Back to the Future
Arkvega prop fund year 1 update
More than a year has passed since we aggressively began deploying prop money into Indian public markets. The use of the operative word “began” is deliberate. What merely started as a capital management exercise to park surplus business income quickly took a life of its own.
Moreover, considering we took a meaningful exposure to equities BEFORE the COVID-19 pandemic struck, we were able to witness the entry and (hopefully) recovery from a metaphorical tunnel of sorts.
With no recent precedent…
Pre-tax returns over the period amounted to 34%, incl. distributions, realized and unrealized gains.
Low leverage + sound fundamentals = a combination for the ages. More so during downturns!
The initial approach was conservative. Look for companies with minimum/no financial debt, well-managed working cap cycles, plenty of cash, a historically rising share price chart <<yes. literally Googling the share price chart, hitting “Max” and seeing if the line’s trending up. What more evidence does one need of long-term shareholder value creation!>>. And of course, reasonable multiples! Note this was all BEFORE the lockdown, the loan moratoriums and TLTROs. The idea was to stay boring and rather focus first on building a process to screen and shortlist opportunities.
This very vanilla and “creditor-like” view of vying for a clean balance sheet with abundant liquid assets plus added filters such as the ability to raise capital, a strategic emphasis on capex, and operations catering to defensible sectors like cement, auto, paint, and financial services served us well when markets tanked.
We believed that conventional identifiers such as large vs. small cap, growth vs. value or concentrated vs. diversified etc. are overrated and only useful when applied in retrospection.
The rules of buying should be simple.
An externally driven downturn must rebound quickly
The lockdown arrived in March. So did the correction. All our names were hit but being backed by deep research and a conviction that this downturn was not really “economic”, we could confidently enhance exposure to the same names while timing for dips. New names were added from sectors where there was either a strong COVID induced undercurrent (such as IT and pharma), expectation of credit-like returns (REITs), or redefined geopolitics (anti-sino sentiment propping specialty chemicals and healthcare).
We strongly subscribed to the K-shape recovery narrative which only made mainstream discussions much later. Then we went into a wait and watch mode between April and June.
How much makes it matter? The importance of knowing when to sell…
Waiting gave us time to figure out two important questions.
First – at what size does a position become large enough to tempt one to sell? And second –what basis one should use to sell?
On the point regarding size, we applied a cap to the maximum number of holdings we would like at any given point in time. Thus followed a periodic check to review which holdings were smaller in size vs. the portfolio’s average holding. The underrepresented stocks were triggered to buy and rebalance, timed for dips.
Also, the development of selling discipline was deemed essential to take advantage of mood/momentum. The mechanics put forth was again straightforward – set a percentage threshold return over average cost within a fixed short period (say x months after buying). If a particular stock gets too frothy, we sell to book profits. This was done on a portfolio wide basis. No exceptions.
The Future
It is almost certain that we are looking at a zero to low interest rate environment globally in the medium-term, implying major institutional flows would continue moving out of credit towards equity.
Hence in our view there is significant credence in opting for equities which have credit-like characteristics i.e. strong dividend payouts, focus on income yielding assets, strong cash flow position, and controlled leverage.
In times of volatility, such names would provide much needed downside protection as well as the opportunity to build a position at a discount.
Our objective for this year is to share such opportunities as and when within the public domain once we trade and formalize the processes derived from our learnings. This is part of the rollout plan to eventually open the fund to third party money.
Stay tuned.