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December 2014 - Investment Newsletter from Gokul Raj. P (Fund Manager)

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December 2014 - Investment Newsletter from Gokul Raj. P (Fund Manager)

  1. 1. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 Dear Members of "The Millionaire Portfolio (TMP)", IndianMarketshad a flattishanduneventful December. The index isslightlynegative fromthe startof the month. There wasa sharp correctionaroundthe middle of the monthbutonly forthe Marketsto retrace backtheirlosseswithinafew daystime. We had writtenanote to Investorduringthe correctionphase whichspeaksaboutourlongtermoutlook forIndianmarketsasbelow : The currentcorrectioninIndianmarketsishealthy andprovides Investorsopportunities toaccumulate goodquality stocksat attractive valuations. Ourstructural bullishness onIndianmarketsoutlookforthe next5yearscontinues tostrengthenfromthe recent
  2. 2. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 Macro & Micro Economicevents. Foranyinvestorwitha3-5 yeartime frame, Marketsare providinggreatbargains. Let'sunderstand reasonsas to why we are Bullishandare excitedtoaccumulate oneverymeaningful correction. EveryBull Market has several correctionsduringthe course of itslarge upmove justas how every Bearmarkethas several strong ralliesduringthe broaderdownmove. Duringthe lastBull Market(2003-07), we have hadfour 10%+ marketcorrections. Infacttwo of those corrections were 15%+ andone wasa massive 30% correctionfromhighs. These corrections strengthenthe Bull Marketby clearingthe frothand keepsMarkethealthy asirrational expectationsgettestedregularly. We certainly believethatIndiaisgoing throughone of itsbiggestBull Marketsandthe structural thesisof the upmove isgettingstrengthenedconsistently. Let'ssee Five prime reasonsforour Bullishness. - Cyclical Recovery aidedbyloweringInflation&WeakCommodity Prices: Indianeconomy isgoingthrougha cyclical recovery onthe back of improvingeconomicsentiment, ,restartingof stalledCAPEX, narrowingCAD, pentup demandetc.While itmightbe difficulttotime the interestrate cuts, there are enoughindications forusto believethatInterestrateshave peakedandare expectedtoslide downgoingforward. There hasbeenamarkedimprovementin Inflation drivers. A lowerinflationary expectationwill ideallyleadtobetterFinancialsavingsandthiscreatesavirtuouscycle thatwill boostgrowthto our trendline growthof around7-8%. The recentcorrectioninCommoditypricesalsoaidesIndia's economicrecovery byboostingFiscal aswell asCurrentaccounts throughhighersubsidy savingsandlowerimports. Eventhoughexportswill be affectedtosome degreedue tosubdued globaldemand, majority of our exportshave low price elasticity andare stable innature. While Capital accountmightgetaffectedwithlowerflowsin the short term, Indiawill be able toattract flowsovertime withstrongperformance. Since commoditiesfollow amegacycle of more than 10 years, we couldlive withsubduedpricesforalongtime and that will boostthe inherentdemandinthe Indianeconomy.
  3. 3. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 We are in a cyclical recovery thatwill notjustboosttopline of companies butalsobottomline withexpandingMarginsfromlowerinput costs. - New Normal (or) SecularStagnationinGlobal Growth, leadingtoglutof Capital : Few eminentwesterneconomistshave writtenaboutthe riskof secularstagnationinGlobal growth, primarily drivenbysoftened Demandacross developed markets.There are several structural factorsatplayfromDemographics, Economicinequality to Indebtedness thatwill leadtosub-parglobal growth. Aswe are seeingalready, Central bankersacrossthe Globe willtrytofight deflation byusingbothlevers(lowerInterestRate &higherMonetary easing). Thiswill certainly leadtoa glutof capital inthe Global marketsthat will continue tochase marketswithdecentreturns. Bond YieldsfromGermanytoJapanhave fallentothe lowestinHistory withshorttermrates ina few marketsinnegative zone. Thiscreatesan environmentforhighercapital flowstocountriessuchasIndiathat isinwant of capital and that can absorbhuge amountsof capital while deliveringhealthy returnsforInvestors. Indiawill alsostructurally be favoredforCapital flowswithitsdomestic economy orientedgrowthmodelcomparedwithmostemergingcountries exportbasedmodel. - India'sdecisive turntowardsembracingCapitalismwill aidflows: While we can debate aboutthe pace of change of India'sorientationtowardsaMarket basedeconomy, the directionof change towardscapitalismisclear. There hasbeenseveral initiatives takeninthe last2 yearsthat improvesthe structural growthstoryof the country such as Subsidy reforms, Governance reforms, IncreasingFDIlimits, Openingupmore sectorsetc.Country isclearingmoving towardsa liberal Economicregime thatwill allow ittoattract more flowsandimprove itspercapita income fromthe currentlow levels to around1.5 Lakh Rs in the next6-7 years. Thiswill create a vibrantdomesticMarketthatcan full fill the aspirationsof ourhuge population.
