Marcellus’ Partners Bulletin July,23

PORTFOLIO UPDATE:

Performance data is net of annual performance fees (Except for Little Champs Portfolio) charged for client accounts whose account anniversary date falls up to the last date of this performance period. Since fixed fees and expenses are charged on a quarterly basis, effect of the same has been incorporated up to 30^th June 2023. For Little Champs portfolio, since performance fees are charged on cumulative gains at the third anniversary of the respective client account, the effect of the same has not been incorporated in the performance data. (The returns are as on 30^th June, 2023)

For relative performance of particular Investment Approach to other Portfolio Managers within the selected strategy, please refer https://www.apmiindia.org/apmi/WSIAConsolidateReport.htm?action=showReportMenu. Under PMS Provider Name please select Marcellus Investment Managers Private Limited and select your Investment Approach Name for viewing the stated disclosure.

Inception Date & Benchmark:

Consistent Compounders Portfolio: Inception: 1st Dec,2018 Benchmark: Nifty 50 TRI

Little Champs Portfolio: Inception:28th Aug,2019 Benchmark: S&P BSE 500 TRI

Kings of Capital Portfolio: Inception:28th July ,2020 Benchmark: Nifty 50 TRI

Rising Giants Portfolio: Inception:27th Dec ,2021 Benchmark: S&P BSE 500 TRI

Please find below links to our latest newsletters and presentations:

 **For product/sales related queries please write to sales@marcellus.in**

All-time highs vs Recession Blues

The last month was dominated yet again by speculation around the future course of interest rate movements. The RBI kept rates unchanged in its June meeting but allowed itself some headroom to raise rates in case inflation soars. The Fed too did not move but maintained a mildly hawkish stance (as reflected in the minutes of their June meeting) as inflation remains sticky (though abating). While the Fed’s decision to pause temporarily is led by ‘concerns around economic growth’, as the 5% rate hike since last year is yet to show any meaningful impact on the economy; the decision to not pause outrightly is also around growth, specifically current growth. In fact, the common factor between the two decisions (by the Fed and the RBI) is the current strong underlying growth in both the economies. The Fed minutes read – “The participants favoring a 25 basis point increase noted that the labor market remained very tight, momentum in economic activity had been stronger than earlier anticipated…”.

Regardless, the market, that appears divided on the tightening bias, didn’t respond too negatively to the minutes, perhaps factoring in a further 50-75bps hike by the end of the year (and then no further hikes). That is a reasonable expectation if the Fed does tighten further. What is still uncertain for the market is the magnitude of the impact of the 5% rate tightening on the economy which is currently chugging along nicely; and the Fed’s ‘wait and watch’ stance in response to the data coming its way.

A related aspect dominating equity markets, particularly in India, is the speculation around the ‘imminent’ US recession coinciding with the market touching an all-time high. This has led to investors asking questions about ‘frothy valuations’, ‘profit-booking’, ‘sitting-on-cash’ and ‘better entry points’.

Let’s look at the numbers in the table below over the last 15 months –

• From the peak of Jan 2022 – as the Russia-Ukraine conflict fructified, commodity prices soared, global supply chains got disrupted and the Fed embarked on a tightening spree – CCP and Nifty Index corrected by 24% and 15% respectively by June 2022. In the same period, CCP and Nifty PE multiples (trailing) contracted by 33% and 17% respectively. A higher multiple de-rating implies that the market is discounting the possibility of a future earnings de-growth. Yet, the implied earnings growth (the ‘E’ in PE ratio) in CCP was 9% and in Nifty was 1% during Jan – Jun 2022.
• Better still, the recovery from the bottom in June 2022 – till date (last one year) is even more interesting – Nifty has recovered by nearly 27% on the back of 12% earnings growth, implying that >50% increase in the Nifty is driven by multiple expansion. On the other hand, CCP has recovered by 23% while the PE multiple hasn’t changed, implying that the entire recovery has been driven by earnings growth alone! (Read more about this here – https://marcellus.in/newsletter/consistent-compounders/ccp-valuation-multiples-correct-30-whilst-fundamentals-continue-to-compound-at-over-20-per-annum/)

• In effect, the initiatives taken by CCP companies – in terms of capex and improving operating efficiencies – over the last two years give us far greater comfort on their valuations, especially in the context of zero multiple re-rating in the past one year. As far as the market is concerned; at some point in time, any level of the market would have been an ‘all time high’ level; it is the assessment of future fundamentals that determines whether or not current valuations are expensive. Just to provide context – the current Nifty 50 trailing PE multiple of 23x is broadly in line with the long-term median of 21x. One’s view of the Nifty 50’s fundamentals going forward would truly determine whether current multiples are justified. In this context, we remain quite comfortable with the valuation of the CCP portfolio.

