom crash, through the financial crisis and demonstrated adaptability and innovation with people discussing things like AI, analytics, cloud computing, etc. This has helped sustain and elongate the megatrend.

The concept of resilient value creation: It is difficult for any company to deliver a ROCE more than the cost of capital for a prolonged period of time along with growth that’s higher than the GDP growth over the long term. These two factors are critical for the sustenance of the megatrend and the success of the companies within that sector. The Indian IT sector and its top companies have been able to demonstrate this consistently over a long period of time. Factors such as the size of the opportunity, quality of leadership and scalability have made sure that the outperformance in the industry has continued over the years.

  • Leadership;

– Leadership attributes are more intangible than tangible as they are not always quantifiable. These include;

  1. Culture – most important yet most underappreciated in the investment process.
  2. Strategy and execution – Strategy is quite important but it’s the execution that’s the hallmark of good leadership.
  3. The leaders must be able to demonstrate profitability, scalability, and durability. These attributes contribute to the longevity of the business and its leadership position.
  4. These leading companies are battle-tested through multiple cycles.
  5. They demonstrate resilience and adaptability.
  6. Have prudent capital allocation and capital structure.
  7. Possess depth in management quality and their ability to transition the company into an institution.

 

– Here are some examples of such companies and their key leadership attributes:

 

A) Quantitative attributes

  1. Market share → Asian Paints (53% market share in the paint sector)
  2. Delta Market share → Bajaj Finance (gaining market share on incremental sales)
  3. Least cost player → Shree Cement
  4. Share of profit pool in that sector → Page Industries
  5. Share of cashflows of that sector → Maruti Suzuki
  6. Leadership Durability → Nestle (has sustained its market share in each of its product categories over a long period of time)
  7. Leadership in new segments → HDFC Bank (as and when new segments in the industry emerge, gradually it ranks in the top 3 in each of those segments)

B) Qualitative Attributes

  1. Culture → Titan (besides culture, it has also institutionalized along with management transition)
  2. Innovation → Nestle (at the product level, packaging level, distribution level)
  3. Execution → TCS
  4. Expanding the total addressable market (TAM) → Bajaj Finance
  5. Elongating the competitive advantage period (CAP) → D-Mart
  6. Embracing disruption → Infoedge
  7. Redefining competition → HUL

 

Economic cycles amplify leadership: 

A) Macro perspective of cycles

In each cycle, there is ‘creative destruction’ where the leaders redefine and expand their leadership. These are ‘non-linear’ shifts one cycle after another. Currently, India is going through one of the most acute economic cycles in recent history.

There is a 4D framework of economic cycle drivers:

  1. Debt
  2. Disruption
  3. Displacement
  4. Dis-intermediation

The economic cycle durations are shrinking now, as a result sustaining competitive advantage period (CAP) for companies is also shrinking. This change has huge implications on the investment decisions that we make going forward. It also challenges the valuation multiples of companies.

 

B) Micro perspective of cycles

  1. In each cycle, men are separated from the boys as new challengers emerge to take on the incumbent leaders. So, investors need to make sure whom are they backing and why.
  2. The treadmill speed and incline keeps rising i.e the bar is raised in each cycle. What was good in the last cycle is just not good enough in the next cycle. That’s why managements need to keep re-inventing and redefining themselves.
  3. The value paradigm evolves in each economic cycle.
  4. Value migration accelerates with each cycle.
  5. Each cycle gives the opportunity to expand the total addressable market but only the adapters can take advantage of that.

 

  • How to value megatrends and leadership?

– There is no fixed formula.

– Must value the intangibles and not just the numbers.

– Value is reinforced and magnified through economic cycles. So, the classic value investing strategy of mean reversion will be challenged here.

– The intersection of Megatrends and Leadership is a multi-sigma event. Hence, standard valuation metrics cannot reflect this ‘Outlier’ event appropriately.

– The terminal value impact of megatrends and leadership is disproportionate that cannot be captured in conventional valuation frameworks as it’s an event that’s far in the future.

– Favorable value migration that happens during each cycle is difficult to capture in a conventional valuation framework.

We overestimate change in the short run and underestimate it in the long run – Bill Gates

 

  • How to inculcate these megatrends into your portfolios?

– Focus on 3-4 megatrends in which you have high conviction.

