newsletter March 2019

Perpetual yield from trees happen only after years of patience

PMS INVESTMENTS
ARE PERENNIAL TREES

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Economic outlook and Indian Stock Market Analysis March-2019 2

Marcellus Consistent Compounder - PMS Strategy 3

Interview - Mr.Saurabh Mukherjea, CIO, Marcellus Investment Managers  6

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Economic outlook and Indian Stock Market Analysis March-2019

Month of February-2019, began with positive note and the Indian NIFTY-50 index appeared as break-out, but, failed
to sustain above 11,100 and corrected back to the bottom of the range to 10,600. Though the later part of the month
witnessed recovery, index could not cross above 10,900. The range bound nature of the index may continue for
some time, giving opportunity for Long term investors to enter the market. The good news is that the FPI/FIIs have
turned net-buyers (till 28th Feb 2019) to the tune of Rs. 12,958/- Crore for the Calendar year 2019 (FII/FPI had withdrawn
4,262 Crore INR during the month of January 2019 - during the calendar year 2018 FII/FPI were net sellers in equity to the tune of Rs. 33,014 Crore) - Data source NSDL

FPI-Monitor.

Global Situation:
The postponed dead-line by The US President, for more tariffs with China, is good positive news for the Global
economy; there are reports of increasing intellectual property protection in china. There are some important Global
economic affairs in the month of March like Federal Chairman's economic testimony to the US senate Banking
committee & house committee, Article 50 Deadline for Brexit, deadline for Assessment of New North American
Free Trade Agreement. Though the slowdown in china is bad for the Global economy; analysts worldwide opine it
will be opening more opportunities to Emerging markets especially to India.

Indian Macro:
RBI's interim dividend to the Government had been a hot-topic politically; but economically whether the dividend
is paid twice yearly or once does not make any difference. The 43,000 Crore INR capital infusion to the Banks is
positive for the banking industry, especially, as this enabled Alahabad Bank & Corporation Bank to come out of the
"Prompt Corective Action" list.

The Q-3 results had been a mixed bag for the Indian Equities. Over-all revenue (for 2464 companies) has been
reported as 14,04,987 crore, this is 17.52% growth Y-o-Y and 3.52% growth Q-o-Q, But, the overall net-profits
have increased 9.29% Q-o-Q and declined -2.71% on Y-o-Y. The important observation is that the Banking sector
reported turning-around numbers from 2,091 crore loss to a profit of 5,374 crore. Automobile / real-estate / aluminum
/ energy are the four top-loosing sectors. After the results and the market price corrections many of the equities
appear trading at huge discount to their fair intrinsic value.

There are Election concerns expressed by the analysts / media. Historically, in the year 2009, 2014 the market
started their bull-run even during the pre-election months. Long-term investors can remain assured that the Indian
economy will grow in spite of the politicians and politics.

We remain Bullish on the Indian Equity Market. Investors with 3 to 5 years investment horizon are sure to convert
their Millions into Billions.

Happy Investing !!

Research Team,
PMSbazaar.com
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Marcellus Consistent Compounder - PMS Strategy

Marcellus Investment Team

Mr. Saurabh Mukherjea - CIO

Saurabh is a CFA charter holder with a BSc in Economics (with First Class Honours) from the
London School of Economics. He also has a MSc in Economics from the same institution. He is
one of the SEBI's Asset Management Advisory Committee. Saurabh is the former CEO of Ambit
Capital and played a key role in Ambit's rise as a broker and a wealth manager. Saurabh has written
three bestselling books: Gurus of Chaos (2014), The Unusual Billionaires (2016) and "Coffee Can
Investing: The low risk route to stupendous returns" (2018).
Mr. Rakshit Ranjan - Portfolio Manager
Rakshit has a B.Tech from IIT (Delhi) and is a CFA charter holder. He has spent 6 years (2005-2011)
covering UK equities with Lloyds Bank (Director, Institutional Equity Research) and Execution Noble
(Sector Lead analyst). During these six years, he was ranked amongst the top-3 UK Insurance
analysts (Thomson Reuters Extel survey) in the mid-cap space. Since 2011, Rakshit led Ambit
Capital's consumer research franchise which got voted as No.1 for Discretionary Consumer and
within top-3 for Consumer Staples in 2015 and 2016.
The investment approach of Marcellus: Marcellus Investment Team with their analytical/logical and assessment
skills, has "zeroed-in" on two important basic tenets to build a portfolio, capable enough to deliver outperformance
through compounding over long period of time.

