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;

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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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Session by Mr. Vinod Sethi at Value Investing Pioneers Summit(VIPS), New Delhi-2019

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Contributed By- Jyoti Soni, CFA

The last  session at the third Value Investing Pioneers Summit was conducted as a tête-à-tête between Mr. Vinod Sethi, ex. MD and CIO of Morgan Stanley India and Mr. Durgesh Shah of Flame Investment Lab.

This was a unique session in a sense that the speaker did not give a presentation. Instead a presentation was prepared by moderator Mr. Durgesh Shah on investment journey of Mr. Sethi. Mr. Shah quizzed Mr. Sethi about his investments, philosophy behind making those investments, investing mistakes, his gurus in the market, experiences which affected his personal and professional behavior etc.

Mr. Durgesh Shah introduced Mr Sethi as an unusual visionary investor and a multi-faceted person. Mr. Sethi did his graduation from IIT Mumbai and his MBA from Stern University with a scholarship. In the 1980s, Mr. Sethi was one of the youngest fund managers when he started working with Morgan Stanley.  Currently, he is  chairman of KCP Sugar and manages his own investments.

In his stint as an investor, he bought anywhere between 5-15% of stock in companies like Infosys, Hero Honda, Hinduja, Concor, Tata Motor etc. when no one was interested to touch these stocks. He has a terrific record of accomplishments in his investing career with his multidisciplinary thought process.

He worked in Morgan Stanley as a Managing Partner till late eighties. He had a fabulous career and splendid performance as money manager at Morgan Stanley. He treated Morgan Stanley as a training platform and learned a lot. After finishing the most exhaustive part of his career stint, he decided to leave Morgan Stanley in order to discover other facets of his life. Valuations of Morgan Stanley at that time aided to his decision as the share was trading at six times its book value and he monetized his ESOPs at the right time. He was the largest private sector fund manager when he left his job at Morgan Stanley in his 30’s.

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His investment decision making and lifestyle was influenced by three mentors in his early career. Lessons learnt from these mentors/investors helped him to become a well alert and humble human being, great analyst and money manager.

  • Michael Milken, the junk bond king of 1980s
  • Barton Biggs, chief of Morgan Stanley till 2008
  • Julian Robertson, known as a tiger, a client and shareholder of Morgan Stanley.

Mr. Vinod Sethi has always had a knack for recognizing the great futuristic entrepreneurs. He believed in their ventures and missions before most others in the market. Mr. Shah specifically probed him about his investments in Infosys, Hero Honda and HDFC.

In early 1990’s, he made investment in Infosys when most of the fund managers were not able to realize the power of IT industry and software services exports. At a time when the focus was on hard assets on the balance sheet, this was a company which did not have much of the hard assets except few computers and furniture with rented office building. Infosys valuation jumped to 5 times within a short span of two years of his investment.  His high conviction in prospects of Infosys was on display when he made another big investment in a preferential issue of Infosys which came after 2 years at a price 5 times higher than his initial investment.

Other unconventional example of his investment style was a motorcycle company, Hero Honda, when scooters were ruling two-wheeler space and motorcycle was not a preferred two-wheeler. Hero Honda was started by Mr. Brijmohan Munjal when he was in his late 60’s. Wherever Honda was selling its product in the world, they had around 15% market share at that time. Hero Honda was available cheap at that time as people thought motorcycles don’t have a future.

Mr. Sethi shared an interesting story as to how he came to know about HDFC. One analyst came to his office with one-page summary of many companies and one of them was HDFC. That time HDFC was trading at 1 or 2 times earning and no one seemed to like it. His thinking behind investing in HDFC was that the country is homeless, and mortgages as a business will pick up.

His acumen to understand the future trends in an industry and high conviction in his ideas resulted in building of an exceptional portfolio.  He never thought that these companies would become so big and neither did the owners/promoters of these companies, but he was sure of making decent returns.

He never believed in the idea of investing in traditional investment assets like gold and real estate. He believes that what is the point of investing in an asset class where your returns are lower than your cost of borrowing.

