the avoidance of loss is the surest way to · pdf file“ the avoidance of loss is the...

“ The avoidance of loss is the surest way to ensure a profitable outcome” - Seth Klarman

www.pramericapms.com 2

Method 1 List out the critical success factors in investing and try and follow the same

Method 2

List out the most probable causes for failure and try and avoid them

Two broad ways to invest successfully….



Qualitative diversification can help reduce chances of failure

We believe big mistakes in the stock market are made when

– An investor buys into a company with questionable fundamentals

– An investor buys a share at valuations that are far higher than what is warranted by fundamentals

Running a portfolio that takes logical steps to avoid these mistakes is a good way to generate long-term wealth

Pramerica Deep Value Strategy Basic Portfolio Assumptions

There exists a strong correlation between consistently high RoCE and stock prices

Companies that generate positive Free Cash Flow (FCF) also have a similar correlation with their respective stock prices

Buying such stocks when they are quoting at close to the lower end of their valuation history reduces the chances of permanent erosion of capital

The stock prices of companies in Cyclical businesses are more volatile than Secular growth companies, but provide better returns over the medium term if purchased at attractive valuations

^FCF = Profit After Tax (PAT) + Depreciation – Preference Dividend - Dividend Taxes – Increase in Gross Assets - Increase in Capital Work in Progress – Increase in Net Working Capital


Pramerica Deep Value Strategy

Stock Selection Approach

Consistent track record of generating above average Return on Capital Employed (RoCE*)

Consistent track record of generating positive Free Cash Flows

History of positive Minority Shareholder Bias

Points towards sustainable Growth in Earnings

Universe of Quality Undervalued Stocks

*ROCE = Earning Before Interest and Taxes (EBIT) / Total Capital Employed


How do we define “Quality” ?

Consistency of financial track record in sales growth, profitability and cash flows

Upon reasonable research, the company concerned shows promise of above-average growth in sales and profits in the years to come. We do not seek to buy a company’s share just because it is cheap

The company concerned has the ability to achieve future growth without frequent infusions of debt or fresh equity (As evidenced by their track record in generating higher RoCE and free cash flows)

Steadiness in operating parameters such as margins or spreads

To a large degree, an alignment of the interests of the promoters and minority shareholders

No major corporate governance issues


A quality company remains so….

The table is the matrix of probabilities for a company to transition from one category to another in terms of quality, where Q1 stands for the bottom rung companies in terms of CFROI, and Q4 for the highest. For example, the probability that a Q1 company will transition to Q4 is just 6%, whereas there is a 51% probability that a Q4 company will remain at Q4.

Transition Probability, % --------------------------End------------------------

Start Q1:-- Q2:- Q3:+ Q4:++

Q1:-- 56 27 11 6

Q2:- 28 40 23 8

Q3:+ 13 28 39 20

Q4:++ 9 12 28 51

Source: Credit Suisse, HOLT

Source: Credit Suisse , HOLT (CFROI = Cash flow return on investment)


Processes in place to track & maintain quality

Initial universe of companies that qualify on the parameters of consistency of RoCE and FCF would be around 150 companies - (Parameters explained separately)

To ensure that at all point in time, at least 75-80% of the portfolio is constructed from within this universe

Periodic meeting with company managements and/or third party analysts would be undertaken to ensure that the original reasons for which the stock was purchased are still valid

Periodic meetings with customers, competitors, dealers, distributors and other stakeholders as Scuttlebutt Research


Companies that the portfolio would avoid

• Chronically capital intensive businesses that consistently use more cash than what they generate

• Companies that are betting on new, untested technologies

• Companies with track record of less than a decade

• Highly commoditized businesses with limited scope for differentiation

• Companies with highly unpredictable sales trends


Investment decision parameters

Buy If the stock price is lower than what we believe is the

company’s worth

If the valuation parameters in “cyclical” businesses are close to historically lows or at least significantly lower than average valuations. Also, if the profit margins in recent quarters are lower than historical averages.

If the company in question has high levels of quality, and if the competitive advantage enjoyed by the company is formidable, we would be less stringent about the price consideration. We are willing to pay a higher price for a higher quality company

At no time are we willing to pay “any" price for any

company

Sell If the reasons for which the stock was purchased has

undergone a change. In such cases we shall sell irrespective of whether the stock is trading at a profit or a loss

If the stock, in our opinion, trades at much higher than its intrinsic value

If in the case of cyclical businesses, the valuations are close to historical highs

If we get a superior purchase opportunity for the same level of perceived risk


When does a good company become attractive?

Any product (including shares) is available at an attractive price only when there is muted demand for it

A share of a company has lower demand only when the general market does not expect the price of the share to go up in the short term (i.e. within one or two quarters)

This phenomenon is driven by the need of the most powerful players in the investment world (the institutional investors) to show continuous good performance. Such investors shun even stocks of good companies when the future is “uncertain”

This presents an investment opportunity for investors who are prepared to overlook short term underperformance


Should we buy when the future is “uncertain”?

