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PMS Performance, Thoughts on the Rising Crude, Rates and Inflation Trifecta

Jan 8, 2018

Performance Attribution for own in-house DPMS products.

Indian Sanctum Titans Performance

Our Flagship Strategy Indian Sanctum Titans Delivered a 51.0% Absolute Return in CY 2017…

…Outperforming the NSE 200 by 17.6%…

…and Outperforming the Nifty 50 by 22.4%

Our Flagship Strategy Indian Sanctum Titans Delivered a 51.0% Absolute Return in CY 2017

Sanctum Titans Had Zero Negative Performance Months in 2017…

…Demonstrating Low Downside Volatility…

…Versus Four Negative Return Months For the Nifty 50 and NSE 200

Sanctum Titans Had Zero Negative Performance Months in 2017

Sanctum Titans Remains Positioned to Deliver in 2018 and Beyond…

Analysis above is for the Sanctum Titans Model Portfolio. Analysis takes entries & exits into account, not rebalancings

Note: Analysis above is for the Sanctum Titans Model Portfolio. Analysis takes entries & exits into account, not rebalancings.

Drawdowns Were In Line With the Benchmark

Managed for Low Downside Volatility and Tax Efficiency

More than half (53%) of the Sanctum Titans portfolio is large-cap oriented, therefore the risk levels are in-line with the Nifty 50 and standard deviation is lower than the NSE 200. Sanctum Titans was able to deliver strong outperformance, despite undertaking below average risk.

Low Turnover and Negative Realized Capital Gains Resulted In No Taxable Exposure

Portfolio turnover has been less than ~70% since launch in Sep 2016, well below peer averages, and managed with an eye for long term value creation. In most cases, turnover was a result of moving money from ideas that weren’t performing to new ideas. This strategy contributed to performance in the second half of 2017.

Sector Breakdown

Sanctum Titans is managed with focus on investing in stocks benefitting from sectoral and thematic tailwinds. The portfolio benefitted from over-weighting Financials and Auto/Auto ancillaries during the first half of 2017.

During the second half, our sectoral and bottom up research moved us towards over-weighting Specialty Chemicals and Industrials and these selections added substantially to our performance.

Sanctum Titans moved to heavily underweight Technology and Health Care early on in 2017, which aided in delivering outperformance.

Outlook

With our view that earnings and price converge over time, and our discipline on reasonable purchase price, we remain confident that over the longer horizon, price appreciation will converge with earnings growth.

We achieved our goal of managing to maximize net client returns. We likely gave up a few percentage points in performance in choosing to follow a disciplined approach, but that’s a choice we’re willing to make to maximize net performance for client portfolios.

Sectoral Analysis – Sanctum Titans vs. Benchmarks

Sanctum Titans Had Zero Negative Performance Months in 2017

Indian Sanctum Olympians Performance

Sanctum Olympians Delivered 33.9% Return for CY 2017

Our core large cap strategy, Indian Olympians, outperformed the Nifty 50 by 5.3% in CY 2017, and also outperformed the NSE 100 by 2.9%.

Sanctum Olympians Delivered a 33.9% Absolute Return in CY 2017…

…Outperforming the Nifty 50 by 5.3% and NSE 100 by 2.9%

Sanctum Olympians Delivered a 33.9% Absolute Return in CY 2017

Sanctum Olympians Had One Down Month in 2017…

…Versus Four Down Months for the Nifty 50

Versus Four Down Months for the Nifty 50

Sanctum Olympians Remains Well Positioned in 2018…

Sanctum Olympians Remains Well Positioned in 2018

Sanctum Olympians Managed for Tax Efficiency

Our DPMS schemes, including Olympians, are managed for maximum tax efficiency. Our average holding period is years. However, we exited six names in CY17 in Olympians, three of which have underperformed the benchmark and also diversified the portfolio by moving to 12 – 15 large caps. As we move forward, the portfolio is now well positioned and our turnover is likely to move lower, with strong potential to generate wealth creation via a robust pipeline of fresh new entrants.

Sanctum Olympians Managed for Tax Efficiency

Sector Breakdown

Being a relatively concentrated portfolio, Sanctum Olympians will have large variances versus the benchmark. The 27% weight in Consumer Discretionary and 39% weight in Financials reflect our strong belief in the domestic consumer economy. Finally, our overweight in Industrials reflects our view of an improving economy and an endeavor to participate in the buildout of the nation’s housing and infrastructure.

Sanctum Olympians vs. Conventional Benchmarks

Sanctum Olympians vs. Conventional Benchmarks

Risk Parameters

Like Sanctum Titans, trailing 12-month volatility in the long run remained below benchmarks indicating the stability of the portfolio. Since strategy inception, weekly as well as daily drawdowns from previous life time peaks were significantly better in the Sanctum Olympians portfolio vs. benchmarks.

On a weekly basis, the lowest trough measured from its prior life time peaks stands at a meagre -18%. For the comparable benchmark however, the drawdown was 3% lower at -21%. Despite the lower downside volatility, the portfolio was able to eke out 5-6% outperformance since inception.