Mr. Sethi believes that formal education is a necessity but not sufficient. He believes that education doesn’t teach you about hunger, relationship, courage, inner voice – listening to yourself, feel the present moment and many other aspects. There are many other aspects and skills which one requires in investing business and daily life. “While a degree certainly helps, it is no insurance policy. it might get you through the door, but you have a whole life to face. One can be rendered irrelevant if he or she doesn’t keep himself or herself up to date”, he says.

Mr Sethireads at least one annual report a day. He might read an annual report of a private company in Europe where he won’t be even able to invest. According to him, an annual report is a summary of collective human effort. Hence, it shouldn’t matter what annual report you are reading. One makes money where one sees financial efficiency, an alchemy or something stands out. There is no need to read an annual report to the last line. Over time one can develop sense as to what to read and what not to read. Also, according to him, speed reading helps.

Mr. Sethi likes to keep half a day of his schedule open to meet people. He is not focused on meeting business people alone; he will meet any one from any field. Meeting people is not about cocktail party or dinner party and just floating around . Having a focused conversation really helps and expands one’s horizon. Only way to meet very smart people is by making yourself very smart. No one would give you time unless you give more than they gave you. If you start every meeting thinking I must give more than what I am expected to gain, then you achieve a very high level of evolution at personal level.You make the world a better place and give someone food for thought. Additionally, he stated that three things are a must do for a good investor:

  1. Pay attention to the Market: He emphasized on deep understanding of market phenomenon.
  2. Read & Research: He opined that speedy and attentive reading is necessary for a money manager. One should read an annual report daily and should take not more than 30 minutes for this. Quick and accurate analysis of company’s financials and performance is key to taking the right decision.
  3. Introspection: One should give time to oneself for self-discovery. One should understand one’s strengths & weaknesses, passion and priorities in life.

When the attack of 26/11 happened, Mr. Sethi was present at the Taj Hotel. He realized during the attack that what we call fear and nervousness, we can only afford that in a movie theatre. In real life, that is not an option. In such situations, you either stay rational and come out of it or get knocked up. Another thing he learnt during this experience is remarkable ability of human beings to survive.

He believes that investing is a combination of teamwork and individual efforts. Basically, it is a lone ranger game but having like-minded people who share and discuss ideas can really help.  .

Mr. Sethi, then, went on to answer a few questions from audience before ending the session.

Link to the complete presentation- Vinod Sethi – 08.11.2019

 

 

 

 

 

 

 

 

 

 

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“Some thoughts on Investing” by Mr. Prashant Jain at 3rd Value Investing Pioneers Summit(VIPS),New Delhi-2019

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Speaker: Prashant Jain, CIO, HDFC AMC

Moderator: Rajeev Thakkar, CIO & Director, PPFAS Mutual Funds

Contributed by : Udai Cheema

Star-studded event with a high impact factor!

Last year, I had attended the 2nd Value Investing Pioneers Summit. 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-

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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 first session of 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.

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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 over focused 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.

 

  • 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.
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Session on “Learnings from My Investment Career” by Mr. Sankaran Naren at the 3rd Value Investing Pioneers Summit(VIPS), New Delhi, 2019

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Speaker: Mr. Sankaran Naren, ED & CIO at ICICI Prudential Mutual Fund

Moderator: Mr. G. Maran, Executive Director, Unifi Capital

Written by: Shagun Thukral, CFA

Mr. Sankaran Naren, CIO at ICICI Prudential Mutual Fund, spoke at the post lunch session at CFA Society India’s Value Investing Pioneers Summit in New Delhi.

Naren’s was an enlightening session as he spoke about his investment style, philosophy and  learnings  through the course of his long and illustrious career in the investment management. He covered a broad spectrum of topics ranging from essentials of investing, his contrarian style, understanding cycles, key metrics for stock picking, wealth creation and limitations of investing.

Naren started with the basics of investing which according to him comprised of – buying, sizing and selling. He made an astute observation – “if one was to look at available literature, 90% of it was focused on buying, when in reality more time should be spent on sizing as well as selling decisions”. He also shared a behavioural hack with the audience – since it is difficult to take a ‘sell’ decision, one should evaluate these decisions as a ‘switch’ – assuming one is always selling to buy something else. This makes it easier to take such decisions. Naren has often been associated with the Contrarian style of investing. He said that since he manages large portfolios, a contrarian style suits him well. Mutual funds get large amount of inflow in bull markets when other investors are shunning what is not popular. This gives him a chance to pick these investments at attractive prices and in large volumes.  According to him, contrarian investors should be careful on leverage as wrong timing in a leveraged contrarian trade can prove to be disastrous.

