All our portfolio companies were flat to up this quarter. As usual, annual commentary on our major positions starts at the end of this letter.
We have opened our last three letters with COVID. This will be the last time we do so, simply because by the next quarter we won’t need to.
The daily case count has now gone below 15,000. Active cases hover around 200k, down from 700k the last time we wrote to you. Fatality rate is now decidedly below 1.5%. Despite its limited resources, poor administrative capacity, and chaotic cities crammed with millions of non-compliant citizens, India has done well so far.
It’s the next phase - the mass vaccination, where India will clearly shine. It produces 60% of world’s vaccines. It administers some of largest vaccination programs in the world. It has decades of experience dealing with infectious diseases. The government plans to vaccinate 300M by July. Even with delays priced in this will be a terrific achievement.
Meanwhile, NIFTY has rallied 75% from its lows and is now trading at all time highs. Sixty percent of the BSE500 companies trade higher than they did at the end of 2019. Many of them are doing so despite little prospect of recovery until 2022. For some, the multiple on normalized earnings is now higher than it was pre-pandemic. Is this a bubble? Or has the pandemic somehow made the companies better than they were?
After long delays, we now have the Q4 2020 (ended March 2020) results for all our portfolio companies except one. Typically, companies have one month to report but this time SEBI extended the deadline all the way to July 31. These results capture only a few days of the lockdown period, which started on March 25 and still continues in a few concentrated pockets. The June quarter will show the full picture. Overall, the picture will be ugly, which is hardly a surprise.
Just when it looked like the Indian economy was finally getting back on track, the entire nation had to go on a lockdown - an extraordinary move for a country of 1.3bn people, with a case-count of less than 500, and hardly any deaths.
Given the exponential spread, the government was likely correct in doing what it did. Cases were doubling every 3 days. Hospitals were wholly unprepared. Testing was close to nonexistent. Epidemiologists were predicting a 1,000-fold increase by end of April. In other words, 500,000 cases.
Instead, we have 28,000 so far. Growth rate has settled around 8% a day, with recoveries growing at the same pace. In fact, by all accounts total mortality in India has DECREASED. Car crashes, train accidents, homicides, have all come down meaningfully. We have the lockdown to thank for all that.
The global death toll from Coronavirus is now over 2,800, with more than 83,000 cases reported. The virus has spread to every continent except Antarctica. US CDC announced cases with no known ties to an existing outbreak. The S&P 500 just recorded its quickest ever 10% correction. Every risk asset, including our portfolio is in significant drawdown.
This letter comes to you later than usual. We decided to wait for the government to present its 2019 budget, so that we could talk about and celebrate together some path-breaking reforms. We shouldn't have.
For folks not quite familiar with the annual tradition of Union Budget, here is a quick overview:
Last year’s sell-off, which paused briefly around the election months, resumed in the earnest starting July. Everyday there is some new bad news. Promoters are going to jail. Companies with long histories are winding up. Everyone has been asking the same two questions - when will India turn around? Will it ever?
Let's look this from a few different angles.
First things first … the elections are finally over. Thank god!
With 302 seats in the lower house and a near majority in the upper, Modi can now push almost any agenda he wants. Will he push the right ones? Our starting point on these issues is this fascinating quote from Thomas Sowell:
"No one will really understand politics until they understand that politicians are not trying to solve our problems. They are trying to solve their own problems - of which getting elected and re-elected are No. 1 and No. 2. Whatever is No. 3 is far behind"
We will keep this one short since we don’t have much to say this quarter. Neither do the Indian business owners we met during our recent travels. There’s a sense of stillness in the community, a quiet anticipation of sorts – itching to make a move, but not quite sure in which direction. Abhi election ke baad dekhenge, “We’ll see after the elections”, is the common refrain. This makes sense. Almost 900m Indians, over 75 days, are selecting 543 representatives, out of the 8,000 plus candidates fielded by 450 parties. No matter which dimension you pick, the scale of the Indian general election looks astounding. So, it’s natural to think that it’s outcome will have an astounding effect on the business as well. We don’t think so. We have looked at the data - market returns, earnings, macro factors like deficits, currency, and other finance-y stuff. None of it has any correlation with the election outcomes.