– In each megatrend, identify & focus on 2-3 players who are showing leadership attributes. They may not be clear leaders at that point in time but should demonstrate leadership attributes.

– Among these, classify them into;

  1. Clear leaders – companies that have shown most of the leadership attributes discussed above. They form the bulk of the portfolio.
  2. Near leaders – companies that are not clear leaders but demonstrate quite a few of the leadership attributes. These form the aspirational component of the portfolio.
  3. Emerging leaders – the probability of these becoming clear leaders 15-20 years down the line is quite low, hence they form the high-risk component of the portfolio.

– Market cap is not the criteria while identifying these company, this framework is based on leadership attributes.

– Finally, have a high concentration of these in your portfolio as it should reflect your conviction in Megatrends and the Leadership.

 

  • The concept of Gorilla Investing
  1. There are many monkeys in a jungle and very few gorillas – Rare
  2. Gorillas are outsized as compared to monkeys – Dominant
  3. Gorillas are not challenged by monkeys – Moats and Knights
  4. Gorillas have lifespan double that of monkeys – Longevity
  5. Find the right jungle where the Gorillas live (Megatrend) and then find the right animal (Leadership)

 

– Over time, the portfolio will have few gorillas and some monkeys which one thought would turn out to be gorillas but didn’t. The gorillas over a long period of time will keep outperforming and become a larger portion of the portfolio plus the monkeys once identified will be eliminated from the portfolio in order to invest more into the gorillas.

 

  • It is difficult to correctly value these leaders in megatrends because valuation is done to calculate the price that we are willing to pay today for the value that we will get in the future i.e we are trying to figure out what the terminal value of the business is going to be but in these companies the change in that terminal value is so large that no matter what number you put on valuations today, it will become insignificant in the future. Such companies usually don’t revert around the means, so that makes it difficult for us to value them by the typical valuation frameworks.

 

  • These companies become a sell only when your hypothesis of the megatrend and leadership is at risk. Simply moving in and out of them based on a temporary change in valuations isn’t a prudent strategy.

 

  • Unorganized to organized shift is a megatrend, contract workers/consultants/temporary staffing is a megatrend as the business cycles are shrinking, the frequency of newer business models disrupting the old ones is increasing and automation is on the rise. The need for certain skills might be temporary, so re-skilling or temporary hiring of the workforce will be a major trend going ahead.

 

  • Money managers should say no to misaligned capital i.e the capital which doesn’t concur with your investment philosophy and time horizon.

One rupee of aligned capital is worth hundred rupees of misaligned capital

Your state of mind is your most valuable asset and things such as misaligned capital can disturb your state of mind which might lead to sub-par decision making on your part.


 

Things I believe in & Contrarian approach to investing

  • Key pieces of the puzzle in contrarian investing are;
  1. Works best for cyclical sectors.
  2. Know the counter view on the stock.
  3. Have a grip on the intrinsic value.
  4. Be cognizant of risk.
  5. Careful on leverage.

 

  • When to sell? – Key is to think of it as a switch i.e if you like what you are buying then don’t worry about selling, one might go wrong on the selling as it might go up further but one needs to evaluate it as a switch and not worry about when to sell.

 

  • If an investor spends less time buying/selling and invests more time on sizing and switching, then he would be much better off.

 

  • For a money manager, capital flows will always come at the wrong time which becomes a bit of a problem when the quantum of assets under management is sizable. Here contrarian approach to investing can really be helpful as one can keep adding to the same contra positions regardless of the quantum of the inflows.

Contrarian investing is ‘not’about buying junk just because it’s contra.

  • One needs to be very careful in leveraged stocks while investing via the contrarian approach. This approach works very well in the case of cyclical. Important to know the other side of the trade as to why the other side is selling. We need to have a good handle on intrinsic value and risk. If the investor doesn’t follow prudent risk management strategies then contrarian investing can become troublesome.

 

  • At the end of the day, everything has cycles. At one end, the investor needs to be very careful and at the other end, he needs to be reasonably aggressive. For example, in the last six months, the credit cycle is showing extreme pessimism.

One of the most important aspects of long term investing is your ability to read cycles

One can’t always predict the top and bottom but all that is required is a reasonable judgment of where the cycle stands. Always ask yourself, where we stand in the cycle and whether it’s time to make money or save money at this moment.

