We have delivered Index beating returns
Stock markets, both in India and globally are scaling newer highs despite multiple waves of Covid pandemic, and several macro concerns. The traditional Chinese curse “May you live in interesting times” truly defines the current state of affairs.
Despite an extremely brutal 2nd wave of pandemic, India markets delivered robust returns during the quarter under review. We fared better as our fund NAV rose 15.9%, outperforming major indices including Nifty (up 7.0%) and benchmark BSE 500 (up 9.5%).
As on June 30, 2021, our fund consists of 32 stocks and a cash surplus of just over 2%. This cash balance is similar to the previous quarter, as we have maintained a consistent bullish stance on equities.
Staying with core investment philosophy
We have strictly followed an investment philosophy of protecting downside despite the possibility of upside being restricted. As such, in our nearly 4 years of managing Ampersand AIF, our fund NAV has mostly stayed above initial face value of 100, except briefly during the initial Covid induced meltdown of Mar/April 2020. Our portfolio beta is 0.88 and Sharpe ratio of 0.91.
Portfolio churned a bit to cultivate new ideas
We have always strived to balance our buy and hold investment approach with business cycles, thereby selectively churning our sectoral and market cap allocation. During the quarter under review, we cut weights in IT and Pharma, and added Financials. This was necessitated by the differential performance of these sectors, and the valuations. A fair share of this alteration is reflected in a higher proportion of Small and Mid-caps in our portfolio. Other key investments are in Consumer Discretionary/Autos and Speciality Chemicals space.
Small-cap frenzy at epic levels
In recent times, Mid and Small cap stocks, more so the latter, have hugely outperformed larger counterparts. Since the Mar 2020 market bottom, small cap index is up 3x, compared to Nifty doubling during the same period. Current outperformance is reminiscent of the late 2013- early 2018 period during which both small and mid-cap indices rose ~3.5x, nearly twice that of Nifty.
However, it is pertinent to note that the performance differential across market capitalisation is not significant over longer time duration. For instance, over the past 10 years, annualised Nifty return is 11.5%, while small-cap index averaged 10.3% and mid-cap index 12.8%. It is also important to note that small-caps tend to be far more volatile compared to large-caps, and regularly see mean reversion. This could lead to periods of sharp underperformance for small caps. Most significantly, poor liquidity adds to the weaker risk profile of small caps, and hence risk-adjusted return relative to large caps is not favourable over the longer term.
However, if one can suitably time entry and exit in small caps, reward can be immense. Most listed small caps in India represent cyclical sectors, and need astute timing. However, there are a set of small caps which eventually will become mid-caps, and over a much longer time frame, large caps. At Ampersand, we aspire to pick small caps which will eventually emerge as much larger companies.
Taper tantrum a possible risk
Interest rates are at historical lows, and the key driver of the ongoing bull market, especially in the US. Excess liquidity has also led to sharp rise in prices of most commodities. Consequent surge in inflation threatens to either reverse easy money policy, or dent disposable incomes that will eventually hurt demand. However, central banks in most other leading countries view the current surge in inflation as transitory, caused by lockdown induced supply disruption, and not excess liquidity. India’s RBI too is following monetary policy in sync with the US, and hasn’t raised interest rates despite inflation having crossed threshold levels.
In our view, easy money policy will be maintained until either, (1) economic recovery
becomes complete, or (2) inflation is deemed to be not of transitory nature. However, stock markets could get adversely impacted by increased visibility of rise in interest rate due to inflation, as had happened in 2013, referred to as the year of taper tantrum.
Impact of the last taper tantrum was quite significant on India as, (1) Currency declined by about 25%, and (2) Nifty contracted by over 10%. However, fear of taper tantrum lasted only a couple of months, and Nifty ended up gaining about 6% in CY2013 itself. Exporters like the IT and Pharma sector gained the most, benefitting from weaker INR. Most other sectors and small caps declined in 2013. So if history were to repeat itself over the next 18 months, INR may yet again be impacted. Of course, India is far better placed with over USD 600bn forex reserves giving it the best ever import cover ratio. Still, we remain overweight on IT and Pharma, as the risk of taper tantrum cannot be brushed away.
Near term could be tricky for markets
While sharp decline in Covid cases and pick up in accination drive seem to be the headline sightings these days, there are some concerns we cannot ignore. Quarterly corporate results will trickle in soon, and not only is there uncertainty related to the financial impact of the 2nd Covid wave, but also possible lack of clarity regarding prospects for the remainder of the year. Additionally, monsoon has been playing truant for the past fortnight. In addition, the mutation of the virus which is reflected in the sharp spike in cases in several countries is raising fears of the pandemic being prolonged globally. All these issues typically tend to come to the fore when markets have performed as well as they have, and valuations then start to get questioned.
This bull market is far from over
Based on growth prospects envisaged a quarter ago, we had indicated in the previous
newsletter (Read the Second Coming) that our markets had potential to re-rate. Much of that has happened during the quarter under review. As things stand currently, growth trajectory should moderate a bit due to Covid, implying market upside could be fairly limited. However, reasonable investment returns are still likely in smaller names, which we have been elucidating for a while now. If market corrections allow for better entry points, we will continue to focus on such opportunities to maximise returns.