April – June 2011

July 26, 2011

Whilst your individual returns are with you, I would like to share how we think about our performance at Jeetay.

1)   We look at a "representative" portfolio. Most of the older portfolios usually have in the past had performance numbers clinging around the numbers of the "representative" portfolio. Newer portfolios take time to build up and usually mask true performance and may even distort it. This "representative" portfolio is that of our oldest client.

2)   We benchmark our returns against the Sensex. We are size agnostic but usually find values in the mid-cap space. However we carry fairly large amounts of cash and so a mid-cap index may not be the right benchmark. We have chosen the Sensex to give you a sense of the "opportunity cost" of not being in the market and not as some sort of a competitor with whom we are in a quarterly rat race.

3)   Short-term underperformance does not bother us and short-term outperformance does not excite us. What should count are long-term figures. Our idea of the long-term is verylong. We will be honest - we do not have performance figures for our definition of the long-term. So we have sliced the performance figures into various shorter-term horizons, to suityour perspective of what should be a sensible investment horizon.

4)   We usually measure the cheapness of our portfolio in relation to each security's historical valuations and not against the current market valuation i.e. we would like to have some sort of absolute cheapness and not relative cheapness.

5)   The figures cited are before taxes and fees. This is because the taxes are paid by you and vary depending on whether you have short-term capital losses and the quantum of short term gains. The fee structure varies due to 1) different plans 2) different entry points (high watermarks). These should shrink the magnitude of outperformance, although not eliminate it.

6)   We do not only look at returns, but at risk-adjusted returns. We do not measure risk by simple volatility, but by downside volatility, drawdowns and portfolio cheapness. On a risk-adjusted basis, our returns, even after taxes and fees, should compare well with the Sensex. Since we believe that markets are unforecastable, we usually hedge our positions by carrying fairly large amounts of cash.

7)   We continue to use the "representative" account methodology so as to be consistent (Tables 1, 2 and 3).

8)   We have found that the "representative" account, which has been that of our oldest account, now has a different portfolio composition from newer accounts and even some of the older accounts. It may thus in the future not properly track overall performance. We have included Table 4 in which four sets of figures are shown:

a)   The "representative" portfolio returns.

b)   The weighted average returns of all the discretionary portfolios in the Jeetay PMS.

c)   The weighted average returns of those portfolios with over 60% equity at any point since inception. These may be generically thought to be the "older" portfolios since "newer" portfolios take some time to build up and may not be representative of portfolio performance. They are of course included in the weighted average returns of all the portfolios.

d)   The Sensex returns.

9)   We will now be reporting "weighted average" returns along with those of the "representative" portfolio.

Table 1

Since Inception

    

Period

Portfolio Return (%)

Sensex Return (%)

% in cash

 

June 07, 2003 to June 07, 2004

80.80%

48.00%

Almost fully invested

Audited

July 05, 2004 to  June 30, 2005

31.45%

42.10%

Around 65%

Audited

July 01, 2005 to  March 31, 2006

30.32%

56.80%

Around 40%

Audited

April 01, 2006 to March 31, 2007

33.73%

15.62%

Around 20%

Audited

April 01, 2007 to March 31, 2008

7.41%

18.60%

Around 30%

Audited

April 01, 2008 to March 31, 2009

-22.26%

-37.94%

Around 35%

Audited

*April 01, 2009 to March 31, 2010

85.16%

80.50%

Around 30%

Audited

April 01, 2010 to March 31, 2011

29.09%

10.93%

Around 27%

Audited

April 01, 2011 to June 30, 2011

6.26%

-3.08%

Around 20%

Audited

Cumulative Return

774.87%

444.63%

  

Table 2

Since 2006

    

Period

Portfolio Return (%)

Sensex Return (%)

% in cash

 

April 01, 2006 to March 31, 2007

33.73%

15.62%

Around 20%

Audited

April 01, 2007 to March 31, 2008

7.41%

18.60%

Around 30%

Audited

April 01, 2008 to March 31, 2009

-22.26%

-37.94%

Around 35%

Audited

*April 01, 2009 to March 31, 2010

85.16%

80.50%

Around 30%

Audited

April 01, 2010 to March 31, 2011

29.09%

10.93%

Around 27%

Audited

April 01, 2011 to June 30, 2011

6.26%

-3.08%

Around 20%

Audited

Cumulative Return

183.59%

65.17%

  

 Table 3

Since 2010

    

Period

Portfolio Return (%)

Sensex Return (%)

% in cash

 

April 01, 2010 to March 31, 2011

29.09%

10.93%

Around 27%

Audited

April 01, 2011 to June 30, 2011

6.26%

-3.08%

Around 20%

Audited

Cumulative Return

37.17%

7.5%

  

*A mistake we hope never to make again - at low levels of the market, do not wait for even lower prices. Ignore all the negatives, because they usually are already in the prices. Mark-to-market losses should not hurt, only permanent losses of capital.

