Resonated a lot with Kuntal Shah’s views. Very good pointers here for us serious learners at VP. The way he strongly articulated his views on Financials space (among others) demonstrates sharp insights.
Would be good to interact with him more at VP and extract better how he thinks, his mental models for working through an increasingly uncertain world - directly from a set of moderated questions from VP readership.
WATCH:@Kuntalhshah, Partner, Oaklane Capital Management, presents on “Practitioners’ Insights: Investing Under Uncertainty”. In this session, Kuntal covers the current canvas of uncertainties & brings in a historical perspective.
Mod:@jaycee77, CFA Video: bit.ly/YT-Web-May13
Q. Depressed news all around. What is one mind hack to view the situation more objectively instead of getting just one side views?
First modern pandemic happening in the time of social media where there is amplification of bad news and where news travel fast literary in the matter of minutes. This is leading to great amount of information overload. Human brains are not able to process the frequency and amount of information. So investor would be best served by taking best and honest view of his/her investing time horizon and their temperament to absorb volatility at this stage and hence create adequate cushion for meeting their lifestyle needs and creating adequate buffer to be buyers and not sellers of the assets at the prices which do not make sense.
While hypothetically it is easy to do DCF and say that I would ride it out as couple of quarters or one/two year of earnings do not make material impact in an era of low interest rate and high terminal value being the biggest driver of the value chain. But when the drawdowns happen, they leave physiologically different kind of scares. So, you got to make up your mind - Whether it is a) fear of missing the opportunity or b) fear of losing capital - which is giving you more pain? One has to take a very meaningful call and position the portfolio for much longer period of time. Analysing your portfolio on real time basis or day to day basis I do not think is going to be counterproductive. Because till the time there is definite end in the horizon, the range of outcome is seriously wide. What is the guarantee this will not be a start-stop start-stop economy? Because there is full probability this virus could mutate and could have second wave which is far more infectious and deadlier than the first wave. One has to be aware of wide range of outcomes and be content to take pause once there is narrow of the probabilities and the optionality. No other way. For investors to commit the capital, you have to analyse large amount of information and then focus on two or three critical parts. Right now, the number of critical parts are just too high. And that’s why very wide range of opinion of some of the best masters. If you ask me, in my almost 30 years of career, this is the worst time I am facing to be able to take a definitive mind-map on where I am positioned. There are days where I feel valuations are becoming very juicy, lot of midcaps available cheaply. And there are days where I feel the worst is yet to come. So, volatility in thinking is there and one should take a very calibrated stance after this volatility dies down in mind as well in market.
Q. Is this high uncertainty and high-risk sort of scenario - Can we even define risk at this moment?
In past all the crises have either come from banking crisis where there was over lending or an asset crisis where a particular asset became hot. Here, two deep things are happening at the same time. There has been a pandemic which is creating havoc with human life . There could be a scenario where the hospital capacity infrastructure may not be able to give treatment to all the people needing it that could give you a sense of helplessness. Also, there is synchronized stoppage of global economies which has not happened in the past. We had world war, we had every kind of crisis, I do not recall a crisis that could spread so quickly. Like through airlines you can transfer it thousands of kilometres away and start the infection process there. And, a stoppage of economy which gives you uncertainty about the cash flows, about the asset collaterals. To that extent this is overwhelming. I would say till the health side issue is not taken out I think volatility is going to be around the corners because nobody with seriousness can tell you that this the bottom or this is the top. There would be volatility in thinking as the epidemic progresses. I think this is inevitable. Till the time we don’t have clarity on the duration of the pandemic, its impact on how deep it is and how long it is, I think so range of outcomes are so wide, it is overwhelming some of the best investors. That is why you see Warren Buffett not investing despite sitting on cash. Stanley Druckenmiller coming and saying it is bad. You have whole host of investors which are more accomplished than people like me which are not able to make up their mind and then who am I to take a definitive call. So, positioning your portfolio to handle a very low prices is a must.
Q. There is a disconnect between economy and the market. You had a very bad March and then April you had the huge turnaround more so in the U.S. market. Covered more than half of lost ground in face much more in U.S. Look at the market and then look at the news - there is some sort of resonance which it causes. How do you explain that? Is the FED which is pushing the market? If that is the case, are investors asking for very low risk premium and will that mean going forward we are entering the era of low equity returns?
