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Game of Thrones

Apr 15, 2019

Disagreeable data are streaming out of the computers of Merrill Lynch and other performance measurement firms. Over and over and over again, these facts and figures inform us that investment managers are failing to perform. Contrary to their oft articulated goal of outperforming the market averages, investment managers are not beating the market: The market is beating them. – Charles Ellis, 1973

Active Manager Under-Performance is Not a New Phenomenon

Much attention has been focused on manager under-performance recently. We highlight the quote above, which was written in 1973 by Charles Ellis, 46 odd years ago. Manager underperformance is nothing new, and four decades later, underperformance and active management remain alive and well in the U.S. and worldwide. More later.

Game of Thrones Underway

Not the HBO series, the elections. These elections, more than other in recent memory, represent a fork in the road India takes: one way leads to populism, the other to self-empowerment. That’s as political as we care to get, our areas of interest are the implications for investment strategy.

FI Flows This Year Aren’t Smart Money, Aren’t Hot Money and Aren’t Betting on a BJP Win

Contrary to popular opinion, the FI inflows this go around are not a bet on a BJP victory. The ishares MSCI emerging markets ETF tops in the global ETF league with $9.8 billion in inflows since late October. Inflows into emerging markets equity funds recorded their third best quarterly number ever recently, to the tune of ~$18.0 billion.

Consistent Alpha, Low Fees, Low Turnover, Tax Efficient High Returns…
…1 Crore Invested in Olympians Has Doubled to 2.11 Cr in 5 Years …
…Versus 1.85 Cr in the Nifty and 1.79 in the Benchmark

Source: Bloomberg

The Investment Outlook for EM – and India – Remains Positive

These inflows are a result of a neutral leaning, eventually accommodative Federal Reserve, alongside stimulative policy out of China, and at the margin, a pro-growth rate cutting RBI. They are a bet on emerging markets, generically speaking, as growth slows in developed economies. This money has not considered the implications of the Indian election. It’s ETF money. It does not appear to be hot money, and it’s unlikely to be impacted by the election outcome.

The Base Case Is Now Consensus Positive on Markets

We’re back with the consensus, or more appropriately, the consensus has caught up with our cautiously positive view on the markets. Our base case – an incumbent party forming the government – is the consensus expected outcome. The alternatives are difficult to forecast.

Should this base case unfold, a flood of domestic capital is likely to enter the markets, and sentiment could improve markedly. Should a second or third front emerge, questions remain on the ability, and intent, of implementing proposed populist spending programs and having them pass both houses.

Should the unexpected come forth, there will be a sell-off and investment strategy adjustments would have to be considered only post facto.


Fixed Income

Debt investors choose to forego high equity returns in exchange for safety of capital, and timely and reliable income streams. Investors appear to be generally unaware of the risks embedded in debt instruments. Recent events are likely to lead to yet another re-examination by individual investors of their portfolios, as well as a re-think on whether the incremental returns from concentrated investments in FMP, NCDs, single company paper is commensurate with the additional risk. This close to elections, we’d advise clients stay patient with fresh money allocations, and wait for the various issues involving debt markets to play out.


Clarity will emerge over coming weeks on the elections. Post-election, one can move forward with the business of investment.

Earnings are off to a strong start with bellwether TCS reporting strong numbers with revenue and margins beating expectations. Digital reported a whopping 46% YoY growth and is now $6 billion and 31% of revenues. All-around double-digit growth, and BFSI grew at double digits.

We summarize our sectoral earnings outlook at the end of this commentary.

Portfolio Strategy

In a business that’s generally about one number, the portfolio return, we delve beyond, focusing on trends in portfolio management and performance attribution.

Big Is Winning…Everywhere

A recent study by the IMF highlights the rising monopolistic power growing around the world. We wrote on this trend last year (Big is the New Black, XXX 2018).

Fund managers that have focused on large companies, have won not only in India but in the U.S. and worldwide, and done a better job of outperforming benchmarks than active managers that invested in diversified cap portfolios. Google, Netflix, HDFC Bank, Reliance Industries, Amazon are policy setting behemoths that enjoy advantages that are just not available to mid and small cap companies. Big is winning.

Diversification Has Not Contributed to Returns

Mutual funds have traditionally chosen 60 to 80 stocks in a portfolio, mimicking the benchmark’s key heavyweights and holding a healthy smattering of mid and small caps. That strategy works unless the largest stocks outperform the benchmark. Concentration worked, diversification not.

Disruption Is Impacting Portfolios

Structural forces are disrupting sectors that had previously been secular growth stories. Change is visible in languishing auto sales, strong technology services demand, incumbent telecom challenges, ecommerce trends, transportation etc.

