EXECUTIVE SUMMARY
|
Dear Fellow Investors
Needless Prudence?
Financial markets continued their unbridled rise in this quarter as well. In India, NSE Nifty 50 stands 12.5% over its pre-Covid high. In less than 10 months, Nifty has seen 40% unidirectional fall from top – fastest ever, and then 86% almost unidirectional rise from the bottom.
Today, of ~1600 actively traded companies on the NSE, 1155 companies are trading over their pre-Covid highs, 802 companies are trading at 20% over their pre-Covid highs and 467 companies are trading 50% above their pre-Covid highs.
Frankly, we are surprised by this ferocious one way rally. Like insurance premiums that seem unnecessary costs when insured events (accidents) do not happen, our cautious stance has been found unnecessary, so far.
India was already slowing down even before Covid-19 hit. The coronavirus has surely affected incomes of many people which should further add to the slowdown. And yet broader Indian indices are up 12%-14% from their pre-Covid highs.
Liquidity, and not fundamentals, justify large part of this rally. As per one estimate, 20% of entire US money supply has been created in 2020. Completion of US elections, and beginning of Covid-19 vaccination drives has further improved the sentiments. Global inflation and interest rates remain near zero and central banks worldwide continue to print money. Rising tide of abundant money, thus, continues to lift all boats including equities.
Many pundits have been wrong about reversal of global liquidity and inflation in last decade and we have no special insight to add on this difficult matter. Liquidity may or may not reverse and inflation may or may not arise in next decade. We don’t know. Nonetheless amidst this dilemma, we continue to stick to enduring investment basics – trying to own durable businesses which look reasonably priced even for higher interest rates (interest rates have inverse relationship with equity value.). They will benefit if interest rates remain low and liquidity conditions benign. But should inflation resurface and easy liquidity reverse, these will not turn out to be expensive buys. While this limits our universe, it protects us from overpaying. Cautious stance stays.
A. PERFORMANCE
A1. Statutory PMS Performance Disclosure
| Portfolio | FY 2021 YTD Dec’20 | FY 2020* | Since Inception* | Outper-formance | Avg YTD Cash Eq. Bal. |
| CED Long Term Focused Value (PMS) | 44.3% | -9.5% | 30.5% | 26.2% | |
| NSE Nifty 500 TRI (includes dividends) | 65.8% | -23.6% | 26.7% | 3.8% | NIL |
| NSE Nifty 50 TRI (includes dividends) | 63.8% | -23.5% | 25.3% | 5.2% | NIL |
| *From Jul 24, 2019; Note: As required by SEBI, the returns are calculated on time weighted average (NAV) basis. The returns are NET OF ALL EXPENSES AND FEES. The returns pertain to ENTIRE portfolio of our one and only strategy. Individual investor returns may vary from above owing to different investment dates. Annual returns are audited but not verified by SEBI. | |||||
For the nine months ended December 2020 our NAV was up 44.3%. NSE Nifty 500 and Nifty 50 were up 65.8% and 63.8% respectively. During last nine months, we were invested in equities, on monthly average basis, to the extent of 73.8%.
Our higher than usual weight of cash equivalents, especially in portfolios of clients onboarded on or after September 2020, is the result of lack of margin of safety in the prices of securities that we track. Our incentive structure remunerates us for results – not size, not activity. And this makes us extremely focussed on protection of capital.
In a breakneck rising market like current one, this can hurt temporary returns. However it allows us to control risk in an uncertain world. While regulations require us to benchmark and report our relative performance quarterly, our attention remains on absolute returns.
A2. Underlying business performance
| Period | Past twelve months | FY 2021 EPU (expected) |
| Earnings per unit (EPU)2 | Earnings per unit (EPU) | |
| Dec 2020 | 5.11 | 4.0-5.03 |
| Sep 2020 (Previous Quarter) | 5.2 | 4.0-5.0 |
| Dec 2019 (Previous Year) | 5.8 | |
| Annual Change | -12.1% | |
| CAGR since inception (Jun 2019) | 0.1% | |
| 1 Last four quarters ending Sep 2020. Results of Dec quarter are declared by Feb only. 2 EPU = Total normalised earnings accruing to the aggregate portfolio divided by units outstanding. 3 Please note: the forward earnings per unit (EPU) are conservative estimates of our expectation of future earnings of underlying companies. In past we have been wrong – often by wide margin – in our estimates and there is a risk that we are wrong about the forward EPU reported to you above. | ||
Trailing Earnings: Trailing twelve months’ Earnings per Unit (EPU) came in at Rs 5.1, lower 12.1% over last year and flat versus last quarter (including effects of cash equivalents that earn ~5%). In comparison, the adjusted earnings of Nifty 50 and Nifty 500 companies fell by 10.7% and 15.0% respectively in the same period (source: Capitaline).
