Overview of the Small and Mid Cap Value Strategy
Almost every imaginable sector and part of the economy is represented via multiple companies listed on the stock exchanges in India. However, of the more than 6,000 companies listed on the Indian stock exchanges, only about 200 companies have research coverage by more than one high quality brokerage firm. As a result, the Indian stock markets behave like two distinct markets in one.
The researched and discovered part of the market consists of companies that are liquid, trade at premium valuations and have high institutional ownership (especially foreign), while the under-researched and undiscovered part of the market consists of companies that are illiquid, trade at discounted valuations and have poor institutional ownership.
One would naturally assume that the more liquid and discovered companies are large-caps and better quality companies while the less liquid and undiscovered companies are small or micro-caps and poorer quality companies. However, in our experience, this is completely untrue in the Indian markets.
How We Invest
The reason we are able to successfully invest in illiquid and undiscovered companies is because of our obsessive focus on the first two filters of Corporate Governance and Capital Allocation. We find that the biggest investment mistakes are made when investors relax their standards for these two filters and get carried away by the business and valuations.
Our investment goal is to avoid a permanent loss of capital and to compound our capital at high rates of return over a long period of time. Given the concentrated nature of our portfolio, our returns are both volatile and lumpy.
Identifying Opportunities for Our India Small and Mid Cap Fund
At Atyant Capital, we run a fundamental's based research strategy and spend an incredible amount of time researching potential investee companies including meeting with management teams, bankers, suppliers, customers, regulators etc. We follow a rigorous research methodology that can be broadly classified into five filters:
- Corporate Governance: The dominant shareholder or the management of a company treats passive minority shareholders fairly and like equal partners.
- Capital Allocation: The management of the company is focused on a single goal and that is maximizing return on (re)invested capital while minimizing leverage and risk, and that when management is unable to find those opportunities, it is willing to return capital to shareholders.
- Business Fundamentals: Companies that have very strong and difficult to surmount moats and operate in businesses that are forgiving and have margin for error. Also, companies that have a strong external opportunity environment and a long runway for growth and compounding.
- Financial Strength: Companies that do not carry too much debt and especially those that generate high amounts of free cash and do not need to keep raising money, neither equity nor debt.
- Relative Opportunity: Good investment opportunities are hard to come by, especially those that meet our rigorous evaluation criteria. We therefore run a concentrated investment strategy and look to have 10-15 names in our portfolio at any given time. We look for stocks that offer a high degree of asymmetry. Asymmetry implies that not only does the stock have a big margin of safety but also offers a large potential to generate meaningful returns (over time). In other words, we look for opportunities with low downside and high upside. We then evaluate the relative opportunity of our investable universe and invest in those names that offer the highest asymmetry.