2017 Annual Letter

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%.

Back when we started, we expected the Indian market to do better than the US market. We were utterly wrong about that. US investors were much better off staying home. Fortunately our own outperformance over the S&P 500 somewhat made up for our lack of our prediction skills. No more predictions. India will do very well over the next decade. Invest in India!

The broad Indian market rallied hard in 2017 posting its second-best year in the last decade. As stated several times before, we fully expect to underperform during such years. Our nitpickiness and caution made new highs in 2017. We kept significant amounts of cash. We even bought Index puts. Despite all this we managed to stay close to even with the broad market. Frankly, this surprised us.

When a market rallies this much it is natural for people to look for reasons. Punditry at large has converged upon India’s “structural reforms” as the primary reason. In our view that’s pure garbage.

For starters, here’s a list of reforms; the top five in our opinion.

1. A new tax code, which has everyone confused for now but promises to be wonderful in the long-run since the tax rates will go down and the base will widen.

2. A note swap that made every Indian’s life miserable but promises to root out corruption in the long run.

3. A real estate bill, which has led to the worst construction slowdown in nine years but promises to make the industry far more customer friendly in the long run.

4. A central bank diktat to force defaults on some large borrowers, an action which has decimated bank earnings but promises to be great for the long term health of the sector.

5. A bailout for India’s government owned banks, funded by the banks’ liquidity, in exchange for newfangled bonds. Apparently, it might lead to some fiscal pressure in the near term but … you guessed it…it’ll lead higher economic growth over the long-run.

The argument that Indian market is looking past all the self-flagellation and betting on the long-term future doesn’t hold water.

Moreover, consider this … a total of 42 out of the top 43 equity markets across the world were in the black in 2017 (sorry Pakistan!). Exactly HALF of those were up more than 30% for the year, in US dollar terms. Clearly, not every country in the world (OK, except Pakistan) could somehow be undergoing structural reforms in the same year.

So what’s causing this rally? Could be easy monetary policy, could be growth in corporate earnings, or could some worldwide joie de vivre. According to President Trump it’s all him. We don’t know and frankly, we don’t care much. Our plan remains the same; bottoms-up, fundamental stock picking.

Fortunately, we have a few things going for us. First, the absurdly high correlation between the markets does not exist within the markets. For every two high-flyer stocks there’s also a loser that has gone nowhere in several years. In other words, scratch the surface and it’s very much a stock-picker’s market.

In our 2015 letter we wrote:

We intend to stick to our plan and go wherever bargain hunting takes us. Lately, most of our energy is focused on companies in sectors undergoing turmoil. When analyzing such companies we ask ourselves three basic questions; 1) can the company make money even if the sector remains depressed? 2) if we buy the stock at current prices will we stand to make money in the long run, i.e., is the price right given the current depressed level of earnings and 3) is there a reasonable chance that conditions will get better soon? Three yesses usually mean outsized future returns.

This still works.

Secondly, while the markets everywhere celebrate new records, the volatility as implied by options dips to all-time lows. In other words, it costs next to nothing to insure against future bad outcomes. We plan to keep our insurance contracts alive and buy some new ones while they are still cheap. As usual, we are completely OK with these expiring worthless; that’s generally the intent with insurance. These contracts will help us invest more aggressively, especially when the inevitable market drawdowns do happen.

Lastly, while it’s true that current government’s zeal is causing considerable pain, it will almost certainly be a point of differentiation for India in the coming years. India is transitioning from being a mish-mash of small unorganized businesses to a collection of large corporates. This is bound to cause societal upheaval but is also bound to lead to higher system-wide efficiency. In sector after sector, year after year, small family owned businesses are ceding ground to larger players. This is as true for consumer products (jeans, paints, packaged food) as it is for B2B (trucking, tiles, PVC pipes). Notwithstanding the possible societal downside, the effect on well-run listed companies is obvious – they will do very well. The process will take time and picking winners at the right price will require patience. Buffett once quipped, “Lethargy, bordering on sloth remains the cornerstone of our investment style”. Ours too!

As usual, detailed write-ups and updates on our major positions follow this letter. Alert readers will notice that little has changed since last year. This is by design. We wish you a happy new year and thank you once again for investing with us. If you have questions regarding this letter or your portfolio, please do not hesitate to ask.


Rahul Bhatia Aniket Khera