1. What is the investment philosophy of Marcellus’ Consistent Compounders PMS?
Marcellus’ Consistent Compounders PMS defines its coverage universe based on a historical track record of consistent and healthy revenue growth and ROCE (returns on capital employed). The number of stocks in the coverage universe is around 30. Within the coverage universe, our research approach includes digging deep into understanding the DNA of these companies which helped them deliver the historical consistency. Based on such understanding of the DNA, we buy 10-15 stocks in our model portfolio of the PMS, where we have a high degree of conviction on the company’s ability to continue delivering healthy earnings CAGR over the next decade or longer, regardless of disruptive and evolutionary changes in the interim.
2. What types of companies form part of the portfolio?
The portfolio is agnostic to parameters like market cap, sectors etc. However, given the nature of the philosophy, most constituents of the Consistent Compounders portfolio are large and liquid stocks of cash generative companies, typically in the consumption and financial services sectors.
3. What is the difference between Marcellus’ Consistent Compounders portfolio and the filter-based / robotic portfolio explained in the books Coffee Can Investing and Unusual Billionaires?
The filter-based portfolios described in these books build annual portfolio iterations using preceding decade’s fundamentals and filtering out companies which have delivered double digit revenue growth and returns on capital greater than cost of capital, each year for 10 years in a row. This filter based portfolio once left untouched for a decade, has historically delivered an average CAGR of ~25% with the volatility in this return similar to that of a Government Bond.
The Consistent Compounders Portfolio combines our deep-dive stock-specific research with the benefits of the filter-based approach explained earlier, and thereby attempts to outperform vs these filter-based portfolios. This is achieved via 3 factors:
Portfolio concentration: The filters might give a longer list of stock which dilutes the reliance of the portfolio on outstanding companies. We narrow the portfolio down to 12-15 ultra-high quality stocks. So, how do we do that?
Ignorable consistency in historical fundamentals: Eg. Many housing finance companies which form part of the filter-based portfolios, are examples of 10 years of consistent fundamentals delivered due to unsustainable macro tailwinds for the Housing Finance Companies from low cost money market funding and a booming real estate market in the country – neither of which to our mind is sustainable.
Excusable blips in historical fundamentals are forgiven: For example, Nestle’s Maggi episode ensured that revenue growth of Nestle India dropped below 10% in FY15. Similarly, the fall in crude oil prices to below US$30 per barrel caused a 6% product price cut by Asian Paints in FY17 which led to its revenue growth dropping below 10% YoY in FY17. Manual intervention in portfolio construction analyses the nature of these blips and might include such stocks in the portfolio.
4. Most stocks in the Consistent Compounders portfolio are well known names. So, what stops someone from replicating this philosophy on their own?
Theoretically speaking, it is possible and simple for a client to replicate this philosophy on his own. However, the ‘simple’ aspect of the philosophy is not ‘easy’ because if an investor doesn’t understand why he has bought a company (because he didn’t do the research on the company himself), he won’t have the conviction to do the following with his stock portfolio:
1. Allocate high allocations in the portfolio to each of the stocks
2. Hold onto the portfolio despite the volatility in external environment (general elections, crude prices, currency movements, GDP growth rates etc)
3. Make timely changes to the portfolio when required – best example was the Gruh Finance exit executed by Consistent Compounders as soon as possible, once its merger with Bandhan Bank was announced
4. Avoid diluting the benefits from the portfolio on the overall investable surplus by diversifying into too many products and hence stocks in the overall investable surplus.
5. Doesn’t a 10-15 stock portfolio, exposed to only few sectors, end up concentrating the risk rather than keeping it diversified?
The quality of DNA which helps deliver consistent and healthy fundamentals of our portfolio companies is the biggest source of reduction in volatility of stocks in this portfolio. Our back testing (explained in the book ‘Coffee Can Investing’) suggests that volatility of this portfolio is as low as that of a Government Bond for holding periods longer than 3 years
6. What is the average churn in the portfolio in a year?
Historically, there has been no more than 5-8% annual churn on average under this philosophy.
