Introduction

As of March 31 2023, Sameeksha completed seven years of managing money in Indian equities. Back in late 2015, we started Sameeksha with the objective to manage our investors’ assets just as we manage our own by investing in businesses that were durable and were managed by stewards who view their company capital with the same care that we manage our investor assets. In Appendix 4, we discuss the performance of our fund over seven years. As we did in our last annual letter, we summarize the highlights of our process below.

 

We have set up an investment process that is rules-based, with extensive due diligence and a focus on generating long-term returns. Our investment process combines qualitative analysis of a company’s strategic positioning, evaluation of financial metrics that verify our qualitative analysis and determination of intrinsic value of the business through a process of triangulation. The qualitative analysis of the company involves industry assessment, positioning of the company within the industry and the leverage it holds with suppliers and customers, management that is both capable and honest, and the threat of disruption. The financial metrics that are important to us are cash flow generation, the return on net tangible capital and a capital structure that can withstand economic stress. Our value discipline means that each portfolio holding has to justify its position based on expected return adjusted for the cost of capital. This has often meant that the portfolio has higher levels of cash when there is a dearth of opportunities based on our stringent criterias. Investing with the goal of generating superior long-term returns requires taking risk. Our view is that the key risk to be minimized is the permanent loss of capital- this is generally driven by the lack of due diligence prior to investing or the failure to correct investment mistakes when they manifest. We discuss our success in generating superior absolute and relative returns (to benchmark and peers) in a subsequent section, but our key message to investors is that we have always maintained the discipline in implementing our rigorous process in analyzing companies and constructing our portfolio.

 

We have also sought to continually attempt to improve our process by implementing small changes from what we have learnt from our successes and failures, and our strengths and weaknesses. The latest fiscal year was a challenge since we trailed our benchmark during the first half, but recognized what we could do to address the shortfall. In the end, we delivered strong outperformance in the second half and finished well ahead of the benchmark for the full year. 

 

Review of the Year

Financial year 2022-23 was not a great year overall for the Indian equity markets. The year ended with the market continuing to clock a monthly slide in the month of March on the back of global uncertainties fueled by a banking crisis. For the financial year, our benchmark index BSE500 TRI was down by 0.9%. The Indian equity markets for the year 2022-23 wrestled with many headwinds. Elevated inflation levels and supply chain constraints triggered by the Russia-Ukraine war was the biggest negative catalyst for the equity market. The Covid-19 lockdown in China amplified the said issues. To tame the elevated inflation levels, central banks across the globe, including RBI, hiked interest rates. The higher prices and borrowing costs have raised recession fears in the U.S. and other major economies. Moreover, major events such as the collapse of the Silicon Valley Bank (SVB) and Credit Suisse’s buyout by rival UBS kept the stock markets on the edge by the end of the financial year. FPIs turned net sellers during the financial year, being wary of expensive valuations. The chaos caused the indices to close the year on a tepid note after stellar gains for the past two financial years. However, strong domestic participation cushioned some losses as investors showed confidence in India’s long-term growth story.

 

In this tough financial year 2022-23, Sameeksha PMS has managed to generate positive absolute return as well as meaningful outperformance as compared to our benchmark BSE500 TRI. The PMS returned 5.1% before performance fees but with the application of performance fees, our returns came to 4.52%, outperforming the benchmark BSE500 TRI by 5.4%. We analyze the Fund performance for the year in greater detail in Appendix 1.  Further, we discuss key contributors to the portfolio performance in Appendix 2.  We discuss the outlook for our key investment positions in Appendix 3. 

Market Outlook

Some of the factors that impacted market performance negatively in FY 2022-23 appear to be abating, especially related to energy costs and inflation. While export growth has weakened sharply, domestic drivers of the economy remain healthy.  In the Union budget presented in February 2023, the Government maintained its thrust on infrastructure with an over 30% increase in the capex outlay. We are witnessing both a higher thrust in building infrastructure but also faster speed of implementation. This is clearly visible in the form of increased and superior road connectivity, expansion of rail network, introduction of new train systems that focus on faster and safer travel with higher comfort, dedicated freight corridor, expansion of existing airports and addition of new airports, build out of ports and equally importantly the digital infrastructure. India is clearly in the middle of a once in a generation upgrade of infrastructure. Multiple sectors of economy that were subdued for a number of years have seen a strong revival in revenues and order book. The revival is also visible in sectors such as real estate thanks to very strong pent up demand. Then there is the Make in India initiative which is coinciding with a global push for alternatives to China and at the same time growth of the Indian economy and technology capability is making domestic manufacturing a very big growth engine. We are witnessing expansion of manufacturing capacity in well established sectors as well as in entirely new segments such as electronics, speciality chemicals, advanced automobile components, defense and more.  A range of policy reforms implemented over recent years has set the base, while further policy action has empowered people and boosted financial savings, driving higher domestic flows into equities. We further discuss structural factors driving the Indian economy in Appendix 5.

