Value Investing Pioneers Summit, Delhi. Session on “My Journey: 0 to 1,000 Crores” – Mr Raamdeo Agrawal

Contributed By : Gaurav Kaushik, CFA

The Delhi chapter of CFA Society-India had the privilege of hosting some of the most famous pioneers of Value investing in India during its inaugural Value Investing Summit on 21st Sep 2017.

The bad weather at Mumbai and all the hassles at the airport that Mr. Raamdeo Agrawal had to endure couldn’t dampen his zeal even one bit as he shared his remarkable journey in the equity markets-from 0 to 1300Cr. spanning 30 years !

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As a young Chartered accountant in Mumbai, Raamdeo found his calling early and he teamed up with Motilal Oswal in the late ‘80s to start their broking business. His investment portfolio grew rapidly during the bull run of ‘91-92.The subsequent crash saw the value plummet by 2/3rd, but by then he was firmly established in business and had created a decent corpus. His outlook changed when he met Mr. Warren Buffet in 1994 .He made Buffet his guru and hence started his journey as a value investor. Following Buffetology and annual trips to the AGM in Omaha made him wiser. He could handle the subsequent peaks (2000,2008, 2014) & troughs (2003,2009) with equanimity .His value investment mantra is summed up in 4 phrases viz.  Quality of business and management, Growth in earnings ,Longevity of Q&G and reasonable Price (QGLP).

He freely shared his learnings and beliefs with the audience. According to him equities is a very powerful instrument.It is a hedge against inflation and tax. Purchasing power doubles in equities in 7 years while it takes 70 years in fixed income. He explained how the principle of compounding works beautifully in equity investing.

He shared some of his most successful picks viz. Vysa Bank (1991),Hero Honda (1996),HDFC Bank (1996),Infosys (1997),Bharati Airtel (2003), Eicher Motors (2012),Ajanta Pharma (2013),AU Financers (2007) and also some bad ones like Mastek (2000) and Financial Technologies(2014)

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He shared some unique tips on understanding management and business. He said while visiting a company he also focuses on how the company treats its staff. He believes that is how they will treat their minority shareholders. Also how meeting with large dealers in tier II and III towns can sometimes reveal much more about businesses and their management vision than the meeting the management directly.

Raamdeo recommended some books to the audience which he found very interesting and urged everyone to read them. These were Common Stocks Uncommon Profits by Philip Fisher,Competitive Strategy by Micheal Porter,Berkshire Hathway letters to shareholders,Value Migration by Adrian Slywotzki, Value Investing- Buffet and Beyond, Expectations Investing by Michael J Mauboussin.

India took 58 years to reach the one trillion dollar GDP mark, however the second trillion took just 7 years,according to Raamdeo every subsequent trillion dollar addition to GDP will happen much faster. He said that by thinking big and positive, using the power of compounding and following his investment mantra anyone can achieve similar success in their investment portfolio.

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Impact of demonetization on NBFCs

Contributed By : Meera Siva, CFA

October 5, Chennai

There are opinions galore about the impact of demonetization. As we near the one-year mark of this historic event, P Avinash, Head Risk, IFMR Capital, shared data and analysed the effects seen by NBFC-MFIs, from his vantage point. IFMR Capital is a Chennai headquartered NBFC which has facilitated debt funding of over INR 45,000 crores using advanced structured finance products.

Avinash started out at the IFMR Group in January 2014 to head the investment function at IFMR Investments where he set up IFMR’s first Alternative Investment Fund (AIF), focused on long term debt financing to retail financial institutions. Earlier, he worked in ICRA for 7 years in their credit rating practice specialising in financial sector entities and prior to that, he was with Deloitte in its Audit and Assurance practice. He is a Chartered Accountant, who ranked 5th in the CA exam.

Avinash Oct

Reduced recovery

Demonetization seems to have adversely affected the Rs 1 lakh crore MFI segment. From 99% collection efficiency on average, collections have slipped and collection efficiency stands at about 80%. The encouraging news is that this is improving from the steep fall seen immediately after the note ban. The big hit was due to loss of income for individuals and businesses as cash was removed from the system last November. This took a few months to stabilize and by January/February of 2017, the situation eased.