  4. 4. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 For the firsttime inIndia'shistory, we are havinganenvironmentinwhichall the 3most importantpeopleinthe Political system(NarendraModi, AmitShah& ArunJaitley) aswell the topbureaucraticteamincludingCEA are pushingona Pro-Businesspolicy framework withlowergovernmentinterference. PressuresonpoliticianstodeliveronDevelopment, GrowthandJobswouldensure that thisisa irreversible change andIndiawillimproveitssustainableGrowthrate.Thisalongwithstructural factorssuch as Demographics, Social attitudes, Aspirations etcwillensurethatIndiastaysfocusedondevelopingitsEconomy. - InflationTargetingandMonetary Framework todrive downcostof capital : In additiontothe goodthingshappeninginthe Fiscal policy, the country ismakingdecisive changestoitsMonetary policy by movingtowardsInflationTargeting. Withthe targetstobe set around4% +/- 2%, we believethatdeeply entrenchedInflationary expectations amongthe economicagentsinthe systemwilldecline consistently. Thisalongwiththe improvingtransparencyinTaxation will have huge impactonIndianpublic'sFinancial SavingsVsPhysical savingsdebate. Thesechangesalongwithanenvironmentof low interestratesglobally woulddrivecostof capital lowerforIndianbusinesses. All thesesetthe stage well forhighergrowthratesgoing forward. RBI governor, Mr. Rajan, hasalso beenfocusedonimprovingthe Financial systemfrombroadeningFinancialInclusion to creatinga Healthy lendingecosystem. Withagoodregulatory framework andhealthy FOREX resources, Indiacanwithstandthe volatilities of Global financialmarketswhichwill seeincreasedfrequency of BoomandBustcycleswithincreasedassetbubblesbeing the side-effectsonthe Monetary easingworldwide. Withastrongman at the forefrontof Governmentandthe Central Bank, Indiadoes have a higherabilitytowithstandexternal shocksandthisdecreasesthe tail riskpremiumtoIndianstockssubstantially. - SevenLongYearsof Market Consolidation setsastrongBase : IndianEquityMarketshave beenthrougha longphase of underperformance. Equitieshasdeliveredameager3.5% CAGR returns overthe last 7 years. The returnsonbroader marketsincludingSmall CapsandMid Capsis evenmore pathetic. Thishasensuredthat
  5. 5. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 Indianretail investorshave movedawaycompletely fromstockMarkets. Overthisphase, there hasbeenasignificantshiftin shareholdingfromweakhandstostrong handsinthe market. Markets have rewardedqualitywell andbadbusinesses, bad Managementshave takenasevere beating. Indianmarketsare quotingat reasonable valuations all round. Evenwiththisyear'srise, we are still nearhistorical average valuations forIndianequities. The cyclically adjustedvaluations are actuallylowerthanhistorical averagesaswe are currently at very low Margins forCorporate India. AsIndiangrowthpicksup,we will see operatingleveragekickinginandseveral companiesexhibiting strongearningsgrowth. Indianmarketshasall the ingredientsforaBull Market - Valuations,Sentiment, Policies, Earnings,Flowsetc. Hence we will expectinvestorstoBUY goodbusinesses atattractive valuations. Itiseasytogetlostin the noise thatcomesfrom Financial marketseachdayand ignore these huge positivechangesthatare happening. While these are ourMacro views, ourstockselectionandportfoliostrategiesare purely basedonBottom-Upprocess. There are only a handful of businesses thatcanbenefitsustainably fromthe Macroeconomicpositives withoutpassingevery benefittocustomersor gettinghurtby competition. Thusit'sveryimportantthatInvestors stickwithquality businesses andinvestwithalongtime frame. Investors shouldlookforbusinesses thatcanamplify the economicpositiveswhile the riskof downside isminimal.These stockswhen heldforlongtermcan continue tocompoundathigherrates, enablinginvestorstogrow theirwealthmultifold. Some InterestingReads for Investors: 1.) Valuation is the primary determinant of long-term returns.