Two things. If you can predict successfully what is going to be the interest rate going ahead, then probably you could answer quite a lot of these question. Let me step back - The markets today are made up of investors with very different time horizons. There could be algorithms trading for a day to investors like pension funds which might be taking 20 years view to management who are taking much more longer view to index funds which are price insensitive to buyers. There is heady cocktail of investors expecting different things from the same asset class. So obviously there would be bound of volatility. So, every rise will be sold into and every dip will be bought . That is, I think given, given the fundamental construct of the market. Longevity of your capital and stability of your capital as well as your mindset is something which needs to be upfront on the table. And if that is doubtful, then you will be whipsawed by this market and tons of volatility. Going specifically into the nitty-gritty, each market and each asset classes have their own nuances. Like oil - it was technical shortage of storage which resulted into abnormal pricing on the derivates market. So, one has to be very cognizant of interplay of the technical and the fact that there are all kind of market participants. So, one should not be driven by this volatility and one can only be allowing one’s own view to prevail by patiently waiting for your pricing for both i.e. buying and selling. Till the time this pandemic does not have an endgame; virus will determine its endgame and human ingenuity in terms of R&D will determine its endgame, this bound of volatility will continue. And even if FED stimulus began to dominate the narrative, it is just a matter of time people will ask the question and-then-what? Then who is going to pay for it? How is this fiscal stimulus going to impact the inflationary expectations embedded? That is why today you’ve bond investors that are worried about the recession because of the debt overrun and you have gold investors who are saying inflation is just around the corner. So, you have contradictions bundled into the current market and one will have to learn to deal with this contradiction in a very calm and calibrated ways.
Q. Investment opportunities - Which are the co which will survive this? Any contrarian opportunity?
Let us focus on what will not change. Lot of things have changed in short term. And many things have to be changed about our lifestyle and consumption pattern in medium term. But in long term I think so human ingenuity will prevail and go back to our society way of interactions and doing the business. So, one thing to find is invert the problem and ask ourselves the question - what makes a company fragile during this time? So high leverage would be one such point. Concentration of client in one location. Concentration of supply chain in one side. There is whole sort of parameters which will bring out fragility of the organization and those kinds of organization have to be avoided. Also right now is a time of plenty. You have haves and haves-not. So, there are some companies which are price to perfection. Many investors have these questions - today I buy Johnson & Johnson and Nestle yielding me 2% dividend yield and far higher earnings yield with a growth optionality or do I buy U.S. government bond. So, there is lot of movement of capital across asset classes. So, investors who are married to asset class have a problem but investors whose mandate permit them to go across asset class have far higher probability of sailing through. Having said that, since we are talking to predominantly equity investor base of our audience, one should look at what happens after two years. One should take a pause and step back what are the things which are not going to change and where there is zone of safety in terms of valuation. Because what is perceived to be highly safe right now can be highly counterproductive in terms of returns. So I give you narrative not to say I am recommending something - Today even with the sub-sector let’s say financials, people are blindly very risk averse to levered financials but are highly embarrassing the distribution companies like insurance/AMC. But when you bring the price to the equation, you will realize that the margin of safety probably lies in the financials which are levered because probably few out of them will emerge from the very low competitive environment. So, one has to go against the narrative and look are you paying very high price for the rosy certainty. The future returns are the function of current price paid. Please understand many of the asset class investors would sell-off very quickly. Let me give one contra example - in commodities, the last man standing in terms of cost of production and the access to the capital markets via lowered leverage could eventually have far more upside than probably safe company which is you’ve already paid price safety for. It all boils down to one’s choice architecture and what one can sleep well at night - it is unique from investor’s propensity to overpay for quality or bear uncertainty but be compensated by lower price .
Q. Across asset classes investing and should we look at other asset classes (say Gold)?
Let us take live example - If debt securities of a corporate giving equity like return why would you look at equity. Ultimately you have to counterbalance your return and risk profile. Many times, investors which are acting in silos are not aware of far lesser risk and more rewarding opportunities emerging in the peripheries. To give you an example - today the dollar bonds of some of our financials are giving equity like returns because of dislocation and the flight to safety. So, the flexibility to invest across asset class is a desirable one and am cognizant of the fact many of us do not have it. Assuming the investors don’t have, then positioning ourselves on cash and defensiveness are the only two options.
Q. Have you also realigned your portfolio or are you waiting for clarity going forward?
Personally, I have created sufficient cash which allows me to have peaceful sleep and take advantage of the price fall if they may happen with a clear thing that should the stimulus and the monitory easing prevail and the asset class again continue their onward journey or suppose a miracle of vaccine or treatment comes around then I am ready to live with the fear of missing out on opportunities. Secondly, my current focus is on the identifying the companies which are gaining market-share and which are antifragile; they are not obvious. Thirdly, the way I have positioned is - I have included Gold as first-time consideration. So yes, things are changing, and I have been candid to admit this has been one of the most challenging times in my investment career, so I am not taking decisions very quickly. I am sleeping over it and am processing much more information and I am seeking out to seniors opinion before doing anything because many a times they have seen much more or are much more intelligent than me and which has helped me currently. Taking help of far more accomplished investors than me is helping and I think investors should do this.