1-Yr Forward Earnings: We continue to expect FY21 earnings per unit of our aggregate portfolio to close between Rs4.0-Rs5.0 per unit.
A3. Underlying portfolio parameters
| Dec 2020 | Trailing P/E | Forward P/E | Portfolio RoE | TTM4 Earnings Growth | Portfolio Turnover1 |
| CED LTFV (PMS) | 25.6x | 26.1x-32.6x | 18.1% | -12.1% | 5.9% |
| NSE 50 | 38.5x2 | – | 11.2%3 | -10.7%3 | – |
| NSE 500 | 43.4x2 | – | 14.7%3 | -15.0%3 | – |
| 1 ‘sale of equity shares’ divided by ‘average portfolio value’ during the year to date period. 2 Source: NSE. 3Source: Capitaline. 4Trailing Twelve Months | |||||
B. DETAILS ON PERFORMANCE
B1. MISTAKES AND LEARNINGS
A cautious approach in a rising market can look like a mistake if judged over a short time frame. Conversely – and history is a testament- rising markets can be the breeding grounds for future mistakes. When our and investors’ hard earned money is involved, it’s okay to err on the side of caution in the above dilemma. Underperforming in a rising market temporarily and looking stupid is the small price of long term safety. Jury is still out whether our current cautious stance turns out prudent or foolish.
From our two past mistakes- “Cera Sanitaryware” and “2015-16” – we learnt that unless fundamentals are extremely compelling, it is better to be gradual in selling and buying respectively. From our past mistake on “Treehouse Education” we have learnt that bad management deserves a low price, it’s seldom a bargain. In Dish TV we underestimated the competitive disruption but thankfully sold at breakeven. Tata Motors DVR taught us that cyclical investing requires a different mindset to moat investing and one needs to be quick to act when external environment turns adverse. In Talwalkars, we learnt that assessing promoter quality is a difficult job and we should err on the side of caution irrespective of how cheap quantitative valuations look. From DB Corp we learned that industries in structural decline will fail to get high multiples even if the industry is consolidated, competition limited and free cash flows healthy.
B4. FLOWS AND SENTIMENTS
US election results and vaccine announcements have augmented flows and sentiments towards risky assets including equities. Some signs of crazy behaviour have started surfacing. Deals are getting done at valuations that don’t make sense. While we are not concluding that everything is going nuts, such incidences point to building up of optimism that ultimately fuels bubbles.
Global primary markets have heated up significantly. As per Refinitive, over 770bn$ worth of equity funds were raised by non-financial firms in 2020 worldover, the highest ever. Renaissance Global IPO index was up 81% in CY2020 vs MSCI’s all-country equity index that was up 14%.
Listing pops– the first day rise of newly listed companies – have become a daily news. DoorDash which had private market value of 2.5bn$ few years ago, jumped 85% on listing day to 60bn$ market capitalisation after raising its IPO price twice. AirBnb closed the listing day 110% up to market cap over 100bn$ (despite travel restrictions in Covid). In Asia, JD Health rose 50% on its listing date in Hong Kong. Recently listed Nongfu Spring, China’s mineral water company, made its founder the richest man in Asia. Chinese toymaker Pop Mart International registered 112% listing gain. In otherwise sombre and conservative Japan, Balmuda – a premium toaster maker – rose 88% on listing day.
Electric car maker Tesla is up 10x since Nov 2019 and is now a part of S&P 500. It now has a greater market cap than the sum of all the other U.S. European, and Korean automakers put together who sold approximately 100 times as many cars as Tesla did in 2019.
Private companies are not lagging behind in optimism either. In June 2015, there were a little over a hundred private companies worldwide with a valuation greater than US$1 billion. Today, over 500 companies are a part of this club of unicorns.