7. How do you time entry and exit from the portfolio? Do you take cash calls?
We do not believe we can time either market movements or share price movements. Moreover, the share prices of the kinds of companies that we hold in our portfolios, have had very low correlation with the broader market movements. The beauty of the Consistent Compounders portfolio is that since the average annual earnings growth of the portfolio is likely to remain healthy regardless of changes in the external environment, short and long term P/E movement is not a significant contributor in helping our clients compound their portfolios at a healthy rate. Please refer to our 1st March 2019 newsletter on this subject.
8. It is perceived that small caps grow faster than large caps. Then why has this portfolio delivered 20-25% annualised returns historically despite a large-cap bias?
On a relative basis, it is true that a champion small cap stock is likely to grow faster than a champion large cap stock. However, on an absolute basis, it is not true that champion large cap stocks grow at less than 15%. In fact firms like HDFC Bank and Asian Paints have demonstrated that no matter how small or how large were these companies, their revenue and earnings growth rates have always remained in the range of 20%-30% CAGR.
9. Most stocks in your portfolio are trading at high P/E multiples. Then is it not prudent to either wait for their P/E multiples to fall, or else invest in stocks where P/E multiples are lower?
Multiples based conventional valuation methodologies like P/E multiples and PEG ratios do not adequately factor in the longevity of a franchise – i.e. the firm’s ability to deliver returns on capital employed higher than the cost of capital for several decades in a row. As a result, if the intrinsic value of a company in the Consistent Compounders PMS portfolio is 100x on a P/E multiple basis, its ‘high P/E multiple’ of 40x-50x continues to be undervalued with a significant margin of safety.
A mathematical way of explaining this point is that share price movement of a stock over any holding period, is a combination of the movement in its earnings growth and change in the P/E multiple. Over a holding period of 10 years or longer, share prices of all stocks converge towards their earnings growth. Over a holding period of less than 10 years, the stronger the earnings growth of the company, the less significant is the contribution from its P/E multiple in determining its share price.
‘While earnings of a company compound, P/E multiple of a stock never compounds’. Hence, we focus only on companies which can compound their earnings at a healthy rate, rather than worrying too much about short term fluctuation in their P/E multiples.
10. When are you likely to sell a stock in this portfolio?
There are two examples of events which can convince us to sell a stock from our holding portfolio:
Sudden event which changes the fundamental prospects of a business: The best example of this was Gruh Finance – our first churn in the portfolio since inception. On the evening of 7th January 2019, HDFC Ltd announced the sale of Gruh Finance to Bandhan Bank, after which shareholders of Gruh will become shareholders of Bandhan Bank. Whilst we had a high degree of conviction on the quality of Gruh’s franchise, we did not believe the same for Bandhan Bank. Hence, we sold Gruh Finance from our clients’ portfolio as soon as possible on 8th January.
Gradual change in the fundamental prospects of a business: This could be due to a change in the management or firm becoming complacent gradually. In such cases, it might take be a few months before our conviction drops to a level where we decide to sell the stock from the portfolio.
11. Will you ever sell a stock due to its valuations, if your conviction on the quality of its fundamentals has not deteriorated?
Hypothetically, this is possible once the traded valuation of a company is higher than its intrinsic value. However, in the real world, it is rare to see the stock price of a Consistent Compounder adequately factoring in its longevity.
12. What is a PMS (Portfolio Management Service)?
A Portfolio Management Service is a platform created especially for high net-worth individuals to provide customized solutions for their financial investment needs. Investment management solutions in a PMS can be provided in three ways – Discretionary Portfolio, Non-Discretionary Portfolio, Advisory Portfolio.
13. What is the difference between a discretionary portfolio manager, nondiscretionary portfolio manager and Advisory Portfolio manager?
The discretionary portfolio manager individually and independently manages the funds of each client in accordance with the needs of the client.
The non-discretionary portfolio manager manages the funds in accordance with the directions of the client.
The Advisory Portfolio Manager advises the client on investments as agreed upon in the client agreement.
14. What will be the tax structure applicable under Marcellus’ PMS?
The portfolio manager is a trustee acting in a fiduciary capacity on behalf of the investor. Therefore, the tax liability for a PMS investor would be the same as that of a direct investor. Marcellus’ PMS invests only in equities. However, the investor should consult a tax advisor for any tax planning related queries. Audited statement of accounts will be provided by Marcellus at the end of the financial year, which would help the investor in assessing his/her tax liabilities.
