Perspectives – Solidarity

Signal vs noise – what game are we playing?

“In life, the challenge is not so much to figure out how best to play the game; the challenge is to figure out what game you’re playing.” (Kwame Anthony Appiah http://appiah.net/)

CLSA is a reputed broking house. It published a report 2 days ago recommending investors book profit in India.

We agree with CLSAs that valuations in India, on aggregate, are stretched. In our last letter we mentioned, we were “cautious, but not bearish” and that because we have borrowed returns from the future, we could be in for a period of muted returns.

Our process for exit decisions

You may observe we are gradually slicing out of our Specialty Chemical positions to re-allocate elsewhere.

A key choice we need to make is whether to trim on valuation excesses or to let positions compound and accept incremental underperformance due to valuation de rating.

Essentially, what game are we playing?

Will Technology firms take value away from Private Banks?

A question we introspect on significantly is whether the next stage of value migration in Banking will be from Private Banks to Digital players.

Our working hypothesis at present: well-run Banks will grow aggregate profits; however, their valuations will drift downwards as ROEs will decline.

The flaws of Sharpe Ratio

Sharpe ratio seeks to determine risk-adjusted returns, or “returns per unit of risk”. The higher the Sharpe ratio, the better the fund’s historical risk-adjusted-performance.

Solidarity’s Sharpe ratio since inception is ~2x that of the NIFTY. This implies for the same level of risk, we have delivered twice the return.

Developing a process to shut out the noise

The most frequent question we get from partners is what do you think will happen to the market.

Bitter truth: it is the wrong question to ask because no one knows.

Why is this so? Because markets move due to multiple variables, not all of which are visible or predictable.

Our perspective to some commonly asked questions (part 2)

What risk in the market do you worry about the most at present?

Markets seem to be ignoring the risk of significantly higher inflation down the road and abrupt change in monetary policy. At present, the markets are complacent that the US Fed will not raise interest rates in the short term and are justified in this because the US Fed, the most important Central Bank in the world, is still buying USD 120 B of Bonds monthly which keeps long term interest rates low. However, company after company is reporting higher inflation in the US even as economic growth in the US is surging.

The shocking resilience of India’s stock markets

Commentators are wondering why the Indian stock market is “shockingly resilient” amidst the devastation caused by the Covid second wave. Their premise is that Covid’s second wave is causing significant devastation and death. 2021 GDP growth has been downgraded. Rising raw material prices will erode margins. The virus has spread across the country and will cause massive unemployment. Analysts have started downgrading estimates. Stock price valuations are 2X of China. So why has the market fallen only 5% since February?

The futility of taking cash calls

In our last blog we explained we don’t intend taking cash calls just because markets may seem overvalued.

In this note we provide more rationale for the same. Even if one was to get market timing – selling and re-entry – both legs perfectly right, and that is a big assumption, the net impact on your incremental IRR vs staying invested is marginal.

Our perspective to some commonly asked questions (part 1)

4 common questions we have recently been getting

1. Is this still a good time to enter markets?

2. Will you invest all additional capital at present?

3. Will you take some cash calls because markets have run up so quickly?

4. Will you rejig the portfolio as cyclicals may do better short term?

Is Value Investing dead ?

Over the last few years, traditionally defined “Value” stocks have continued to get cheaper while “Growth” oriented cos have done very well. The divergence is stark and is now prompting questions whether Value Investing is dead.

The categorization of stocks between “Growth” and “Value” is erroneous. Anything that is low PE multiple and out of favour with markets is typically labelled “Value” and anything with high multiples and fast growth is labelled “Growth”.