Naren said that contrarian investing works best in cyclical sectors (as these sectors are prone to mean reversion). He also emphasised on knowing the counterview on the stock, having a grip on the intrinsic value of the stock and doing appropriate risk management.

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Naren said that when it comes to investing, he believes in three things – Cycles, Charts and Common Sense.

He explained that markets go through cycles because of investors’ irrational behaviour. However, these cycles also give smart fund managers opportunities to buy and sell He also advocated the use of charts before a buy/sell decision for the primary purpose of understanding how many people have the same thought process, e.g. if many people are thinking like you, it may not be good trade as it would have already affected the price.

The next big learning shared by Mr. Naren was the importance of taking a cash call. Although cash is often considered a residual asset class, the importance of holding cash was highlighted during the 2007-09 period as the global financial crisis unfolded. Only those investors who had some cash could utilise the opportunity available and it helped them to recover quickly from the drawdown.He advised that if everything is expensive then invest in gold or cash. If everything is cheap, then keep nothing in cash.

Naren then moved on to discussing key metrics that he considers important while picking stocks. These included the trailing P/E, P/B, P/cash earnings ratios as well as market cap, balance sheet quality and IPO/QIP activity in the sector. Specifically, he felt that comparing the market capitalization of stocks, sectors etc had served him well in the past as it helped identify extremities in the market. He explained this with several examples.

In 2007, the market cap of DLF was greater than the entire pharma sector put together, indicating a clear sell in the stock in hindsight. In 1999, at the height of tech rally, the combined market capitalisation of Infosys and Wipro was 3x of combined market cap of some leading metals and cement companies. He even pointed out how currently (Sep ’19) market capitalisation of HUL was higher than combined market capitalisation of top 10 pharma companies in India.

For wealth creation, Naren follows the following framework (VCTS) : Valuation (the data)-Cycle (how others are behaving)-Trigger (the event)- Sentiment (the flows). Of these he believes that valuations are the easiest whereas identifying the trigger is the toughest (as these are not knowable and controllable). Ideally if the other three (VCS) are in place, one must act and not wait for the trigger.

Given his thought process and investment philosophy, Naren finds it difficult to buy high trailing P/E or high market cap stocks which at times leads him to miss growth sectors. He also tends to avoid stocks that have consensus among fund managers.

Naren then highlighted the key traits required in a person who wants to succeed in investing These include: 1) Time management 2) Thinking 3) Temperament 4) A habit of reading,

In conclusion, Mr. Naren shared some ‘truisms’ that budding investment managers may keep in mind. These were as follows:

  • Hubris is a reality – use hybrid funds, credit funds, close ended funds and avoid leverage to deal with this
  • No decision is also a decision
  • There will be mistakes and it is not possible to get all calls right
  • Money comes to a fund manager till he fails (Success leads to more inflows, which makes managing tougher and tougher till one fails)
  • Nothing called consistency in performance, only in processes
  • Forced buying or selling are good investment/disinvestment opportunities

The session was extremely well received and Naren went on to address several questions from participants as well. During the QnA , he stressed on the need to follow a transparent and responsible fund investing. He also advocated on being an ‘unemotional’ fund manager as it helps in taking key decisions like not giving buy calls all the time.The mutual fund industry is sometimes criticized on being over diversified but Naren cleared the air that diversification is a function of the size of fund one manages and the big mutual fund houses are bound to be well diversified. Lastly, the speaker opined that ” The challenge of investing is the ability to take a process and religiously follow it on a continuous basis”.

