Create your absolute return quarterly portfolio

In the Times of COVID-19

"Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again." (JM Keynes)

We are launching a new product this week, one for those who believe that many short-terms make a long-term. The product is called “Create Your Absolute Return Portfolio” (short-term); the product has an objective of bringing in positive returns (that is, the benchmark against which we will evaluate ourselves is cash), and has an aspiration to bring in a +10% return over the next three months.

Why this product, in these times? One, of course, there is a demand for such a product. Two, because we think that (particularly in these times) just dumping your excess cash into any large cap MF/ Nifty-based ETF may yield significantly different outcomes in terms of absolute returns.

Here is why we don’t think that, particularly in the times of COVID-19, the investor needs different choices from Nifty/ Sensex-based investing:

• 1. As of now (March 19 prices), the median decline from 52-week high price of Nifty stocks is 38%, with a standard deviation of 13%; true, we don’t know exactly how bad the consequences of the pandemic can be, but we do have a rough idea what the losses will likely be in months of GDP and lower productivity (say, 6 months of negative growth, and several quarters of sub-trend growth). There will be consequences on earnings of all firms, and the impact on leveraged firms shall be difficult to estimate/ guess. The consequences for several debt-free firms, however, maybe estimated roughly, and will often found to be “in the price”. Ergo, you are likely to find stocks that can, as the dust settles, generate healthy positive returns. This will be particularly true for a patient investor, one with ghaat (lurking around with patience) capabilities.
• 2. Investing in an economy benchmark-index (Nifty/ Sensex), while expecting that the returns shall be favorable (and positive) in the short-term is effectively betting that normalcy shall be restored very quickly, and secondary effects (on working capital, defaults etc) will be minimal. We don’t think all investors are thinking of that as a rich possibility. Most investors believe that the “time to normalcy” will be much greater for some firms that the others, the “time to prior confidence in earnings estimates” will be much lesser in some businesses than the others.
• 3. India has a very lop-sided benchmark index, heavily weighted in favor of companies that have been deemed “dependable” for their consistency, and into which, people (even fund managers) have now begun to invest in as a matter of habit; many of these companies, particularly financials, will see a lot more deviation in earnings expectations than has traditionally been the case.
• 4. While fund managers too will likely move incremental flows to a larger degree into the “still dependable” stocks, on a portfolio basis, the allocation of large cap “blue chip” kind of funds will change relatively little. Individual investors don’t have the same compulsions as institutional investors, and can do a lot more to address the specific situation than a large fund manager can.
• 5. Financials and IT constitute 41% and 13% of the Nifty; these are sectors that face considerable uncertainty in the current environment, and the market has been paying a premium for “certainty” for several financials names – this premium has got and could get eroded further as the certainty associated with several of these names reduces.
• 6. Pharma and consumer goods have 2% and 12% weights in the Nifty; these (and by “these” I mean only one part of consumer goods, that is staples, and pharma) to emerge as among the more “dependable” sectors, for the next month or few months, or few quarters, depending on how the virus progresses. Telecom is another, which has a pretty low weight and whose business shall be unaffected by the virus (the sector needs dealing with caution anyway, though).
• 7. In times of great volatility, even the “safer bets” will tend to offer small windows of opportunity, which can be utilized if the investor has agility on his side. These opportunities can be more reliably utilized through a direct participation in equities.
• 8. Lastly (not specific to the current environment) not every investor who is looking at the equity market to generate wealth is looking for massive returns. Quite often, investors are content with consistency and growth rather than utilizing opportunities such as these to maximize percentage returns.

There are several factors playing out at once, which the investor must watch out for: there will be companies that will be least affected in terms of revenues; there will be those that will be least impacted in terms of profits, there will be those which may be impacted in the near term but will gather momentum quickly either in terms of earnings or valuations; there will be those that don’t benefit much from either (but lose relatively little) and offer extremely attractive valuations, likely leading to positive flows over a short period; there will be those that will not do any of the above, and whose earnings trajectory could be altered by an year or more.

How do we propose to achieve our objective of a positive and healthy return (in that order)? What we think is required is: a/ to begin with, having your portfolio more weighted to companies that have a greater likelihood of coming out unscathed (more or less) from the ongoing uncertainty, b/ having some companies in your portfolio that are potential beneficiaries if Indian industry (manufacturing) benefits from the virus uncertainty that the world has seen (assuming India doesn’t see an epidemic of the scale that several countries have witnessed), c/ we think that the “best return strategy” shall be one that moves in stages: “Stage 1” that constitutes growth companies that will likely benefit from the situation and modest amounts of manufacturing plays, “Stage 2” constituting companies that, in addition, take account of dependable low growth companies with a strong dividend yield, and “Stage 3” that builds in recovery possibilities, and thus includes discretionary products, financials (it may not happen in the next three months), d/ we think investors require a portfolio that responds to changing news-flow on the virus and builds it in.

With this in mind, we are constructing a list of short-term ideas, with an investment horizon of three months (or less). The objective is to keep the investor liquid and positive, particularly on a 3-month end basis. While the investor may choose the weightage according to his comfort/ risk profile, we shall create a “model portfolio” (which includes our best estimate of cash as a % of portfolio, to be deployed at lower prices) at our end and share the same with the investor. The model portfolio shall assume a diversified investor (i.e. incremental Rupees of investment moving into the absolute return initiative), and shall be used for the purpose of evaluating whether we were successful in generating absolute return/ aspirational targets/ hurdle targets. The list and the model portfolio shall be dynamic, and changes shall be notified to subscribers by e-mail/ phone.

Disclaimer: This is not an assurance or a guarantee that the investor’s portfolio shall generate positive returns. The list/ model portfolio is an expression of our thoughts on the best way to do it. We recognize and emphasize that in case a complete (and durable) economy/ market collapse happens/ continues, or if we misjudge market dynamics, positive returns may not be generated – we just think that is a relatively small probability compared with our base case.

We have set a high bar (hurdle target) for ourselves: if we don’t make a 3% return on our model portfolio for the three-month period, the service shall not be charged for the quarter (for the first quarter, there is an invitation offer of 5% hurdle rate). It’s possible we are setting ourselves too tough a target; but we think it’s worth a shot. Those interested may e-mail: invest@ritwikrai.com, or call 9930538880 for details.