However, collections never went back to pre-demonetization levels as other issues began to surface. One, some MFIs had relaxed credit norms to grow their business. While this would have been manageable in the past, the new stress in the system pushed some loans to default. One example was the high exposure many MFIs had in Bengaluru city. After demonetization, defaults increased in this region, possibly due to risky lending practices. Two, in geographies where there were issues such as ring leaders and pipelining, repayment was affected – due to financial distress from business issues or just greed.

Three, some borrowers had lost their discipline of regular payments – in some cases due to MFIs that did not follow-up. As success depends on process and discipline, loss of process by MFIs led to loss of discipline and hence defaults.

Four, when there were defaults, MFIs in general tend not to take any legal action, considering the background of the borrowers and as the cost of such action may outweigh likely benefits . As a result, those with regular credit also opt to default, as there are no consequences to bad credit.

Data points

Data from IFMR Capital shows that there was mostly no difference between recovery rates of MFIs, at a district level, but rates varied across geographies. For example, bulk of the losses in Maharashtra were clustered around the Vidharba region. Weekly collections and smaller loan sizes had better recovery than monthly repayment and larger loans – intuitively enough.

In some cases, poor operational structure of MFIs aggravated collection issues and lowered recovery. Typically, a field staff handles about 900 borrowers. Some MFIs had pushed the limit to 1,500 borrowers in areas that witnessed high growth. While this was manageable and yielded efficiencies when collection was smooth, when multiple follow-ups were needed for collection, the staff could not handle it.

MFI response

The MFIs, by luck or by design, had raised funds in September 2016 and had good liquidity. New loan disbursals, which were growing at a fast clip of 80% year-on-year in the past, fell in the December and March quarters. Growth has since recovered and in the September 2017 quarter it increased 20% y-o-y.

MFIs have been able to raise equity and are looking to grow. Investors continue to be interested in the segment, as seen by the success in fund raise. MFIs are looking at newer geographies for their expansion. For instance, Bihar and Rajasthan have shown good repayment resilience and there is interest to start operations in these States.

The segment has good scope for growth as there are still many districts that are under-penetrated. It takes over six credit cycles before a MFI borrower, who is lent on the joint liability group model, is eligible to be given an individual loan. Better credit data availability, technology adoption by MFIs and eKYC through Aadhar should help the industry’s growth in the long run.   Consolidation – where there is little or no geographic reach – is an option to achieve better economies of scale, but has not happened due to culture issues in the MFIs. MFIN – the network of MFIs – has been doing a great job of communicating issues and working out solutions with stakeholders such as borrowers, local authorities, MFIs and the community.

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A Primer on Insurance in India

Contributed by: Manoj Khokale, CFA 

The year 2017 has been the year of IPO’s in India and it is more so true for insurance sector with listing of companies like ICICI Lombard, SBI Life, upcoming ones like GIC Re and Reliance General. Insurance being a complex topic, Prof. K Sriram, a Consulting Actuary, in his session organised by the Bengaluru Chapter of CFA Society India, helped gain a better understanding of basics of actuarial science and also elements of balance sheet accounting specific to Insurance firms.

The session began with the type of Balance Sheets for Insurance firms viz. Statutory Balance Sheet and Economic Balance Sheet. The Statutory Balance sheet is the one that the Regulator will look at, and the Economic Balance sheet is the one that the companies would prefer to look at. The Balance sheet as per account standards falls somewhere in between the two.

Liabilities & Ratios

Prof. Sriram emphasised on few major components of liabilities. The most important being ‘Prudent estimate of liability’. The ‘Net Liability’ of an insurance company would be the difference of Present Value (PV) expected payout (from claims) and PV of expected premiums. The role of an Actuary is to help determine prudent (conservative) estimate of liability. Factors like mortality rates in life insurance products, longevity in annuity products etc. are used to make estimates more prudent. The other important component being ‘Regulatory Capital’ also called as ‘Required Solvency Margin (RSM)’. It is the additional capital required to meet unforeseen exigencies. The RSM is laid down by regulatory body like IRDA.