15. Is there any contract between Marcellus and its clients?
Yes. The portfolio manager, before taking up an assignment of management of funds or portfolio of securities on behalf of the client, enters into an agreement in writing with the client, clearly defining the inter se relationship and setting out their mutual rights, liabilities and obligations relating to the management of funds or portfolio of securities, containing the details as specified in Schedule IV of the SEBI (Portfolio Managers) Regulations, 1993.
16. What is the setup fees, entry load, exit load and lock-in applicable on my PMS account at Marcellus?
There is zero entry load, zero exit load, and zero setup fees. There are no lock-ins applicable either. A client may at any time, at the client’s risk and cost, withdraw any asset from Marcellus’ PMS by giving 30 days’ notice of the same.
17. What fees can a Marcellus portfolio manager charge from its clients for the services rendered by him?
No. Scheme Particulars/conditions of fees to be charged Periodicity with which fees will be levied
1 Discretionary (Fixed Fees Only) Fixed fee of 2.0% of the Net Asset Value (with NAV calculated based on average daily NAV over the course of the quarter) Quarterly
2 Discretionary (Fixed & Variable Fees) Fixed fee of 1 % of the Net Asset Value (with NAV Calculated based on average daily NAV over the course of the quarter) plus Variable fee of 15% on all returns in excess 12% (no-catch-up) subject to a high watermark Quarterly for fixed fees and Annually for variable fees
3 Discretionary (variable fees only) Variable fee of 20% on all returns in excess of 8% (no-catch-up) subject to a high watermark Annually
18. What is the Meaning of “no-catch-up”?
No catch-up means that profit share will be applicable only on the incremental return over and above the hurdle rate. For example if the value of a portfolio increases from Rs 100 to Rs 120 during a year when the fees structure included a hurdle rate of 8% (i.e. hurdle rate was at Rs 108), then the profit share will be applicable only on Rs (120-108) = Rs 12, rather than it being applicable on the entire Rs 20 profit delivered.
19. What is the meaning of ‘high watermark’?
‘High Water Mark’ is the higher of either ‘corpus investment value’ or ‘highest NAV at which fees has been paid historically’.
Illustration of how the High-Water Mark would work: A client’s initial contribution is Rs 1,00,00,000 which then rises to Rs 1,25,00,000 in its first year. Therefore, a performance fee would be payable on the Rs 25,00,000 return. Next year, the portfolio value drops to Rs 110,00,000. Therefore, no performance fee is payable. In the third year, the portfolio value rises to Rs 1,40,00,000. Performance fee is payable only on the Rs 15,00,000 which is in excess of the previously achieved high watermark of Rs 1,25,00,000.
20. Are there any other charges incurred by a client in the PMS, other than the fees structure highlighted above?
Other applicable charges include: a) one time charge of Rs 1100 for stamp paper charge incurred at the time of account opening; b) annual charge of Rs 2000 + GST as audit fees; c) brokerage charge of 0.132% (inclusive of all taxes) on the value of trades carried out in the account; and d) STT (securities transaction tax) of Rs 0.1% of value of trades carried out in the account.
21. What is the minimum investment size to open a PMS account with Marcellus?
The minimum ticket size applicable at the time of opening a new account, is the same as regulatory minimum of Rs. 50 lakhs.
22. Are investors required to open new demat accounts for a PMS services?
Yes. For investment in listed securities, an investor is required to open a new demat account in his/her own name.
23. What is a Disclosure Document related to a PMS?
The portfolio manager provides to the client the Disclosure Document at least two days prior to entering into an agreement with the client.
The Disclosure Document contains the quantum and manner of payment of fees payable by the client for each activity, portfolio risks, complete disclosures in respect of transactions with related parties, the performance of the portfolio manager and the audited financial statements of the portfolio manager for the immediately preceding three years.
24. What are the rules governing services of a Portfolio Manager?
The services of a Portfolio Manager are governed by the agreement between the portfolio manager and the investor. The agreement should cover the minimum details as specified in the SEBI Portfolio Manager Regulations. However, additional requirements can be specified by the Portfolio Manager in the agreement with the client.
