Prosperity Discovery Fund - Quarterly Update Q3FY22
Updated: May 30, 2022
Greetings from Prosperity.
As we navigate through turbulent times, I hope this quarterly letter assuages any concerns you may have regarding the recent volatility in the Indian and global equity markets.
Rest assured we have rebalanced our portfolios to better face the present market scenario.
Before we understand what lies ahead, let me shed some light on the key factors that have been agitating the equity markets in the recent past.
By the beginning of the third quarter of this financial year (October 2021), The valuations of the Indian equity market had reached a peak as a result of the excess liquidity in the economy. This coincided with hyper-inflation in the price of key raw materials and commodities such as metals, coal, oil & gas (in addition to the surging freight costs) resulting in muted corporate earnings.
High stock valuations in tandem with a drop in corporate earnings are a text book recipe for market correction. This is evident from the sharp correction in the Indices graph shown below, especially after the results of the third quarter (15th Jan - 15th Feb 2022).
[ Please note, this however does not mean one tries to time the entry and exit in the market, as markets can remain significantly overvalued or undervalued for extended periods of time. A better strategy is to invest in good companies that can continue compounding their earnings in the long run resulting in valuations once again becoming attractive to prospective investors.]
In addition to the above, the recent tightening of monitory policies to curb inflation and a pressing Ukrainian crises have further agitated the global markets.
While the situation may seem daunting, we have faced such challenging situations many times in the past with the equity markets emerging stronger each time. Be it the attack on Pearl Harbour in 1941 where the S&P 500 (A key US stock index) fell 11% in a single day, the Oil crisis in 1973 resulting in oil prices rising over 300% in a few weeks which led to a 17% drop in the S&P 500, the annexation of Crimea in march 2014 resulting in a 2% drop in the S&P 500, or more recently the covid 19 Pandemic where the markets both sharply corrected and recovered roughly 35% in span of 6 months. While such major events are a few and far apart they demonstrate the resiliency of the stock markets post crisis for long term investors.
At this point I would also like to re-embellish the old adage of ‘time in the markets’ being a greater predictor of investing success than trying to ‘time the markets’. In fact, going by history, the greatest returns have been made in periods following great turmoil. Wise investors have benefitted by investing in high quality asset classes available at great bargains during testing times.
A graph has also been presented below to further explain the same. From the graph, while it may not be possible to accurately predict point Y (The market's lowest point of inflection) an investor can make superior returns by incrementally investing through points X and Y while the Intrinsic value of a company is much greater than its market value.
Moreover we also believe that adversity makes great companies better, it demands higher levels of efficiency, forces companies to better plan their supply chains to reduce areas of high dependencies, explore newer markets and develop more innovative products to restrengthen their business.
Let us now look at our portfolio in detail. Prosperity Discovery Fund was instituted as a multicap fund to enable us to optimise between managing market volatility and making high returns, based on what the market situation demanded.
As the situation stands now 50% of our portfolio is invested in large companies (up from 15%-20% large cap allocation a few quarters earlier). 10% is held in cash and equivalents and 40% in high quality mid and small companies. The large cap allocation combined with the cash position will cushion any further fall in the market while the smallcap and midcap portions are poised to strongly rebound upon broader market recovery. We have also made a few modifications to the existing portfolio as follows.
During the quarter gone by, we have added a logistics company to our portfolio which will also help us participate in the divestment theme taken up by the Government of India. This company has a monopoly market share of 66% in the containerized cargo segment transported through the railways. It will also stand to benefit from the Government's decision to invest in building dedicated freight corridors. The management of the company has further planned to invest Rs. 8000 Crores over the next 5 years to develop dry ports and logistic centres to take advantage of India’s growing EXIM business.
We have also picked up a small stake in a debt-free pharma company which follows an asset light model of supplying pharmaceuticals to emerging markets such as Africa & Latin America. We see a deep moat in its supply chain network in an otherwise tough to service geography. The management is also planning to spend Rs. 430 Cr for capacity expansion and backward integration of 70% of its products by 2024. Further the company also holds a subsidiary backed by the US based Eight Roads ($8Bn in AUM) and F-Prime Capital ($3Bn in AUM) which focus on R&D and manufactures high quality Injectables for Regulated Markets, from which the company plans to generate 100mn US$ by 2026.
As per Budget 2022, the Government of India is expected to roll out 5G services in FY23 and the launch is expected to increase the usage of telecom equipment and ancillary infrastructure across India. To take advantage of this, we have added a telecom equipment manufacturer which is at an inflection point after a takeover by one of India’s biggest conglomerates, the TATA Group. The company produces optical, broadband and data networking equipment which it sells to internet & telecom service producers across 75 countries. The company’s is poised for a strong turnaround following a de-bottlenecking in the global semi-conductor supply chain.
We have also recently added a fully backward-integrated specialty chemical manufacturer with an expertise in 35 chemistries (For chemistry enthusiasts: ammoxidation, vapor phase reactions, Grignard, ketene handling, photochlorination etc.) The main products the company produces are acetyl intermediates (used in Pharmaceuticals, Agrochemicals etc.) which the company further uses in synthesising value-added chemicals such as Pyridines which are also subsequently used by the company in the production of Vitamin B3 and B4. Recently, the company has entered into the growing Diketene segment roughly 50% of which is currently being imported in India. The company has outlined a CAPEX plan of Rs. 900 crores in the coming 3 years, and the management firmly believes that this will help it double its topline by FY2026.
Apart from the above we have also added large corporations in the banking, retail and IT sectors to make our portfolio more defensive.
While global events may continue to keep the Indian markets jittery in the short run we are confident that the markets will stay resilient and continue to grow at a good pace over the years to come.
To investors holding cash, it may be a good idea to continue buying high quality business in instalments over time while they are still available at reasonable valuations.
As always we are committed to ensuring that we make the best returns possible for our investors while being mindful of the margin of safety in our investments.
MD, Prosperity Wealth Management.