Thinking about Portfolio Construction
How do we think about Portfolio Construction -
Before delving into the specifics of our portfolio construction, let us emphasize our primary objective: maximizing returns while minimizing drawdowns or risks. When we talk about risk, we are primarily concerned with the possibility of the business growth story not unfolding as we anticipated, rather than short-term price fluctuations.
Our approach to portfolio management is built upon several key pillars:
Compelling Valuation and Story: Each investment we make must be a clear and compelling opportunity, either in terms of valuation or the underlying narrative surrounding the company. We thoroughly assess both factors before considering an investment.
Bottoms-Up Stock Picking: Our investment strategy is entirely grounded in a bottom-up approach to stock selection. We meticulously analyze individual companies rather than relying solely on macroeconomic trends or market sentiment.
Cyclical Investments and Tailwinds: While focusing on bottom-up analysis, we also consider investing in cyclical industries when favorable market conditions or tailwinds exist. Our team possesses a deep understanding of various sectors, having traded commodities like iron ore, steel, cement, and sugar.
Diversification and Risk Management: We ensure that our portfolio does not have an excessive concentration in any particular sector or company size. This diversification helps mitigate risks associated with sector-specific or company-specific events.
Management Evaluation: Whenever possible, we engage in face-to-face meetings with company management to gain valuable insights. In cases where physical meetings are not feasible, we conduct thorough reference and market checks within their industry ecosystem to ensure a comprehensive evaluation.
Long-Term Focus: Our intention is to hold each stock in our portfolio for an extended period unless significant changes occur that materially impact our investment thesis. We believe in the power of patience and strategic long-term thinking.
Optimal Portfolio Size: We aim to maintain a portfolio comprising 12 to 15 carefully selected stocks. This allows us to closely monitor and manage each investment effectively, ensuring diligent oversight and attention to detail.
By adhering to these principles, we construct a portfolio that aligns with our goal of maximizing returns while minimizing risks, ultimately providing our clients with a well-rounded and thoughtfully managed portfolio.
Now that we have covered the fundamental aspects, let's delve into the three distinct categories or "buckets" in which we allocate our investments.
Deep Value:
The deep value bucket comprises companies that possess exceptional intrinsic value and robust underlying businesses, yet are significantly undervalued by the market. In our internal discussions, we often refer to these investments as equivalent to fixed deposits (FD) but with a long-term risk profile. Companies falling under this category typically exhibit the following characteristics:
Strong Core Business and Undervalued Growth: These companies have a solid core business with consistent growth potential that is undervalued by the market. This indicates that the company's true worth is not yet reflected in its stock price.
Significant Investments and Assets: Deep-value companies often hold investments and possess tangible assets that exceed the market capitalization of the company itself. This adds an additional layer of value and potential upside for investors.
Minimal Debt: These companies generally maintain low levels of debt, which enhances their financial stability and reduces the risk associated with leverage.
Distinct from Holding Companies: Although they may resemble holding companies, deep-value companies are not merely conglomerates or entities primarily focused on holding and managing assets. They have operationally solid businesses driving their value proposition.
It's important to note that the examples mentioned, such as GSFC, Ramco Industries, and RPSG Ventures (with a high debt warning), are provided solely for illustrative purposes and not as explicit recommendations.
By identifying such deep value opportunities, we aim to capitalize on the significant upside potential that can be unlocked over the long term, while managing the associated risks effectively.
Listed Startup:
Another category within our investment portfolio is the "Listed Startup" bucket. As investors in both public and private markets, we possess the advantage of identifying these companies at a very early stage. It is important to note that these companies typically have a market capitalization below 500 crore, which brings along liquidity and execution risks. However, we firmly believe that any company we choose to invest in from this category has the potential to grow tenfold in a span of five years and even achieve a hundredfold growth over a period of ten years or more. Although we cannot disclose specific names due to their limited liquidity, we can provide some general examples to illustrate the nature of these investments:
(A) An asset and wealth management company, trading with a market capitalization below 100 crore, which is owned by a conglomerate with a combined market capitalization exceeding 3000 crore.
(B) A startup non-banking financial company (NBFC) established by two experienced professionals who have held CXO positions in India's leading banks and financial service companies.
(C) A multigenerational family business operating in the infrastructure sector is now being managed by the next generation. These individuals possess Ivy League education and have brought the company to a crucial inflection point in terms of size and scale.
Although these companies may face challenges related to liquidity, their potential for exponential growth aligns with our long-term investment strategy. By identifying promising listed startups, we aim to participate in their early growth stages and potentially benefit from substantial returns over time.
Special Situations:
Another category we actively consider in our portfolio is "Special Situations." Over our 10+ years of experience, we have witnessed firsthand how special situations can create value in both listed and unlisted businesses.
These situations can encompass various events such as takeovers, one-time settlements or restructuring, mergers and acquisitions, changes in management, and more. Even in special situations, we prioritize investing in companies that are fairly valued, where the intrinsic value of the company exceeds its current market capitalization at the time of purchase.
Let's provide a few examples to illustrate this category:
(A) An iron and steel company recently underwent a significant reduction in its debt through a one-time settlement (OTS) and subsequently raised funds from a special assets fund to repay the remaining debt. Presently, we believe the company is undervalued by approximately 50%. If they execute their operations at their current capacity, we anticipate the potential for at least a fivefold increase in value.
(B) A glass company was recently acquired by a promoter family renowned for creating wealth across various industries for its shareholders. While the stock may not be undervalued at present, we have confidence in the new promoters' initial actions and their track record, suggesting the potential for significant appreciation and the creation of a multi-bagger investment.
(C) A technology-focused business recently underwent a takeover via the National Company Law Tribunal (NCLT) route, resulting in zero debt post-acquisition. The net assets of the company currently reflect a conservative estimate of more than five times the current market capitalization.
It's important to note that our intention is not to exit a company entirely but rather to book partial profits when appropriate. For instance, in one of our special situations, where we entered in 2021 and have witnessed a fivefold increase in value, we have decided to book profits on 20% of our position or recover our initial investment. In such cases, selecting the right company can make selling the most challenging task.
By actively seeking special situations that offer favorable valuations and potential catalysts for growth, we aim to capitalize on these unique investment opportunities and maximize returns for our clients.
Return Targets:
In order to maintain a balanced portfolio, we strive to allocate a minimum of 35% of our investment cost to "deep value" companies. These companies hold significant potential, and our target for them is to achieve a two to threefold increase in value.
When it comes to investing in "listed startup" companies, our goal is even more ambitious. We envision a remarkable growth trajectory, aiming for a tenfold increase in value within a five-year timeframe.
In the case of "special situation" investments, we anticipate substantial returns as well. Our objective for these opportunities is to achieve a fivefold increase in value over a period of five years.
By setting these target multiples for each category, we ensure that our portfolio is diversified and has the potential to deliver significant returns across different types of investments.
Happy to chat and discuss these in detail
About Us -
Govind Shorewala - Entrepreneur (Mining, Textiles) & Investor (Private & Public Markets) → Reachout at: govind.shorewala@gmail.com
Aaroah Mittal - Early Stage VC → Reach out at: aaroah.m@people-group.com