2018 was a disappointing year for us. Disappointing not just because of the negative performance, which obviously was painful, but more so because of our unforced errors. Poor choices caused about one-third of our negative performance. Rupee depreciation and indiscriminate mid-cap selling caused the rest, in roughly equal measures. We spent the entire Q2 letter dwelling on our four problem stocks so we will not rehash it here. We fixed the problems when we found them, even though the temptation to “just wait things out” was quite high at the time. We have a process for handling bad outcomes, and we stuck with it. For that, we are proud of ourselves. Now we just have to work on being less stupid when buying. That’s work in progress.
The malaise afflicting the small and midcap companies has now spread throughout the market. In fact, this correlation-one event is not just restricted to India. Remember, in our 2017 annual letter, we mentioned how 42 out of the 43 markets we track rallied last year? This year 37 of those markets are down. Investors are running away from anything that’s not America, fundamentals be damned
We are suffering our biggest drawdown yet, and broadly, there are three sources of this misery, a) our mistakes, b) re-rating of small and midcap companies, and c) depreciation in the Indian Rupee
A broad market sell-off in India was partly responsible for our Q1 drawdown. Additionally, since most of our holdings are of the small cap kind, a category that sold off violently, we underperformed the benchmark indices. It’s disappointing when your better-than-average stocks do worse-than- average. But history tells us that Indian market can pretty much make anything happen in the short term. Letting that dictate our investment process would be a sure-shot road to ruin. We buy good businesses at good prices. After that, we have no choice but to wait for the market to agree with us. So far it has.
Willow turned five this year. We thank you for your support through all these years. Many of you have been with us from day-one. Most of you have had to endure significant drawdowns, more than once. None of you left us. Several of you have asked to increase your allocations. We could not have possibly hoped for better.
Since the beginning we have asked that you evaluate us on a 3-5 year time frame. You now have a total of six periods (three 3-year rolling, two 4-year rolling, and one 5-year period) to use for your evaluation. We have outperformed the India index in all such periods, our 5-year cumulative outperformance being 74%.
We started our previous letter by pointing out that despite its 20%, Indian market is not very special – other countries have rallied as well, some far-far more. The ensuing three months have made Indian equities even less special. Everything seems to be rallying. Economist ran a cover feature recently called The bull market in everything. It had a picture of a bull with Bitcoin hanging from one horn and iPhone hanging from the other. How appropriate.
Despite the continuous barrage of negative newsflow, which has us all believing that the world as we know it is coming to an end, India is up more than 20% percent. What a special country.
But wait – Poles and Mexicans are saying the same about their countries. After all, their markets are up even more, 38% and 31% respectively. What about Greeks, Italians and Hungarians? Same! Turks, Koreans, Chileans? Same! In total, 38 of the 40 markets we track are up year to date. It’s worth keeping our celebrations and our anxieties in this context.
Since that fascinating November day when India switched its banknotes and America its president, both the markets have done rather OK. Expectations for them had been anything but OK. So quite naturally the bears are getting progressively shriller. Apparently the valuations are so high - both NIFTY and S&P 500 are now trading at 24x P/E (some coincidence!), that markets will soon spontaneously combust. We have our doubts but will happily side with the bears. It’s been a long time since we have seen a market-wide garage sale so a part of us yearns for a sell-off.
Our long-term goal remains the same – to significantly outperform the Indian market in US Dollars. We believe that India will do very well over the long term. We want to improve upon that performance.
