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Mr. Market Plays Catch-up While Scientific Investing Generates Alpha

Science of Alpha from Safety

Mr. Market Plays Catch-up While Scientific Investing Generates Alpha

Global OmniView July 2020

Mr. Market plays catch-up while Scientific Investing generates alpha

  • Scientific Investing portfolios exhibiting broad-based outperformance
  • All segments of the Omni Supreme US Multicap strategy have outperformed benchmark. All segments continue to be fundamentally strong with attractive valuations
  • Omni Supreme US Multicap and AIoT are inevitables that investors must consider adding to their ‘Core’ equity portfolio.

Scientific Investing is delivering alpha across Developed (US) and Emerging (India) markets...

In June, Omni Supreme US[1] delivered 8.8% (in USD) as compared to S&P 1500 which delivered 1.8%, thus generating an excess return of 7%. The Barclay Hedge Fund Index, reporting on more than 800 hedge funds worldwide, was up by 1.77% for June 2020. Equity long-bias index from Barclay Hedge was up by 2.12% and the Technology index is up by 4.1%. According to the Lipper mutual fund report for June 2020, the US equity mutual funds delivered average returns ranging from 0.37% to 4.07% for different mutual fund categories, with multi-cap funds delivering an average return of 2.01%. Omni Supreme US has performed better than all these categories of hedge funds and mutual funds.

For the April to June quarter, Omni Supreme US delivered 32.2% compared to 18.5% for S&P 1500 and 21.4% for S&P 600, thus generating excess returns of over 13.7% and 10.8% respectively. Omni Supreme US also performed better than the mutual funds for the quarter. According to the Lipper mutual fund report, the multi-cap mutual funds delivered average returns of 22.38%. Again, the Omni Supreme US performed better than that.

Scientific Investing delivered alpha in the Indian markets as well. Last month, based on PMS-AIF World data, Moneycontrol ranked 3 schemes based on the Scientific Investing philosophy in the top-10 performers across all PMSes (Portfolio Management Services). A comparison on Value Research with the large-cap mutual funds shows that the Scientific Investing based large-cap strategies also beat all the mutual funds for the period.

[1] Based on the proprietary Omni Supreme US model portfolio returns on gross basis. See detailed disclosures at the end.

In June as well, the performance of Scientific Investing strategies continued. Similarly, the Nifty 500 delivered 8.3%, while the Omni Supreme India model portfolio delivered 13.6%. Moneycontrol and Economic Times put Scientific Investing India strategies in the top performing bracket for the month of June and the April-June quarter.

It is interesting to note that Scientific Investing is performing across two completely different markets representing economies as different as US and India. This should not come as a surprise since the Scientific Investing philosophy and framework are based on the first principles of investing which apply across markets. It is an indication that Mr. Market is seeing the value in segments and stocks in the SuperNormal Portfolios based on the Scientific Investing framework.

Alpha is created when companies with SuperNormal economics are bought at SuperNormal prices; the Alpha is manifested when Mr. Market agrees with this and is willing to pay higher prices.

Alpha manifestation is not a one-time event but rather a process which works out over time. The current alpha manifestation is a result of Mr. Market realizing some of the fundamental strengths of the portfolio companies and the significant discount to their intrinsic values. A partial unlocking of the discount has been manifested in the current time frame.

The focus on the monthly returns is not with a view to highlight the returns per se, but rather to illustrate that there are periods when there is a change in the market perception and Mr. Market’s view starts converging with Scientific Investing. While this happens in a spurt sometimes, it could take several such spurts before the full convergence happens. Further, the investor needs to have the patience to stick with the strategy until Mr. Market starts loving the portfolio companies and when it is time, eventually, for the Scientific Investor to bid adieu to those stocks once the convergence is near-complete.

Scientific Investing takes originality, character, and patience. Investing and winning in the stock market is a long-term endeavor requiring patience and holding power of more than 3 years and sometimes 5 years or more.