The Tier 1 and Tier 2 capital of the firm should exceed ‘Required Capital’. The excess capital (above ‘Required Capital’) represents free assets of the company. The financial statements of an insuarnce firm has analytical ratio called free asset/total assets % (usally between 10%-15%). The excess capital determines the degrees of freedom of an insurance company. For example, when a new product is introduced, the ‘new business drain’ is funded by excess capital. The Share Capital and Reserves & Surplus represents the Available Solvency Margin (ASM). The regulator decides the Solvency Ratio (ASM/RSM) which could be a minimum of 150%.

Then Prof.Sriram explained the role of Re-Insurer. This is when an Insurance company transfers some of its risk which is above its pre-defined risk to a Re-Insurer. For example Life Insurance Company re-insuring death risk above a certain threshold level. Another critical component of Balance sheet he brought up was ‘Expense Gap’. An ‘Expense Margin’ is the expense loadings built into the premium income less actual operating expenses. When the ‘Expense Margin’ is negative it becomes ‘Expense Gap’. It is usual for a ‘Startup’ operation to have an expense gap in the first few years. Then he discussed the importance of ‘Persistency ratio’ that reflects the total business the insurance firm is able to retain in a financial year without policies being lapsed.

The various types of products available under Life Insurance, Health Insurance and General Insurance were covered to explain the different kind of risks that the Insurance firm is exposed to when such products are offered.

Assets

In the Assets section, Prof. Sriram started with an example of a Statutory Balance sheet and explained the biggest asset class that an insurance firm holds is debt and this component is invariably taken at book value and not mark-to-market. Then few other components were discussed like ‘Premium Received’, ‘Interest Accrued’, ‘Deferred Acquisition Cost’ (smoothened cost due to uneven nature). In a Statutory Balance sheet there is no place of ‘Deferred Acquistion Cost’ as all expenses have to be reflected in the same year. Another component is ‘Segregated Assets’ which actually belongs to the customers (example ULIPs).

Prof.Sriram then pointed that in the annual report of a insurance firm one can find ‘Appointed Actuaries Report’ which will have details on assumptions, discount rates used etc. He also pointed that an Actuary helps in building the cashflow model and specifically while constructing a new product, an Actuary’s role is critical in determining the pricing of the product as well as assessing financial viability of the product. He also went through calculation of solvency requirement as an exercise.

Valuation Framework

From the valuation perspective, Prof. Sriram discussed the calculation of key component viz. ‘Embedded Value (EV)’. EV is a measure of how much a life insurance company is worth (one of the determinants of market value for life insurance company). The calculation for EV was explained based on an example. The main components of EV are Value of Business, Free Surplus, Mark to Market adjustment and Expense Gap Adjustment. The other determinant of market value is the ‘Appraisal Value (AV)’ which is EV added to ‘Value of New Business (VONB)’.

Dwelling on to some key ratios he advised Free assets/Total assets > 10% is a good indicator of growth. For a stable company, the change in policyholder liability/premium income should be between 70%-75%. The Embedded value/Premium income is a function of risk that the company is taking. Few other ratios to note while valuing are Expense Gap ratio and Solvency ratio.

It was a very interactive session holding on to the interest of all participants. In the vote of thanks Abhishek concluded by expressing that this topic would be complete with another session by Prof. Sriram focussing on detailed exercises.

-MK

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A Primer on Indian Private Equity: A Practitioner’s Perspective

Contributed by: Varsha Dhamasia 

Historically asset allocation was focused on only traditional asset classes, i.e., equities and fixed income instruments but over the last few decades, investors have increasingly inclined towards investment in alternative asset classes owing to their wonderfully high and uncorrelated returns. Backed by significant reserves of primarily foreign capital, the private equity industry is fast catching up an alternative source of financing for the up and coming businesses in India. Even when the primary markets weren’t doing well during 2010 – 2014, almost $40 to $50 billion were invested in the Indian private equity markets. India had 253 active private equity funds in 2016.

