Selecting the investments
Core to the investment strategy is an evaluation of the quality of the companies that make up the portfolio. The Manager draws on a framework of principles and potential investee companies must meet well-established criteria based on analytical models that seek to identify robust businesses, with high quality management. The investment time frame is over the medium to long term and the strategy is to invest in companies which can be expected to survive an economic cycle. Management must display a track record of rational capital allocation, a clear succession plan, and an alignment of interest between shareholders, owners and management. The following are a must –
- sound competitive position
- healthy balance sheet
- generate sufficient free cash to sustain growth expectations
- non-reliance on excessive debt funding or frequent equity shareholder dilution
Equally important to the strategy is the price of acquisition, minimising impact cost on the net asset value, and ensuring that there is a sufficient “margin of safety” in the purchase cost to reduce the risk of capital loss. Once acquired, we expect the power of compounding returns to expedite the realisation of absolute value. Seeking out “value” in potential investments is core to the process of reducing the risk of capital loss and maximising the opportunity to generate absolute returns.
The strategy does not engage in market timing, strives to minimise turnover and transaction costs, and disregards an approach of “index hugging”. Although the investment strategy has a value bias, the Manager recognises that growth can create its own value, and that high-quality businesses are seldom cheap. The strategy can involve making an investment ahead of any expected turn around in the operations of the business or forecasted share price appreciation.
The Investment Advisory Team in Mumbai use a set of well-established but flexible principles that make up the investment process.
We see ourselves as being proportionate owners of a business.
The Manager and the Investment Advisory Team generate investment ideas through a bottom up approach, including:
- A systematic screening process
- Meetings with senior management of potential investee companies
To identify companies which have a proven track record of generating superior returns to investors
For us this means –
Ability to generate free cash flow, sufficient to fund the future growth, whilst having some “edge” over the competition to ensure some pricing and margin stability, at least;
Interacting with industry practitioners and company management teams (across the quality and market cap spectrum);
This philosophy leads to a detailed understanding of the business model, the competitive structure of the industry, long term growth opportunities in the sector, and the overall size of the market.
Numerous meetings over an extended period, in relation to a potential investment may be necessary in order to ensure full comfort has been obtained, before any investment is considered.
Ownership of the process
Each member of the Investment Advisory Team has a particular area of sector and stock expertise, and shares responsibility for the screening process, for building and maintaining analytical models on investee companies, using quarterly corporate interaction with the market, and liaising with sell-side analysts.
Each model contains 10 years of historic data across a selection of investment ratios and profitability metrics, providing a standardised approach to analysing the quality and intention of management.
All forecast data, seldom more than three years, (but including assumptions on the capital requirements of the potential investee company to maintain a sustainable competitive position), is created internally with a healthy dose of scepticism accorded to sell-side and management forecasts. Particular emphasis is placed on an historic track record of generating free cash flow, paying both taxes and dividends, and a proven ability to generate a return on capital employed (ROCE) in excess of 14%. A solid balance sheet combined, with a track record of efficient capital allocation are also prerequisites.
Close attention is given to Board composition, management’s attitude to risk taking, its ability to handle adversity, succession planning, and a clear alignment of interest between all stakeholders.
- Investing in a range of Indian equity and equity-linked securities, predominantly listed mid-cap and small-cap Indian companies with a smaller proportion in unlisted Indian companies
- Some large-cap companies incorporated outside India which have significant operations or markets in India
- The portfolio concentration currently ranges between 30 and 40 stocks, however, as the Company grows, the number of stocks held may increase
- The principal focus is on investment in listed or unlisted equity securities or equity linked securities, however the Company has the flexibility to invest in other types of securities
The Company’s investment limitations:
- No more than 10 per cent of total assets (at the time of investment) may be invested in the securities of any one Issuer
- No more than 10 per cent of total assets (at the time of investment) may be invested in listed closed-ended funds.
* Although the investment policy permits a broad investment approach – including bonds, convertibles and other types of securities – since 2013 the portfolio has only included companies listed on domestic Indian exchanges. The Company may use derivative instruments such as futures, options and warrants for the purposes of hedging currency and/or market risk but the Board does not intend on using derivatives for investment purposes. The Company may, from time to time use borrowings to provide short-term liquidity and, if the Board deem it prudent, for longer term purposes. The Directors would intend on restricting borrowings on a longer-term basis to a maximum amount equal to 25 per cent of the net assets of the Group at the time of the drawdown. At present, the Company does not have any borrowings and does not intend on hedging its exposure to the Rupee.