1. Filter Based Portfolio:

a. By filtering-in companies with the history of very consistent fundamentals, it is ensured that the DNA is not
affected by any disruptive changes inside or outside, due to their strong competitive moats. Such DNA
sustains over the subsequent 5-to-10 years.

b. Long-term-holding for 10 years or more allows the power-of-compounding of the winning stocks dominate
loosing stocks (if any) to inconsequential Levels.

c. Low churn portfolio can be maintained through proper filter based approach. This would reduce transaction
cost as well as the taxes, hence the returns will be boosted by more than 120 bps CAGR, thus better returns
over longer-period of time.

2. Bottom-up deep dive research:

This is achieved through 3 types of interventions;

a. Portfolio Concentration filter creates long-list of stocks (of about 20), this dilutes the reliance on the portfolio
on outstanding companies. Manual intervention is done to produce more concentrated portfolio.

b. Though the filter approach demands "consistent-performance", Manual intervention is beneficial to ignore
"temporary-blips" in the Business cycle; Such companies are added or retained in the portfolio, through
manual intervention.

c. Filter based portfolio has identified companies in the housing finance, which were great performers in
the past 10 years due to macro-tailwinds. The logical analytical acumen of Marcellus Investment Team
experience in the financial markets cautions that this performance may not be sustainable; such filters are
avoided through manual intervention.

Marcellus Consistent Compounders Portfolio PMS:

Marcellus launched its PMS strategy on 01st December 2018, christened Marcellus Consistent Compounders
Portfolio (CCP). The basic filtering concept has been back-tested by the company and found offering good return
over a period of 10 years.
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An example, back-testing was conducted using their filtering algorithm for the ten year period from FY 1998-2008,
selecting leaders based on 5 years-average-rolling ROE. The selected companies' performance was measured
for the period from FY 2008-2018, the results are tabulated. The gap between ROCE and COE (cost-of-Equity)
is maintained only by few companies, this is possible by companies with high pricing power and competitive
advantage. The CCP portfolio has meticulously selected such stocks to be held in their portfolio.

"Return on Equity - Average"

ROE - Average
Company
FY-1998-2008 FY-2008-2018

Asian Paints 32% 38%

ITC 30% 30%

Nestle 65% 71%

Pidilite 25% 27%

Page ind 38% 52%

HDFC Bank 21% 19%

"10 years rolling return comparison"

The current portfolio of the CCP: Marcellus CCP, currently is a concentrated 12 stocks portfolio, which is believed
to perform over-long-term. The 'back-testing' results are very convincing, however, investors should note that this
is only for explanation and example; the true future performance may vary from the back-tested results.

The power of Marcellus intervention has been displayed in their first-churn since inception. Gruh Finance was in
the portfolio. This company was filtered-in due to its competitive advantage to maintain asset quality discipline,
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low cost of funds, and high operating efficiencies, driven by the holding company HDFC Limited. On 7th January
2019, HDFC announced that it sold the Gruh finance to Bandhan Bank, this implied that all Gruh finance share
holders will be issued with the shares of Bandhan Bank. This equity does not qualify the filtering norms of Marcellus
CCP, hence Gruh finance was sold the next day in all the portfolios. The portfolio was launched on 01st December
2018 and this decision to churn the portfolio was made within 2 months of the launch. This exhibits the adherence
to the basic investment philosophy of the strategy to follow filtering concepts. This has to be decided by over-
ruling the secondary concept of low-churn/holding for longer periods. Such a decision exhibits the conviction and
confidence of the PMS Strategy Managers of Marcellus CCP.

The portfolio was incepted on 01st December 2018 and performance analysis for 3 Months appended below.

Performance summary (Marcellus CCP)

Returns CCP PMS Nifty 50

1 Month -2.10% -0.20%

3 Months -0.80% -0.80%

Since inception -0.80% -0.80%

*Returns are absolute and as on 28th Feb 2019.Inception Date 01/12/2018

The top-holdings and sectors are displayed. The Marcellus CCP - strategy is currently with Large-cap bias with
76.13 % in large cap, 17.16% in mid cap and 6.71% as cash.

