Capitalmind Focused portfolio is up 42% vis-à-vis the Nifty 50 at 29% in FY24. However, we are underperforming on a trailing 3-6 month basis.
The portfolio is down -6% YTD and up 4% on 6-month basis. Nifty 50, on the other hand, is up 3% and 15% respectively. We have to understand that theses kinds of phases of underperformance is a feature and not a bug.
Reading this chart: ₹100 invested on day 1 in Jan 2019 be worth ₹280/- in Focused vis-a-vis 217/- in Nifty 50 at the end of Mar 2024
Our Four-Quadrant Framework
As we complete just over five years of managing the Focused portfolio (including its erstwhile avatar as LT Multi Cap), we would like to re-emphasize our investing framework. Let’s delve a bit further to see how we examine our portfolio at any given point in time.
Broadly, our framework revolves around two key metrics:
1) Our company’s growth potential
This is a core metric for us. Growth is what we seek in our companies. What are the growth triggers? Is the growth sustainable? Is the company capturing market share from the competitors, or by expanding the market, etc.?
- Note: Growth doesn’t mean we like everything showing high EPS CAGR. There are four categories of growth we appreciate. Read: The kind of growth we like
2) Market sentiment & sector tailwinds
Everything runs in cycles. I am not referring to the post-Covid market cycles, which are short and shallow. Real market cycles are different. Bear markets can be brutal; we must acknowledge this. Sit with someone who witnessed 2008, 2000, or even better, 1992. Deep drawdowns are painful. We aim to avoid them. Therefore, we need to understand market sentiment and align, at least marginally, with the overall trend.
Market sentiment can be influenced by various factors like interest rates, GDP growth, consumption patterns, FII flow, macroeconomic indicators, geopolitical tensions, etc. Broadly, we can gauge if the market is in a Risk-On or Risk-Off scenario. Market sentiment can also be sector-specific. Any sector expected to have a tailwind over the next 3-5 years such as Defence, Railways, Power utilities, etc.
- Note: In a Risk-On scenario, investors will be willing to take more risk hoping for higher returns. On the other side, a Risk-Off scenario is when investors get nervous and pullback, moving their money in safe instruments.
Now, let’s represent our portfolio holdings & the overall market sentiment in a 2×2 matrix.
Quadrant 1: High growth potential & strong market sentiment
This is the goldilocks scenario. Our companies are delivering, and the market sentiment or the sector is in a strong tailwind. In this scenario, we will have minimal cash holding and be fully deployed in our high-conviction names. The market is in Risk-On mode, our holdings are showing growth, and this is the time to put some load on the accelerator, or, to use cricket parlance, aim for a boundary.
Quadrant 2: Strong market sentiment & low growth for the company
This is more of a Wait & Watch mode. This scenario allows some time for our laggards. In other words, the company is not delivering, but since it has a tailwind from the overall positive market sentiment, we can afford to give it more time before we face the risk of PE-derating for the company.
In such a scenario, if we are holding the stock, we will continue to hold. Or if we find any stock worth considering, we will take a plunge with an initial allocation and wait for the earnings to catch up.
For example, SAMHI Hotels. We like SAMHI Hotels because it has a strong tailwind, and the overall market sentiment is also positive on hotel stocks. However, the company is still loss-making at the PAT level and progressing slowly towards profitability. In such a scenario, we will take the initial position and wait for the company to deliver.
Another example is our recent entry into CG Power. While the company is growing at 20-25%, the valuations of 95 times PE doesn’t justify its growth. However, the market is giving it a premium due to the upcoming growth triggers in the form of semiconductor manufacturing & growth in power utilities. In such cases, even though the current growth is suboptimal, we took a plunge to participate in the overall theme.
Similarly, for the companies we are already holding and for some reason, they failed to deliver or are going through medium-term hiccups, we will give them some more time to get back on track.
Example: MTAR Tech. We held on to MTAR for over two years, even though the company earnings growth was inconsistent. But given the underlying strong theme of defense, we continued with it, giving it time to report growth. However, it didn’t happen, and we eventually sold after being held for more than two years.
Quadrant 3: Weak market sentiment & portfolio companies not delivering
This is arguably the riskiest quadrant, where we risk falling into the trap of cheap or value stocks. It’s also possible that we are witnessing a change in the overall market trend or in a specific sector. Bear markets typically starts from this quadrant.
In such scenarios, we reduce our allocations, avoid aggressive buying, and prefer to stay in cash. The companies, the sector, or the overall market may appear cheap, but we prefer to stay put. During these times, the cash position will generally be high. Since we don’t see any major underlying trends, we will not be in a hurry to redeploy the cash in the markets.
Scenarios like Q3 may eventually evolve into sideways markets or, in some cases, bear markets. Hence, we will wait for opportunities to emerge and spread our investments over time.
For example, the current state of small caps. There has been a constant push from regulators (SEBI & AMFI), such as restricting inflows for Mid & Small cap mutual funds, alerting AMCs to stress testing, and limiting NCD liquidity in the form of margin funding, etc. Despite that, small caps are inching higher. But we decided to decrease our smallcap allocation and stay in cash. Over the next few months, we will gradually move to Mid & Large caps.
Quadrant 4: Weak market sentiment yet strong earnings growth
This phase is characterized by weak markets or sectors, yet there are emerging names within these areas showing decent growth potential. In such cases, we will initiate new positions and increase allocations to core holdings as well.
For example, Arman Finance is one stock where the sector is somewhat weak. The spreads are increasing for non-AAA rated NBFCs, impacting NIMs & growth. On the other hand, the company is still performing well. We entered the position and are looking to increase the allocation as things begin to stabilize.
This is the broad framework by which we manage our portfolio. Of course, we are flexible and ready to adapt our rules when the time calls for it.
Let’s see what FY25 have in store for us!
Read more about our Focused Portfolio here:
Get Focused Portfolio on Smallcase
Subscribe:
Investing isn’t easy, but it’s quite simple.
It works really well when you invest with a robust process, for long periods of time. While you do start off by investing with a long-term view. But then, sell out on a market rally or a quick correction. Obviously, you will miss the future long-term upside after you sell off.
Do you struggle with holding on to your investments?
This new Financial Year, REVISIT your style and invest for the long term.
Pick a well-researched, long term smallcase:
- Momentum: Quantitative, data-driven, factor based strategy
- Focused: Fundamental stock picks, growth driven strategy
Get 20% Off on the annual plan. Discount code available at checkout page.
Subscribe here
*Offer valid till 4th April, 2024 only.