 

Meanwhile, aiding a positive backdrop for economic expansion are positive macro factors related to fall in energy prices and an overall downward trend in inflation which releases pressure on RBI to raise rates. At the same time, Indian banks and other financial sector companies have ended FY23 with probably the strongest balance sheets in a very very long time thus making credit availability plentiful.  There has also been a clear focus on formalization of the economy through reforms such as GST and the growth in direct as well as indirect tax collection remains accelerated suggesting robust growth in corporate profitability as well. This bodes well also for employment. At the same time, multiple government schemes ensure a good safety net for a vast cross section of the society and that in turn improves the ability of Indian consumers to spend. 

Strong economic fundamentals are aided by increasing participation in equities by Indians that has helped cushion the impact of two years of negative flows from foreign investors. Removal of tax loopholes for investment in other asset classes (removal of capital gains benefit for debt and capping of some benefits for assured return products camouflaged as life insurance) will only induce Indians to focus on equities to realize higher long term returns.  

Against the backdrop of positive economic outlook, Indian equities (Table 1) are valued near long term averages on some measures and attractively valued on some other measures. Widely talked about Bond to Earnings Yield ratio is quite reasonable  at about 25% percentile of historical average. While the market looks very expensive on Price to Book matrix, a more important measure – we call it Sameeksha ratio that takes into account Return on equity, interest rate to gauge Price to book ratio is not as alarming. Market cap to GDP ratio is near its historical peak but a ratio of 1.0 is far cry from what we see for the US market (close to 2) and a ratio closer to 1.0 may be a new normal for a much larger Indian market today versus the past.

Table 1: Indian equity market monitor 1 as on 15th May 2023
Particulars	TTM PE 3			PB 3			PB to Nifty PB ratio		10 year Treasury Yield (%)	BEER 3 on Normal PE	Sameeksha Ratio PB/(ROE-Rf) 3	Inflation (%)	Unemployment Rate (%)	Mcap/GDP
	Nifty 50	Mid Cap 150	Small Cap 250	Nifty 50	Mid Cap 150	Small Cap 250	Mid Cap PB	Small Cap PB
15-May-23	21.8	24.5	18.6	4.3	3.3	3.2	0.8	0.7	7.0	1.5	53.4	4.7	8.1	1.0
Median	21.1	21.5	24.6	3.6	2.7	2.0	0.7	0.5	7.5	1.6	49.1	5.3	7.2	0.8
Max	42.0	813.5	306.6	6.6	6.5	5.0	1.1	0.9	9.3	2.5	111.3	8.6	23.5	1.0
Min	10.7	7.5	6.7	2.1	1.1	0.9	0.5	0.3	5.3	0.7	13.6	1.5	3.4	0.6
Average	21.6	31.0	36.0	3.7	2.8	2.1	0.7	0.6	7.5	1.7	49.9	4.8	7.3	0.8
Historical percentile (%)2	58.3	56.1	34.5	82.9	71.7	85.7	58.9	90.4	24.9	25.4	60.0	36.8	74.2	97.3

1. Approximate values as on 15th May 2023

2. Situations for allocation to equity 

Below 25th Percentile  – Most Favourable   

Between 25th  to 50th Percentile – Neutral   

Between 50th  to 75th Percentile – Expensive  

Above 75th Percentile – Not favourable

3. TTM – Trailing twelve months; PE – Price to Equity Ratio;  PB – Price to book ratio; BEER – Bond Equity Earnings Yield ratio; ROE- Return on Equity (%) ; Rf – Risk free rate of return (%)

The Nifty valuations on PE basis have corrected from the peak and are back to historical averages. However, outside of the large caps, the broader market has corrected significantly from the top and currently, that is where we have found risk reward more favorable over the last one year. This is clearly reflected in a shift in our portfolio towards small cap.  Looking ahead, we will remain focussed on identifying bottom up opportunities across the market cap spectrum. 

As a whole, the outlook for India is still positive in our view, and knowing well the strong structural tailwinds across many sectors in India, we remain optimistic for Indian markets.  Having said that, the key factors which can impact markets and need to be closely monitored are:Geopolitical situation, Commodity and crude price movements, monsoon season and global economic outlook. 

Sincerely,

Bhavin Shah             Eswar Menon

Links:

Appendix 1: Performance Of The Fund For FY2023
Appendix 2: Key Performance Contributors In FY2023
Appendix 3: Current View On Top Seven Positions
Appendix 4: Analysis Of Our Performance Over Last Seven Years

Appendix 5: Outlook For Indian Economy