Please find below our key excerpts from investor Memos Published in 2019 by one of the well respected Fund Managers in Indian Capital Market - Mr. Viraj Mehta.
Dec 2019 Memo - Why taking lower conviction bets despite of low allocations did not turn out to be right approach
Key Excerpts
Lower conviction in these stocks was due to one or more of these factors:
o Lack of confidence in sustainability of growth/profitability
o Regulatory/judicial overhang
o Worries on capital allocation skills of managements
We initiated smaller positions to adjust for lower conviction we had in these names. Our thought process was that we could adjust for the element of risk/discomfort with a lower position size.
In an ideal scenario, other things remaining same, as stock prices fall, the risk-reward becomes more favorable. However, with these stocks, we painfully discovered our lack of confidence in scaling up these positions when stock prices went down. - We also discovered that the mental bandwidth occupied by these stocks is the same, if not more, as high-conviction positions.
Read Full: https://www.equiruswealth.com/pdf/ELHF%20Dec'19%20Investor%20Communiqu%C3%A9.pdf
Sep 2019 Memo - Analyzing various degrees of impact of HISTORIC tax rate cuts on Indian businesses
Key Excerpts
"Type A advantage - Direct profitability increase:
Companies will enjoy this benefit of increased profitability which will directly add to the bottomline and RoE. Companies can use this extra buffer to increase growth by implementing price cuts, increase in marketing spends, employee incentives, etc. Or they can choose to increase shareholder distributions. All the companies will enjoy this benefit. For example, companies catering to consumer staples and its value chain will most likely be restricted to this benefit.
Type B advantage - Increase in demand related to credit growth:
Substantial amounts of capital will be added to the balance sheets of financial services companies. This capital buffer should increase the risk appetite and lead to growth for the credit starved economy. This will lead to a multiplier effect in the economy.
Type C advantage - Increase in demand for companies that are mainly driven by capital formation:
Capex demand should be stimulated at multiple levels. We believe companies where demand is driven by capex will be the biggest beneficiaries of these tax cuts. Apart from growth, which by itself can be substantial, there can be a big spike in profitability due to operating leverage.
Some of the triggers are:
i. Unviable projects becoming viable: There projects which over the years become unviable because of various reasons and stuck due to lack of capital should become viable and attract funding.
ii. New private capex: Private capex has stagnated in India for past many years. The new entities setting up manufacturing units post October 1, 2019 and coming in production before March 31, 2023, will attract only 15% tax rate (~17% effective). This will give a big incentive to corporates and entrepreneurs for setting up manufacturing plants.
iii. Foreign Direct Investments (FDI): With tax rate in teens and the disruption caused by the trade war, India will become very attractive destination for US companies looking to move manufacturing away from China.
Read Full: https://www.equiruswealth.com/pdf/ELHF%20Sep'19%20Special%20Investor%20Communiqu%C3%A9.pdf
June 2019 - Some Key insights while analyzing Small Finance Banks (SFBs) & Microfinance industry (MFI)
Key Excerpts
Focus Area & Target Market: Rural, urban, marginalized Urban Poor - While SFBs face more stringent regulations than normal banks, especially on asset side, they have established a profitable business model by catering to the pyramid base profitably. This is in line with India’s financial inclusion objective and related policy actions like setting up of MUDRA bank, and Pradhan Mantri Jan Dhan Yojana.
Customer Focus and Qualities to attract talent along with Great technological investments for collection efficiency & branch operation
Huge Opportunity Size: India, with over 400mn of the world’s unbanked population, provides a huge opportunity. Microfinance-focused SCBs and NBFCs stand to benefit the most as they operate in a space which other banks and have not been able to venture into profitably. The MFI industry is expected to grow at over 25% CAGR for many years.
Operating Leverage: As most of the physical and technological infrastructure happens upfront, topline growth should outpace fixed expenses, resulting in a sharp increase in profitability.
Perception of Huge Risk: Microfinance is still at a nascent stage in India with barely two decades of history. During these years, it has been affected by many adverse events (Andhra crisis, demonetization), which has hit the financial health of MFIs. Despite this, the industry has thrived to become an integral part of the financial system. Due to bitter experience, investors are wary of investing in these businesses.
Read Full: https://www.equiruswealth.com/pdf/ELHF%20Jun'19%20Investor%20Communiqu%C3%A9.pdf
March 2019 - Logic behind why having 15-20 uncorrelated stocks in a portfolio is sufficient for diversification
Key Excerpts
"a fully deployed portfolio will have at the most 15 stocks. To add a new company to the portfolio, we will have to replace it with the existing one. In other words, a new company must have a better risk-reward ratio than the one with the least favorable risk-reward ratio in the current portfolio. Hence, whenever we add a new stock, the portfolio quality improves while benefits of adequate diversification are maintained"
"Seth Klarman explained it very well in his seminal book, Margin of Safety:
"Even relatively safe investments entail some probability, however small, of downside risk. The deleterious effects of such improbable events can best be mitigated through prudent diversification. The number of securities that should be owned to reduce portfolio risk to an acceptable level is not great; as few as ten to fifteen different holdings usually suffice."
"Diversification for its own sake is not sensible. This is the index fund mentality: if you can’t beat the market, be the market. Advocates of extreme diversification – which I think of as Portfolio Management and Trading over-diversification – live in fear of company-specific risks; their view is that if no single position is large, losses from unanticipated events cannot be great."
"My view is that an investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings. One’s very best ideas are likely to generate higher returns for a given level of risk than one’s hundredth or thousandth best idea.”
Read Full: https://www.equiruswealth.com/pdf/ELHF%20Mar'19%20Investor%20Communiqu%C3%A9.pdf
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