Dear Investor,
Q1 result season has ended. The result season again saw companies which represent the newer growth spaces in the market, deliver much stronger numbers vs the indices. This sustained strength in relative earnings should be a key driver for alpha of our constructs over time.
- US trade issues should have a much better outcome vs the present
- Time for alpha
- High beta constructs may prove to be better for performance focused investors
- Index funds aim to replicate the performance of indices, while active funds seek to maintain a high active quotient.
- A portfolio of long constructs makes you hold the entire market. A focused construct may be better.
- Sustained growth may offer opportunities but does not always provide safety; company size alone is not a safeguard.
- Valuations in certain segments have undergone a correction
US trade issues should have a much better outcome vs the present
US has put a 25+25% tariff on India. Ex of pharma, electronics which are excluded, other exports from India in spaces like textiles, leather and shrimps are de-facto denied entry. In spaces like steel, aluminium and copper, the duties are at 50% across the world and companies are at par. At current juncture, the impact on market is limited as spaces, which are impacted, have only got a marginal presence in the market. In any case, if we believe that the global demand and supply can’t be changed very quickly, then in most cases, we expect shifts in target market vs permanent damage, especially if the issues can be resolved in due course.
We are the 4th largest market already while our per-capita incomes remain low. As our incomes rise, we would be one of the top 3 markets globally. In many spaces such as defense, energy, modern food, etc we would be largest importers in the world. A partnership of large markets may prove to be mutually beneficial.
Time for alpha
This is a thought that we have been sharing for over 2.5 years now. Let us start with a simple belief that markets follow earnings growth. Hence one needs to find spaces that can deliver strong growth in earnings for several years, which could potentially result in alpha. Such opportunities are often seen in relatively younger sectors that are less burdened by the overall size and growth dynamics of the economy.
In the 90s, the combo of high growth sustaining for longer was delivered by Software for example and later by private sector banks. In the same light, we think, newer spaces in the market, such as capital market participants such as brokers, mutual funds etc; new tech players offering large operating leverage, renewables, electronics manufacturing, EVs, spaces like GLP1 in pharmaceuticals, hospitals, luxury – are currently being observed for their growth potential.
This quarter again, the experience was the same. As the table shows, many of our investee companies had a strong quarter, beat expectations and overall, the portfolio growth in earnings achieved was significantly higher than index earnings growth.
At Motilal, our funds have a large presence of newer growth-oriented sectors vs legacy sectors. We believe that with the country embracing change and innovation, newer sectors are expected to play an increasingly important role in the economy over time, though outcomes remain subject to market risks.”
High beta constructs may prove better for performance focused investors
Beta is a measure that reflects how strongly a stock’s price tends to move in relation to the broader market’s movements. For example, if the beta were 1.5 and the index moved up or down 1%, the stock would have moved 1.5%, on average and vice-versa. Typically, beta changes overtime.
While general belief is that low beta constructs are better since this indicator comes in higher focus when markets are down. However, since over time, markets have tended to move higher over longer periods, for a return-focussed investors, sustained good higher beta constructs may involve higher risk along with potential for strong performance.
Higher betas on account of sustained earnings growth can be seen as good beta as our belief is that market often follows earnings growth. However, higher betas on account of say earnings volatility on commodity character of business or leverage may be considered bad beta. Endeavour in portfolio construction is to maximise good beta while limiting exposure to bad beta. For example, the Nasdaq has historically displayed a higher Beta vs S&P 500 but has overall provided better outcomes over time.
Beta tends to get higher focus in a period when the indices are not doing well and is associated with funds that may experience a larger fall in such periods. This can make low beta appear relatively better than high beta. Over longer period of time as market typically moves up, the opposite may be true for better outcomes.
Betas for many high growth constructs are expected to be higher and is the case with us, though outcomes are subject to market risks.
Index funds aim to replicate the performance of indices, while active funds seek to maintain a higher active quotient.
In the industry, consistency of performance, i.e., performance in a narrow range of index, is often seen as a virtue. However, if an investor has invested in more than one fund of this attribute, wouldn’t overall performance may remain close to index itself. In such cases, a low-cost index passive fund can deliver this need more economically.
High tracking error vs the index can result in sharply lower outcomes also. That is the risk. However, if there is a long-term investment approach guided by data and experience then the risk of sharp sustained long-term underperformance can be considerably reduced.
At Motilal, we run funds with relatively higher tracking errors. However, the constructs are aligned with our belief that markets follow earnings growth. The earnings growth quotient in our constructs is consistently kept high by inclusion of multi-year growth themes.
A portfolio of long constructs makes one hold the entire market. A focused construct may be better.
Most investors today typically build portfolios with multiple schemes across fund houses. If several long funds are held together, the combined portfolio often mirrors the market, leading to outcomes similar to the index — something that can also be achieved with passives
At Motilal, we believe in focussed high conviction fund constructs, which, in our view, are aligned with the preferences of investors seeking differentiated strategies in today’s environment.
Valuations have undergone a correction
Nifty has barely changed over the past one year while earnings have expanded by 8%. This points to a significant valuation correction over past one year. In a period when interest rates have declined and liquidity has improved, this is even more significant.
US actions on trade did impact sentiment but while spaces like shrimp farming, textiles and leather which were potentially impacted; these are small spaces in the market. Even for the broader economy, the damage is very contained. Moreover, since setting new capacity takes time and overall global demand and supply dynamics tend to adjust gradually, in most cases, the near-term effect may be more visible on margins rather than on overall sales, at least in the short term as most profitable spaces are taken by players who have fared better in the US import duty outcomes and less profitable spaces are taken by others.
Most of the larger spaces in the index remain unimpacted. However, we continue to be positive on expecting a significantly better deal wherein our exports are taxed closer to 10%, given that we are the 4th largest market globally and also the fastest growing. In categories like defence and food, India could potentially emerge as the largest market — a position unlike most other economies with whom the US has trade agreements. Greater access to the world’s largest market would also support the Government’s ‘Make in India’ initiative.
Indian markets have seen valuation correct and once sentiment improves, it can result in a period of outperformance.
May the Good Times Continue.
Happy Investing
Source: Bloomberg, MOFSL, RBI, NSE Indices, ICICI Securities, Kotak Institutional Equities, MOAMC Internal
Disclaimer: This article has been issued based on internal data, publicly available information, and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. These statements are based on current market conditions, which may change, and past performance is not indicative of future results. The Stocks/Sectors mentioned herein are for explaining the concept and shall not be construed as investment advice to any party. The information/data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. The views expressed above are those of the MD and CEO of the AMC and are based on current market conditions and informational purposes only and should not be construed as investment advice. The term ‘alpha’ is used in the context of broader market opportunities for differentiated performance through stock selection. It does not indicate or guarantee outperformance by any specific mutual fund scheme. All opinions, figures, estimates, and data included in this article are as of date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses, and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied in such statements. This material does not compare or promote any specific investment product or strategy over others. References to investor flows or macroeconomic factors are for informational purposes only and should not be construed as market predictions or investment recommendations. Past performance may or may not be sustained in the future. Readers shall be fully responsible/liable for any decision taken based on this article. Investments in the securities market are subject to market risks, read all relevant documents carefully.
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