• A purely earnings growth-led valuation exercise is prone to mistakes as P&Ls can be fabricated. Valuations of businesses with deep moats, prudent capital allocation and a consistent focus on deriving incremental operating efficiencies should NOT be carried out using P/E multiples. Such businesses will always deserve to trade at higher P/E multiples – both compared to the P/E multiples of other lower quality businesses, as well as compared to their own historical P/E multiples. (Read more on this here –https://marcellus.in/newsletter/consistent-compounders/p-e-multiples-are-deceptively dangerous/)
• Our assessment of valuation takes into account returns generated in the business (ROCE/ROIC), initiatives taken by the companies in protecting/defending their current moats (lethargy) as well as succession planning.
• In a recent edition of Three Longs and Three Shorts, we highlighted an article by Michael Mauboussin and Dan Callahan of Morgan Stanley on how RoIC should matter for investors and businessmen alike (Read the synopsis here – https://marcellus.in/story/roic-and-the-investment-process/).
• On succession planning, our research team has discussed this aspect in detail in their latest newsletter, which is summarized below. 

Succession Planning – a critical driver of prudent capital allocation

• Why do large dominant companies run the risk of stagnation? Key phrases that immediately come to mind include: ‘saturation of growth potential’, ‘disruption from new competitors’ etc. However, these adverse outcomes are nothing but the result of imprudent capital allocation decisions taken by highly cash generative companies on two fronts –
  • a) Innovation / disruption; and
  • b) adjacency expansion.
• Several companies in Marcellus’ CCP portfolio either control large market shares in their current core businesses or are in industries where disruption / innovation is likely to redefine the drivers of market share gains. As the core segments (which led growth in earlier years) become a cash cow for the company, having individual new business leaders which’ve been with the firm for a long time (many a times in cross functional roles) and are well versed with the company’s ethos around prudent capital allocation, competitive advantages and corporate governance becomes key for increasing the success probability.

To read our entire newsletter, please click on the following link: https://marcellus.in/newsletter/consistent-compounders/succession-planning-is-critical-for-disruptive-capital-allocation/

If you missed the webinar, you can watch it here – https://www.youtube.com/watch?v=kTgOMSTXlw4

Global Compounders (GCP) – Modern Utilities as a lucrative Investment Theme

• Charlie Munger has said: “Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”

• In this context, our international equities team have published their third thematic piece in the GCP series – Modern Utilities – how they differ from traditional utilities and their attractiveness in the global investing paradigm.

Characteristics of a Utility

Utilities posses distinctive characteristics that set them apart from other businesses. They cater to our daily lived by providing essential services. The value add from these service is often taken for granted, for e.g. electricity, water supply and public transportation. These indispensable service create a unique dynamic:

1.   Scale and Time Advantage (Moat)

2.   Customer Lock-in

3.   Recurring Revenue

 How modern utilities differ from traditional utilities

At Marcellus, we perceive a remarkable opportunity in what we term “modern utilities.” These businesses share commonalities with traditional utilities, such as revenue visibility, customer lock-in, and scale/time advantages. However, modern utilities possess key differentiators that make them incredibly attractive:

1. Growth Potential
2. Technological Catalyst
3. Lack of regulatory oversight (risk mitigation around pricing power)

Investment implications

Fundamentals of businesses that are modern-day utilities built on the Time and Scale based moats, aided by lack of restrictive regulatory constraints, include:

• Higher Return on Capital Employed (For instance, GCP Modern Utilities demonstrates an average ROIC of 18% compared to the S&P 500’s 11% and the 5-6% range seen in best-in-class traditional utilities in the US).
• Higher Growth Rate (Over the past 10 years, GCP Modern Utilities have achieved an EPS CAGR of 15-20%, surpassing the 7% of the S&P 500 and the 6-10% range observed in best-in-class traditional utilities).

To read our entire newsletter, please click on the following link: https://marcellus.in/newsletter/global-compounders/modern-utilities-operating-on-a-global-scale-make-for-lucrative-investments/

To know more about Global Compounders, do write to us or refer to the this link – https://marcellus.in/portfolio-management-services/global-compounders/

Operations Update- 

1.Minimum Top up & SIP investment amount – The minimum Top up and SIP investment amount is now 50,000/- for all products. This will enable many more clients to channel monthly savings into investments in an automated way (much like MF SIP). This can also be a great way to minimize portfolio churn due to rebalancing your portfolio or settlement of any due expenses. 

