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  • 1. HBJ CAPITAL VENTURES LLP Jan'14 Monthly Newsletter: HBJ Capital Ventures LLP Dear Partners, The month of February was less eventful with no big bang news flow. Markets were also very range bound with little to write about. However, the overall market construct was positive with certain quality Mid-Caps and Small-Caps registering healthy gains (including few of our stocks). As we near the Big Event (General Elections), market movements will continue to be dominated by Political news flow. Most of the market participants seem to believe that a favorable Election outcome can propel Markets to new highs. We would like to dwell a little deeper on this assumption and analyze it in detail. There is no doubt that a NDA Government would be a sentiment booster to the economy. Improving sentiments combined with a stronger execution can solve a lot of our problems. Considering that India is affected by Supply side constraints rather than Demand side constraints, Economy can recover much faster than what most Economists believe. There is a lot of Reflexivity in the Indian economy and we believe that simple executive decisions combined with a cyclical upturn in the Economy (Inflation topping out, CAD under control, Fiscal consolidation, improving Financial savings) can propel GDP growth to 7% levels. While this may get reflected in a healthy re-rating of Indian markets, a secular Bull Market would require far more serious Legislative reforms. None of us should forget about the huge potential this country holds and the positive effect a strong leadership can have on the economy. Hence, unlike some of the well respected Analysts who believe that Elections is a one-month event, we believe that the outcome has serious implications on the Long term story of India. #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 1
  • 2. HBJ CAPITAL VENTURES LLP Jan'14 That said, while Election outcomes can have a huge impact on India's growth - stock market returns are not highly co-related. We have given enough examples in our previous newsletters as to how these two are sparsely correlated and as to why we believe that a bad election outcome can actually be a stock picker's delight. The inherent contradiction in what we say about Election outcome can be reconciled by understanding three factors - Several sectors and stocks are totally delinked from Government policies, Markets during sell-offs don't differentiate between quality stocks and Big Money is made in markets only by buying bottom-up ideas during troubled times. Most of our Portfolio stocks are quality businesses which have an inherently attractive Growth rate and Returns potential. A Favorable macro environment is only an added bonus that can improve the returns further. Our initial investment rationale in our stocks is definitely not based on any of the broad macro events. Most of our stock's long term returns would be determined by the company's performance and the overall sector fundamentals and relatively less on the overall Macroeconomic environment. We are fully aware that such a Portfolio construct can lead to Portfolio underperformance in the short term in case of a favorable election outcome. Companies that are highly correlated to economic cycle and Government policies will have a big shot in the arm and hence can deliver substantially higher returns. We are ready to live through such underperformance as we would not like to take bets on Government policies and Economic cycles that we know are outside our "Circle of Competence". Anyways we have a lot of stocks in our Portfolio that derive significant Alpha from higher GDP growth and hence they will be great proxy beneficiaries from a favorable Electoral verdict. The structural valuation re-rating combined with consistent Earnings growth in our Multibagger stock picks that are held for many years will help us generate far superior returns as compared with the returns generated from a strategy of continuous portfolio churning based on Market events. Unlike Mutual fund managers, we don't run Portfolios of HOT Money and hence short term underperformance is no Big deal. We are more concentrated on delivering strong absolute returns on the back of a disciplined betting process. We believe that our Portfolios can certainly deliver strong returns over a 3-5 year time frame irrespective of Election results. As a stock picker, I would be happy with a bad election outcome, but as a Indian, I would like to have a strong Government which can boost Economic growth in this country. With our Portfolio strategy explained - let's understand the real hurdles for a secular Bull Market in India in case of a strong electoral verdict. While analysts point out several barriers for growth, the one which intrigues me most is the state of the Financial sector. A secular bull market is always built on a strong Credit cycle that in #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 2
  • 3. HBJ CAPITAL VENTURES LLP Jan'14 turn is a function of the Inflation levels in the economy and the Capitalization levels of the Financial sector. We believe that both these factors will be strong hurdles which need to be cleared for a sustained up move. We have discussed about Inflation several times in the previous newsletters and also about the strong policies that can break the structural element of Inflation. With a new RBI governor who is determined to get the Monetary rates in line and hopefully a new government that can take policy action, Inflation genie can be controlled. The issue that is little more difficult to resolve is "Restarting Credit cycle towards the Investment part of the economy". This is especially tough given the low capital adequacy ratios of the Financial sector at current point of time. There was a wonderful article from "Aakash Prakash" in Business-Standard on this issue. He points out that 30-40 Billion $'s are required to recapitalize Indian banks in order to get credit growth back to 15% to 18%. Funding this is not going to be easy and unless the credit cycle revives, it's difficult to make a case for a Secular Bull Market. While this is certainly a big issue, we also believe that Indian policy makers have several tools to solve this problem. We believe that majority of the NPA's in bank accounts are from projects whose viability can be brought back with a combination of Policy intervention, Credit restructuring and infusal of additional Equity. This is possible as there is no demand collapse or over supply. The current unviable nature is mostly due to regulatory hassles and high cost inflation. Hence, even the issue of an improvement in Credit cycle can be solved on the back of decisive executive action. Considering that there are a lot of "If's and But's" in such analysis and that a large number of variables are interlinked, we believe that the effect of a Good government vs an Ineffective government would be magnified this time around. The reflexivity in the system is very high and hence an uptick in sentiment can solve a lot of simpler issues. Hence as well meaning Indians - we would definitely hope for a strong sentiment booster from the upcoming general elections in the form of a decisive government. Regards, [Principal Fund Manager, HBJ Capital Venture LLP] Date: February 28th 2014, Place: Bangalore, India #912, 1F Main, Girinagar 2nd Phase, BSK 3rd Stage, BLR - 85 Page 3