Top - Holdings

Asian Paints Ltd 11.14%

Page Industries Ltd 10.92%

Berger Paints Ltd 10.88%

Pidilite Industries Ltd 10.86%

Relaxo Footwears Ltd 10.56%

Top - Sectors

Furniture, Furnishing and Paints 22.67%

Other apparels and accessories 10.92%

Specialty Chemicals 10.86%

Footwear 10.56%

Banks 10.09%

LARGE Cap MID Cap SMALL Cap CASH & Equivalent

76.13% 17.16% 0% 6.71%

Conclusion: Marcellus Consistent Compounders Strategy PMS, is recently launched PMS strategy. Though there
is no real data to analyse the long-term potential of the portfolio, back-testing results appear satisfactory. If the
Strategy tenets are strictly adhered-to in the future, the strategy CCP is likely to yield better outperforming returns.
The Management is well experienced and their recent churn based on the basic tenet of the strategy is assurance
enough that the strict adherence to the principles of the strategy will be sustained for a long-term. Investors willing
to hold their investment for long-term horizon beyond 5 years can benefit from this portfolio. However, we advise
investors to calibrate their risk appetite with the strategy before investing.
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Interview - Mr.Saurabh Mukherjea, Chief Investment Officer, Marcellus

Marcellus "Consistent Compounders Portfolio" PMS, being newly launched cannot be assessed using real long-
term data; PMSbazaar research team has interviewed Mr. Saurabh Mukherjea, CIO of Marcellus PMS, in order to
understand the strategy and Investment Process. The excerpts of the interview are appended below.

1) Should equity investors really worry about elections and its outcome? What would be your advice to
investors?

The Indian stock-market is peculiar insofar as it not only fails to predict election results, even after the election
results are known, the stock-market has no idea what real implications of the results are. For example, in 2004, the
stock-market responded to the UPA's victory by collapsing. What followed was the greatest bull market in Indian
history. Then in 2009, the stock-market celebrated the UPA's victory. What followed was five years of poor returns.
So, the less investors worry about the impact of the elections on the stock-market, the better.

2) Your recent article "The Virus Spreads Beyond the Banks" says that your research team is of the
view that over 70% of India's listed entities publish accounts which don't make sense. You have also
highlighted the need for investors to strengthen their forensic accounting. But, Novice-investors do not
have the skills. What is your advice?

If you are investing in Indian stocks directly you really do have to have forensic accounting skills. You can get such
skills from books like "Financial Shenanigans" by Howard Schilit or my book "The Unusual Billionaires" (which
has a chapter on the subject). On the other hand, if you are giving your money to professional money managers to
manage, you should assess whether he/she has forensic accounting skills. Ask them how they figure out whether
a company's books are cooked. If they cannot give you a clear answer, you should walk away with your money
safely in your pocket.

3) Marcellus "says" "India is blessed with consistent compounders", What is "consistent-compounding",

How Marcellus uses this as a strategy in a PMS construct?

India is perhaps the only large economy where several industries are dominated by one or two players, and these
dominant players make returns on capital employed (ROCE - earnings generated on each unit of capital employed
on the balance sheet) significantly higher than the cost of capital (or COE - cost of equity) for several decades.
For instance, the table below shows a list of global players who dominate their industries, but none of these
companies make ROEs substantially higher than their cost of equity.

Exhibit 1: ROE of firms which dominate their sectors in large economies accross the world

Company Name FY16 FY17 FY18

Walmart Inc 18% 17% 13%

Carrefour SA 7% -5% -5%

Hanesbrands Inc 43% 6% 6%

Toyota Motor Corp 14% 11% 14%

JP Morgan Chase & Co 9% 9% 12%

Median 14% 9% 12%

Source: Bloomberg, Marcellus Investment Managers

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On the other hand, there are several industries in India where one or two companies not only have a dominant
market share, their ROCEs have remained substantially above the cost of equity for decades in a row (see table
and chart below). A wide gap between ROCE and COE invites intense competition which forces the gap to narrow
down as the dominant players compromise on the quantum of earnings generated on each unit of capital employed.