A stock is available cheap only when the general market does not expect it to do well in the short term

Therefore, if an investor wishes to “beat the market”, he/she should purchase stocks before the market does (i.e., buy when the uncertainty still exists in the minds of most investors)

If we are confident about the quality of the company, then its short term price movement should be of less importance

Of course, this strategy will work only if the investor is confident about the quality and the future of the company concerned.

“High uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen” – Seth Klarman

Source: “Margin of Safety” by Seth Klarman


There is less competition to buy and therefore prices are more attractive

Helps accumulate a decent quantity before the price moves up

Significant holding helps the overall portfolio if the stock goes up manifold

If price falls after the initial purchase, we have the chance to buy more of a good company’s stock at a cheaper price

1 2 3 4

Advantages of buying early


Some examples…..


Some companies with consistent RoCE & FCF

Secular growth Infosys

ITC

Hindustan Unilever

Asian Paints

Bosch

Castrol

Colgate Palmolive

Procter & Gamble

CRISIL

VST Industries

Cyclical Lakshmi Machine Works

BHEL

Crompton Greaves

Siemens

Voltas

Larsen & Toubro

Honeywell Automation

Motherson Sumi

Carborundum Universal

Automotive Axles

Disclaimer: The references of companies mentioned above are for illustration purpose only for providing an understanding of Secular Growth and Cyclical companies, based on certain parameters. It should not be considered as recommendation or opinion from Pramerica Asset Managers Private Limited (Portfolio Manager) on the above mentioned companies. The Portfolio Manager or its affiliates may or may not have any present or future position in the above companies.


Secular growth business – Example 1

CAGR returns if bought at (1) = 40.0 % (5 yrs) CAGR returns if bought at (2) = 3.9 % (5 yrs) CAGR returns if bought at (3) = 19.7 % (4.5 yrs)

Disclaimer: The reference to stock is for illustration purpose only. The intent is to provide the reader a perspective of its life cycle. It should not be considered as a recommendation or opinion from Pramerica Asset Managers Private Limited (Portfolio Manager) on the above mentioned stock. The Portfolio Manager is not guaranteeing or promising or forecasting any returns. The Portfolio Manager or its affiliates may or may not have any present or future position in the above stock.


Secular growth business – Example 2

CAGR returns if bought at (1) = 22.1 % (5 yrs) CAGR returns if bought at (2) = 13.8 % (5 yrs) CAGR returns if bought at (3) = 38.3 % (4.25 yrs)



Cyclical business – Example 1

CAGR returns if bought at (1) = 61.2 % (5 yrs) CAGR returns if bought at (2) = (12.7) % (5 yrs) CAGR returns if bought at (3) = 42.1 % (4.25 yrs)



Cyclical business – Example 2

CAGR returns if bought at (1) = 44.3 % (5 yrs) CAGR returns if bought at (2) = (20.1) % (5 yrs) CAGR returns if bought at (3) = (6.6) % (5 yrs) CAGR returns if bought at (4) = 26.4 % (4.5 yrs)



Common investing misperceptions

Superior investing calls for superior analytical skills and information availability

Superior investing calls for perfect timing of purchase

Conservative investing delivers lower returns (Higher returns = higher risk)

In such a dynamically changing business environment, there is really no such thing as “long-term investing”


Analytical skills and information availability

The “market” is controlled by institutional investors, who are manned by professionals with more or less similar educational backgrounds (and intellectual capability)

Almost everyone in the market has access to the same (or very similar)databases, attends the same conference calls, and attends the same analyst meets

There is very little to choose between the information availability at the hands of one investor with that available with the rest of the market

The same can be said about analytical capabilities

Therefore, the difference between a good and a mediocre investor lies elsewhere


More on investment

information….

The problem today is not of insufficient information – it is that of a surfeit of information

So much so, the investor’s real task is to sift relevant information from the “noise”

After a point, information also suffers from “diminishing marginal utility”

“Respect the difficulty of working with a mass of information. Few of us can use it successfully. In-depth information does not translate into

in-depth profits” - David Dreman

Source: Contrarian Investment Strategies – the next generation – by David Dreman, Simon & Schuster


“Timing” the purchase

It is the dream of many investors to purchase a stock just before it goes up (or sell it just before it falls)

The irony is that, since a majority of investors in the market want to do just that, it becomes impossible for a majority of the investors to achieve it

In our opinion, the attractiveness of an investment is better measured in terms of its pricing rather than trying to predict the best timing to buy it (or sell it)

Buying a sound business at an attractive (or even reasonable price) provides the compensation for any waiting period that one may have to endure.


Trying to “buy at the bottom” is futile

“While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up and competition from the buyers will be much greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from a bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better”

- Seth Klarman

Source: www.valuewalk.com


Pramerica Deep Value Strategy - Why invest?