Investment Outlook

An Economic Breakout…

Two years ago, in Apr-16, we witnessed emerging green shoots. Today feels much the same, but different nonetheless in key ways. This time around, global growth is supportive for starters. The Eurozone Manufacturing PMI hit 60.6 recently, the highest number since June 1997. Germany and France are doing well. China’s growth also hit a four-month high, and the U.S. is showing reasonably strong growth.

Domestically, the strength is coming in manufacturing with a new high of 54.7 in the Manufacturing PMI. The PMI Output index and New Orders index are particularly encouraging. Core sector growth has come in at 6.8%. Consumer durables and passenger vehicle sales have picked up. Commercial vehicle sales growth has skyrocketed, albeit from a low base last year. We are also witnessing strong growth in Steel and Cement. Finally, exports seem to be recovering from GST woes, and at least stabilizing.

If there’s such a thing as an economic breakout, this feels a lot like it.

Are Structural Reform Benefits Kicking In?

From our admittedly optimistic perch, it seems that the structural reforms – and key drivers – which we’ve been discussing for weeks now and we’ve been basing our outlook on, are possibly starting to show dividends. (“Key Drivers for the next leg up”, 16-Oct-17). A year ago, we thought that equities were very attractive on a relative and absolute basis. Today, it’s much tougher to find value, but the business cycle remains in place and is possibly about to accelerate into 2019.

The worry du jour is Crude, Inflation and Interest Rates…

Our analysis begins with the strong correlation between Brent and the 10-year G-sec, with Brent leading G-sec rates lower in 2015 and 2016, and reversing ahead of rates in 2017. Our area of focus is periods of rising Brent, rising rates and market action during those times. We find four such periods, dating back to 2005, which are shaded in grey in the following charts.

Brent & the 10 Year G-Sec Have a Strong Correlation, With Brent Leading Generally…
…We Focus on Periods of Rising Crude & Rising Rates

Brent & the 10 Year G-Sec Have a Strong Correlation, With Brent Leading Generally

Equities Did Well During Initial Periods of Rising Crude & Inflation… (2005, 2006, 2007, 2010)
…But Eventually a Correction Loomed… (2008, 2011)

Equities Did Well During Initial Periods of Rising Crude & Inflation

The Peak in Brent Trailed the Peak in Equities As Expected… (2008, 2011)
…But the Peak in Brent Was Generally a Good Time to Allocate to Bonds & Duration

The Peak in Brent Trailed the Peak in Equities As Expected

The upshot is that peaks in Brent are opportune times to consider a rotation into debt, and duration exposure. Which brings us to the billion-dollar question: Where, and when, is the peak in Brent?

Are We in 2005 or Late 2010?

This is admittedly a small dataset to base conclusions on, but the thesis of commodities trailing equities, and raising bond allocations and duration post a business cycle peak in equities, is fundamentally sound.

But this is most certainly not where we are today. Today’s economic environment remains one where we are seeing a strong pickup in economic activity globally, and domestically, alongside a moderate rise in inflation, crude and interest rates. Crude crossed $120 in late 2010. Today, 7 years later, we’re at a substantially manageable $67 per barrel. With a coordinated global recovery underway, and a ‘breakout’ in the Indian economy, our prognosis is that we’ve got room to run.

At some point, an asset allocation shift to bonds, and duration, or protection, will be on the anvil. . Things shift rapidly, so that’s something we’ll attempt to be watchful for. But that point could be at least months if not years away, and is not our call at this time. .

Incidentally, this coincides with the message out of the shape of the U.S. yield curve.

As a corollary, we’ve been neutral on interest rates since the beginning of last year. Now, our sense, based on the analysis as well as an emerging bearish consensus herd mentality, is that the worry around fiscal deficit financing is reflected in yields and probably overdone.

But that’s not a call we have sufficient evidence for at this time, given sensitivities to debt capital preservation and long holding horizons. We await clarity on the government’s budget and deficit financing plans.

In equities, the macro environment remains conducive but the tri-facta of crude, inflation and rates are headwinds albeit balanced by emerging growth. At the portfolio management level, we remain confident in identifying names at attractive valuations that will deliver returns and buck any cyclical softness.

Sectoral Takeaways… Energy Consistently Outperforms During These Periods

Energy and Commodities in particular do well in the current environment, alongside Industrials and surprisingly, Financials.

MSCI GICS Sectors Generally Show Strength

MSCI GICS Sectors Generally Show Strength

Industry-wise granular breakdown

Industry-wise granular breakdown

Technical Outlook

The Nifty closed at new all-time high of 10559 levels. For the last couple weeks NIfty has been trading in a range and consolidating its gains after the rally the index witnessed in the month of December last year. Now looking at price movement of last couple of months price has broadly traded in a range of 10500-10000 odd levels and formed W shaped pattern. The narrow consolidation at breakout levels and last trading session breakout from this range indicates market is going to move higher. Sustaining above 10550 levels on tradable basis index can rally initially towards 10700 and then 10840 levels. On the downside index has immediate support at 10400 which was last week low. In Nifty options, Strike price 10400 Put option has the highest open interest suggesting this level as good support for the near term. If Nifty breaks below 10400 levels then it may decline initially towards 10320 and then 10230 levels. INDIA VIX, post the events in December month slid down to 11.59 levels and since then inched up to 13.11 levels. Further rise in volatility could be cause of concern for bulls.

Technical Outlook

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