To us the 2 most important investment rules are: 1. Strive to never lose money 2. Never forget Rule 1!

Transcription

1 To us the 2 most important investment rules are: 1. Strive to never lose money 2. Never forget Rule 1! This adage, made famous by Warren Buffet is our guiding light and we strive to ensure Capital preservation. We believe that if we contain the downside, superior returns will be taken care of by a multitude of options i.e. business/ strategic developments, appreciation of earning power of companies, investor psychology, etc.

2 Thoughts on the Economy Key highlights: GST implemented in India from July 1, 2017; The implementation of GST in the near term could lead to some disruptions as production processes will likely take time to align with the new framework. Over the medium term, GST will create a more efficient taxation system in the country and broaden the tax base by ensuring that the entire value chain comes under the tax net. Minutes of the June RBI meeting suggests that members are less hawkish than before; MPC (Monetary Policy Committee) will be looking at further economic data to decide on rate action; Possibility of an August policy rate cut exits. Banking sector NPLs: Need for faster resolution of corporate accounts; RBI directs banks to initiate proceedings under the Bankruptcy Code for 12 corporate accounts account for 25% of the Gross NPLs for the system RBI s Financial Stability Report (FSR): Taking a hard stance on corporate loan frauds; System stressed loans at 12% of total loans. Note: Past performance is not an indicator of expected future performance. Net FII inflows into debt and equity (USDBn) The Indian markets took a breather in the month of June 2017 with the large cap Nifty index declining 1.2% while the Nifty midcap index was marginally lower at 0.88% (both in USD terms). On a one year basis though, the nifty is up 20% in USD terms. Performance has been aided by momentum in policy reforms, stable macro trends and liquidity support. The month of June 2017 saw India gearing up for its biggest tax reform since independence with the rollout of the Goods and Services Tax (GST) on July 1, Even while near term disruption is likely considering the extent of change GST will bring to indirect taxation in India, the structural benefits of the same will flow through over the next few quarters. Flows into the Indian equity markets remained strong with FIIs (Foreign Institutional Investors) being net buyers to the tune of USD385mn and DIIs (Domestic Institutional Investors) being net buyers to the tune of USD1.01Bn in the month of June GST The new paradigm in the Indian tax system Source: Bloomberg, Kotak Institutional Equities The country has moved to a new paradigm in taxation with the implementation of GST from July 1, This marks a new era in taxation in India and GST will likely create a more efficient taxation system in the country and broaden the tax base by ensuring that the entire value chain comes under the tax net. Further, the implementation of GST is likely to reduce the incidence of tax avoidance and over time will help India improve its tax-gdp ratio. Structurally, the adoption of GST would in our view lead to a migration from the unorganised to the organised sector and lead to market share gains of entities in the organised space in sectors which till date have had a large unorganised presence. GST in summary: Tax rates declared unlikely to be inflationary in nature The Goods and Services Tax (GST) is an indirect tax that will subsume all current indirect taxes being levied except basic customs duties and a few state and local taxes. The new taxation system under GST is aimed at making a simplified indirect taxation regime which has pan-india uniformity. Alcohol for human consumption and electricity are outside the purview of GST while levy on petroleum products (crude, diesel, petrol, natural gas, and ATF) will be recommended by the GST Council at a later date.