A different approach to portfolio building

Bulk of the participants in the market (because of the way the system works) seek quicker returns and the tend to avoid opportunities that do not show a promise of quicker returns

Pramerica Deep Value Strategy sees an investment opportunity by having a different time horizon to investing. We see opportunities in good businesses when they are in the midst of temporary difficulties

− If such opportunities arise in poor businesses, we are not interested in exploiting them

Our investment proposition is to buy good businesses when they are ignored by a majority of investors in the market and hold on to them till they become popular again

We seek to reduce the business risk by running a “conservative” strategy of sticking to companies with a long track record, reasonably predictable business models and better quality managements


“Conservative” does not imply lower returns

A “Conservative” investor’s primary interest is to conserve his/her capital

Capital is conserved by (a) investing in superior businesses and (b) buying at reasonable or attractive prices

There is a strong correlation between quality of the business and long-term returns generated by the stock

The lower the price, the higher the chance of increased returns

Therefore, by being conservative, an investor increases the chances of higher returns on stock market investments.


Some caveats

While it is our endeavor to be right in all our investments, we would request the investor to appreciate that it is impossible to be right all the time

It is simply not possible to buy all stocks or all sectors that go up

While it is our intention to buy at “attractive” or “reasonable” prices, it not our intention to buy at the “bottom” prices

While purchasing, we will continue to buy if the prices keep falling, so the investor, in such cases, runs the risk of showing short term negative returns


Pramerica Deep Value Strategy Performance

Performance depicted as at the above stated date is based on all the client portfolios under the Regular portfolio of Pramerica Deep Value Strategy existing as on such date, using Time Weighted Rate of Return (TWRR). Past performance is no guarantee of future returns. The above portfolio performance is before charging of any expenses (as depicted above). Return for period upto 1 year is absolute. Since inception date stated is considered to be the date on which the first client investment was made under the strategy. Please note that the actual performance for a client portfolio may vary due to factors such as expenses charged, timing of additional flows and redemption, individual client mandate, specific portfolio construction characteristics or other structural parameters. These factors may have impact on client portfolio performance and hence may vary significantly from the performance data depicted above. Neither the Portfolio Manager, nor its directors or employees shall in any way be liable for any variation noticed in the returns of individual client portfolios. The Portfolio Manager does not make any representation that any investor will or is likely to achieve profits or losses similar to those depicted above. Investment objective of Pramerica Deep Value Strategy: Pramerica Deep Value Strategy seeks to generate returns by investing in a portfolio of value stocks which have the potential of superior wealth creation over long term.

Consolidated Portfolio Performance of Pramerica Deep Value Strategy As On 5-Feb-2015

Period Portfolio Nifty CNX 500 CNX Midcap 3 Months 6.11% 4.48% 5.41% 7.40%

6 Months 14.43% 12.46% 13.65% 17.47%

1 Year 73.93% 44.65% 51.47% 70.91%

Since Inception Date 08/07/2013 53.93% 28.36% 32.46% 42.07%

Returns over 1 year period are annualized. Report Options : Before Expenses.


Strategy Snapshot

Target Capitalization Range No bias

Target Diversification 15 – 25 Stocks

Max. Long Equity Exposure 100%

Max. Short Equity Exposure 0%

Min. Investment Horizon 3 years

Leverage No


Terms of Engagement

Charges

Upfront Fee

Investment Management Fee

Exit Load

Minimum Investment Amount

For detailed charges, please refer to the Managed Account Services Agreement

Limits

Up to 2.50% of investment amount

Up to 2.50% p.a. of investment amount

Up to 2.50% of redemption amount

Rs. 50 lakhs


Important Information

Pramerica Asset Managers Private Limited is registered with SEBI as Portfolio Manager as Portfolio Manager under SEBI (Portfolio Managers) Regulations, 1993.

RISK FACTORS

This Document is for information purpose only. This Document and the Information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products (collectively “Products”) mentioned in this Document or an attempt to influence the opinion or behavior of the Investors/Recipients. Any use of the information contained herein for investment related decisions by the Investors/Recipients is at their sole discretion & risk. Please read the Disclosure Document and the agreement along with the related documents carefully before investing. Investments in Products are subject to market risks, various micro and macro factors and forces affecting the capital markets and include price fluctuation risks. There is no assurance or guarantee/warranty that the objectives of any of the Products will be achieved. The investments may not be suited to all categories of Investors/Recipients. Investors/Recipients must make their own investment decisions based on their own specific investment objectives, their financial position and using such independent professional advisors, as they believe necessary, before investing in such Products.

Pramerica and Pramerica Financial are trade names used by Prudential Financial, Inc.,(PFI) a company incorporated and with its principal place of business in the United States, and by its affiliated companies in select countries outside the United States. None of these companies are affiliated in any manner with Prudential plc, a company incorporated in the United Kingdom.

Presentation dated 6th February 2015


Thank You

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