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Hbj capital ventures llp monthly newsletter [august 2013]

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  • 1. AUG'13 HBJ CAPITAL VENTURES LLP Monthly Newsletter: HBJ Capital Ventures LLP To The Partners & Co-founders, HBJ Capital Ventures LLP, #912, 1F Main, Girinagar, BSK 3rd Stage, Bangalore – 85, Karnataka, India Dear Partners, As I write this letter, the Rupee is plunging towards new lows with no apparent bottom in place. The ferocity of the Rupee's fall would have surprised even its ardent Critics. Indian Currency has depreciated by almost 20% since the start of the year, which alters the dynamics of every Financial parameters leading to more uncertainty. Apparently, Stock Markets have continued their downward trend breaching key Support levels as the Economic sentiment continues to worsen. While every Economist continues to speak about the Rupee's movement as overshooting of its intrinsic value, continuation of such a trend could easily lead to a "Run on the Currency" and thus creating a vicious cycle of self fulfilling prophecy. Animal Spirits and Sentiment is very important in an Economy and that has been broken. As Howard Marks writes in his latest Memo - "Role of Confidence" is vital to Markets but also notes that "Confidence is a Pendulum which can swing to either direction fast". Should this constant flow of Bad news mean, all Investment bets are off and we should sell of Stocks which we hold. No, in fact this could be one of the best Buying Opportunities. Don't think, we are not Nuts ? Let me explain this with some Myth breaking and some silver lining which we see in current situation. Let's take examples from some of our neighbors, to break some Common Market myths. Myth 1 :- You need high GDP growth to have a boom in Stock Markets. Over the last 15 years, the fastest growing country in the world has been China with an Annualized GDP Growth rate of over 10% in real terms. During this period, the Shanghai Composite Index has grown by a meager 2% CAGR. The Nominal GDP growth of a country and Stock Market returns are not directly proportional. #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 1
  • 2. AUG'13 HBJ CAPITAL VENTURES Myth 2 :- You need a GoodLLP Government & Politically stability in the country for Stocks to deliver handsome returns. One of the most politically unstable Nations over the past 15 years has been Pakistan. During this time, the country has lost Kargil War, Shuffle between Civilian governments and Military rule and a Chaotic Social situation with US war on terror. But to your surprise, Karachi Stock Index (KSE-100) has multiplied by around 15X in the last 15 years giving a 20% CAGR returns compared with the fastest growing country in the World (China) which gave only 2% CAGR to Investors. Take also the Indian example of, stock market performance during 1986-1990 which was one of the most tumultuous phase for Indian Macro Economy and also Indian Politics (Bofors, VP Singh etc). Turn your History books and you can see that, Indian Stocks were on a tearing Bull phase during this time. So, are we saying that - none of the current Currency Crisis and Government policy matters. Certainly not. We know that such poor Macro Economics is a disaster for the country, but what we are trying to do is to explain the fundamental ways in which Markets operate, where its only Incremental or Delta which matters and not the Actuals. To understand it better, Markets through their collective Wisdom price in a lot of news flow and the inefficiency in pricing occurs, when there is either extreme Fear or Greed in the system, which leads to unrealistic expectations or extrapolations of current trends into the future. Thus Market movements are dictated by Expectations Vs Reality. So, Profits are made when the reality turns out to be better than expectations and vice versa. Simply put, share price movement is not dependent on whether a company makes profit or loss - but by what amount it varies from Consensus expectations. This fundamental understanding of Markets would explain the cyclical nature of Stocks and Economy. During good times when the sentiments are good and news flow is positive, expectations are high and Markets prices these expectations. During the peak, extrapolation of the current positive trend and unrealistic expectations leads to a negative Delta and thus causes lot of losses to market participants. Similarly during bad times, expectations are so low that, minor incremental improvements can produce a big positive Delta and thus can bring huge profits to people who Invest during this time. So in times like present, where Fear rules the street and Investors have completely lost hope on Government, Markets, Long Term Investing and Midcaps, the Expectations are very low and the probability of a positive Delta (or) Higher #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 2
  • 3. AUG'13 HBJ CAPITAL VENTURES returns going forward is extremely high. Investing during Fear and Uncertainty LLP always has more odds of giving good returns and this time would be no different. A similar case can be made against buying the highly priced Quality businesses which are offering no Margin of Safety. For example, any slowdown in the Consumption demand from the expected levels and lower Interest from FII Investors could shave a significant bit of their Market value. While they can continue to grow, a slower growth than expected will still result in value erosion because of negative Delta. More over fundamentally, we also believe that the current Consumption boom can't continue for a long time in a slowing job market, slow increase in real wages, lower savings and higher Interest rates. One of the reasons for consumption to hold up is the "Wealth Effect" created from strong Real Estate prices across the country. The expectations behind the Real Estate prices are even higher and no one believes there could be a correction indicating, classic Topping signs. Just look at the news flow, which the Real Estate markets continues to ignore. Interest Costs for builders are sharply up, Unsold Inventory are at record levels, End user demand is subdued and builders like HDIL, Orbit and Hiranandani have defaulted on their loan commitments last month. The signs of a correction are obvious. Let's take one small change which puts a lot of these stock prices at huge risk, - The US Bond Yields have risen from 1.4% to over 2.7% within weeks and this ensures that all the money which came with a search for stable Yields into Consumption stocks and rental Real Estate needs to get re-priced. With the Earnings Yield expected to go up on the change in US Bond yields, the share prices needs to correct significantly. The Fixed Income markets are also going through their own troubles, with the Bond Yields spiking strongly in the wake of a weak currency, leading to wide spread losses across Liquid and Gilt Funds. Considering all this, Equities are certainly not a very bad space and good Quality Bottom-Up ideas which are cheap are good spaces to deploy capital. With the current Currency moves, we might also be adding a few good Exporting stocks to our Portfolio over the next few weeks. We believe that except 1 or 2 stocks, majority of our Portfolio is not exposed to Political or Macro risks. While our Portfolio doesn't suffer from Currency Risks as we have a good mix of Importing and Exporting stocks, the recent Interest rate spike will have a effect as we have Banks like XX in our Portfolio. This can be seen from the steep correction in its share price. The Interest rate uncertainty will continue to affect our #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 3
  • 4. AUG'13 HBJ CAPITAL VENTURES Portfolio. On a broader theme, we believe that a lower Interest Rate is more positive LLP for the Rupee & Economy than Higher Interest rates. This is because, there is 10X more foreign ownership in Equity Markets than Debt Markets and they are sensitive to growth prospects which are in turn dependent on lower Interest Rates. Another important reason to note is that the concentration of the Portfolio has increased, with the Top-2 Stocks occupying a higher percentage of the total Funds and this is due to the high relative outperformance of these Stocks. We believe that overtime, most of our Stocks should do well and earn better returns than the overall Markets. For people who believe that Market is undervalued but would like to wait for more better prices, here are some advice from Investing Legends. "Certainty belongs to mathematics, not to markets and anyone who awaits clarity, visibility or the diminution of uncertainty pays a high price for a chimera " Bill Miller. "While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up and competition from other buyers will be greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from the bottom can be very swift. Therefore, an Investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better"- Seth Klarman. We certainly believe that the above Quotes clearly capture the current situation and Investors mentality. Our belief in the Wisdom of these Legends would serve us to maneuver the Portfolio through the current crisis and emerge with flying colors. Regards, [Principal Fund Manager, HBJ Capital Venture LLP] Date: August 30th 2013, Place: Bangalore, India #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 4

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