 

“Alpha is created when companies with SuperNormal economics are bought at SuperNormal prices; the Alpha is manifested when Mr. Market agrees with this and is willing to pay higher prices.“

Omni Supreme US-The US multi-cap strategy

Omni Supreme US is a multi-cap strategy based on Scientific Investing. This strategy creates a SuperNormal Portfolio of 20-30 stocks from an investment universe comprising of the 1500 largest companies listed in the US markets. Selection from this is based on the Scientific Investing Framework which eliminates the “Capital Destroyers”, “Capital Eroders”, and “Capital Imploders” from the investment universe, leaving the “Capital Multipliers”. From the “Capital Multipliers” a SuperNormal Portfolio of the best 20-30 stocks is created.

The Scientific Investing Framework establishes an economic alpha of companies with supernormal profitability as compared to the investment universe represented by the benchmark. Further, since these companies are bought at a discount to their intrinsic values, i.e. supernormal prices, a value alpha is established. The conservative allocation with caps on sector/industry allocation and stock allocation and the regular monitoring, realignment and rebalancing provides portfolio governance alpha. It is no surprise then that an alpha is embedded in the portfolio. Manifestation of the alpha requires that Mr. Market agrees with valuation and as Ben Graham says “in the short run the market is a voting machine, but in the long run the market is a weighing machine”.

An important aspect of the Scientific Investing philosophy is that the investment process, i.e. the framework should be original, resulting in an original portfolio, different from the market portfolio. Allocation of investment capital to this original portfolio requires character to go against the herd, i.e. against Mr. Market. Further, it requires patience to allow Mr. Market to realize the value and agree with your assessment. This process can take 3-5 years sometimes. Sometimes it is a consistent gain when the economic alpha is manifested over the years and sometimes it is a sudden spurt when the catalyst might be economic gains, but the manifestation is in the form of value alpha. Probably the current performance is a result of the second scenario.

Digging Deeper—Segments and their performances

As discussed in an earlier OmniView, the Omni Supreme US portfolio can be classified into 4 segments, viz., AIoT (Artificial Intelligence and Internet of Things), HNWMA (High Net Worth & Mass Affluence), Sports & Wellness, and Consumption. Below we see the performance of these segments. All of the segments in the portfolio outperformed the benchmarks.

Consumption and HNWMA segment performed extremely well with a segment return of 20.5% and 19.5% respectively. Sports & Wellness also did quite well with 11.2%. AIoT segment which is primarily technology oriented delivered 6.7%.

Are these SuperNormal Companies?

Here we compare the Omni Supreme US Multicap portfolio with its benchmark S&P 1500 on selected fundamental parameters. We have added a comparison with Nifty 500 as well so that an Indian investor can do a comparative analysis of the strength of the US portfolio.

Cashflow based earnings have been used rather than the reported GAAP earnings. US GAAP earnings have a lot of non-cash components, including non-recurring expenses which make the estimation of normalized earning power difficult. Cash flow-based earnings have also been used to estimate the RoE and the RoCE. The Omni Supreme US portfolio has higher RoE compared to both S&P 1500 and Nifty 500. The asset turns are also much higher. The net debt to equity is much lower.

The fundamental superiority of the Omni Supreme portfolio arises out of the strong balance sheet signified by the low net-debt levels. The persistent competitive advantages of these companies is reflected in the higher RoE.

These strong fundamentals make these SuperNormal companies compared to the investment universe of S&P 1500. These are SuperNormal compared to the typical Indian companies, too, as can be seen in a comparison with Nifty 500.

Are these available at SuperNormal Prices?

We again illustrate the same companies on their valuation parameters. The Omni Supreme US portfolio is available at a Price to Cash flow of 7.3. This is a cash flow yield of nearly 14%. Compared to S&P 1500 with a Price to Cash flow of 13.8, it is nearly at 50% discount. It is at an even higher discount compared to the Nifty 500, busting the myth of the US market being overvalued. The other valuation parameters also clearly show that the Omni Supreme Portfolio remains at a significant discount. These multiples are a strong indication that the SuperNormal Companies are available at SuperNormal Prices.