The CFA Society India – IAIP organized a session on “A Primer on Indian Private Equity: A Practitioner’s Perspective” presented by Mr. Kazi Zaman, CFA and Mr. Abhishek Loonker, CFA in Bangalore on September 9, 2017. An all engrossing and engaging session where everything was discussed from the concept to the real world matters in private investing straight from the seasoned private equity professionals.

What is Private Equity (“PE”) and How the PE Model works:

PE refers to the value added investment approach wherein the fund manager or partner of the PE firm called General Partners (“GPs”) raises fund from investors called as Limited Partners (“LPs”) by getting a significant amount of capital commitments from LPs. When the GPs find an investment opportunity, they issue capital call notices to LPs to draw down the required investment amount from LPs. The LPs undrawn commitments to GPs is called Dry Powder. The return expectations of LPs is generally at an IRR of 25% net of fees and carry.

In PE investing, the GPs are also required to show some skin in the game in order to ensure alignment of interests with LPs, so the GPs put in at the most 5% of the committed capital. The PE manager receives an annual management fee (typically 2%) on the committed capital of the fund. In addition to that, the fund manager receives carried interest or carry, i.e., a share of the profits paid to the GPs (typically 20%) after a minimum rate of return, i.e., hurdle rate or IRR (usually 8%) is realized.

The carry/returns are distributed to LPs and GPs based on the liquidity waterfall: under the deal by deal carry waterfall, at every exit carried interest is returned to the GP if the deal IRR is above the hurdle rate. Whereas under the conventional and more preferred waterfall the returns are first distributed to the LPs and carry is not paid until the entire fund amount and the returns equivalent to hurdle rate is distributed to LPs and beyond such amount 20% of the returns are distributed as carried interest to GPs. Most investment managers prefer this distribution waterfall to prevent LPs to compensate for the early positive deals exit and a bad performance later. For example when Softbank decides to sell its stake in Flipkart then all the Softbank LPs and GPs will exit the investment simultaneously and not the subset of investors within the vehicle; as this would ensure no conflicts of interest between parties within the vehicle.

When the fund is liquidated and LPs receive less than the expected return, there can be a clawback provision in the agreement that allows to make-up for the difference by taking carried interest from GPs and distributing it to the LPs. Furthermore, GPs usually hold back a portion of the cash as a reserve to cover for future contingencies, tax-related or so. An example of such would be the Vodafone Hutchison deal tax dispute.

Since PE is a fairly long and illiquid investment into a non-traded equity, the reasonable estimates of the value of portfolio companies are calculated using market, income, asset or a combination of valuation methodologies. These valuations are also performed as part of the audit or NAV evaluation exercise after each specified period, however, these valuations are merely an opinion and may or may not reflect the true value of a company and will only surely be commented upon post return realizations.

Who are Limited Partners (LPs)?

LPs or the investors are referred to as “GOD” by GPs in the PE industry. LPs can be domestic or foreign; institutional or non-institutional. PE investors generally comprise of pension funds, endowment funds, sovereign wealth funds, insurance companies, fund of funds, families and individuals. In practice, GPs generally prefer institutional investors over individuals/families mainly because of the individuals/families’ misjudged appetite for the long holding period and in turn defaults on capital drawdown call.

Characteristics of Private Equity:

PE asset class not only delivers higher and uncorrelated returns to public equity but also differs from public markets investing such that it is illiquid, requires higher involvement, have longer gestation period and is expensive.

PE funds have a long investment horizon and require at least five years’ time to exit. As PE funds are invested mostly in non-traded companies, the fund manager sort through private companies with the intention to hold a significant stake in the company and assess the companies’ ability to generate expected returns in some time duration. PE managers look for a superior business model, strong and experienced management team, strong promoter track record and good corporate governance and assess whether the investment is a good fit based on the fund’s existing strategy, time horizon, return expectations and mode of exit.