Although the fund performed very well in 2016, one year performance means very little. Let’s defer our victory laps for another time. For now, we would like to focus on something more important, - not how well but how differently the fund performed in 2016. Differently not just from the index but also from ALL the well-managed India funds we track. It’s a big difference so we should explain what’s causing it and what that means for our future
Unlike the previous quarter, this one produced very little in terms of news-flow unless you consider Summer Olympics to be newsworthy. We certainly do. Everyone needs a little inspiration now and then and what could be more inspiring than watching mere humans do superhuman things? Call us stupid but we fall for the same magic trick every four years. Compare this to the political drama that’s currently dominating the American news media. Nothing could be more uninspiring. Growing up in India, where such nonsense is commonplace, we are largely immune to it. It’s sad nevertheless
In a quarter filled with exciting news items like Britain’s exit from the EU, and Raghuram Rajan’s from the Reserve Bank of India, our views and our portfolio changed little.
Brexit, no doubt, has serious long-term repercussions for Britain, but what exactly those repercussions are, is anyone’s guess. Notwithstanding the knee-jerk effect on asset prices, Brexit’s effect on global economy is debatable. Its effect on the Indian economy is even less clear. Finally, its long-term effect on the health of companies we own, or would like to own, is likely nothing. And that is all we really care about.
Our portfolio experienced higher than usual volatility last quarter, as did the broader market. MSCI India was down about 14% by the end of Feb, and then up 13% in March. China, yet again, was the scourge. In other words, if markets were to be believed, something happened China, which made things materially worse in India for two months, and then suddenly awesome in March. We wonder what that “something” was. We have looked around but haven’t found it yet. If we do, we will be sure to report it.
Our long-term goal remains the same – significantly outperform the Indian market in US Dollars. Although ultimately it’s the absolute, not relative performance that should matter – after all you cannot eat relative performance, we believe that Indian markets will do very well over the long run and we intend to do better.
Consider this – For the last decade, MSCI India in US Dollar terms has returned an annualized return of 7%, similar to that of the S&P 500 including dividends. For the last 15 years, India has returned 11% while US has returned 5%. That’s a cumulative difference of 300%. Meanwhile, the US Dollar which used to be worth 43 Rupees in early 2000 is now worth 67 Rupees.
For a contrarian value investor like us, a lot of good things happened last quarter. It all started with China. Shanghai Composite, after the June sell-off, dropped another fourth or so. We aired our concerns regarding the Greek exit and Chinese slowdown in our last letter. It turned out that China was a far bigger problem than Greece. This is not entirely surprising given that Chinese economy is now responsible for about half of world’s GDP growth. However, the extent of slowdown, the Chinese government’s reaction to it and the resultant fall-out took the markets by a huge surprise. Then came the US Fed’s do-nothing decision, which just added to everyone’s confusion. The US market, worried sick at this point, promptly dropped to make the quarter one of the worst since the global financial crisis.
The harmless looking selloff – MSCI India US is down 3.61% for the quarter, is hiding a far more interesting dispersion. Several companies, and some entire sectors, have suffered massive sell-offs. Valuations, after a long time, have started making sense in some cases. We are looking through the rubble with substantial deployable cash on hand. The returns from these investments will take a few months to show up but they’ll be substantial.
By all traditional valuation measures the Indian equity markets are now looking expensive. The reasons are two-fold.
First, there’s a flood of liquidity that’s inflating asset prices across the world. Global discount rates are now at unprecedented levels – a dozen or so countries have negative short term rates. A few of these are fast approaching negative long term rates (imagine buying a bond and having to pay interest for the next few years!). Surely, some of this liquidity is finding its way into the Indian markets. Foreign Institutions currently hold 50% of the entire free float for the 200 biggest Indian stocks – an all time record. We are concerned.
In all likelihood, our 2014 performance was atypical. We hope that 2013 was atypical as well. Together, the two years resulted in satisfactory returns. Our goal is to significantly outperform the Indian market in USD terms over the long run. Two years is hardly long run, but we are pleased to get off to a good start. These returns have, and will in future, come with considerable volatility. The Indian markets and our investing style all but ensure that. We are contrarian investors. We want the market to present us with deep discounts, and we want these discounts to disappear as the market rallies. In that sense, an inefficient and volatile market is far more preferable than a stable one.
Notes & Letters
A collection of our thoughts, views, and excerpts from our investor letters.