Is your portfolio ready for high performance in the next investment cycle?

In this webinar, Mr. Kenneth Andrade (Founder & CIO of Old Bridge Capital Management), who has more than 30 years of experience, shed light on how at different points of time, different investment cycles have played a role giving opportunities to various fund managers and investors to build wealth across sectors and themes.

To set the context, let us analyse some data:

• The past 3 cycles:
  • 1993-2000: The cycle of Information Technology
  • 2000-2008: The cycle of Infrastructure and Engineering
  • 2008-2020: The cycle of consumer spending
• Investment Results:
  • Rs 100 invested in Infosys in 1993 would have grown to Rs 1,54,000 in 2020
  • Rs 100 invested in L&T in 1993 would have grown to Rs 2,400 in 2020
  • Rs 100 invested in HUL in 1993 would have grown to Rs 6,400 in 2020
  • BUT if the same Rs 100 were navigated across the 3 companies with each market cycle, it would have become Rs 13,20,000 today!

Financials and Consumers have gone from 21% of the index to 53% of the index by 2020. But the question is, will it continue to appreciate at the same pace? The economy is governed by cycles and each cycle witnesses different companies performing differently.

With the shift in global economic powers, the team at Old Bridge Capital Management anticipates a cycle favouring companies with an international footprint. The thing about capex and investment cycle is that they always remain the same. While the above data highlights three different cycles, all 3 of them offered an investment space to generate wealth. The behaviour of the capex cycle across industries and sectors, generally remains the same. It transcends from a period of under-investment to a period of over-investment. During the former phase, the supernormal profits start to kick in, which gradually increases the no. of customers or clients for the business, which eventually leads to the over-investment phase. Here, the profitability for the business or industry becomes flat because competitiveness is at its peak. Then, reversal happens and the process continues the same way.

The current top performing companies will probably be the weakest performing companies over the next decade.

The underlying environment is changing quiet rapidly and the aim is to move towards the investment cycle that will play out in the next decade. If one catches hold of the right businesses from the beginning, the momentum later on will only expand it. As Value Investors, identifying the right companies at the right time make way for the team to get hold of those companies at significantly attractive prices and fair valuations. Such portfolios require a reasonable amount of patience and inactivity.

It is not necessary to pick the most cream companies; if a particular sector expands, all participants benefit from it. For instance, in the first cycle mentioned above, not only did Infosys perform well, all IT companies- big or small- did great.

Today, as investors, finding an easy way out, have thrown caution to the wind and are probably just looking at investing in seculars or consistent compounders, being indifferent towards the investment cycle going on.

All good companies do not make great stocks and all great stocks are not usually good companies.

Most companies fall into the “Consistent Compounders” category once they’ve reached he peak… and from there there’s usually flat growth. Quality companies, many times, start off at very high prices and by the end of the investment cycle, investors give up. This happens in almost every cycle. The quality bis. or consistent compounders of 2008-09 were say, L&T, Tata Steel, and so on. But where do they stand now, with respect to the rankings? Of course, these are companies that will stay around for a long period of time (companies like Asian Paints, Nestle, Tata Conglomerate, etc) but whether or not they will consistently generate capital appreciation or not is not guaranteed. It is all about cycles and will remain so for times to come. To put this into perspective, let us look at India’s largest sugar company— Balrampur Chini Mills Ltd.— this company has remained debt free for all the 3 cycles mentioned above and should fall under the category of a ‘good company,’ but it has not seen such stock movement; so does this make it a bad company?

Nobody predicted the 2008 financial crisis, but when that happened, the most leveraged part of the economy (the financials & the corporates) collapsed and it did not come through in the last decade. When the 2020 pandemic hit (again, unpredicted), the most leveraged sector now (household debt) collapsed; spending collapsed. Now, to grow the economy further, incremental amount of leverage is needed. That’s why the team thinks that that’s the end of the leverage cycle in personal balance sheets and the only unleveraged part in the economy today is corporate balance sheets (yes, even the government today is over-leveraged).

Every industry usually grows in tandem with the GDP Growth. If one must outperform the GDP, it needs more money, and that’s how leverage/incremental debt plays out.

The second leg to this discussion is that of demand. A large part of corporate India places (and will place) itself in a position to address the global economy, which is essentially addressing 100% of the GDP. India has the opportunity to satiate this global demand hunger. This, in essence, will mark a shift from a domestically grown consumer economy to a much more wider global industrial franchise.

“Value Investing: Find an industry where only one company makes money and the rest all lose it.”

Giving a biased view, Mr. Kenneth Andrade explained that they have two fertilizer companies in their portfolios since a very long time— one is based out of South, and one out of North. Both these companies, taken together, account for 15% of the industry volumes, but account for 100% of the profitability of the listed fertilizer companies. These, according to him and his team, are high quality businesses that have outnumbered every other business in alignment. What happens when this 15% market share becomes 25%? How will the industry behave? This is Value Investing— along with looking at relevant ratios, find an efficient business at the bottom of the cycle, park money there and sit patiently. It requires a lot of conviction, patience, and discipline.

Ideally, such companies should stem out of the Midcap and Smallcap space as when an industry is badly hit, it is the Largecaps that are majorly hit as their inefficiency creeps up. This does not mean buying small companies but buying the biggest company in its category, not necessarily having the largest market cap.

So, it is not required to be convinced about the market cap but about the business and its growth potential— if the industry expands, the business should follow suit. To give an example, look at a company called Balkrishna Industries; a company in the OTR business. This was not a very large industry in the early 2000s, and then the mining boom came and the industry maxed out to almost $4.5 bn and Balkrishna Industries took maximum amount of the market share and the biggest part of the market cap that existed.

Look for big businesses in a small industry OR big businesses in a big industry in a downcycle.

When the markets start fragmenting the industry, one can understand that the particular investment cycle has reached its potential. The top of the cycle is always met with significantly more investment than demand can carry.

Given the pandemic and the current economic situations in India, it is not compulsory to remain skeptical on India’s growth; adversity does bring out the best out of us. As Indians, we are more reactive rather than being proactive and we always operate out of a crisis. Yes, there will be struggle for sure, but we will continue the bullish trend in the long term (not may be too much in the near term, but corporate India will find its way out).

With that unnerving thought, we leave you with just one question- Are you ready for the next cycle?