Investment Strategies for Alpha Generation

Today, there is more capital chasing opportunity than at any time in history. A few enhancements can meaningfully improve expected returns. Private equity, alternatives, structured products, income yielding real estate and other low correlation income streams beyond equity and debt can enhance portfolio expected return.

More generally, a robust wealth manager platform providing a diversity of products, unbiased by internal versus external considerations, and an established framework for disseminating investment advice is an essential requisite for sustained wealth creation.

Portfolio Strategies for Alpha Generation

Today, the investment manager is bogged down in a maze of details, rapid sectoral moves, price moves and an avalanche of information. The pressure to act is persistent.

In such an environment, consciously choosing to make investment decisions for the long term, in the best long-term interests of the client, while keeping short term considerations in focus invariably pays rich dividends.

Our priorities will remain quality growth, reasonable valuation, concentration, patience, benign yet active oversight, low turnover, and continuing what has worked for us in the past – owning dominant businesses that are proven and consistent wealth creators.

Sanctum Olympians – Large Cap
Olympians +16.7% CAGR Over the Past 2 Years

The returns put Olympians in the top 5% versus peer mutual funds and PMS managers.

Breaking performance down, we prefer to review bull market and bear market performance separately in evaluating a fund manager. In the bull market of 2017, Olympians outperformed the Nifty 50 by 5.3%, delivering 33.9% returns. Meanwhile, in the bear cycle of 2018, Olympians again outperformed the benchmark by 2.5% and the Nifty 50 by 0.5%.

Olympians Beat the Benchmark NSE 100 by 1.5% in the Past 1 Year,
…+4.9% Over 2 Years…
…Delivering 16.7% CAGR Over 2 Years

Sustainability of Performance

Concentration: Olympians is a concentrated portfolio owning 15-16 stocks. The average fund owns 40-60 stocks if not more.

Low Turnover: Olympians is a low turnover strategy. 2018 was an aberration due to a mid year course correct out of cyclicals into giant large cap. The average fund has a 70% turnover. We aim for a number lower than half that number.

Low Fee: Olympians is a low fee strategy. In a world where fund managers charge 2.25% expense ratios, our fee structure is low.

Tax Efficient: Olympians is a tax efficient strategy. We are comfortable trimming our losers and letting our winners grow which ensures no large capital gains tax bills will be presented to clients, reducing client net profit.

Low Down Capture: Olympians is a low semi-variance strategy. It’s also called down capture or downside variance. The portfolio has less volatility than the market during sell offs.

Most importantly, Olympians is built to take advantage of the rising power of dominant firms with strong barriers to entry. The core of Olympians represents companies with dominant positioning, size, scale benefits, and barriers to competitive erosion. It’s a strategy Mr. Buffett used to build wealth. So yes, we think the strategy returns are sustainable.

We Raised Exposure to Giant Caps in Olympians by 20% in April 2018…
…Exiting Cyclical Positions, and a Key Contributor to Outperformance

Source: Morning Star

Rotation to Giant Cap in April 2018 a Key Contributor to Return

As the chart above demonstrates, exiting cyclical growth in April as the economy and markets headed into a slowdown, was critical in avoiding subsequent losses experienced in the exited names, and generating positive alpha from giant cap purchases.

Staying True to Mandate, Olympians Has Stayed Solely Invested in Large Caps

The portfolio has a 76.5% allocation to giant cap and 23.5% allocation to large cap, and 0% to mid or small. While large cap funds were purchasing mid caps and small caps for years, Olympians stayed true to style and invested only in large caps.

Olympians Is Giant & Large Cap, Quality Growth…
With High Growth, High ROEs and High Margins

Sectoral Attribution

Overweight in Financials, Energy, Basic Materials, Consumer and Technology were key contributors to the portfolio return. On the other hand, exposure to Health Care at the sectoral and stock level was a negative contributor. The negative contribution was mitigated by a low sectoral and stock exposure.

Sector Weightages for Olympians

Financial Services, Energy, Basic Materials, Consumer & IT Were Key Contributors

Source: Morning Star

Indian Titans – Multi Cap Portfolio
Titans 9.9% CAGR Over 2 Years, 16.4% Over 3 Years

Titans outperformed the benchmark NSE 200 during the bull market of 2017 by 17.6%. In the bear market of 2018, Titans was able to minimize losses by exiting a slew of small caps and mid caps, which went on to much lower levels. Titans did, however, underperform the NSE 200 in 2018 by 9.0%.