Q. In this entire scenario are there any positive for India and economy which we can benefit from?
Chinese have a saying - Never waste a crisis. And if you really look at our government has got their act together in the times of crisis. Am very optimistic on our country because if you are an investor you have to be cautiously optimistic but at the same time be realistic on what can happen in short run. Apart from near term issues of stimulus and getting the country back to the economic activities and dealing with contagion pandemic, I think we will be best served if we can take bold labour, land, and laws reform. Especially on legal side, because in India legal system is not functioning and financial system is all about contracts. Many times, sanctity of those contracts is not enforced in right point of time. So, if we can get our act together on attracting investments and making the business environment more conducive for productive growth and corporate activities I think so will be very well served going ahead.
Q. Any last words of advice?
Big results are driven by tail events like this. This is one of the rare events unfolding in front of our eyes. Few pieces of advice - Don’t buy a security till you don’t understand what debt market is thinking about it and vice-versa. Also, nobody knows how and when this will end. In the interim, supply of paper can rise, and capital calls can come in considerable time. Till the effective vaccine or treatment is not found, there is a distinct possibility of very adverse scenario also playing out. And if history is any guide, the decisions that we take now for regulator and corporates and investors will reverberate for quite some time to come. Falling on the side of caution might look foolish in the end but I think so that is price worth paying for at this stage.
Opening up for questions to Kuntal Shah.
Please use this opportunity judiciously. Questions posted by Members will be queued up. Moderators will prioritise and approve a set of curated questions from the queue - that might help us get inside an astute practitioners head like Kuntal’s - to get better insights on how best to work smartly and very productively - through the uncertain times ahead!
Questions can be posted till 4 pm Monday 18 May, 2020.
Q1: In your current interactions you have been cautious and called out the current situation as highly uncertain. The situation on the other hand seems to have gotten more clear. In someways we have moved from unknown unknown to known unknown. Two months back we had little clue about the virus, the fatality rate, preventive measures etc. Today we have data that places an upper bound on the impact, the hospitalization rate, the fatality rate, the demographic distribution and various other measures. Europe is coming out of it, US has flattened the curve. Do you agree that things today are far more clearer than they were two months back from a Covid perspective? The financial impact/economic perspective is still muddled. What are the key data points that you are looking at to become more certain?
Q2: We have had so many events like demonetization, GST, Covid 19, ILFS crisis which have resulted in significant liquidity issues. We also see ample money parked with RBI and a complete risk aversion from banks. Also during multiple such crisis we have seen even the top rated NBFCs had to raise debt at significantly higher rates. Do you think in absence of liquidity from RBI in crisis situation for NBFCs (which banks have access to), the NBFC model itself is flawed? Do you see large NBFCs moving towards obtaining banking licenses? Do you see a lot of NBFCs becoming asset aggregators for banks?
Q3: In the run up to the COVID-19 crisis, there were some dominant narratives in the Indian market like
-It is preferable to pay up for consensus quality rather than make bets on out of favour businesses (even if cheap)
Bigger necessarily means better, all other things remaining the same
The MNC premium is well deserved
Industrials and Capital Goods rarely make for good quality secular businesses
Post the crisis some of these narratives appear to have been reinforced, at what point of time would it make sense to start doubting the durability of these narratives? Or is it just the beginning of Polarization 2.0 in your assessment?
Q4: Unprecedented times like these tend to bring to light some strengths/weaknesses that are inherent in businesses and managements that may not be visible during normal times…
If so, how should one revisit their framework on the following parameters -
Management Quality - While the initial reaction maybe the same, over a period of time we might see some divergence in how managements react to the situation. Current actions will have a bearing on future business performance, do they not? How would you revisit your evaluation of management quality based on how they react to the current situation?
Power centers and synergy in the value chain - Power imbalances tend to be revealed during tough times, how should one translate any developments on this front into the framework of business quality? Any specific indications which you would want to monitor in this context?
Q5: What are the factors that demonstrate anti-fragility of a business? Are there any quantitative factors that can help in that regard?
Also what factors/characteristics can help differentiate between resilient businesses and anti-fragile businesses but can be observed before ex post facto? Next, how does capacity to suffer tie in to that?