3 Minutes of the June RBI meeting suggests members are less hawkish than before; possibility of an August policy rate cut emerges The Minutes of the 6-7th June 2017 Monetary Policy Committee (MPC) meeting released by the RBI show that one member, Mr Ravindra Dholakia, called for a 50bp cut in the repo rates. The other five members voted for status quo. Most members continue to be concerned about nonfood inflation, which remains sticky. The RBI governor highlighted upside risk to inflation on Pay Commission hikes and farm loan waivers. The June MPC minutes suggest that most of the members are looking for more information regarding inflation, growth and Federal Reserve policy before easing rates. However, except for the June inflation data and May IIP data, RBI will not have any new information to form their opinion. HRA (House Rent Allowance) related inflation uptick will not be captured in the June inflation data and the immediate effect of GST will also be known from July onward. Source: SEBI website, Bloomberg. The GST Council has decided the tax rates while trying to keep the rates closer to present effective rates for most commodities and services. Tax rates in GST will be kept under four specific slabs: 5%, 12%, 18% and 28%. Luxury and sin goods, as identified, will attract additional cess over the peak rate of 28%. With tax rates under GST being largely in line with the existing rates, our estimates suggest that GST would largely be inflation neutral from a Consumer Price Index (CPI) standpoint. However in the near term with some increase in costs on account of the formalisation of the GST regime, CPI inflation would see some increase but would be within manageable levels Near term pain long term gain In the near term, the implementation of GST could lead to some disruptions as the production processes will take some time to align with the new framework. SME (small and medium enterprises) could see costs rising due to higher compliance. Prior to the implementation of GST, the month of June 2017 also saw some degree of destocking at the dealer level which could impact growth in Q1Y17. Further, some technical challenges could become visible post implementation. However, in the medium term, businesses will move towards reforming business models and gaining efficiency. We believe that CPI inflation, which surprised on the downside in the May reading, is likely to be followed by a benign print in June and July This will be below the lower range of RBI s inflation target of 2-6%. With inflation likely to remain on an average for the year FY18 close to or below the RBI s medium term target of 4%, we do believe that the August meeting offers scope for RBI to cut policy rates by 25bps. The approval of the increase in allowances under the 7 Th Central Pay Commissions (7 Th CPC) for central government employees would add ~ 90-95bps to March 2018 inflation which could rise to ~5%. However, this is a statistical impact. We must also keep in mind that on June 30, the RBI announced an OMO (open market operations) sale of INR100bn of government securities to mop up excess INR liquidity in the banking system which was somewhat of a surprise but is part of the normal liquidity operations of RBI. This is the first OMO sale after July The OMO sales comes even though the excess liquidity condition have not materially worsened in the recent past and the overnight rates have generally remained close to repo rate. Banking sector NPLs: Need for faster resolution of corporate accounts; RBI directs banks to initiate proceedings under the Bankruptcy Code for 12 corporate accounts Till date, the resolution process for the pool of large corporate loans under stress has been slow despite RBI providing tools such as SDR (Strategic Debt Restructuring) and S4A (Scheme for Sustainable Structuring of Stressed Assets). Given the urgency to resolve these loans and bring the banking sector back to health, the Government of India passed an Ordinance enabling RBI to facilitate the resolution of these assets and directly intervene in the process. RBI has since identified 12 accounts (which are ~25% of the Gross NPLs of the banking system) and has asked banking to initiate the resolution process for these loans under the Indian Bankruptcy Code (IBC). Apart from the 12 accounts identified, RBI has recommended that banks should finalise a resolution plan within six months for other large corporate NPLs (Non-Performing Loans). In cases where a viable resolution plan is not agreed upon within six months, banks should be required to file for insolvency proceedings under the IBC.

4 While the process of resolution could result in a near term impact on the profitability of banks on account of higher provisioning requirements, we believe that the resolution of the assets under stress is of key importance to the sector and hence the steps to finally start the process are in the right direction and would be positive over the longer term especially for the well capitalised corporate lenders. This would help banks clean up their balance sheet and the resume credit growth over the medium term. RBI has also asked banks to make a provisioning of 50% on the 12 accounts identified. We expect that on an average banks would have provisioning of 35-40% on these loans at present. Hence, the additional requirement for provisioning would be to the tune of 10-15% at most in FY18 (RBI may allow the banks to spread it over 4 quarters). Most of this impact would already be built into analyst estimates for credit costs in FY18 given higher provisioning requirements due to aging of NPLs. However, if the banks are unable to resolve the loans in the period stipulated (180 days extendable up to 270 days) then these accounts would go in for liquidation necessitating banks to make a 100% provisioning on these loans. With higher provisions, some of the state owned banks which are poorly capitalised at present would require capital infusion over the next year or so. However, for banks which are well capitalised, the speedy resolution of these loans would help clean up their balance sheets and enable them to start afresh in the corporate lending space. This would be positive for the sector as a whole in the medium to long term. RBI s Financial Stability Report: Taking a hard stance on corporate loan frauds RBI released the Financial Stability Report (FSR) June 2017 which provides an overall assessment on the stability of India's financial system. The report has taken a hard stance on rise in corporate loan frauds, and stated that banks can do more to control and mitigate such cases. The report also states that corporate health and in turn the banking sector's asset quality and profitability are dependent to a very large extent on demand revival. The sectors that pose the most risk to the balance sheet of banks includes power and telecom. The report also goes on to state that the implementation of Ind AS (the new Indian accounting standard) for banks may need transitional arrangements to avoid a capital shock. Some of the key highlights are as under: The banks' share in systemic flow of credit declined sharply to 38% in FY17 from ~50% in FY16 owing to a sharp increase in private placements of debt by non-financial entities and net issuance of CPs (Commercial paper) Asset quality of banks deteriorated between September 2016 and March 2017 with gross NPL (Non-Performing Loans) ratio rising from 9.2% to 9.6%. This could rise further to 10.2% by March 18 under the baseline macro stress case. The overall stressed loans fell from 12.3% to 12.0% during the same period (likely on account of the decline in the restructured loans). While stressed loans in agriculture and retail sectors fell, those in the corporate segment rose due to sectors such as cement, vehicle, mining and quarrying and basic metals. Overall CAR (Capital Adequacy Ratio) improved from 13.4% to 13.6% between September 2016 and March 2017, The share of large borrowers, both in total loans portfolio as well as GNPLs, has declined between September 2016 and March 2017, Imminent transition to Ind-AS (Indian Accounting Standards) will be challenging for Indian banks in terms of skills as well as the requirement of higher amount of provisioning,

