August 2007

Markets

Markets in India and across the world fell sharply during the course of the month on the back of a possible global financial crises and concern over the continuance of the current government. Markets picked up towards the end of the month as the concerns started easing off – thanks to policy response in handling the crises – though, it is not certain if the problem is over.

Environment

• Global Financial system has been, for about 3-4 years, been flush with liquidity leading to excesses in several asset pockets.  Problems started emerging in the US sub-prime mortgage market leading to several leveraged hedge funds blowing up. Primary problem has been with those investing through excessive leverage. Many funds borrow 10 times their original corpus and small fluctuations in the underlying assets can lead to severe fall in the corpus values.
• Apart from the sub-prime mortgage market, there are several other areas like commodities, emerging markets, some currency markets, real estate, etc where excesses continue to exist. As of now, the problem seems to have been curtailed and more importantly, several governments are willing to take serious measures if these problems sustain. On the other hand, the real problem of excessive leverage existing in the system is far from over.
• Apart from global financial crisis, concerns over the continuity of the Congress government continued to affect investor sentiment. In the worst case, elections are expected towards the end of next year – so this uncertainty is not inevitable.
• On the positive side, the Indian economy continues to grow at over 9%. One of the reasons Indian markets were not as badly affected as compared with several other markets is due to the strong domestic growth.
• As discussed last month, the government clamped down on External Commercial Borrowings, which has led to artificial strength in the Rupee. Rupee has been reversing against the $, which should bring some cheer to exporters.

Companies

In times of stress, we did an analysis of the ‘value’ part of the portfolio. The typical company is trading at about 8X earnings, growing at about 21% and generates a Return on Equity of 23%. We believe the portfolio consists of companies that are in the top quartile in term of profitable growth and trading at less than 50% the average market valuation.