  6. 6. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 There isultimatelyonlyone waytogenerate goodlong-runreturns,andthatisto buycheapassets. Value investingisthe only safety-first approach. The goldengoldenrule of investingisthatnoasset(or strategy) issogoodthat youshouldinvestirrespectiveof the price paid. No assetisso good as to be immune fromthe possibility of overvaluation, andfew assetsare sobad as to be exemptfromthe possibility of undervaluation. If whenbuyinga house the mantra is 'location, location, location,'whenthinkingaboutanyinvestment(be itan assetor a strategy), the equivalentrefrainshouldbe 'valuation, valuation, valuation.'He likensittothe closestthingtothe law of gravitythatwe have in finance. he said that the curse of being a value manager is being too early – too early getting out of market positions and too early getting in. Patience is also required when investors are faced withan unappealingopportunity set.Many investors seemto suffer from an “action bias”– a desire todosomething. However, whenthere isnothingtodo, the bestplanisusually todonothing. Standatthe plate andwait for the fat pitch, referencing a baseball metaphor. Patience, he concedes, though integral to any value-based approach, is in rare supply. - James Montier 2.) As I have written many times before, leverage is far from costless from an investor’s point of view. Leverage can never turn a bad investmentintoagoodone, but itcan turn a good investmentintoabadone by transformingthe temporary impairmentof capital (price volatility) intothe permanentimpairmentof capital byforcingyou to sell atjust the wrong time. Effectively, the mostdangerous feature of leverage is that it introduces path dependency into your portfolio. BenGraham7 usedtotalkabouttwo differentapproachestoinvesting:the wayof pricingandthe wayof timing. “Bypricingwe meanthe endeavortobuystockswhentheyare quotedbelow theirfairvalue andtosellthemwhentheyriseabove suchvalue…Bytimingwemean the endeavor to anticipate the action of the stock market…to sell…when the course is downward.” Of course, when following a long-only approach with a long time horizon you have to worry only about the way of pricing. That is to say, if you buy a cheap asset and it gets cheaper, assuming you have spare capital you can always buy more, and if you don’t have more capital you can simply hold the asset. However, when you start using leverage you have to worry about the way of pricing and the way of timing. You are forced to say something about the path returns will take over time, i.e., can you survive a long/short portfolio that goes against you? - James Montier - GMO
  7. 7. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 3.) The error lies in expecting that venture returnswill be normallydistributed: that is, bad companies will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x. Assuming this bland pattern, investors assemble a diversified portfolio and hope that winners counterbalance losers. But this “spray and pray”approach usually produces an entire portfolio of flops, with no hits at all. This is because venture returns don’t follow a normal distribution overall. Rather, they followa power law: a small handful of companies radically outperform all others. If you focus on diversification instead of single -minded pursuit of the very few companies that can become overwhelmingly valuable, you’ll miss those rare companies in the first place. The biggestsecret inventure capital isthat the bestinvestmentina successful fundequalsor outperformsthe entire rest of the fund combined. This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. VCs must find the handful of companies that will successfully go from 0 to 1 and then back them with every resource. Of course,no one can know withcertainty exante which companieswill succeed,so eventhe bestVC firmshave a “portfolio.However,everysingle companyin a goodventure portfoliomust have the potential to succeedat vast scale.”- Peter Thiel. 4.) On a price basis it took 25 years to surpass the 1929 stock market peak as risk aversion stayed with that generation for a very long time (although on real return basis, with dividends reinvested, it took only four and a half years because of the severe deflation experienced at the time). GoodSnippetsfrom Motilal Oswal'sstudy on 100X Multibaggers: "Transitory multi-baggers attract a lot of crowd and media attention, but they always give nasty end-results. Deep cyclicals and fad companies broadly fit into this category. The tragedy with this class of companies is that if you cannot sell in time, you are left with no gains, and most often, with a permanent capital loss."
  8. 8. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 "Enduring multi-baggers are those companies, whose wealth creation is long-lasting. Great businesses run by good managements purchased at huge ‘margin of safety’ will create enduring multi-baggers. InterestingQuotesfrom InvestingLegends: --> "The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions” – Seth Klarman
  9. 9. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 --> "If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring” - George Soros --> "Everybody thinks that the other fellow’s stock is overvalued but my stock's valuation is okay. That is human nature" - Rakesh Jhunjhunwala --> " Companies that are making bets all along, even big bets, but not bet-the-company bets, prevail. I don't believe in bet-the-company bets. That's when you're desperate. That's the last thing you can do." - Jeff Bezos,Amazon. --> "If we were as impatient about gardening as we are investing: Sam plants some seeds in his backyard. He checks back four hours later. Nothing. He digs them up and replants them. Four hours. Still nothing. A week later he is dismayed that he has no oak trees in his backyard. He calls oak trees a scam". - Morgan Housel --> "In evaluating a common stock, the management is 90%, industry is 9%, and all other factors are only around 1%." - Phil Fisher Wish you all a "Happy & Prosperous - 2015" !! Regards, GokulRaj. P,
  10. 10. [HBJ CAPITAL - THE MILLIONAIRE PORTFOLIO] December1,2014 [Principal Fund Manager, HBJ Capital] Date: December 31st 2014, Place: Bangalore, India.