Portfolio Positioned for alpha generation

Economic Alpha

Given the persistent competitive advantages of the Omni Supreme portfolio, the economic alpha signified by higher RoE is likely to persist over the long-term and continue adding to the portfolio returns and alpha.

Value Alpha

If the valuation multiples of the Omni Supreme portfolio start converging to the market multiples, a large value alpha contribution can be expected as the value unlocking takes place.

Investor actionable—Continue investing in a staggered manner….

Consumption, HNWMA, Sports & Wellness, continue being important segments of the US economy. Irrespective of the temporary economic impact of the Covid19 situation, these segments are likely to continue growing on a secular basis in the long term. Due to the unfolding Covid19-related impact the near-term economic impact in terms of revenues and earnings as well as market prices is likely to remain volatile. This makes it a good situation to continue investing in a staggered manner to take advantage of the market volatility.

For Indian investors, the INR returns of the strategy have been quite rewarding. With the fundamental strength of the US companies it makes sense for an Indian investor to allocate to the US markets to have exposure to their growth opportunities. Further, the INR depreciation in the long-term adds to the returns favorably.

That the strategy has a low beta compared to Nifty 50 also makes an Indian portfolio with US allocation much less volatile compared to a pure India allocation portfolio.

Download pdf version of the report:

OmniView_GL_Jul20_Mr. Market plays catch-up while Scientific Investing generates alpha

Disclosures & Disclaimer

Omniscience Capital Advisors Private Limited (Omniscience Investment Advisers) is a SEBI registered Investment Advisory firm with registration no. INA000007623.

Equity investments are subject to market risks. Global investments are subject to currency risk, country risk and other risk factors. Please read all related documents carefully. An investor should consider the investment objectives, risks, and charges & expenses carefully before taking any investment decision. Wherever there is the potential for profit there is also the possibility of loss. Therefore, investors may lose capital in markets. Past performance is not necessarily indicative of future results. This is not an offer document. This material is intended for educational purposes only and is not an offer to sell any services or products or a solicitation to buy any securities mentioned or otherwise. Any representation to the contrary is not permitted. This document does not constitute an offer of services in jurisdictions where the company does not have the necessary licenses.

Performance is based on the investments done in portfolios with proprietary money. The performance numbers are pre-expense and unaudited. Global portfolios are maintained by an independent global custodian and the performance is calculated based on the portfolio holdings. India portfolios are maintained by Orbis Financial Corporation ltd, an independent, SEBI registered custodian and fund accountant; performance is based on the NAV maintained by the fund accountant. All benchmark returns and global portfolio returns are price returns starting from May 1, 2020. Beta and Standard deviation are calculated based on daily returns since inception. Individual returns of Clients for a particular portfolio may vary significantly from the mentioned model portfolio performances and the performance of the other portfolios. No claims may be made or entertained for any variances between the performance depictions and individual portfolio performance. The data is provided as an illustration of the behavior of the strategy under different market conditions. Reader should not use it to form an opinion about the future returns from the strategy. No express or implied guarantees or warranties about the accuracy and/or completeness of the performance are being made and OmniScience Capital shall have no liability for any damages, claims, losses or expenses. Neither the investment adviser nor its Directors or Employees shall be in any way liable for any variations noticed in the returns of individual portfolios.

Our discussion may include assumptions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual outcomes to differ materially. We assume no obligation to revise or publicly release any revision to these forward-looking statements in light of new information or future events. No guarantee can be given about the accuracy and/or completeness of the data, Omniscience makes no warranties or representations, express or implied, on the products and services offered. It accepts no liability for any damages or losses, however caused, in connection with the use of, or on the reliance of its product or services. The information relating to any company or economic trends herein is derived from publicly available sources and no representation as to the accuracy or completeness of such information can be made. We may have recommended stocks, or stocks in the mentioned sectors to clients, including having personal exposure.

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