 

  • Charts can be a useful tool for contrarian investing as one can use the data to figure out as to how many other people are thinking like or unlike you.

 

  • Common sense is an integral part of the investment process. For example, the small-cap universe was so expensive in January 2018 that it was logical to take some money out of the small caps. Similarly, in 2013, the charts of real estate prices were clearly telling us that it was time to sell real estate. Most of these decisions look sensible in retrospect but it’s useful only when you apply this common sense at the opportune moment.

 

  • According to Warren Buffet, one of the most important things while investing is;

The ability to have cash.

Cash is a residual asset class but an important one. The ability to have cash at the right time is the most important requirement to make big money. Warren Buffet could invest in late 2008 after the crash because he had cash while others didn’t.

  • All big mistakes can be avoided by looking at;
  1. Trailing P/E
  2. Trailing P/B
  3. Trailing price to cash earnings per share
  4. Market cap
  5. Balance sheet quality
  6. IPO/QIP activity in the sector
  7. Dividend yield
  8. Leverage of the company

 

  • In times of extremes, one of the best indicators is Market cap. In 1999, the market cap of Infosys and Wipro combined was Rs 1,07,604 crs whereas that of the entire cement and metal sectors combined was Rs 31,623 crs. In such a situation, one might sell early out of such high valuation stocks but eventually, one is proven right and the shifting should not be a problem when you are getting the entire sectors for the market price of two stocks. Similarly in Dec 2007, the combined market cap of the entire pharma sector in India was Rs 1,31,249 crs whereas that of DLF alone was Rs 1,83,082 crs. Currently, the market cap of top 5 stocks in India stands at Rs 30,84,528 crs whereas the market cap of the entire PSU universe is at Rs 16,81,081 crs. Note that this approach might not work if the company in question is in a disruptive tech sector like Google or Apple but in India, we don’t have companies that are at the forefront of global innovation at scale. Using indicators such as market cap at the extremes might not work over the short term but if the time horizon is five odd years then this concept works really well.

 

  • For wealth creation across asset classes, a simple framework that can be used is the VCTS Investment framework;

V – Valuations

C – Cycle i.e how others are behaving in that asset class

T – Trigger i.e what changes a cycle and it is usually unknown

S – Sentiment i.e whether people are putting money in that asset class or not

The trigger is the most unpredictable factor and that’s why an investor will be better off relying on the other three parameters of the VCTS framework i.e valuation, cycle, and sentiment. When there are low valuations, people are generally scared about the prospects of that asset class. At that time, one mustn’t worry about when the trigger will happen and when it’s the other way around (bubble) then one should simply exit rather than waiting for a trigger that will push the markets into pessimism.

  • Broadly, one can use the following indicators for evaluating the broader equity markets in terms of whether it’s time to be aggressive or conservative;
  1. Price to earnings
  2. Price to book
  3. Market cap to GDP
  4. Earnings yield

Don’t use just one indicator, instead use the above in combination.

 

  • One can use gold and cash as residual asset classes. If credit/debt/equity is expensive like it was last year i.e when nothing is cheap then one can put money in gold.

 

  • For real estate, it has been observed that when the difference between the mortgage rate and rental yield becomes less than 4%, it’s a good time to get into real estate.

 

  • In general, the market cycle can be divided into;

Burst → Best → Boring → Boom → Bubble

Burst = Negative global news, aggressive institutional selling and valuations attractive

Best = Best time to invest as institutions are not buying but valuations are attractive

Boring = Institutions both buying and selling, valuations not cheap (eg: the current market)

Boom = Institutional buying, valuations costly, strong inflows of capital into the market

Bubble = Valuations off the charts, new valuations models emerge which are non-earnings/cashflow based, investors forget the existence of the word ‘risk’.

 

  • For 99% of the people, average ways of investing are good enough i.e do SIP, proper asset allocation, hybrid funds, index/ETF investing. Achieving average returns over a long period of time can actually be a very good thing for the passive investor pursuing a career outside of equities.

 

  • Some of the key traits of an investing person include;
  1. Time management: Most successful individuals know how to manage their time. Reading is one of the most crucial activities for an investor and one must create time for it.
  2. Thinking: People might be able to find time to read but not to think. Investors need to have a separate ‘thinking time’.
  3. Temperament: It takes courage to buy at the bottom and clarity to sell at the top.
  4. Reading: Crucial habit to become a successful investor.