Before investing the PE investor also conducts due diligence on the target company and its promoters. It makes deal-making a lengthy process. Further, the fund manager helps the portfolio companies’ strengthen internal capabilities by providing value-added services to the firms by helping in with their cost-cutting and revenue-boosting measures, improving capital efficiency, bettering corporate governance and much more. To better understand it using a sports analogy – if cricket, a non-contact sport, is like public equity investing then rugby, a close contact sport, is like PE investing where PE managers get actively involved in the business operations which is not the case with public market investing. Another characteristic of PE is blind pool investing which means that the investors (or LPs) invest in the fund without knowing where the fund manager will invest and rely on the fund managers’ expertise for the entire duration of the investment.

Although through our studies we have learned that alternative investments provide portfolio diversification to investors, the public and private markets’ fund flows have indicated higher correlation and the returns in both the markets also seems to be correlated at all times.

Structure of Private Equity Funds:

The PE funds in India are structured as either Unified or Parallel. Under the Unified structure, the investment manager floats the Alternative Investment Funds (which is registered with SEBI under the AIF Regulations) with investments from both domestic and offshore investors. The domestic investors would directly contribute to the AIFs whereas the overseas investors pool their investments in an offshore vehicle and this offshore vehicle enters into a subscription agreement as Foreign Venture Capital Investors-registered with SEBI. Under the Parallel Structure funds from the domestic and foreign investors are pooled separately and investments are made directly into the Indian portfolio companies.

Type of Private Equity deals:

1. Minority Growth Capital wherein GPs invests series B-C onwards or in the mid-market companies when the money is needed for working capital, expansion or restructuring to increase the growth rate. One such example of minority growth capital PE is Ascent Capital.

2. PIPE (private investment in public equity) Deals – Many PE funds invest in public companies through preferential route or in secondary markets. Typically long-only funds invest in public companies with the gestation period of about 5 to 7 years. Risk Capital Partners and WestBridge Capital Partners have done many PIPE deals lately.

3. Passive/Active control – PE funds sometimes take passive and occasionally active control in the portfolio company. In their active control, GPs play a prominent role in the company’s operations For Example India Value fund – wherein they own 100% in few and 50-90% in most portfolio companies. It hires management team or engages people from their fund for monitoring (e.g. – Meru Cabs, Act Fibernet). While taking passive control, funds may have majority investment in the firm but promoters or the existing management team continue to run the show. GPs just maintains checks and balances but do not actively control or take part in the operations.

4. Platform Plays in which the portfolio company develops the platform and the GP invests and owns that platform. Few examples of Platform Plays are the investment into iNurture and Big Basket platform by Ascent Capital and investment in Burger King by Everstone Capital. Platform Play differs from a control transaction because GPs collaborates with the promoters to create a platform from scratch, and differs from venture capital investment such that the size of the opportunity in platform play is very large, i.e., investors are not looking at the incremental growth but a rapid growth rate.

How Private Equity (“PE”) differs from Venture Capital (“VC”):

The PE and VC investing are used interchangeably due to the much similar investment features. PE and VC are both illiquid, long-term investments in private companies and follows similar funds structure and fees structure. VCs invests in startups, pre-revenue stage, and small- and medium-size private companies and takes concept risk and bets on the promoter’s idea/business model whereas PEs provides working capital for expansion, new-product development, or restructuring of the company. Using Cricket jargons, VC is similar to T20 form of cricket where more boundaries are required to win the match and PE is like test cricket where regular singles with occasional boundaries are sufficient to perform well in the overall match.

Term sheet Jargons:

• Pre and Post Money – It is the value of the company before and after the new investment comes in. The pre and post money values are calculated using the post money fully diluted count.

• Anti-Dilution (full ratchet) – If the new money comes in at a lower price than the previous funding, the already existing investor’s shares are adjusted based on the price of the latest funding round.

• Tag along – When there is a change in control, the promoter provides an exit to the PE investor before transferring its majority stake, or when there is no change in control and the promoter wants to dilute its stake in the firm then PE investor also dilutes its pro-rata stake in the firm.

• Earn-outs are a clause in the investment agreement which states that if the company earns returns beyond a specified limit, say 3x or 4x, then they would share part of that return with the promoter.

