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Is Mr. Market chasing the SuperNormal Portfolio?

Science of Alpha from Safety

Is Mr. Market chasing the SuperNormal Portfolio?

India OmniView July 2020

Market has just begun unlocking the value in the ‘Unique’ SuperNormal portfolio

  • Recently, Scientific Investing strategies have had a high absolute performance and outperformance relative to the benchmarks, as well as to other PMS or mutual fund managers.
  • The performance has been broad-based across market caps and countries (US and India).
  • Despite the performance, the valuations remain inexpensive. Fundamentals have remained strong and positive developments in the segments provide secular growth opportunities.
  • We advise investors to continue investing in a staggered manner.

Scientific Investing is working across markets

Last month, according to Moneycontrol several Scientific Investing strategies were ranked at the top across all PMS strategies. Further, a comparison with the large cap mutual funds shows that they beat all the large-cap mutual funds. This month, too, the outperformance continues with Omni Supreme India* (multi-cap) delivering 13.6% outperforming the benchmark (Nifty 500) by 5.3%. Both Moneycontrol and Economic Times ranked Scientific Investing strategies in the top bracket for 1 month and 3 months. A comparison with the multi-cap mutual funds shows that Scientific Investing beat virtually all the multi-cap mutual funds as well. Scientific Investing worked in the US markets as well, with Omni Supreme US* delivering 8.8% for 1 month and 32.2% for 3 months, beating the US multi-cap benchmark S&P 1500 by 7% and 13.7%, respectively.

What can be inferred is that the outperformance is broad based, i.e. across strategies, across market capitalizations and across different countries. This clearly indicates a possible qualitative change in the way Mr. Market is allocating across the market. Mr. Market seems to be tired of the QRAP portfolio (Quality Required at Any Price) and looking for other investment ideas. In this search, Mr. Market might be buying indiscriminately as indicated by the small-cap rally. Going forward Mr. Market is likely to start discriminating between the fundamentally strong companies and the junk companies, with the rally in junk companies fizzling out eventually, while the fundamentally strong companies continuing to attract more investors.

“The top performance of this month is a testimony to the originality of the Scientific Investing thought process”

  • 2/3 portfolio cos beating benchmark indicate broad-based unlocking.
  • Portfolio and segment valuations continue to be attractive

Having an Original Portfolio pays off

We believe that investors should focus more on the investment strategy and less on the past returns as the returns are just an outcome of the investment strategy; in short, the strategy determines the future performance. One of the three Scientific Investing tenets is Originality, which implies that to have market beating performance you need to have an Original portfolio, i.e. a portfolio different from the market. Our multi-cap portfolio is clearly a original and differentiated portfolio with fundamentally strong and undervalued, i.e. SuperNormal, segments. Recent performance of Scientific Investing strategies across countries and market-caps is a testimony to the originality of the Scientific Investing thought process. Performance based on a strong philosophical foundation is sustainable over the long term while random rallies eventually fizzle out.

Digging Deeper, Segment performance...

The performance is also broad-based as far as the various portfolio segments are concerned. 5 of the 8 portfolio segments outperformed the market with Housing finance (38.5%), Defence (34.5%) and Power (31.6%) delivering more than 20% excess return over the benchmark. At individual company level also, the performance is broad-based with more than 2/3rd of the portfolio companies (17 out of the 25 stocks) outperforming the benchmark.

The illustration below lists down the average performance of the segment companies for the month of June 2020.

It is important to know and understand this from the sustainability standpoint for the performance and alpha. Consider a highly concentrated portfolio with 5-7 stocks and a skewed allocation with the largest stock being 20% or more. An outperformance in such a portfolio can be due to a lucky. one-off increase for the largest stock. This performance is unlikely to continue in the long-term, thus making it an unsustainable alpha.

In contrast, the Scientific Investing portfolios are highly diversified with 20-30 stocks with nearly equal weightages at the time of allocation. Further, there are several unrelated sectors, industries, and segments in the portfolio. A broad-based performance across these segments and companies reinforces the likely sustainability of the performance. Also, while the segments are unrelated they do share one thing in common, that they are all fundamentally strong companies with strong balance sheets, persistent competitive advantages, high profitability and are all available at significant discount to their intrinsic values.

SuperNormal Companies at SuperNormal Prices?

The portfolio continues to be a SuperNormal Portfolio @ SuperNormal Prices. As per the exhibit below the multi-cap portfolio continues to have much stronger fundamental parameters compared to the broader market such as ROE (13.5% vs. 8.5%), ROCE (19.7% vs. 10.2%) and much lower debt levels; rather, the SuperNormal portfolio is cash rich. The popular valuation metrics also indicate that the portfolio is attractively priced. This is important on two counts. Firstly, the outlook for this portfolio is strong and it is expected to continue to deliver good performance. Secondly, the performance seen so far is delivered by a set of companies with strong fundamentals and is not driven by a rally in a set of poor-quality, distressed stocks, which is a high-risk and unsustainable approach.

SuperNormal Segments: Fundamentals and Valuations

The selected portfolio segments, as shown in the exhibit below, have strong fundamentals with attractive valuation. Specially, even after the recent run up all segment valuations are still very attractive.

Scientific Investing Alpha generation continues

Scientific Investing alpha has three drivers, Economic Alpha, Value Alpha and Portfolio Alpha. The economic alpha is at continuous play as all portfolio companies are SuperNormal Companies with superior resources in the form of strong balance sheet and growth opportunities. Further, the companies have persistent competitive advantages to capitalize on these opportunities. The Second source of alpha is Value alpha which manifests when Mr. Market realizes the mispricing and starts repricing the SuperNormal Portfolio companies.

A number of these segment companies have had revenue and earnings surprises on the positive side. Several segments are exposed to much large growth opportunities due to recent government initiatives like Self-reliance and the rearchitecting of the global supply chains from China to India and other countries. This is what has started in the last three months and, given the fundamentals and current valuations, should sustain.

Investor Actionable: Investors should continue investing in a staggered manner…

Scientific Investing portfolios have typically seen significant value unlocking happening during a volatile event. A volatile event breaks the momentum rally of the overvalued stocks which had become high-risk bets with market giving them hefty premium given these names had been giving good returns. The volatility event, followed with price correction of the overvalued stocks, compels market participants to undertake a reevaluation exercise which results in identification of undervalued stocks. We see that this trend has started, and it is expected to continue till the undervalued stocks rise to become fairly priced or overvalued. We continue to advise clients to add staggered allocation to their Omni Supreme India/US portfolios and speak to their advisors or reach out to us for any queries.

* Based on the proprietary Omni Supreme India and Omni Supreme US model portfolio gross performance. See the detailed disclosures at the end.

Download the PDF version of the report:

OmniView_IN_Jul20_Mr. Market Chasing SuperNormal Portfolio

Note on the Addition of Secondary benchmarks

We have added secondary benchmarks across all the major strategies for a better performance comparison. India, US and Technology multi-cap strategies warrant a small cap index comparison as up to 40 to 60% allocations have been made to small cap stocks. The right benchmarking is important to be aware of the relative performance which helps investors and advisors to take better capital allocation decisions.

Disclosures & Disclaimers

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.

This communication is confidential and is intended solely for the addressee. This document and any communication within it are void 30-days from the date of this presentation. It is not to be forwarded to any other person or copied without the permission of the sender. Please notify the sender in the event you have received this communication in error.

 

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