June 2016: Volatility is the friend of an intelligent investor

Despite concerns over Brexit (Britain’s exit from the European Union) and Dr. Raghuram Rajan’s exit as the RBI governor, Indian equity market was up 1.6% for the month. The move, seems strong, given the scale of negative press coverage these events got over the past few days. Nifty is still up 7.1% for the year (Apr – Jun). We believe the positive factors surrounding a possible good monsoon and lower interest rates, along with fair valuations, are making up for the larger negative news. Our portfolios performed in line with markets.

Concerns over Brexit have been reigning high over the past few days. It is difficult to gauge the long term impact of Brexit on equity market, especially so for the Indian markets. What we do know is that over the past decade, equity markets have seen several such crisis, like the Mortgage meltdown in US, Lehman collapse, Russian Rouble collapse, Greece debt crisis and its larger fall out in the Euro zone, Oil market meltdown and a large scale slowdown in China. Despite all these major issues, our portfolios have seen fairly good returns. More importantly, most companies in the portfolio have done reasonably well through this period.

Crisis situations in global markets is an ongoing phenomenon and we will see more of them in the future. What is important is to focus on the companies that one has invested in, and evaluate if the external issues will have any major impact on the prospects of these companies. Many of the companies that we have invested in are expected to benefit from the growth in consumption in India – which, we believe is on the upswing, due to lower inflation and lower interest rates. We do believe this broad theme is intact and will continue over the coming years. Over the past several years these companies have delivered good growth in revenues and profits, despite several ‘crisis’ seen in global markets. There is no compelling reason to believe this trajectory will change in the coming years. Good companies have a habit of delivering, despite uncertainty in the global markets.

What is also interesting is that great companies deliver above average returns over time, with volatility far less than markets – contrary to popular beliefs and ignoring the framework of ‘low risk means low returns’. We studied stock price performance of Nifty companies over the past 20 years. Out of the 50 companies in the Nifty, 32 have traded on the stock exchanges over the past 20 years. The top 10 best performing stocks delivered a median annual return of 31% p.a. over the past 20 years, with lower volatility than the Nifty, and the bottom 10 stocks delivered a median annual return of 13%, with higher volatility than the Nifty. The same is a biased sample, as companies enter and exit the Nifty. What is clear though, is that that the top performing companies have delivered exceptional returns despite a long list of crisis over the past 2 decades with less volatility than the market as a whole.

Our objective has been to collect an array of companies which we believe should deliver exceptional shareholder returns over time. We do believe several companies will grow consistently over time and deliver above average growth in intrinsic value. More importantly, these companies should deliver results despite a constant flux in the macro conditions. If one can put together a collection of such companies, as an investor, one should see satisfactory returns over the coming years. Crisis like these, at best, are an opportunity to buy into these companies as sensible prices.