Recommended reads:-
• Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar
• The Second Bounce of the Ball: Turning Risk into Opportunity by Ronald Mourad Cohen

-VD

 

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Value Investing Pioneers Summit, Delhi. Session on “MOAT-A four letter word” By Rajeev Thakkar

Contributed By :

Deepak Mundra, CFA and Kanwaljeet Singh, CFA

The Delhi chapter of CFA Society-India had the privilege of hosting some of the most famous pioneers of Value investing in India during its inaugural Value Investing Summit on 21st Sep 2017.

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Mr. Rajeev Thakkar in his session on “MOAT- A four letter word” used a framework provided by Pat Dorsey in his book The Little Book That Builds Wealth to explain how moats are created by companies. He explained how moat provides a competitive advantage to a company as compared to its competitors.

Economic Moat refers to identify companies with durable competitive advantage.

Morning star’s Pat Dorsey, CFA, suggests that there are four kinds of economic moats that we should look for when analyzing businesses:

  1. Intangible Assets- Refers to the Brand power of a Company. The Company’s brand is its ability to lock in the customer permanently as a result of which the customer wouldn’t look any further and thereby reduces the search cost of the customer as well.
  2. Customer Switching Costs-This represents a huge cost to customers when they think of switching a product or a brand and as a result of it the company will command a pricing power from its customer
  3. Cost Advantages- An excellent example in a case would be of “Dollarshaveclub” (Company) which challenged the existing and a marquee player “Gillette” purely based on its low cost shaving blade advantage. The Company’s CEO reminded its customer as to why they need to pay for a fancy handle and endorsement cost of tennis star Roger Federer for the shaving blade that they get for 1$ a month and thereby offering a great competitive cost advantage to the Company.
  4. Efficient Scale (cost economics)-This refers to the similar Moat as discussed above but the one which is purely backed by the scale-based cost advantage to which the customers are going to stick for long.

He then proceeded to take contrarian view using “ABC – Arrogance, Bureaucracy and Complacency” framework as explained by Warrant Buffett in Berkshire Hathaway Report of 2014. Rajeev pointed out that these moats are at risk due to disruption by a new comer, complacency which creeps in due to long period of competitive advantage enjoyed by the company. It results in taking the customer for granted, using an inferior raw material, increasing prices at will etc. all of which in turn may result in losing competitive advantage built by the company. Customers start taking note of these changes and look for alternatives.

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He used following examples to make his point:

Kwality icecream: This company was very famous in the late 1990s and commanded lion’s share of the icecream market in India. After enjoying this leadership position for a long period of time, complacency started creeping in. The company started using the synthetic material in lieu of natural milk product. The Customer took note of it and started deserting company when Amul came with the promise of giving the product which had natural milk ingredients. He mentioned that though sales of Kwality probably kept increasing due to increase in the market as a whole but it slowly started losing its leadership position.

Nespresso of Nestle: Nestle has retained its leadership position in instant coffee market through series of innovation. However, these innovations had cost attached to them but with innovations, the company was able to keep its competitors at bay. One of these innovations was “Nespresso pods” which in a way killed the company’s existing business but the company had a first mover advantage with these pods. However, in last few years, local manufacturer started offering pods at very low prices, challenging the company. If the company doesn’t heed to this challenge, its leadership position is at risk.

HP Printer: HP had a long leadership position in the printer industry. Once a customer had HP printer he became a life-long customer of HP as only the refill provided by HP would work on these printers. The cost of refill by HP was much higher than refill provided by other companies. When HP realized that customers found the loophole to circumvent this by using refill provided other manufacturers, it started putting sensors so that customers cannot use refill provided by other companies and the company will get to know if used. It gave an opportunity to company like a EPSON and others to offer printers for which refill cost was much lower than HP.

Suggested reading:

The Little Book that Builds Wealth on value investing by Pat Dorsey

Suggested Videos:

Google talk by Pat Dorsey:

https://www.youtube.com/watch?v=YFS5JBgz1Xc

The Capacity to suffer by Thomas Russo

https://www.youtube.com/watch?v=GSNBTaPYAng&t=51s

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Volunteer Orientation Day – Bengaluru

Contributed by: Shreyans Jain

The Bengaluru chapter of CFA Society India hosted the Volunteer Orientation Day at The Grand Magrath Hotel on 19th August 2017. The CFA Institute and CFA Society India (IAIP), thrive on the energy and contribution of member volunteers. They are at the core of all its activities and events. They find time from their demanding day jobs to give back to the Institute and Industry through volunteering. The event was organized to apprise its candidates and Charter aspirants of the benefits the membership to CFA Institute brings with it and the benefits of being a volunteer.