Managing a Multi Cap Fund Versus an Index with 88.5% in Large Caps

The NSE 200 has an 88.5% weightage in large caps. Titans on the other hand, has 62% in large caps, or a 26% underweight to large caps. Despite this, Titans performance is in line with the NSE 200. In a world with large and giant dominance, Titans has held its own against the benchmark.

1 Cr Invested in 2009 In Titans Would be 2.91 Cr Today…
…While the Nifty 50 and NSE 200 Would Be at 2.5 Cr

Titans Performance Remains In Line with Blended Mid and Large Indices…
…Outperforming Mid & Small While Underperforming Large

Source: Bloomberg

Shifting Allocations to Giant from Small in 2018 Aided Performance

One would expect a multi cap manager to reduce exposure to mid and small caps in 2018. We did, in fact, do precisely that. Small caps were 20% of the portfolio in May 2018. We reduced exposure substantially to under 10% by September 2018.

Correspondingly, we raised Giant caps from 20% in Dec 2017 to 50% by Oct 2018. These moves enabled us to sidestep deeper losses in 2018. Over the past quarter, we increased our exposure to mid-caps by 5%.

Source: Morning Star

Portfolio Strategy

Quality Growth Portfolio with 1/3rd Exposure to Mid and Small Caps

Titans is a 20-22 stock portfolio. That’s a number that we feel is necessary to achieve appropriate diversification across large, mid and small caps. We expect a steady state allocation mix of 65% large, 25% mid and 10% small cap.

Titans Is a True Multi Cap Portfolio, Anchored Around 65% Large, 25% Mid, 10% Small…
…With High Growth, High ROEs and High Margins

Sector Weightages for Titans

Consumer, Financial Services, Technology and Energy Were Key Contributors…
…And Health Care a Notable Negative Contributor (Sun Pharma)

Source: Morning Star

Sector Earnings Outlook


Private and public banks are expected to report a strong set of numbers led by lower provisioning and write back of provisions in certain cases due to resolution under IBC. Credit growth has remained strong and recovered to five-year highs of ~14.5% YoY, driven by growth in the retail segment. Growth in deposits has been consistently lagging loan growth resulting in stretched CD ratios for private banks.

NBFCs are expected to report the slowest growth in the last 2 years. Even though liquidity started improving towards start of 4QFY19, it hasn’t been easy to raise longer term finance either through capital markets or through banks. The quarter has been particularly tough for vehicle financiers due to the slowdown in auto sales. Housing finance companies with good parentage are likely to witness healthy retail growth while the remainder struggle with liquidity issues.

Consumer Discretionary

Autos -There were severe demand issues across all auto segments primarily led by the increased cost of ownership and stress in the rural economy. Tight tap on availability of credit further impacted the auto volumes across segments. Barring LCV volumes which reported ~4% YoY growth in Q4FY19, all other auto segments viz. PVs, MHCVs, two wheelers and three wheelers witnessed a volume decline. As a result of the decline in volumes and operating leverage playing out negatively, we expect margin contraction for most auto players. The sector is expected to revive only by Q2FY20 as pre-buying ahead of BS-6 implementation kickstarts. However, the increase in regulatory cost to comply with BS6 emission norms is likely to take a toll on demand post FY20, as players will have to pass on the higher cost to consumers to tackle the consequent pressure on margins.

Media – Broadcaster’s – are likely to see muted revenue growth, marred by implementation of TRAI’s new tariff order and increasing thrust on digital content which should put pressure on margins. Exhibitors are likely to continue growth momentum led by strong box office collection which was up 46% YoY and addition of screens. Print media should see some improvement led by higher ad spends, increase in DAVP rates and softening of newsprint prices.


Post the GST speed breaker, domestic execution has picked up pace. Industrials and Engineering companies are likely to witness healthy revenue growth, backed by smooth execution of projects in hand. Over the last few years, the capex cycle in India has been supported by government spending on infrastructure projects like roads, railways and power T&D sector. But private sector capex has remained subdued given the underutilization of assets created by companies historically. However, with the impending general elections, government capex has started witnessing a lull, but we are seeing early signs of pick up in private capex. Overall, ordering activity has started to see signs of a pick-up, driven by ordering from Steel, Cement, Fertilizers, and Oil & Gas sectors. With capacity utilization level inching up, new orders from private players should keep on moving north in our view.

