Active management...alive and well

Mugunthan Siva

India Avenue

As interest rates have fallen globally over the last decade in response to “kicking the can down the road” post GFC, valuations have mattered less and less. Discount rates used to assess investments allow you to write your own ticket in terms of what a company or for that matter anything is worth.

Given the lower dispersion in outcomes, choices mattered less, setting off a wave of passive/ETF investing. Considering the huge surge of passive investment in the last decade, our thinking has become attuned to participation in fast moving upward trends, backed by the ongoing liquidity tailwind.

The domain of passive investment is significantly dominated by replicating market cap weighted indices. Many of us have forgotten or devalued real insights which drive active manager behaviour - something the markets cannot survive without. Theory will tell you that active investing can only bear fruit in an inefficient market where information is not priced in instantaneously. However, in essence, no market is perfectly efficient. A greater level of efficiency simply means the horizon of the trade needs to be longer to add relative value to a benchmark.

Investing in markets like India, China and other so called emerging markets can lead to more fruitful results for active managers given lower broker coverage of stocks down the capitalisation curve. For example, India’s equity markets are home to 6,000 plus listed companies, with only significant coverage on the top 150-200 or so by market capitalisation. However, there are at least 1,000 investable companies and above 6,000 listed in total.


Source: Motilal Oswal

A case study for active management in India:

Buying Real Estate Stocks in 2020

1. Early Identification of an investment theme before consensus

India’s real estate sector was going through significant issues over the last 5 years. Firstly, demonetisation impacted physical assets and the cash-economy significantly and led to a shift towards financial assets and away from areas like real estate and gold. Secondly, this led to the collapse of several real estate businesses and impacted financiers leading to a withdrawal of liquidity. The cost of capital also remained high and the lack of liquidity in the system meant capital was increasingly rationed. As a result, there has been significant consolidation in the space over the last 5 years, leaving only survivors. 

Source: Motilal Oswal

However, post COVID-19 (wave 1) what occurred was lower interest rates, increasing liquidity injection, a booming IT industry, rising IT wages and a real estate industry with fewer players, stronger balance sheets and demand rising to clear existing supply.

2. Leveraging your idea with the best companies

There are several ways to play the Real Estate sector such as developers, landlords, cement producers, infrastructure plays etc. When a theme has been identified, the next steps revolve around how to express that thematic via a call-option type pay-off. If you are right, then the return achieved can be significant and importantly if incorrect then the loss is limited.

IT firms are benefitting significantly from a significant surge in tech capex spending. Indian IT firms serve 60% of the worlds outsourcing requirements. These firms are noting significant orders and workflow since COVID-19 which is leading to higher rates of staff attrition as salaries rise handsomely. This is translating into much faster moving stock at hand for real estate compared to the last 6 years. This is particularly the case in the Southern part of India, which is where most IT firms are headquartered.

Lower interest rates, financial system liquidity and lack of other consumption options are also playing a significant role in a recovering Real Estate sector. This is likely to lead to a significant increase in the bottom line for the remaining stronger players in the property developer’s industry.

It's important to ask the question as to whether you seek to play the thematic or cycle over the long-term with a quality company or try to gain operational leverage to the theme with a riskier, but cheaper lower quality company.

3. Smart Implementation

Recognise what the market is short and is therefore under-owned. Realty was a small and under-owned part of the market given its checked history. Given there is some risk to the thesis it does not have to be a high conviction position, but an initiation which can be added to as the timeline for your idea starts taking place.

Source: Motilal Oswal

The Mutual Fund Industry in India has held extremely low exposure to this thematic given its history of a chequered past of the last decade. As can been seen from the charts below the BSE-200 (a broad index of 200 stocks by market cap has only 0.5% exposure to the Real Estate sector). Despite the success of this trade over the last 9 months, Index exposure has risen from 0.3% to 0.5% and Mutual Fund exposure only to just 0.6%.

Summary

Whilst the consensus view is that efficient markets are difficult to outperform in, it quite often depends on the length of horizon on the trade. Thematic investors can add value by identifying a theme/trend early through their insights and research, rather the relying on broker research and insight on company fundamentals.

In less efficient markets such as India, value can be added by active managers not just from identifying a trend before consensus, but also by insights on which companies will benefit and why. Active management is as much about top-down / thematic thinking as it is about underlying company research.

With interest rates only likely to stay flat or rise from here, valuation will start to play a more important role in the dispersion of stock returns. This will bring to the fore the skills of active managers who are able to exploit inefficiencies through insight, knowledge and intelligent implementation.

........
This document (‘Document’) has been produced by India Avenue Investment Management Limited (‘IAIM’) ABN 38 604 095 954, AFSL 478233 and has been prepared for informational and discussion purposes only. This does not constitute an offer to sell or a solicitation of an offer to purchase any security or financial product or service. Any such offer or solicitation shall be made only pursuant to a Product Disclosure Statement, Information Memorandum or other offer document (collectively ‘Offer Document’) relating to an IAIM financial product or service. A copy of the relevant Offer Document relating to an IAIM product or service may be obtained by writing to us on info@indiaavenueinvest.com or by visiting www.indiaavenueinvest.com. This Document does not constitute a part of any Offer Document issued by IAIM. The information contained in this Document may not be reproduced, used or disclosed, in whole or in part, without the prior written consent of IAIM. Past performance is not necessarily indicative of future results and no person guarantees the performance of any IAIM financial product or service or the amount or timing of any return from it. There can be no assurance that an IAIM financial product or service will achieve any targeted returns, that asset allocations will be met or that an IAIM financial product or service will be able to implement its investment strategy and investment approach or achieve its investment objective.  Statements contained in this Document that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of IAIM. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. Additionally, this Document may contain “forward-looking statements”. Actual events or results or the actual performance of an IAIM financial product or service may differ materially from those reflected or contemplated in such forward-looking statements. Any trademarks, logos, and service marks contained herein may be the registered and unregistered trademarks of their respective owners. Nothing contained herein should be construed as granting by implication, or otherwise, any license or right to use any trademark displayed without the written permission of the owner. Certain economic, market or company information contained herein has been obtained from published sources prepared by third parties. While such sources are believed to be reliable, neither IAIM or any of its respective officers or employees assumes any responsibility for the accuracy or completeness of such information. None of IAIM or any of its respective officers or employees has made any representation or warranty, express or implied, with respect to the correctness, accuracy, reasonableness or completeness of any of the information contained in this and they expressly disclaim any responsibility or liability therefore. No person, including IAIM has any responsibility to update any of the information provided in this Document. Neither this Document nor the provision of any Offer Document issued by IAIM is, and must not be regarded as, advice or a recommendation or opinion in relation to an IAIM financial product or service, or that an investment in an IAIM financial product or service is suitable for you or any other person. Neither this Document nor any Offer Document issued by IAIM takes into account your investment objectives, financial situation and particular needs. In addition to carefully reading the relevant Offer Document issued by IAIM you should, before deciding whether to invest in an IAIM financial product or service, consider the appropriateness of investing or continuing to invest, having regard to your own objectives, financial situation or needs. IAIM strongly recommends that you obtain independent financial, legal and taxation advice before deciding whether to invest in an IAIM financial product or service.

Mugunthan Siva
Managing Director
India Avenue

Mugunthan Siva is Managing Director of India Avenue, an Australian based boutique asset management company with offices in Sydney and Mumbai. He has over 25 years experience in Australia and is lead portfolio manager for the India Avenue Equity Fund.

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.

Comments

Sign In or Join Free to comment