Q6: Let us say some pockets of B2B businesses in India (Agrichem is one example) has been benefitting from a somewhat structural shift away from China over last 3-4 years due to frequent supply chain disruption events even pre-Covid. This trend is seen accelerating now (post Covid) and valuations seem to be in favour too; however the businesses are small emerging businesses which are somewhat resilient businesses (strong entry-barriers) certainly a business-under-positive-transition for next 3-5 years; but certainly can’t be clubbed under “antifragile”. These usually have low-liquidity patterns too 
In one of the presentations you mentioned “Invest big when the odds are in your favour”. How should one think about/invest in such businesses in current times for this not-so hypothetical pockets of businesses? How are the ODDS stacked for such small businesses?
Q7: COVID 19 has prompted many of the veteran investors to question the entire business model of various comapnies, some of them were even considered having strong competitive advantages (like unsecured retail lending of BAF/ Bandhan ) and existence/survival of many industries (Hotels/Airlines/Tourism/Restaurants/Movie screening) with the underlying argument that the current event will bring permanent behvioural shifts across the globe. On the other hand history also suggestes that habits/behaviour formed over a long period of time and rooted in the basic desire of human being change, if at all, only incrementally. What are your views on this aspect and how are you realigning/repositioning your portfolio considering this context?
Q8: In last 2 years we have heard a lot about manufacuring in chemical industry moving from China to India due to multiple reasons which people predict will gain further traction post Covid-19 crisis and such shift of manufacturing facility from China to India may pan across many other sectors. How realistic do you find such hypothesis and how should one think about re-orienting/structuring portfolios for actively prospecting candidates should we see some evidence on the ground?
Q9: In last decade-decade and half we have seen emergence of the extremely large technology/platoform companies across the world like Google/Amazon/Netflix/Facebook/Uber and many unicorns across the India like Paytm/Oyo/Byju etc. Most of these companies (barring few exceptions) have a business model that neither generates free cash flows nor high return on capital. In fact many of them are cash guzzling machines with growing scale and expanding losses. However those companies have created tremendous wealth for their investors in last 10-15 years. Even today in India, companies generating high FCF and high return on capital get very rich multiples as the business model is considered to have longevity and strength. How do you reconcile this dichotomy? According to you what makes such cash guzzling/loss making business models so attractive for investors?
Q10: Government recently announced major reforms in agriculture sector including amending Essential commodities act, introducing new APMC framework and facilitating contract farming in the country. Many agri sector experts consider these reforms (if implemented in true spirit) tantamount to 1991 reforms of removing license-raj from Industries. This means opening up the agriculture sector to market economy which has the potential to unleash animal spirits in that industry.
How should one assess such watershed events, how could we go about preparing/keeping a tab on more evidence emerging on what is actually transpiring on the ground; What pointers/triggers should one look for while deciding to participate/narrow down to investment prospects in such emerging themes?
In essence, how does someone like you think about this and other such emerging themes - many of them might be government-intervention led in coming times? How do you prioritise research and focus areas - shedding some light on these aspects - would be invaluable for us at VP.
Q11: Currently everybody is bearish on financials and don’t want to touch it with bargepole. On the other hand for decades, this sector has created humongous wealth for investors. Precisely 3 months ago, some of the names in this sector were touted as secular growth story on India’s growing economy. Considering that a very significant part of a company’s intrinsic value comes from it’s terminal value and many of these financial companies have enough capital to survive this crisis, their terminal value has not got impacted much.
How should one go about separating the wheat from the chaff in Financials space now? If we were to attempt to classify into resilient and anti-fragile categories, say, what are the 3-4 critical attributes that assume centre-stage? If we were able to classify accordingly say on hard-facts/granular data-points would you think it might provide great opportunity for investors to buy such strong franchise at attractive valuations? Notwithstanding that some veterans opine that overall Financials as a sector (may see tremendous pain/upheavals going ahead), and may no more be the flavour of the season, might actually see much reduced NIFTY representations going forward?
Q12: How should Indian insurance companies be valued (both general and life)? For an insurance company with sustainable ROEs of 20% and a dividend payout of 20%, what should be a reasonable P/book multiple? Should it be similar to banking valuations or is there a different way to understand insurance valuations?
Going forward (post-Covid) do you see Insurance playing a more central role in the scheme of things both globally and in India. Given that in India under-writing skill and track record (General Insurance) is still to be proven (relatively short tenure of 10 plus years) how should one go about dissecting this space in terms of sustainability and longevity of the leading players?
