There has been an endless sell-off in mid and small-cap stocks in the last 18 months. Making matters worse, the country has been hit by one major scam after another, the biggest one being the IL&FS scam. This spilled over affecting several banks and NBFCs, causing many portfolios to perform poorly with low returns.
This has also been echoed by one of India‚Äôs most sought after investors, Kerala-based Porinju Veliyath. In a letter to his investors, the managing director and portfolio manager of Equity Intelligence India sought to explain the poor performance of his portfolio, which has reportedly delivered a negative return of over 8%.
He said that he expected the elections to be the turning point for investors to come back to equities after the bear market in mid and small cap stocks sustained for an unusually long period. Bear market is a scenario where there is a fall in the stock markets, indicating poor or negative investor sentiment.
He listed out various factors that he believes have been causing the bear market to sustain for long in the country, while also explaining his rationale behind holding on to a few underperforming stocks in his portfolio.
Porinju says that while the continuity of the government was a positive sign, he was disappointed with some of the provisions announced in the budget, especially from a term stock market perspective.
‚ÄúWhile the monetary impact of these changes is minimal, the message it gives to the larger investment community is rather regressive. Intentions of the present government without doubt have been good and their efficiency in utilizing tax revenues has been excellent, but these factors aside, it seems that policy makers are not acknowledging the cardinal principles of a free market economy,‚ÄĚ he said in his letter.
And while there have been several challenges emerging in the Indian economy, he says that we underestimated the extent of the first and second order consequences of some. While he welcomes the government‚Äôs efforts to strengthen the tax base, improve traceability, reduce black money and corruption, he believes that they have choked the economy for the near term, more than anyone anticipated.
‚ÄúDespite RBI repo rate cuts, transmission of the reduction has not happened and the cost of capital to corporates have remained tight, thereby delaying any major industrial recovery,‚ÄĚ he added.
He further pointed out other factors that have affected the market, such as the IL&FS scam, the ‚Äėfrustratingly slow‚Äô IBC process, SEBI directives on reclassification to mutual funds industry, which triggered forceful selling in small and mid cap companies.
‚ÄúOverall, there has been a divergent and narrow market performance for a long time now. Though Nifty has held up, broader markets have shaved off 50% or more in this period. Close to 90% of listed stocks are down anywhere from 30% to 90% whereas top 10% large companies have not fallen much,‚ÄĚ he added.
Despite all the above factors, which have impacted his portfolio negatively, Porinju believes that there will be a significant recovery going forward, though he says he cannot give a timeframe for it. While the factors mentioned above are beyond our control, Porinju says that most of the stocks in his portfolio are fundamentally strong and some of them are industry leaders with the potential to create wealth.
To sell or not
And while a large part of the current factors may lead several investors wanting to sell and move away from underperforming stocks, Porinju is still holding on to a few of them in his portfolio.
There are four important aspects he wants to look into before deciding to sell any under-performing stock and shift to other alternatives.
First, according to his letter, is to see if the original investment thesis has been permanently jeopardised or delayed indefinitely, that makes shifting (placing a bet on another stock instead) a better decision than waiting?
He also wants to assess what the implicit cost of liquidating these investments would be in a sentimentally depressed market devoid of buyer participation.
The third aspect is to see if there is an alternate opportunity with potential upside, which can compensate the sell-off in these stocks, available, and finally to see what would the further downside in these stocks be and what is the probability that when market sentiment turns around, these stocks would perform better than the available alternatives.