The context of this question is to gauge the level of risk we are taking. Too low? Too high?
We manage your money as we manage ours. We are not attempting to generate the highest returns in the short term but for consistent returns over the long term. The guiding framework is resilience over speed.
Small/Mid/Large composition is misleading to gauge underlying portfolio risk. As a group, Small caps tend to be more volatile and more illiquid. However, Small caps do not necessarily equate with higher risk and Large caps with lower risk. Some small caps dominate niches, are debt free and high ROE businesses. Paradoxically, low liquidity can be an advantage as many funds will not want to invest in these spaces. Low liquidity creates higher volatility during periods of stress. That is confused by many participants as risk. But it is actually opportunity if one can stretch time.
Hence, we do not track the traditional Mutual Fund Small/Mid/Large categorization. Rather, the portfolio is constructed by organizing companies in 4 phases of their evolution basis the maturity (and hence implicit risk) of their business models and liquidity relative to our AUM.
- A ~10000-15000 Cr company (small cap in traditional MF definition) could be a large allocation for us (7-8%) in our context (1700 Cr AUM). Kama Holdings, India Mart are a few examples of Small caps with large weights today.
- However, a ~2000 Cr Market cap company would never be more than a 3-4% weight at cost as liquidity would be poor even relative to our AUM. We would not have more than 20% in relatively illiquid names in aggregate.
The criteria used for categorization of companies across 4 phases is as follows:
|Phase 1||Phase 2||Phase 3||Phase 4|
|Category||Special Situation||Emerging Leader||Almost Clear Leader||Clear Leader|
|Rationale for portfolio inclusion||Very cheap. But not compounding stories at present||Potential to become compounders. But still need to demonstrate ability to execute at scale.||Strong business model and moat visible.||Strong moat and clear competitive edge. Growth fly wheel is spinning|
|Position size per company||3% at cost||3-5%||6-8%||8%+|
|Aggregate weightage expected in SOL portfolios||5%||~25-30%||~30-50%||~40-50%|
We design portfolios to have a mix of smaller positions in Phase 1 and 2 companies that are “Emerging leaders” (~25-30% of portfolio) and larger positions in Phase 3 and 4 companies which are “Clear” leaders (~70-75% of portfolio).
- We take very small positions in Phase 1 companies where valuations have to be insanely cheap. If we are wrong, we won’t lose money. If we are right, we should do really well. But these are also stressful to own as there is often a variation perception on governance that explains the really cheap valuations. Questioning yourself every day is not a peaceful way to invest.
- We take small positions in Phase 2 companies (3-4% allocations) as there are higher chances of errors here. A change in environment could impact these companies more as they will be over-reliant on a few products/customers or people. No amount of analysis can tell us which of these promoters will evolve from “Ranji players” to “playing for India”. One understands these promoters better only after investing in them for a while and the probability of future evolution becomes more obvious over time. Multiple interactions over time help us learn much more about how they are wired and the gaps between what they would like to do vs what they actually do and whether that will narrow or not.
- Phase 3-4 companies have more stable business models where there is more track-record. One can take bigger positions here and often there is a longer promoter history to scrutinize.
- Phase 3-4 will provide stability to the portfolio with Phase 1-2 providing the return kicker as they can both grow faster and have potential for re-rating if they evolve into more robust business models. Good examples of Phase 2 to Phase 3 evolution in the recent year have been Axis Bank, RACL Gear Tech – where execution resulting in enhanced market credibility and hence higher valuation multiples.
- Our bias is to let our Phase 2 winners grow into higher position sizes while exiting Phase 1 and 2 companies where we see promoters not evolving at the appropriate pace and we can allocate capital into more promising ideas.
Our key holdings mapped to this framework at present are as follows. Please note that these can change tomorrow and we will not share advance intimation of change in our thinking as that is against the partnership interests.
|Themes||Phase 1||Phase 2||Phase 3||Phase 4|
|Banks||Axis Bank||ICICI BankHDFC Bank|
|Manufacturing||MAN Industries||Mayur UniquotersShaily Engg.Hester BioYasho Industries||Kama HoldingsRACL Gear TechNeogen Chemicals||Garware Technical|
|Life Insurance||ICICI Pru Life||SBI LifeHDFC Life|
|Health Insurance||Star Health|
|Digital and enablers||India Mart||Bharti Airtel|
|Consumption||Restaurant Brands Asia|
|Aggregate weightage in SOL portfolios at present||< 4%||~25%||~32%||~40%|
Basis the MF industry categorization, Large Caps are about 60% of the portfolio today. As we intend to allocate more capital to non-financials over time, we expect this ratio to gradually decline. However, it would ultimately depend on where we see the best opportunities.