Performance and Portfolio Activity
The portfolio was up 5.88% Dollar terms for the month of February, 2017, compared to the investible Indian index, Nifty, which was also up 5.39%.
Indian markets saw a continuation of the uptrend that began in late Dec, 2016. Upbeat global markets dragged Indian equities up although considerable lot of the flows have been led by domestic investors, a changing dynamic which might be positive or negative for local equity market stability depending upon how local market participants behave at times of volatility. From Dec 26, 2016 till March 6, 2017, overseas investors have put in about $1 Bn to work while domestic investors have put in about $1.4 Bn into Indian markets. To consider this a sign of maturing domestic investors (most of the money came in via SIPs) remains to be seen. It is easier to go on a low carb, low sugar diet for a day than to continue for an extended period of time.
Portfolio action wise, there were no changes during the month. I am confident about the quality of businesses that we hold in the portfolio and sanguine about their long term prospects, although it is impossible to determine what will actually happen next quarter or even six months down the line about their stock prices. Scientists have found it hard, next to impossible, after years of dedicated hard work, to predict natural phenomena like weather even two days in advance with meaningful accuracy. I am no scientist with super computers. We all seek order among randomness as a human fallacy and it would be unwise of me to attempt seeking order.
Over the past one to two years, Indian broad markets have traded in the range of 19x earnings to 27x earnings on a 12 TTM basis. As you may assess, such valuations are certainly not mouth watering. However, given where Indian interest rates are at present, such valuations may not be dangerous. On the other hand, with the Fed on an upward cycle on rates, the scenario may change quite a lot if the RBI has to follow suit although the strength of the INR gives the central bank some cushion. The earnings yield of the top 500 companies in the country on an average have ranged from 1.5% at depressed times to 4% on the flip side less than the RBI base rate. At this point of time, broad markets are neither depressed nor at the top end and hence are probably in the range of reasonableness.
Cockroach in the kitchen: The changed landscape of the banking industry in India.
Almost everyone is probably aware of the Non Performing Asset issue in public sector banks in India. This problem had stuck its neck out since 2010 and the situation has worsened since. Without going into a rant commenting on the lack of care of majority of PSU banking officials for a job well done (the cases I have personally seen highlights nothing else), gross corruption, and the inability of the government to understand that they should mostly have no business in business (listen to Milton Friedman!), I will try and highlight the nature and scale of the problem.
The gross NPA's of listed public sector banks in India ranges from ~7% to ~22% of their respective total assets. The total stressed assets of the banks highlighted below combined comes to around $92 Bn, or in other words, ~4.5% of the GDP of India's ~$2100 Bn economy, and ~11% of the total assets of these banks. Moreover, the Tier I capital of these banks are at their lowest, just meeting regulatory requirements, ranging from 8-9%. If we take into account the inconsistencies of these public sector banks related to method of accounting for stressed asset classification, increase in stressed assets still coming in Q4FY2017, stressed assets in private sector banks and stressed assets in other unlisted private banks and unlisted public sector banks, the total NPA's of the country as of date may as well be around 10% of the GDP of the country.
While the government has been infusing capital into these public sector banks in inconsequential amounts, talked about a bad bank to accumulate all stressed assets in the public sector banking system, I feel apprehensive that the government may be behind the curve. RBI's Asset Quality review implementation will bring in more transparency but may not be enough to resolve the system. Without credit growth (last data point points to a multi- year low of ~4.8%) in the system, I fail to see how the government comes out of this mess without a hard hit on the hand.
Since more than 60% of deposits are in public sector banks, anyone calling for a bank run? On a lighter note, it is actually quite humorous to view interviews of the C- Level executives of these banks. Since the past so so many quarters, everytime they would come in and say that the worst is over, that they have killed all the cockroaches and a quarter forward, more cockroaches come up which again they say they have killed. Maybe they should take advise from pest control consultants, who would say, "There is never just one cockroach in the kitchen".
While this dynamic has been happening, Private Banks, Non Banking Financial Companies, Micro Finance institutions have been lapping up market share form the public sector banks and deservedly so making the situation worse for the public sector banks.
Without credit growth to lead capital formation, these private players have been concentrating on diversified consumers feeding the Great Indian Consumer Demand. Atleast for now, personal debt to GDP remains pretty low to cause any source of concern.