October – December 2011

January 25, 2012

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 very long. 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 suit your 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 quantumof 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:
   
   
   1. The “representative” portfolio returns.
      
      
   2. The weighted average returns of all the discretionary portfolios in the Jeetay PMS.
      
      
   3. 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.
      
      
   4. The Sensex returns.
      
      
9. We will therefore 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
July 01, 2011 to September 30, 2011	-3.75%	-12.69%	Around 7%	Audited
October 01, 2011 to December 31, 2011	-11.14%	-6.07%	Around 7.5%	Audited
Cumulative Return	648.08%	346.64%

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
July 01, 2011 to September 30, 2011	-3.75%	-12.69%	Around 7%	Audited
October 01, 2011 to December 31, 2011	-11.14%	-6.07%	Around 7.5%	Audited
Cumulative Return	142.54%	35.45%

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
July 01, 2011 to September 30, 2011	-3.75%	-12.69%	Around 7%	Audited
October 01, 2011 to December 31, 2011	-11.14%	-6.07%	Around 7.5%	Audited
Cumulative Return	17.32%	-12.84%

*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%	79.00%	80.50%
2010-2011	29.09%	18.57%	18.40%	10.93%
2011-12(April 01, 2011 – December 31, 2011)	-9.13%	-13.35%	-13.41%	-20.52%

**Returns are before fees but after all other expenses

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Whilst I normally do not give too much importance to analyzing quarterly performance numbers of companies or funds, I do believe that the latest quarterly performance of Jeetay needs to be commented upon. It is significant because we have underperformed the market when it was bearish and any self-respecting value investor would consider that to be the equivalent of having forgotten his umbrella on a rainy day. Whilst contrasting the six-month (upto September 2011) to the nine-month performance (upto December 2011) of Jeetay, one feels like Cinderella at the ball at midnight. I had commented on my committing the “error of optimism” in the last letter, but that must now stand corrected and read as the “error of super-optimism”!

This soul-searching must start with an analysis of the companies comprising the portfolio and whilst they differ from portfolio to portfolio (since we find the notion of a “model portfolio” abhorrent), two notable commonalities are present:

1. A significant focus on small-cap and mid-cap stocks because
   
   1. Ecologists will readily point out that big fierce animals are rare (for which there are very cogent reasons), and value investors will confirm that big fierce companies with strong moats are rarely cheap (for which there are behavioral reasons).
      
      
   2. Every species in the ecological world has its niche and the struggle to preserve one’s position in that niche is shaped by the forces of natural selection. Since the carrying capacity of the land does not change in the short-term, focus and development of those characteristics that enhance survival value are key. A dominant position in a smaller niche is easier to find in the corporate world than such dominance when the landscape is vast.
      
      
   3. The ecological (not the psychological) principle of association – there are species that are faithful to the presence of others because they get their living in association with those others. Biologists loosely call it “symbiosis”. Value investors give it another name – “switching costs” and again populated by companies in the small-cap/mid – cap space.
      
      
   4. Gause’s principle of competitive exclusion – the owner of a niche excludes all others from it. Contrary to conventional wisdom, natural selection designs different kinds of plants and animals so that they avoid competition. At Jeetay, we think hard about inclusion of companies into portfolios based on the ‘exclusion principle’ – how is competition in the industry avoided? It’s not just olisopoly, but overall (small) market size. Rather than just thinking about scalability, we also like to think about exclusivity.
      
      
   5. Small predator and prey interactions can be deadly and entire colonies can be wiped out as contrasted to large predator/prey interactions. At Jeetay, we like to think about which companies in the small-cap/ mid-cap space are more likely to be predators rather than prey. A whole arsenal of competitive characteristics for such identification is on our checklists.
      
      
   6. “Territorial behavior” which on many occasions leads to turf battles in nature (and boardrooms) is often observed. Smaller territories are usually easier to defend.
      
      
2. Some “special situations” or “potential special situations.” Let me give some examples. Delisting moves by subsidiaries of some MNC companies is an obvious (and lucrative) trade. And waiting for such announcements have allowed us to hold on to some positions which we would have normally exited. Another example. A cheap mid-cap company in a troubled industry. This company is extremely well-run and cash rich. A fund manager who we respect is building up a sizeable stake. Whilst the chances for immediate revival in the industry are bleak, corporate action is a distinct possibility, especially when we wonder how the fund manager is going to get his exit. Another example. A highly profitable engineering company in the South, which had recently gone through extensive restructuring, is available at a valuation which is at a significant discount to its private market value. The owner is getting old with no successors. A change of control in the foreseeable future can unlock significant value and to which we do not ascribe a small probability. Since the company is growing well, we do not see a ‘value trap’.

If the relatively dim showing in the last quarter was not due to poor stock selection or purchases at inappropriate prices, then it must be the result of a combination of the following three factors.

1. Asset allocation where I increased our weightage to stocks at overall market levels which were not at their cheapest on historical valuations.
   
   
2. The poor showing of the mid cap/ small cap indices vis-a-vis the Sensex.
   
   
3. Overconfident behavior on my part especially after a good showing in the recent past. Self – serving evaluations are the ultimate form of self – deception. I overestimated the degree to which I understood market cycles. This was more a factor at the subconscious level where there is a “team of rivals” operating which baffle even neuroscientists today. Clearly being underweight in equities at the last market turn must have played a role, combined with the uncertainty of the timing of the fully predictable behavior of central bankers to print money and artificially buoy asset prices. When should fear turn into greed in a market cycle is often a decision taken of which one is not consciously aware. The result is a quarter that I would rather forget but will painfully remember.

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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!.

Warm Regards,

Chetan Parikh