Table 4

Jeetay Returns**

 

"Representative" portfolio

Weighted average return of all discretionary portfolios

Weighted average return of "older" portfolios

Sensex Returns

2006-2007

 33.73%

 28.66%

 30.11%

 15.62%

2007-2008

  7.41%

  7.12%

  8.68%

 18.60%

2008-2009

-22.26%

-23.85%

-23.85%

-37.94%

2009-2010

 85.16%

 78.40%

 79%

 80.50%

2010-2011

 29.09%

 18.57%

 18.40%

 10.93%

2011-12

(April 01, 2011 - June 30, 2011)

  6.26%

  2.64%

  2.74%

 -3.08%

**Returns are before fees but after all other expenses

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In a recent introductory lecture to my students at Jamnalal Bajaj Institute of Management Studies (JBIMS), I spoke about Benjamin Graham's declaration in the first paragraph of Chapter 2 of the 1951 edition of "Security Analysis" that the process of determining the value of stocks and bonds "is part of the scientific method." I quoted from a recent book on Richard Feynman by Lawrence M. Krauss on what Feynman had asserted:

"Science is a way to teach how something gets to be known, what is not known, to what extent things are known (for nothing is known absolutely), how to handle doubt and uncertainty, what the rules of evidence are, how to think about things so that judgments can be made, how to distinguish truth from fraud, and from show."

Feynman could well have been talking about "Security Analysis". But the parallels to investing don't stop there.

Here are excerpts from a review of Kraus's book:

"Feynman's picture of the world starts from the idea that the world has two layers, a classical layer and a quantum layer. Classical means that things are ordinary. Quantum means that things are weird. We live in the classical layer. All the things that we can see and touch and measure, such as bricks and people and energies, are classical. We see them with classical devices such as eyes and cameras, and we measure them with classical instruments such as thermometers and clocks. The pictures that Feynman invented to describe the world are classical pictures of objects moving in the classical layer. Each picture represents a possible history of the classical layer. But the real world of atoms and particles is not classical. Atoms and particles appear in Feynman's pictures as classical objects, but they actually obey quite different laws. They obey the quantum laws that Feynman showed us how to describe by using his pictures. The world of atoms belongs to the quantum layer, which we cannot touch directly.

The primary difference between the classical layer and the quantum layer is that the classical layer deals with facts and the quantum layer deals with probabilities.In situations where classical laws are valid, we can predict the future by observing the past. In situations where quantum laws are valid, we can observe the past but we cannot predict the future. In the quantum layer, events are unpredictable. The Feynman pictures only allow us to calculate the probabilities that various alternative futures may happen."

Investing deals both with the world of facts and the world of probabilities.

Mr. Munger has spoken about the need for a multi-disciplinary approach to decision making. And again I quote Richard Feynman:

"Perhaps a thing is simple if you can describe if fully in several different ways without immediately knowing that you are describing the same thing."

I told my students that as they went along the course, they would realize, being mostly engineering graduates, why security analysis and investing are simple; but as they practiced them later in life, they would also come to realize why they are not easy.

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I recently read the book "The Rational Optimist" by Matt Ridley after Mr. Munger spoke about it at a recent meet.

Investing is also about optimism, but only after a bout of rational pessimism grounded in inverted thinking  - finding out all the ways that things can go wrong and figuring out if it is in the price or not. And optimism in the face of bad news can come only by applying "second level thinking" as Howard Marks calls it or "and then what?" as Garrett Hardin would.

For example, a current favourite with value investors is a toll bridge company whose moats need not be elaborated on. A generous concession agreement which guarantees a high rate of return and an extension of the concession period till it isachieved, has had many investors drooling, especially since the company is available at near book value and is paying down debt with its operating cash flows. It is still operating at less than half its vehicular capacity and could develop some parcels of land adjoining the bridge. So has the Mr. Market become insane with such capricious pricing? Or are investors not understanding some of the not-so-visible risks?

I'm not going to give the answer, although we've bought it at current levels. But the standard arguments of low price to book, indefinite concession period till the promised rates of return are achieved, and development rights to the adjoining "land bank" are, to my mind, incorrect and many recent incidents support that observation. What can go wrong has not been answered with the pessimism that it deserves and the optimism is based thus on a faulty foundation. The situation is far more complex than the simple descriptions dished around. ‘And then what?' cannot be correctly answered if one has not understood properly the causes of the market's apparent mispricing. Rational pessimism must thus precede rational optimism in investing.

One can always get lucky by buying cheap. But a good value investing process must attempt to distinguish true value from a ‘value trap'.

Having said that, we've gone on a shopping trip and bought companies selling below current cash, below next year's cash and in some cases below projected cash two years out. We prefer cash today to cash tomorrow or the year after, but if Mr. Market is willing to throw in businesses that have value for free, we' re prepared to look not at the cat but at its kittens. And we still have cash should Mr. Market become really generous, instead of being selectively so.

We have views on the US economy, the European mess and India's governance deficit, but we would rather be "astronomers not astrologers". We simply do not know how to make a forecast of market action based on our deeply subjective, and in all probability, biased world view. (We feel like Richard Feynman probably did: "Today we cannot see whether Schrödinger's equation contains frogs, musical composers, or morality - or whether it does not. We cannot say whether something beyond it like God is needed, or not. And so we can all hold strong positions either way.")

That is why we carry what may look like excessive cash - it is hedge against our self - acknowledged ignorance and a protection against our subconscious predictions.

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Let me caution you again against taking the current set of quarterly numbers too seriously. For that matter, do not take the quarterly numbers of any fund manager too seriously.

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Should there be any queries, I'm always available. Please do not hesitate to contact me or members of the Jeetay team at the office - Divya, Rashmi, or Shakir! There are some changes underway on the research side which I'll write to you about in due course.

Warm Regards,


Chetan Parikh