Information Technology

The trend of acceleration in deal wins is set to continue although at a slower pace than earlier. Most companies are expected to report decent topline growth, but margins would be where there could some strain due to cross currency impacts, increasing cost of onshoring and aggressive bidding. Need to watch out on management comments / guidance w.r.t growth and margins in the face of deteriorating macros in the developed economies


Upstream companies and OMCs are set to report YoY growth primarily due to inventory gains in refining, retail margins of OMC’s have improved, while GRM’s have declining further from USD 7.0 / bbl in 4QFY18 to USD 3.2 /bbl in 4QFY19 (V/s USD 4.3 / bbl in 3QFY19), the lowest in 4 years. Petchem margins declined despite weakness in feed stock prices. City gas distribution companies are likely report steady quarter on back of sales volume growth and price hikes, owing to INR weakening and higher domestic gas cost.

Consumer Staples

Managements’ of various consumer companies have already cited relatively weak demand environment in 4QFY19, hence growth and profitability are likely to remain in single digit. Companies with high rural exposure are seeing more impact of slowdown then the urban centric companies. Going forward, rural growth is likely to outpace urban growth on the back of government schemes aimed at boosting consumption and normal monsoon is a key to good rural demand.

Health Care

Trend of earnings has been improving over the last couple of quarters, led by domestic formulation business and moderating of price erosion in US, healthy ANDA approvals and currency benefits. Overall, regulatory concerns have been easing / complied upon and momentum in approvals and potential launches over the next 12-15 months would be the key monitorable in the US generics segment.


Metals and Mining – In the non-ferrous space, prices of most of the base metals except aluminium were higher on QoQ basis. Average Zinc prices increased ~3% QoQ to USD2,694/t. Lead was up ~4% QoQ to USD2,039/t; while copper was up ~1% QoQ to INR6,202/t. Steel prices in India were down 9% QoQ thus expect margin contraction, which would lead to PAT degrowth for first time in almost 2 years. While all India steel sales volumes were up 5% YoY, bigger listed players are expected to report stronger growth led by market share gains. Apart from the contraction in margins in coming quarter, there is a big overhang of risk of a trade war and on concerns pertaining to the slowing demand in China. Hence, prefer structurally efficient companies with low capital and operating cost, access to cheap raw material and a strong balance sheet.

Cement – Cement volume growth was stellar over first nine months of FY19. Though, the volume growth has moderated in the quarter preceding the election, the average growth 9.5% over Jan and Feb-19 has been respectable. Volume growth which was driven primarily by strong growth in South has moderated in March. Despite, strong volume growth, the key to watch out for is price hikes and sustainability of the hikes. In Feb’19, south-based companies announced price hikes to the extent of INR30-50/bag. However, these hikes couldn’t sustain as Mar’19 approached because of selling pressure due to the year-end impact and the lack of demand. Prices increased 5% QoQ in the west (led by healthy prices in Pune/Maharashtra), remained flat QoQ in the east and increased 2% QoQ in the central region in 4QFY19. All India cement prices increased 3% QoQ. There has been some respite for cement companies with cost pressures easing out. Petcoke prices declined 3% QoQ (up ~8% YoY) in 4QFY19. Prices of imported coal (adjusted for USD/INR) also decreased 13% QoQ. This should result in lower power & fuel cost. Additionally, the decrease in diesel prices (-6% QoQ) would result in lower freight cost for the companies.

Communication Services

After several quarters of revenue and EBITDA de-growth, telecos are likely to witness some stabilisation in their revenues / EBITDA performance with roll out of minimum recharge plans by incumbents coupled with continuous shift in subscribers from feature phones to smart phones, bodes well from the ARPU accretion.


Companies are largely going to report high single digit growth but are likely see good improvement QoQ led by under recovery of fixed cost and asset capitalisation. Going forward, the reversal in interest rate cycle should benefit valuation of utility stocks, which have a negative correlation.

Technical Outlook

The Nifty closed marginally lower by 0.19% for the week at 11,643. For the last two weeks has Nifty has been sideways with a negative bias and consolidating in a narrow range of 200 odd points below its all-time high levels. It has formed bullish pole pennant pattern on daily which is a continuous pattern. Thus, recent low of 11,549 becomes the near-term support for the market. Holding above 11,549 bias remains positive and expect market to breakout on upside. Crossing and sustaining above 11760 on tradable basis expect the rally to continue towards 11,900-12,000 levels. However, breaking below 11,549 market can see correction towards 11,350-11,300 where next set of supports are seen. In Nifty options, maximum open interest for Puts is seen at strike price 11,000 followed by 11,500; while for Calls it is seen at strike price 12,000 followed by 11,800. Thus, on downside market has support at 11550-11500 levels, while on the upside 12000 will act as resistance. India VIX has risen by 14.2% to 21 levels in last one week. It is due to ongoing Lok Sabha election that has driven the VIX to six month high.

Nifty Weekly Chart

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