 

  • Some of the well-known truths of investing are;
  1. No decision is a decision.
  2. There will be mistakes as we cant get all the calls right.
  3. Forced selling or buying are good investment/dis-investment opportunities.
  4. One must watch out for ‘hubris’ setting into fund managers as irrational exuberance can affect the best of them.
  5. Money comes to a fund manager till he fails.
  6. There is nothing called consistency in performance, one must strive for consistency in the investment process.

 

  • Hybrid funds are a good option to protect from hubris. Here the fund manager, by default, has to sell when there is euphoria in an asset class and has to buy the pessimism, hence reducing this behavioral misstep. Closed-end funds have an advantage that they just don’t get money whether the market is booming. Credit as an asset class is quite illiquid in India as the investor mentality towards credit is that it should be held till maturity, as a result, it promotes good decision making as you are not looking for a bigger fool. All these options help protect against hubris from creeping in.

 

  • Some advantages of being an investment professional;
  1. The challenge of implementation of your investment theories. The gap between theory and practice is driven by one’s emotions that makes the whole process quite challenging.
  2. There is no age limitation. One can continue as long as mentally fit.
  3. There are multiple ways to make money in the long run. We need to keep refining our ways based on thinking and introspection.
  4. Over the short duration, there is no correlation between competence, capability, and alpha generated.
  • Some things to ponder over;
  1. Can one’s weakness/biases go away?
  2. Can you keep on learning as you age?
  3. Managing public money has its own challenges and you need to continuously ask yourself whether you are doing the right thing for your investors.
  4. Handling irrationality in the market is crucial.
  5. Short term performance is never driven by process.
  • Investment Professionals to follow;
  1. James Montier – for his contrarianism.
  2. Howard Marks – for his understanding of the cycles.
  3. Michael Mauboussin – believes in pre-mortem rather than post when it comes to investing.
  4. Atul Gawande – the importance of checklists and improving their implementation quality.

After his presentation, S.Naren and G.Maran took to the stage for an insightful 20mins discussion, Bloomberg Quint has shared that video on their Twitter account. Click on the [Link] to watch.


 

The Journey

  • Credited for being one of the early discoverers/investors of Infosys, HDFC, Concor, Ambhuja, Tata Motors, Hero Honda and BHEL. He is an investor with multi-disciplinary interests who left the institutional money management profession at the peak of his career to set up a boutique firm of his own and pursue his other interests.

 

  • His three mentors are Michael Milken, Barton Biggs & Julian Robertson. According to Vinod, Julian is a great listener and one of the sharpest guys in the room. He recollected one of the quotes by Julian from when he met him for the first time and told him that he had some investment ideas to share;

In a bull market who needs research and in a bear market who can afford research

  • He shared how in 1993 when the IPO of Infosys came, there were not enough people to buy the 13 crs issue. When he met Narayan Murthy for the first time, the business model made sense to him and found the team at Infosys quite humble. They ended up picking up a large stake in the IPO. At that point in time, they thought that Infosys will do well but no one had thought that it will turn out to be what it has.

In life, everything is unbalanced as it goes into excess on one side or the other

  • For him, Brijmohan Munjal of Hero Honda is a testimony to the entrepreneurial spirit of India. He started the company when he was 69 years old. When they invested in Hero Honda, the market cap of the company was barely 40-50 crs. His humble demeanor and the passion for his business made Mr. Munjal stand out. The way he transformed the lives of thousands of people was evident from the level of respect he got from his colleagues, factory workers, and dealers alike. Besides great management, other reasons for buying Hero Honda were that Honda had more than 50% market share in every market they entered globally then why would that be any different in India. The contra stance on Hero Honda was that most people in those days did not believe that motorcycles would replace scooters in a big way but Vinod and his team firmly believed that it will happen. Hence, they picked up a large stake in Hero Honda.