Link to complete presentation-S. Naren – Presentation

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Session by Mr. Utpal Sheth on “Megatrends and Leadership” at 3rd Value Investing Pioneers Summit(VIPS) , New Delhi 2019

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Speaker- Mr. Utpal Sheth, CEO of Rare Enterprises

Moderator- Prof. Sanjay Bakshi, Managing Partner, ValueQuest LLP

Contributed By : Parvez Abbaz, CFA

The Delhi Chapter of the CFA Society India successfully organized the Third Value Investing Pioneers Summit on Nov 08, 2019 at Hotel Pullman in Aerocity, New Delhi. The financial industry veterans addressed the jam packed gathering of seasoned and budding professionals, who came from all corners of the country. Those present at the conference had the privilege to listen to Mr. Utpal Sheth – CEO of Rare Enterprises and one of the most respected value investors in India – for the first time ever at a public forum. The topic of his presentation was ‘Megatrends and Leadership’. According to him, these two are the foremost determinants for value and wealth creation.

Mr. Sheth started the presentation by sharing his learnings from market history. There are sectors like consumer durables, cement, FMCG and private banks that have consistently outperformed broader indices over long-term due to structural changes or megatrends. Top 3 companies in these sectors (in terms of market cap) have constituted more than 50% of the market cap of the sector on a sustained basis. In fact, they kept rising inexorably over long-term (leadership). On an incremental basis, these companies created most value across sectors over many cycles. These formed the basis of his presentation.

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He then explained that megatrends are structural shifts that are longer term in nature and have irreversible consequences for the world around us. They transcend geographies, governments and generations. They throw new opportunities and threats and bring about new winners and losers. Some of the megatrends over time are:

  • IT revolution
  • Urbanization
  • Consumption boom
  • Women in the workforce
  • Digital transformation
  • Unorganized to organized sector shift
  • Demographic evolution

He further explained megatrends through the case study on Indian IT sector. The change in the management thought process to focus on core competencies led to evaluating the possibility of outsourcing. This led to plethora of offshoring opportunities and the opening of offshoring delivery centres. The decline in network and storage costs further provided impetus to the IT sector. IT budget as a % of revenue across sectors has remained in the 1% to 6% range. Indian IT market share in global IT services spend rose from 2.2% in FY04 to 13.0% in FY19. Indian IT successfully broke into newer verticals like Healthcare, Energy & Utility and Hospitality besides BFSI, manufacturing and telecom. Offshoring kept on increasing and accounts for roughly 70% of total revenue of Indian IT giants like TCS and Infosys. Mr. Sheth took data for the past 10 years to depict how TCS and Infosys have managed high ROCE consistently. The top 4 Indian IT companies’ revenue growth has remained higher than the global GDP growth in the last decade. He explained how the IT giants managed to achieve these because of excellent leadership, continuous innovation and scalability.

Mr. Sheth emphasized that leadership attributes are both qualitative as well quantitative. He gave examples of quantitative attributes of leadership like market share (Asian Paints), least cost player (Shree Cements), share in cash flows (Maruti Suzuki), elongating competitive advantage position (D-Mart), leadership in durability (Nestle) and leadership in new segments (HDFC Bank). Some of the examples of qualitative leadership attributes are culture (Titan), innovation (Nestle), embracing disruption (Info Edge), redefining competition (HUL).

To value megatrends and leadership, it is important to value intangibles. The intersection of megatrends and leadership is a multi-sigma event and valuation metrics cannot reflect this outlier event appropriately.

He then advised on the portfolio management for megatrends and leadership. One should focus on 3-4 megatrends with high conviction. In each megatrend, focus on 2-3 players with leadership attributes. From the above list, classify them as clear leaders (major component of the portfolio), near leaders (inspirational component) and emerging leaders (high-risk component).

In his closing remark, he explained the approach of megatrends and leadership through the concept of gorilla investing. There are many monkeys in a jungle but few gorillas. Gorillas have double the lifespan of monkeys and are not challenged by them. One has to find the right animal (leadership) in the right jungle (megatrend).

The Q&A session was moderated by Prof. Sanjay Bakshi, Managing Partner, ValueQuest LLP. The questions revolved around identification of megatrends and leaders. What is perceived as a megatrend in one country may or may not get replicated in other countries. On being asked if government policies play a role, he said that they might accelerate or decelerate the shift in the short-term but not in the long-term. For budding professionals with limited capital, Mr. Sheth advised that there is no harm in starting small. There is no set formula and one is bound to make mistakes but it is important to learn from those mistakes and not repeat them.

Link to complete presentation- CFA Society – Megatrends and Leadership – November 2019 – Delhi

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