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Back to the basics

Amid wild price fluctuations in the markets, our fund manager swears by fundamentals. He buys a couple of shares each for the two portfolios.

Dipen Sheth | Print Edition: March 6, 2008

Click here to see Safe Wealth portfolio
Click here to see Wealth Zoom portfolio

For those who have tuned in late to this regular feature in Money Today, we are now into the eighth month of our two model portfolios, a relatively stable and mature portfolio for your retired parents (Safe Wealth) and a more aggressive one for your bright preteen kids (Wealth Zoom). Our model portfolios have, alas, followed the recent meltdown in Indian (and global) stock markets.

Courtesy the events of the past three weeks or so, we have pretty much reduced the entry price (net asset values) for our model portfolios to acceptable levels. We’ve got mauled, hammered and beaten out of shape. This is only to be expected for equity addicts once in a while. A recent report by a leading foreign brokerage talked of the ominous “return of risk” across global markets—implying that valuation multiples for equities were heading downwards.

Are we therefore staring at a double whammy? Price/earnings (PE) contractions may then combine with an earnings slowdown to swing our fortunes back into gloom. Scary thoughts indeed for your fund manager. While we are still in the green in both models, some of our holdings have suffered acute losses. That’s why the two model portfolios underperformed their benchmark indices, with Wealth Zoom losing a shade over 13% as against the CNX Midcap which fell by 9.8% during the fortnight ended 13 February.

Safe Wealth eroded your wealth by 4.7%, almost in line with the 4.6% fall in the Nifty. What’s happening? Why does research-based investing not seem to work anymore? And what do I do with these model portfolios, these two public displays of my incompetence as a fund manager? Tough questions, for which I have some gritty responses, which should hopefully help me re-establish my credentials as your fund manager.

First, let’s concede that the current downward momentum defies normal investing logic, and cannot be fought in any rational way that I know of. Remember that this irrationality was present on the upward ride as well, when stock prices of not-so-great companies shot up to unjustifiable levels. Now that the pendulum has reversed its swing, prepare to see shares of perfectly good companies quoting at illogically low prices.

And they may stay that way for an unpredictable interval. This is what happens when people are willing to sell with no consideration for the fundamental goodness of a company’s business. There’s no point using fundamentals to argue with momentum—you’ll get swept away. This is why research-based investing will not work anymore, at least not in the immediate future.

On to the portfolios. It seems idiotic to panic and sell across the board. I wish I had more cash in the kitty, but like my brethren in the money management industry, I got carried away in the momentum. Still, selling now does not seem to make sense, because we are (hopefully) pretty close to the worst that this market can give us. Even if we are not, I doubt if we will have the guts to buy sensibly at lower prices.

On the other hand, it makes more sense to figure out what we might bravely want to buy in our portfolios with whatever cash we are holding. This can, admittedly, backfire if the markets go into a deeper swoon. The guiding principle should be safety and quality of the business. In Wealth Zoom, we have added to our holdings in two great businesses: Opto Circuits and SKF India.

Both are way off their 52-week highs and are run by highly respected and capable managements. Valuations are not so attractive for Opto, but it’s spewing out cash and growing at almost 100% year-on-year in profits for the past three years or so. Given its niche presence in optical sensors and coronary stents, this might continue. SKF, a high-pedigree industry leader in bearings, is cash rich.

It has a supportive multinational parent who sees the Indian company as a global outsourcing opportunity and is investing in capacity creation. If the capex cycle in India continues, SKF looks very attractively priced at just around 12 times 2007 earnings. Safe Wealth has also seen some buying this fortnight, again in items that we own already.

We are adding to our top pick (ICICI Bank) two other stalwarts that should bounce back when (and if) the India story revives—L&T and NTPC. My only regret here is that I should have been chicken enough to hold cash in Safe Wealth. How’s that for a rejoinder to all my critics who were rubbishing my “book profits” attitude on every rise?

Disclaimer: Model portfolios are based on the independent opinion of Dipen Sheth, head of the research team at Wealth Management Advisory Services Ltd. They do not reflect the opinion of the firm. They are for personal reference and information of readers.The firm is not soliciting any action based on the portfolios.

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