 

  • When he identified HDFC, it was trading at 1-2 times earnings and his thesis was that people will need mortgage going ahead as more and more Indians were buying homes but nobody seemed to be interested in the stock. He met the management and liked what he saw and ended up investing in HDFC. While analyzing a mispriced security, one question that the money managers often grapple with is ”whether you are stupid or the market is stupid ?”. Similar was their situation when they were thinking of buying HDFC trading at 1 times earnings. Finally, the reason that he figured out was that markets in those days loved hard assets, so no one was interested in businesses like Infosys & HDFC.

 

  • Wipro was their biggest miss. So much so that in the mid-90s, Azim Premji had written personally to them to come and visit Wipro but, unfortunately, they gave it a pass.

 

  • Had always believed that a day will come when we will enter ‘Satyug‘ in the Indian markets and with all the corporate misgovernance being severely dealt with of late, it seems to have arrived. Markets are impatient now to clear out the garbage and this will lead to a much healthier corporate ecosystem going ahead.

 

  • In an emerging market, being overweight on real estate and gold as an asset class is a ‘poverty mentality‘, simply because you can touch it and see it makes you feel wealthy but that doesn’t necessarily make it a better investment. Simply by borrowing at 8-10% for a rental yield of 2-3%, you are setting yourself up for an inferior investment return. Real estate prices in India are simply too high to give a decent yield.

 

  • Formal education is necessary but not a sufficient condition for success. Life isn’t so linear that one goes to school then college and finally he has arrived, it doesn’t work that way. Education doesn’t teach you things like hunger, leadership, courage and other intangible things needed to succeed in life. The Internet has democratized knowledge in a big way, so the necessity of having a formal degree for learning/acquiring new skills isn’t true anymore and with broader/easier accessibility of knowledge, the competition in various fields will also become more intense going forward.

 

  • Reading annual reports help an investor hone his investment skills. While reading the annual reports especially the financials of a company, one should try to imagine how the stock would have performed over the last 10-20 years based on its fundamentals. As you start practicing that more and more, you will notice that your predictions about the past performance of a company start moving closer to reality over a longer timeframe. Get into the habit of speed reading and try to finish off an annual report in 30 mins & know the key points in it.

 

  • As an investor, one needs to divide his time broadly into 4 activities;
  1. Staying up to date with the markets and what they are doing.
  2. Reading and doing research
  3. Thinking and introspection
  4. Meeting people from diverse backgrounds and having focused discussions with them in such a way that it adds value to both.
  • Fundamentally, investing a one-man game but sharing/brainstorming ideas with like-minded people is important. Buffet would not have been Buffet without Munger, he made Warren a better investor.

 

  • One must also read the history of the global financial markets for it offers some great lessons. One should look at investing both top-down and bottom-up.

 

  • With advancements in technology and the power of social media, one would have thought that easy/timely access to information would have made our lives better but it turns out that we have actually moved from a period of lack of information to a period of ‘stupidity’. The amount of disinformation and the lack of analysis have increased. Silverlining is that this state of affairs is good for sensible/patient investors as this phenomenon has lead to the formation of ‘herds’ swinging collectively to both extremes and therein lies the opportunity for an intelligent investor.

 

  • More than books, an investor must spend time listening to one’s inner voice, intuition, and analysis. Introspection can lead to a stage where you will be able to cut through the noise and hopefully the markets will start whispering to you. Spirituality can help investors quieten the mind, get control over emotions and stay level-headed in tough times. Outside of investing, one can read a good translation of  Lao Tzu’s Tao Te Ching as it tells us how the world works. Also one can read Yogavasishtha, these are the lecture notes of Ram’s education.

 

  • It’s important to meet the management in order to know the people behind the company. Sometimes, the managements are delusional about what they can do and one can only get to know that by meeting/talking to them. While doing scuttlebutt rather than listening to what the management has to say/forecast, see if there is continuity between what the management is saying and what’s real. Look for evidence of a well-run company with humble individuals and good work/corporate culture i.e focus on the intangibles, so to speak. Try to figure out whether the team has what it takes to build, scale & sustain a great company.

 

  • Sell good to buy better, should be the mantra behind selling decisions. Be skeptical when your entire portfolio is doing well, it’s healthy to have 70% of the portfolio doing well and the other 30% not so much. In a portfolio, moderate diversification is the way to go. One cant start off being concentrated but gradually as the management teams execute then one can think of concentrating but still not too much because no one knows the future. Humility in the markets is a great attribute to have for an investor.

 

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