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Portfolio Commentary

Jan 21, 2023

Looking back and ahead
The Indian headline indices closed the tumultuous year with moderate gains after hitting new highs, which is a decent outperformance compared to the major markets across the globe. Though the top and midcap indices ended in green, the year was quite somber for small-cap indices, which closed in deep red and saw selling across the board.

Source: NSE, Sanctum Wealth Research

The markets have bounced back well from the lows a few months ago, but the animal spirits are still missing in the wake of uncertain global macro. For the move to sustain, we need more sector leadership along with broad-based participation from small-and-mid caps. That’s not happening yet because of the risk-off sentiment and dwindling liquidity across the world. But there is a silver lining. Most times, the more time markets spend vacillating, the better tends to be the ensuing rally.

In times like these, our job as portfolio managers is to not get badly bruised by volatility and prepare the portfolio for the good times.

The pluses
The marginal returns on the headline indices during the year majorly came because of the robust performance of the banking stocks and resilience in consumer sectors as can be seen in the table above.

As we highlighted in our various communications throughout the year, the banking sector was ripe for a run as credit growth returned after a multi-year lull and banks were ready to serve the growth with their cleaned-up books. The price move, however, was more pronounced in PSU banks and smaller private banks that were grossly undervalued due to the lack of growth and years of stress in their books.

The resilience in the consumer sector, despite its high valuations, was majorly led by a flight to safety in the extremely volatile market environment. Amongst the consumer names, the focus was mainly on the companies catering to premium and luxury segments, which, unlike the rural and value segment, were unscathed from the inflation-led slowdown.

Apart from the two large sectors, there was a positive contribution from industrials, a sector that we participated in through our positive view on the manufacturing theme. Though the auto and capital goods sectors, which were star performers of the theme, were mainly focused on the domestic markets, we believe that the export opportunity in manufacturing is still a big theme, which would resurface when the global turmoil recedes.

A large part of the gain in the benchmark indices also came from PSUs and Adani group stocks, which stood out as some of the biggest gainers of the year. The gain in PSU stocks (banks and non-banks) was largely due to value buying in the otherwise neglected PSU space.

The minuses
A major drag on the indices for the year was the IT sector, which was the star of the 2020-2021 rally. We advocated an underweight on the sector at the beginning of the year due to high valuations of the sector that built in little margin of safety. As it turned out, the sector had to face twin issues of wage inflation and back-to-office expenses, and a gloomy demand outlook due to inflation and recession in the developed world. The damage in mid-and-small-cap IT, which was grossly overvalued at the beginning of the year, was much more pronounced than in the large-cap IT stocks.

Performance review
The returns in the calendar year were flat for the Sanctum Indian Titans (Titans) portfolio and marginally positive for the Sanctum Indian Olympians (Olympians) portfolio. Given that it was a tough year and how some of our peers have done, we believe that our risk-first approach has helped us deliver resilient performance. Both our strategies continue to deliver on the stated objectives and will continue to deliver on the same consistently going forward.

Performance is calculated using Time Weighted Returns, net of fees and expenses. Returns over one year are compounded annually; returns for less than one year are absolute. Please note that SEBI does not verify the performance information provided above. Please note that past performance is not a guarantee of future performance

In our portfolios since the beginning of the year we were positive on certain themes like financials and manufacturing while we remained underweight on IT for the entire year. This helped us contain the portfolio damage from the sector. Notwithstanding the short-term pain, we believe that the sector still holds promise as there are only a few sectors that provide top-notch cash-generating machines with a structurally large runway of growth.

Despite not participating heavily in PSU and Adani group stocks, we managed to close the year with flat returns. This was largely because of better stock selection across large, mid and small cap space.

The current Titans portfolio is well-placed fundamentally as we have highlighted in our previous notes. While that instils confidence, we always remain on vigil to make the necessary portfolio adjustments when required.

In Olympians, we got some major themes right and we position-sized the bets accordingly to make the most of our conviction in the themes. Furthermore, we remain confident of the portfolio companies to continue delivering robust business and earnings performance. Here is a table showing top performers and laggards of the portfolio.

Some of the top performers and laggards in the portfolios are shown in the table below along with their return contribution.

Source: NSE, Sanctum Wealth Research

Looking Forward
As we enter the new year, it’s logical to revisit the runway in the performing themes and identify potential themes that could perform well going forward.

– Manufacturing – a multi-year theme
Given the favorable policy framework in manufacturing, the theme may continue to be investable in the current year as well. There will be an abundance of opportunities in the theme as India not only aspires to become self-dependent in manufacturing key products but also emerge as a decent alternative to China and manufacture for the world.

The current year also has a major tailwind of margin normalization for manufacturing companies. As the supply chain issues have receded and the inflation is cooling, lower input costs will be a major fillip for earnings growth in manufacturing companies this year.

– Financials will now be a normalized growth play
We believe that the financials theme has more legs overall as a backbone of the economy. However, the move hereon will largely be dependent on the advances and earnings growth as a large part of valuation rerating gains have already come through last year. Though there could be a few outperformers in the midcap banking space, the best risk-adjusted returns may come from the frontline banks, which have prudent underwriting capabilities.

– Domestic cyclicals to charge ahead
India might see a significant push in infrastructure development and housing this year, given that 2023 will be the last calendar year and FY24 will be the last financial year before the 2024 general election. The infrastructure sector gives an immediate boost to the country’s growth and provides an opportunity to invest in several ancillary beneficiaries of this growth. We believe that the major beneficiaries of the boom will be capital goods companies and building material suppliers.

– IT to stabilize
The IT sector has seen a tough last year and 2023 may be the year of stabilization. However, the sector will take its sweet time to become a leader and return to glory. Unlike the COVID time, when the western clients of these companies were flushed with cash and were willing to spend big on digital transformation, the current turmoil has hit those clients hard and made them cautious. It will be some time before the discretionary spending comes back in IT. The necessary IT spends will continue though, that will keep the engines humming, but not at full force.

The final word
The correction that the markets are going through is the markets’ way of normalizing the excesses built in the boom period. Most times, such corrections are followed by fresh rallies and many newer names emerge to lead the rally.

Despite our broad sectoral thesis outlined above, we believe there is a lot of global uncertainty looming around which makes us believe that 2023 will be a year of stock-specific action than being a theme-specific broad-based market.

All that needs to be done then is constant monitoring and need-based rejigging of the portfolio, that we continue to do on a regular basis.

On that note, the entire Sanctum team wishes you a very happy and a prosperous new year.

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