Hence, an investor is advised to read the agreement carefully before signing it.
25. What is stock transfer process for Initial/Top up stock corpus?
After the demat account opening process has been completed with Marcellus, the client will be provided a copy of the Client Master List (CML) of the new demat account. The client will then have to produce this CML copy and fill up the depository slips at the entity where the client has his old demat account.
26. Can we accept stock corpus from clients having Joint De mat account in that of PMS account?
Yes, we can accept the stock corpus.
27. Can we accept fund from client ‘s bank account having third/other party involved?
Yes, we can accept this fund. However, first holder of the PMS account must be one of the joint holders of the bank account from which payment is made.
28. Can we accept stock from third party accounts to client’s portfolio?
No, we cannot accept the same.
29. How can the client access his PMS account statement and other details?
The client will receive, via email, a monthly account statement around the 7th day of every month. This monthly statement will include all details related to the portfolio holdings, transaction statement and statements of dividends received and expenses incurred. Also, soon after the PMS account has been activated, the client will receive login credentials to Kotak Mahindra Bank’s netbanking website and mobile app, through which the clients can access all details related to their PMS account updated as of end of previous day.
30. Do we reinvest client’s dividend in his portfolio?
Yes. Dividends against securities are credited directly into the client’s PMS account and hence get reinvested into the PMS account.
31. What is the process to add/delete joint holder in PMS?
No. Holders cannot be added or deleted in a PMS account after it has already been activated. Clients will need to open a new PMS account with required holding pattern and for this, clients will have to complete the entire documentation required to open a new PMS account.
32. Whom has been appointed as the custodian to Marcellus’ PMS accounts?
Kotak Mahindra Bank Limited has been appointed as the custodian.
33. What is the process to change the fees schedule?
Fees schedule can only be changed on a prospective basis, from the 1st April of a new financial year. No retrospective changes to the fees structure are allowed. Clients are required to intimate their desire to change the fees structure for the forthcoming financial year latest by 31st March of the ongoing financial year.
34. What is the procedure to change nominee in PMS account?
Changing the name of a nominee in the PMS account just requires the client to fill up and sign one form. The client should reach out to his / her relationship manager to get this done.
35. What are the charges included in “Expense Report” specified in Portfolio Snapshot Statement?
Management Fees (annual), brokerage + STT incurred on trades (as and when trades are carried out), GST, custodian and fund account charges (annual), and one-time stamp paper charges incurred during account opening.
36. How is In Person Verification (IPV) carried out in the case of Non Resident Indians?
In Case of Non-Resident Indians who are visiting India during their account opening documentation process, IPV will be carried out by employees of Kotak Mahindra Bank at a time and place convenient for the client. However, considering the infeasibility of carrying out IPV of NRIs not visiting India, attestation of KYC documents by Notary public, any court, magistrate, Judge or local banker of the client where client is residing, may be permitted. For NRIs who are either US persons or Canadian persons, IPV has to be done only when they are visiting India.
37. Why do resident Indians have to transfer money into a Marcellus Investment Managers’ pooled bank account? Doesn’t this transfer lead to change in ownership of the funds?
All resident Indian clients become beneficiary owners in the pooled bank in proportion to the value of funds transferred by them into this account. Marcellus Investment Managers is NOT one of the beneficiary owner of this account. As a result, the pooled bank account will NOT get affected even in the unlikely event of all bank accounts of Marcellus Investment Managers getting locked / sealed by the regulatory bodies. Use of pooled bank account is a structure provided by SEBI to help ease operations and reduce operational costs related to execution of PMS accounts.
38. What is the difference between the structure of an NRI account and other accounts?
NRI discretionary PMS accounts include a PIS bank account (in the name of the client), a non-PIS bank account (in the name of the client), a trading account (in the name of the client) and a demat account (in the name of the client).
However, for resident Indian discretionary PMS accounts, corporate accounts and HUF accounts, the structure includes only a demat account opened in the name of the client. For the purposes of a bank account, the client becomes one of the beneficiary owners of a pooled bank account which is used for funding, top-ups and other banking requirements.