We could not have got a person better than Mr. Jayesh Gandhi, MIM, CFA and the present president of the IAIP, Indian CFA Society for this. An active volunteer & board member for over five years, Jayesh made us aware of the opportunities, responsibilities, and resources that becoming a member and volunteer brings. To complement Mr. Jayesh’s volunteering experience, we had on the dais Mrs. Aarti Porwal, Director of Society Relations in India at CFA Institute. Her presence was enough to motivate the budding women CFA Charter holders and Charter aspirants of Bengaluru chapter to put their best foot forward and make the best use of volunteering at CFA events.

Jayesh, after congratulating the Level 3 successful candidates, wasted no time to clear our ”Why” of joining as a volunteer and member of the CFA Institute India’s Chapter. He narrated inspiring tales of leading volunteers who got better professional as well as business opportunities by connecting with the extensive network investment professionals across the globe. He also highlighted how becoming an active volunteer has helped him as well as many volunteers across the globe to develop leadership, communication and organization skills. Few of the material benefits of becoming a regular member of CFA Institute highlighted by him are as under: –

• Connect with a global network of more than 145,000 investment professionals known for their expertise and integrity

• Gain access to outstanding financial publications, education resources, and specialized career services

• Obtain member discounts at our events worldwide

• Getting access to Career Center for job listings etc.

He laid out the benefits, the requirements and the checklist which one must adhere to before applying for the membership. He also informed the audience about the affiliate membership which candidates who don’t qualify for regular membership can opt for to enjoy similar benefits of regular membership. He also encouraged the audience to make the best use of reduced rates of Annual dues for getting membership of $150 against the regular/affiliate dues of $275.

Following the encouraging and in-depth speech of Mr. Gandhi, the audience had the opportunity to gain insights from the rich experience of Mrs. Aarti Porwal. As a Director of Society Relations in India at CFA Institute, Mrs. Porwal has been the responsible for membership growth and volunteer management, in addition to supporting university affiliation and prep providers in India. She narrated all the details related to the eligibility criteria for regular membership and affiliate membership. She addressed queries of the audience and addressed doubts which the audience had related to the membership criteria.

She explained to the audience various volunteering opportunities that were up for grabs for the candidates. Candidates could opt for the volunteering opportunity that best suited their skills set. If someone was good at communication and people to people engagement, he could get himself registered for communication and similar volunteering opportunities. In case someone felt he is better at connecting the society to speakers across new areas of study, then there were opportunities for that also. She also highlighted how one could be a member of the institute without pursuing the CFA program, like herself.

The success of the event could be gauged from the fact that most of the members of the audience who were present had signed up for volunteering event and Bengaluru chapter looked forward to a renewed energy and renewed bank of ideas from its upcoming volunteers and members.

-SJ

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Topic: Value Investing Pioneers Summit, Delhi. Session on “Not everything that counts can be counted” by Prof. Sanjay Bakshi

Contributed by: Ankur Kapur, CFA

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The Delhi chapter of CFA Society-India had the privilege of hosting some of the most famous pioneers of Value investing in India during its inaugural Value Investing Summit on 21st Sep 2017. The bad weather at Mumbai and all the hassles at the airport that our prominent speakers had to endure couldn’t dampen the zeal even one bit and the event was a huge success.

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Prof. Sanjay Bakshi started the much-awaited conference. He shared his thoughts on the topic – “Not everything that counts can be counted”. There are many situations in which applying a financial model may not help in any decision-making. For example, in 2012, Ajay Piramal sold the stake and had a huge pile of cash but no business plan. The company was trading at a value of less than cash, an attractive buy but no financial model could have indicated whether it is a good investment or not since the promoter did not have any business plan. However, given that in the past promoter was able to create immense value for the shareholders was the only basis to assume that promoter will be able to create value going forward as well.