5 Investment Strategy The main objective of our strategy is to generate capital appreciation through investments in equities with a medium to long-term perspective. This strategy invests in all listed equity and equity related instruments with emphasis on capturing Value and Special Situation opportunities. Key investment strategy parameters A. Large market opportunity 1. Market Size at least 2 times of current company sales, and/ or 2. Growing at 1.5x of India's GDP B. Robust competitive strength or economic moat 1. Intangible assets like brands, patents or regulatory licenses 2. High switching costs for customers thus giving pricing power 3. Companies having network economics 4. Robust cost advantages 5. Innovative products or services which consistently serve unique client needs C. Strong financials and earnings growth 1. Portfolio Debt to Equity under 1x 2. Compounded earning growth at least in line with industry growth 3. Healthy margins, having the ability to withstand business volatility D. Management dynamism and corporate governance 1. Passion to become a larger player in field of business 2. No unrelated diversifications 3. Capital allocation which optimises business performance 4. Asset turns and working capital turns at industry levels or trending there 5. High promoter shareholding E. Fair valuations 1. Companies having negligible implied growth in Discounted Cash Flow valuations 2. Relative valuations are at reasonable levels vs growth and return ratios Investment Philosophy The portfolio shall be a mix of Value Opportunities and Special Situations. 1. Value Opportunities -are ones, where in the opinion of the fund manager, the company s Intrinsic Value is X, while the stock is trading at a discount to X. The discount should be such that it offers reasonable Margin of Safety for an investment in the stock. This discount to Intrinsic Value is a result of multiple reasons i.e. temporary miss in performance, risk aversion at broad market level, regulation uncertainty, etc. As uncertainty regarding these aspects abates, the Intrinsic Value is expected to be realized. 2. Special Situations- These shall be investment opportunities dependent on the probability of occurrence of one or more corporate events, rather than market events. These situations can largely be classified as: a. Price related situations: In Price related situations, stocks shall be bought at a discount to the price, which is/ maybe guaranteed by any institution. These situations can arise in the form of buybacks, de-listings, etc. b. Merger related situations: In Merger related situations, shares of a company can be created at a discount to the current market price. c. Corporate Restructurings: In Corporate restructurings, consequence of specific corporate action in the form of spin offs, asset sales, management change, etc. could lead to either value unlocking or cash payouts to investors.

6 Model Portfolio Details Top 10 Holdings as of 30th June 2017 Sectoral Exposure as of 30th June 2017 Security Name % Wt Agri Commodities Siyaram Silk Mills Ltd 8 Coal India Ltd % 2.80% 6.01% 2.20% Agrochemicals Banking and Financial Services Consumer Products MAGMA FINCORP LIMITED 7 KRBL 6 Karur Vysya Bank Ltd % 22.52% Engineering and Capital Goods Media Mining Others Shriram City Union Finance Ltd % Paper Ashiana Housing Ltd 5 ICICI Bank Ltd 5 D. B. CORP LIMITED 5 J B Chemicals & Pharamaceuticals Ltd % 2.50% 4.50% 7.11% 3.80% 6.71% 4.80% Pharmaceutical & Healthcare Real Estate Development Technology Textiles Cash & Cash Equivalent Risk ratios Portfolio Nifty 500 Fee Structure Date of activation 31-Jul-12 Volatility 14% 12% Sharpe ratio Fee Structure Fixed Fee 2.5% per annum for the tenor, No performance Fee Exit Load 3% (1st Year), 2%(2nd Year), 1% (3rd Year) Brokerage 0.10% Custodial Charges As levied by the custodian. Treynor ratio 27% 8% Beta Annual Tracking Error 0.09 Information ratio 1.76 R2 76% Jensen's Alpha 17% Frequency of MIS *Indicative Fee Structure Portfolio Strategy No. of Stocks Benchmark Min Initial Investment Disclosure of portfolio through printed MIS on a quarterly basis. Strategy Details Special Situations Value Portfolio stocks Nifty 500 Index Rs 25 lakhs

7 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Model Portfolio Details Performance of 100 invested at Inception (31st July 2012 ) SSV Nifty Date of Inception 31-Jul-12 INR (%) 3 Months 6 Months 9 months 1 Year 2 Year 3 Year 4 year Since Incp. KMAMC Special Situations Nifty * Returns are of Model portfolio (net of management fee) ** Returns are annualised for periods greater than 1 year Risk Disclosure: Investments in securities are subject to market risk and there is no assurance or guarantee of the objectives of the Portfolio strategy being achieved. The investment returns from the portfolio strategy may be a function of stock selection and portfolio actions as well as market conditions during the investment tenor of the portfolio strategy. Past performance does not indicate the future performance of the strategy. Investors must keep in mind that the aforementioned statements/presentation cannot disclose all the risks and characteristics. The investors are requested to take into consideration all the risk factors including their financial condition, suitability to risk return profile, and the like and take professional advice before investing. Since this is intended to be a concentrated portfolio there could be situations that the scheme may not match the underlying benchmark.