Rebalance Rationale of Windmill Capital smallcases
The Why Behind Our What!
Many a time, we receive queries from our investors, asking us to explain the rationale around including or excluding a stock(s) from a smallcase. In this edition of musings, we have decided to pick a few examples and walk you through the thought process behind those decisions. To make it simpler, we shall categorize them into Model, Non-model, and Tracker smallcases. Before dissecting any of the rebalance decisions, it is important for you to know that our focus remains to keep the portfolio churn low and hence we include stocks with the sole motive to hold it for as long as possible. Please note that all the examples pertain to the rebalance executed on June 15, 2022.
Non-Model smallcases:
- Apollo Hospitals – The company was included in the Brand Value smallcase. Apollo, as a brand, commands strong credibility and trust. The company has a healthy segment split – Healthcare business (~53%), Pharmacy business (~41%), and lifestyle business (~6%). The company operates at a pan India level, with around 10,000 hospital beds, 3,800 pharmacies, and close to 950 diagnostic clinics. Since the onset of the pandemic, we have wanted to gain exposure to the healthcare space however the run-up did not provide valuation comfort. The recent correction piqued our interest yet again and that is when we decided to go ahead with it. Per the theme of the smallcase, the most imperative aspect is a brand aspiration. Especially in the healthcare space, an individual is ready to spend more on healthcare costs given she trusts the brand. And Apollo is that brand!
- Indian Energy Exchange (IEX) – The company was included in the Digital Inclusion smallcase. To begin with, IEX is a monopoly, operating in the energy sector. IEX is a true disruptor in the way the company has entirely digitized energy trading in India, being one of a kind. With more than 6700 registered participants on the platform, IEX has a market share of more than 95%. Ever since the advent of the smallcase, we have been on the lookout for a quality platform-based company, that facilitates financial or non-financial transactions. IEX has given us the opportunity to make the smallcase more diverse through its inclusion.
- Indian Railway Catering and Tourism Corporation (IRCTC) – The company was excluded from the Digital Inclusion smallcase. We have been holding the stock since December’19 and have had our fair share of success out of it. Back-of-the-envelope calculations suggest that our investors have drawn a return of ~240% in this holding period. As far as the rationale behind the decision is concerned, there were two key risks that made us uncomfortable. First, revenue overdependence on the 2S class. As per industry estimates, 2S contributes ~40% to IRCTC’s ticketing volume. Second, uncertainty around sharing revenue with the government. In October’21, the government announced that it would take 50% of the convenience fee generated by the company. And then, all of a sudden the decision was scrapped. Therefore, on the back of this regulatory risk intervention coupled with the above-mentioned reason, we decided to drop it from the smallcase.
Tracker smallcases:
- Siemens – The company was included in the Infra Tracker smallcase. One of the major triggers for us is the potential it holds to benefit from the upcoming capex by cement and metal players. The fresh cycle of capex is just beginning to be announced by several infrastructure players, given the consolidation in the sector. Siemens stands to be a major beneficiary with a robust order book and diverse segment mix.
- Ambuja Cements – The company was excluded from the Infra Tracker and Rising Rural Demand smallcase. The major trigger behind this decision was the acquisition by the Adani Group and the subsequent open offer. The problem with the open offer is that since the offer is usually at a premium to the market price, most of the upside is captured during that time and the price usually plummets once the offer window closes. To avoid this possibility of price erosion from our investors’ portfolio, we took the decision to drop it.
- Wipro – The company was excluded from the IT Tracker smallcase. We have had a close watch on Wipro’s trajectory, given we had identified growth issues, a couple of quarters before. The company has been grappling with weak revenue growth and unconfident margin guidance by management.
Model smallcases:
For models, it will be easier for us to understand this by taking a specific smallcase. So, let’s talk about the two changes that were made on the Value & Momentum smallcase in the last rebalance.
Firstly, it is imperative to understand the way model smallcases work. They have a set of parameters pre-determined, and if the criteria are met it is included or retained in the smallcase or else it is excluded or not included. We excluded two stocks from the smallcases – Federal Bank and Vardhan Textiles. Post the exclusion of these stocks, they have run up ~19% and ~16% respectively. Now, a few of our investors have written to us pointing this out and asking about the rationale behind our decision.
As mentioned, the decision framework is pretty straightforward. There are 4 criteria that are used for the Value & Momentum smallcases. And a collective pass-through on all the 4 criteria, gets the stock to enter the basket. Sometimes, buffer rules are applied to avoid unnecessary churn in the portfolio. For instance, out of 5 criteria, say 1 criterion is – ‘select stocks that have a P/E ratio of greater than 20.’ At the time of rebalance, if an existing stock’s P/E ratio has dropped to 19.8, the buffer rule kicks in and the stock is retained notwithstanding it flouting 1 criteria, as it has passed the remaining ones. Therefore, during the June quarter rebalance Federal Bank and Vardhan Textiles failed on 2 criteria, which was the reason behind their exclusion.
The objective to take you through the detailed explanation behind our rebalance decisions is to maintain transparency with you. It is important for you to know the outlook we have when it comes to managing smallcases and we continue to improve in the future.
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The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy/sell any security or financial products.Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.
Windmill Capital TeamWindmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.
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