*Note- This deployment of cash is at the discretion of the Portfolio Manager. The amount as small as 50,000/- may remain undeployed for few weeks as it will be just 0.5% in a 1 crore portfolio and would not be substantial for preparing a buy order. 

To set up SIP refer to the template provided in this link https://marcellus.helpscoutdocs.com/article/100-systematic-investment-plan-sip-faqs , client can either send this filled template to us or login to their Mobile App to send us a request. 

The minimum Top up amount through STP mode has been changed to 5 lakhs, i.e., Rs 5 lakhs divided in 5 tranches each of Rs 1 lakhs. The STP account should be active when the top-up is made. The top-up tranche will have its own schedule and tranches.

2.Bank Account Registration for funding from unregistered bank account- It is important to register a bank account for the purpose of funding or redeeming in a particular PMS account. In case a bank account is not registered and still funds are transferred by the clients, the funds will be not mapped to the portfolio. 

In order to register a bank account please request clients to write to clientsupport@marcellus.in along with the cheque copy to register the bank details. In case of joint bank account where the joint holder is not a PMS account holder, we would require his/her PAN details or PAN copy to conduct due diligence. 

3.DP Closure for full redemption/full switch- It is mandatory to send hardcopies of demat closure forms in case of full redemption as well as full switch to our office address. For initiating the request, you can share an executed scan copy. However, the hard copies should be received at our office within 4-5 days of initiating the request. 

4.Fee Recovery Process– Earlier our invoice communication emails requested clients to let us know their choice if they want us to recover the invoice amount by liquidating securities or if they would top up the portfolio with equivalent amount. From now on, we will just send clients their invoice copy. If clients wish to top up, they can transfer funds within 14 days of the receipt of the invoice. If clients do not wish, then they don’t have to take any action. We will check the account after 14 days, and if no sufficient cash available to recover fee, we will liquidate few securities and settle the expense.

Note: the above material is neither investment research, nor investment advice. Marcellus does not seek payment for or business from this material/email in any shape or form. Marcellus Investment Managers Private Limited (“Marcellus”) is regulated by the Securities and Exchange Board of India (“SEBI”) as a provider of Portfolio Management Services. Marcellus is also a US Securities & Exchange Commission (“US SEC”) registered Investment Advisor. No content of this publication including the performance related information is verified by SEBI or US SEC. If any recipient or reader of this material is based outside India and USA, please note that Marcellus may not be regulated in such jurisdiction and this material is not a solicitation to use Marcellus’s services. This communication is confidential and privileged and is directed to and for the use of the addressee only. All recipients of this material must before dealing and or transacting in any of the products referred to in this material must make their own investigation, seek appropriate professional advice and carefully read the Private Placement Memorandum/Disclosure Document, Form ADV, Form CRS and any other documents or disclosures provided to them by Marcellus, as applicable. The recipient, if not the addressee, should not use this material if erroneously received, and access and use of this material in any manner by anyone other than the addressee is unauthorized. If you are not the intended recipient, please notify the sender by return email and immediately destroy all copies of this message and any attachments and delete it from your computer system, permanently. No liability whatsoever is assumed by Marcellus as a result of the recipient or any other person relying upon the opinion unless otherwise agreed in writing. The recipient acknowledges that Marcellus may be unable to exercise control or ensure or guarantee the integrity of the text of the material/email message and the text is not warranted as to its completeness and accuracy. The material, names and branding of the investment style do not provide any impression or a claim that these products/strategies achieve the respective objectives. Further, past performance is not indicative of future results. Marcellus and/or its associates, the authors of this material (including their relatives) may have financial interest by way of investments in the companies covered in this material. Marcellus does not receive compensation from the companies for their coverage in this material. Marcellus does not provide any market making service to any company covered in this material. In the past 12 months, Marcellus and its associates have never i) managed or co-managed any public offering of securities; ii) have not offered investment banking or merchant banking or brokerage services; or iii)have received any compensation or other benefits from the company or third party in connection with this coverage. Authors of this material have never served the companies in a capacity of a director, officer or an employee.

This material may contain confidential or proprietary information and user shall take prior written consent from Marcellus before any reproduction in any form.