However, there are a few firms in India which have such a high pricing power / competitive advantage, that they
can sustain a wide gap between ROCE and COE over very long periods of time. The chart on Asian Paints below is
probably the best example of such firms.

The gap between ROCE and COE is the free cash flow that a firm generates for its shareholders. Provided these
firms sustain this wide gap whilst also growing their capital employed, they will give a healthy earnings growth,
consistently over long periods of time, regardless of changes in the internal or external operating environment of
these companies. We call these firms "Consistent Compounders".

Marcellus builds a portfolio of such firms in its Consistent Compounders PMS. The PMS intends to hold these
stocks in the portfolio for long periods of time and benefit from the power of compounding of healthy returns. The
volatility in these returns for holding periods longer than 3 years, are like that of a government bond!
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4) "Consistent Compounders" Strategy holds very less number of stocks (about 10 to 12) in the portfolio,
and the theme appears to be stating that the strategy's volatility is as low as that of a "G-sec", how do
you make this possible with such a "concentrated" portfolio?

Volatility of portfolio returns under this philosophy remains low due to a combination of the following factors:

‡‡ Exposure to the most resilient part of Indian macro: Interestingly, all the stocks in this portfolio belong to small-
ticket B2C (business to consumers) sectors like banks, FMCG, apparel, footwear, diagnostic labs (retail) and
home building materials. As a result, the portfolio benefits from the scale, relentless drive and resilience of
Indian middle-class households by taking part in the evolution of day-to-day basic needs of these households.

‡‡ Unique fundamental DNA of companies held in the portfolio: Our coverage universe consists of only those
companies which have a history of very consistent fundamentals over long time periods. Our research on
these companies aims at identifying stocks which have a unique DNA that helps deliver consistency of healthy
fundamentals despite evolutionary and disruptive changes in both the external environment (macro factors,
competition, etc) as well as the internal environment (management's succession planning, capital allocation,
etc). Hence, the portfolio is skewed towards companies with a DNA built around relentlessly deepening their
competitive moats which significantly reduces the volatility in their fundamentals over any time period.

‡‡ Non-fundamental factors supporting P/E multiples during periods of market stress: During periods of uncertainty
and stress in the broader stock market, often liquidity / equity flows get skewed towards companies which
offer a high degree of resilience in their fundamentals. Hence, not only do the earnings of these companies
remain less volatile (due to the unique DNA highlighted above), but also their P/E multiples remain less volatile
than that of the broader market

5) Why should investors look at investing in Marcellus - Consistent Compounder's strategy?

Consistent Compounders PMS promises to deliver 20-25% CAGR (annualised returns) to investors, post fees and
expenses, for any holding period longer than 3 years. Given the sustainability and low volatility of these returns,
this portfolio should be the core holding in any investor's investable corpus. One of the most frequently asked
questions on this philosophy is - "This philosophy sounds very simple. Hence, why should an investor appoint
Marcellus to implement it for them instead of executing the philosophy themselves?"

We agree that the philosophy is very simple. But simple is not always easy! The first challenge is that whilst it is
easy to find firms like Maruti Suzuki which maintain their industry dominance (>50% market share of cars in India),
their average ROCE (for the last 10 years) is only 17% - like that of Toyota and Hanes highlighted above. The
second challenge is that amongst firms that sustain a wide gap between ROCE and COE, there will be examples
like Hindustan Unilever (HUL) which do not find avenues to grow their capital employed and hence, despite
maintaining >80% ROCE over the past 10-15 years, end up generating an annualised earnings growth of only 8%
(CAGR) over this same period. The third challenge is that even if an investor holds stocks like Asian Paints in his
portfolio (healthy ROCE with healthy growth), lack of enough conviction in the fundamentals of firms like Asian
Paints leads to a less than ideal percentage allocation in the portfolio and shorter than ideal holding period of such
stocks in the portfolio.
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Disclaimer
The content in this newsletter is a broad based opinion by the research team of PMS Bazaar. Your suggestions to include / exclude specific topics, critical comments on the views expressed
are welcome. This is not a recommendation to buy any product. PMS Bazaar is not responsible for any investment action initiated. Please consult your financial advisor before investing.