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In a presentation to CFA Society India members, Prof. Bakshi in 2012 talked about “understanding the universe of the unknown and the unknowable”. Prof. provided two pointers to assess risk 1) uncertainty is not risk 2) Exposure to uncertainty on favorable terms is desirable. If you are not certain of the risk of investment, it is a speculation at best. Equity markets are volatile and that provides the value investor opportunity to invest. However, these opportunities have to be availed at attractive or favorable terms. Investing in Piramal Enterprises in 2012 provided an opportunity to invest at favorable terms but typical discounting of cash flow approach would not have provided an answer. The way to achieve is to go beyond number and understand the underlying – culture of the company and strength of management.

Prof. Bakshi highlighted the relationship of investor and management through a picture from a hit Hindi movie, Sholay.

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Dharmendra is the management and Amitabh is the investor. An investor has to ride along with the management; therefore, the strength and professional ethos of management have a significant role to play in order to make this relationship work and especially create value.

Albert Einstein “not everything that counts can be counted, and not everything that can be counted, counts”. Piramal Enterprises risk was not measurable but years after 2012 Piramal has created immense value for its shareholders.

Prof. Bakshi quoted Charlie Munger “It’s my view that economies could avoid a lot of trouble that comes from physics envy”. It is particularly for those investors who focus on precise numbers and make investment decisions. Munger provided a solution “I want economics to pick up the basic ethos of hard science..but not the craving for an attainable precision that comes from physics envy”. Financial analysis is an important aspect of investing but it is not the only thing to be looked at, there are other factors that are qualitative and often become more important aspects of investing.

A lot of investors and analysts use various definitions of measuring risk. One of the most popular ways of assessing risk is using CAPM i.e.

r_a= r_f+β_a (r_m+r_f)

Where r_f=risk free rate
β_a=beta of the compnay
r_m=expected market return

It is one of the most popular ways of assessing risk and provides a precise value, but often it is entirely wrong.

Buffet’s risk framework to assess risk:

  1. The certainty with which the long-term economic characteristics of the business can be evaluated.
  2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flow.
  3. The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself.
  4. The purchase price of the business.
  5. The level of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing power return is reduced from his gross return.

Buffet “IT IS BETTER TO BE APPROXIMATELY RIGHT THAN PRECISELY WRONG”

Even the smartest people commit the most stupid mistakes. For example, LTCM founded by Nobel laureates committed the most fundamental mistake of not understanding the risk that eventually led to the winding up of LTCM.

Six factors critical but hard to quantify:

#1 Owner earnings
Buffet “Owner earnings represent A) reported earnings plus B) depreciation, depletion, amortization, and certain other non-cash charges less C) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in C)”

If C) is less than B) the company will be able to grow without investing in growth. However when C) is more than B), the company will need an additional amount of investment to achieve growth. Sustainable growth at a reasonable price may be achieved in the case where A) + B) > C).

Three reasons for the divergence between reported and owner earnings.

  • Capex charged to revenue or vice verse.
  • Depreciation and obsolesce.
  • Changes in working capital.

#2 Unquantifiable people factor

Prof. mentioned about the most fundamental equation in finance.

A= P (1+R/100) ^n

The benefit of compounding is achieved only in the long-term. Focus on quarterly results and daily price movement does not add value. Business leaders must focus on the long-term and take strategic business decisions considering the long-term company goals.

#3 Ability to shut down system 2
A company focused on delighting customers, eliminating unnecessary costs and improving products and services, creates value.

#4 The value of reciprocity
If a company takes care of the stakeholders including suppliers, customers, and employees creates loyalty across the broad ecosystem of the company that is hard to calculate but has a great value.

#5 Reputational advantage
If the buyer has an advantage for the kind of value they bring to the table, the seller often prefers them and ready to sell at a price attractive to the buyer.

#6 Optionality
Operating within one’s circle of competence, avoiding auction type situation, avoiding leverage and a solid exclusive deal pipelines are ways to create value through optionality.

-AK

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