Back in India too, we can see initial signs of exuberance. Fear of US dollar depreciation owing to unprecedented dollar printing and an increase in weight of India in MSCI index from 8.1% to 8.7% led to record foreign inflows in Indian equities. In the December quarter, foreign portfolio investors (FPIs) have bought stocks over 18bn$ (over Rs.1.3 lac cr.), highest ever in a quarter.
Indian primary markets are heating up as well. Burger King and Mrs. Bector Foods IPOs were subscribed over 150x and jumped 100% each on listing day. The 15 IPOs of CY 2020 were oversubscribed, on an average, to the extent of 75x with average listing pop of over 35%, highest in last decade. Only 13% of the proceeds went to the companies, rest was offer for sale by existing investors including smart private equity investors. Thirty two (32) new fund offers (NFOs) were launched by mutual funds between August and December, one of the highest ever. In December alone, mutual funds are estimated to have raised INR 8000cr through NFOs.
Retail participation in Indian markets is rising. 8 million new demat accounts were opened in 8 months (April-Nov) this year, twice the number of accounts that were opened up in full FY20. Retail holding in listed companies has touched an 11-year high at 7%, as more and more people have opened up to investing directly in markets while working from home.
Many questionable companies of past decade are finding favour again. Many jumped over 100% in November. A renewable energy company is up 6x in 2020. It has entered MSCI India Index. Vanguard bought 13.1mn shares in September. It’s market capitalisation has crossed 165 trn Rs (pushing it in among top 21 companies in India by market cap) and is now trading at 77x book.
These discrete data points donot conclude a bubble, but as Buffett says “be fearful when others are greedy”.
C. OTHER THOUGHTS
Envy, FOMO and Greed
It’s agonisingly difficult to stay on sidelines as stock prices rally. Every day’s rise, calculable from daily prices, reminds of returns forgone. And, if friends, family and neighbours are gloating about it on social media, the chance of staying cautious amidst rising prices is close to nil.
Envy and fear of missing out (FOMO) are evolutionary emotions that supported survival of human beings. It propelled our hunter forefathers into action and ensured that they were not staying behind in the survival queue. So is greed. There were survival benefits in over eating or storing excess food or accumulating things beyond immediate need. We inherited these emotions as their legacy.
Envy and FOMO pushes those staying on sidelines to participate in a rising market, often at the top. And greed pushes those who are making money to continue chasing rising prices often on leverage (trade on borrowed money/ margin). This fuels feel good emotions and a feedback loop. Sadly, financial history shows that what cannot go on forever, will stop someday. While good for survival; envy, FOMO and greed are hazardous during investing.
You will be attracted to narratives about how things are different these times and time to make money is now. The origins of these narratives are often from those who get their payday selling part or full of assets/ companies. When someone comes to you with a deal, check how is he/she getting remunerated.
Most of the times, most of the prices donot go in one direction. What’s wise at one price, is foolish at another. Plan of buying assets in hope of passing it on to a greater fool can backfire and one can end up holding the can.
The only antidote against succumbing to envy, FOMO and greed in investing is a sense of intrinsic value and discipline to wait if prices donot leave a sufficient margin of safety against bad luck or error. Both of these – sense of intrinsic value and discipline – come from an understanding of underlying assets/ businesses. Avoid poor businesses &/or poor managements &/or poor prices. And one can avoid many mistakes.
***
In a world gush with liquidity and incentives driving short term behaviour, it’s a blessing to have company of partners who truly think long term. Thanks to you, we can act rationally and choose to opt out of ‘craziness race’ once in a while.
2020 has been a forgettable year. Wish you a normal 2021!
Kind regards,
Team Compound Everyday Capital
Sumit Sarda, Surbhi Kabra Sarda, Suraj Fatehchandani, Sachin Shrivastava, Sanjana Sukhtankar and Sumit Gokhiya
—————————————————————————————————————————————————–
Disclaimer: Compound Everyday Capital Management LLP is SEBI registered Portfolio Manager with registration number INP 000006633. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities. This transmission is confidential and may not be redistributed without the express written consent of Compound Everyday Capital Management LLP and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Reference to an index does not imply that the firm will achieve returns, volatility, or other results similar to the index.