An evening with Nilesh Shah

On Friday, Nov 26, we had a fascinating session by Mr. Nilesh Shah, an ICFAI alumnus and founder of Envision Capital. Mr Shah completed his MBA from the prestigious Institute of Rural management, Anand and his CFA from ICFAI. He was with the Kotak group for 13 years and quickly rose to be part of the leadership team and managed assets amounting to about $ 1.2 bn. Mr Shah has also worked with the HDFC group. Mr Shah’s leadership potential was evident even at a young age when at Jaycees, he was recognized as a high achiever. The topic of the session was “Investing in India: New investment opportunities and challenges”. But as Mr Shah mentioned, it might well have been titled: ”New investment opportunities for New investors in New India”.

The investment hypothesis

India at 75 is young and agile. The country has become an attractive investment destination and an exciting period of growth lies ahead. We are the only large economy (GDP of about $ 3 tn) with a huge population (of about 1.4 billion) and a sub middle per capita income (of about $ 2000). There is no reason why we cannot become a $ 5 tn economy (and subsequently $ 10 tn) and take the per capita income to $ 10,000 over the next few years. With this kind of a journey ahead of us, there are large and attractive investment opportunities. We can also draw comfort from the fact that China went through a similar journey from the late 1970s to about 2015 driven by its large population, economic reforms, and foreign direct investment. The US also traversed the same path from about 1950 till 1990.

The three Ds

Three Ds, Demographics, Digitization and Decarbonization will shape and redefine India’s economic landscape over the next few years.

Demographics

With a population of 1.4 billion, the majority being under 30, rising incomes and growing aspirations, India has a structural growth opportunity for a range of consumer-oriented businesses.

Consider kitchen appliances. The largest Indian company in this sector has an annual revenue of Rs 2500 crores. India has some 25 crore households which means there is scope to expand the market multiple times. Currently, there are about 140 mn air travelers in India. This number may well go up to 700-800 mn in the next few years. Mr Shah feels that many consumer businesses in India can grow 5 times over the next 10 years.

Digitization

Thanks to the pandemic, the adoption of digital technologies has accelerated. If Aadhar and Jio set up the foundation for digital business models, the pandemic has accelerated the trend towards digitalization.

Many frictions in setting up new businesses have been removed. Before the pandemic, it would have taken a lot of effort to set up an all-India business. But with online channels available today, this can be done very quickly.

Digitization has also created a great start up environment. Digitization has helped the government in running targeted social welfare schemes in which the beneficiaries can be identified clearly, and money sent directly to their bank accounts. Many businesses have moved online following the pandemic. Individuals too have embraced digital channels in various spheres of life including ticket booking, hotel booking, ordering groceries and purchasing medicines. Indeed, we could not have lived through Covid, without the help of technology.

Decarbonization

The third big trend is decarbonization. This is a must if we want to safeguard the interests of future generations. There will be attractive investment opportunities in renewables and clean technology. Ideas that will improve energy efficiency will attract investments.

During the Q&A, Mr Shah explained that the three Ds will drive a major socio-economic transformation, affect various sectors of the economy and help the formation of new businesses. When it comes to IT, India has so far been an exporter of IT services (about $ 200 bn) currently. Going forward, we will also become a major consumer of software. Many SaaS startups are being launched in India. The technological transformation will also affect various industries like insurance and banking. The three Ds will also give a boost to agriculture and manufacturing. New industries such as ready to eat foods (as more and more women join the workforce and spend less and less time in the kitchen) will take off. The government’s PLI (Production Linked Incentives) scheme will also be an enabler. Many Indian companies will have opportunities to integrate themselves into the global value chain. Companies which can leverage the potential of the huge Indian market as well as the global market will do well.

Summing up

Mr. Shah summed up the situation with the help of some useful statistics. In a country of 140 crores, there are only 10 crore demat accounts and less than 5 crore mutual fund accounts. The per capita spending on general and health insurance is only $ 20 against a global average of $ 400. In short, there are exciting investment opportunities in various sectors including consumer goods, infrastructure, financials, healthcare, precision manufacturing and clean energy. These investments will come in various forms: the secondary markets, IPOs, private equity, venture capital, fixed income.

(During the Q&A session, Mr Shah spoke in more detail about the hospitality sector. While it is a very attractive sector, the tech companies within the sector are better positioned. They operate with an asset light model and are focused on understanding and attracting customers. The traditional capital-intensive hotel chains are at a disadvantage as their businesses tend to be cyclical and get into trouble during recessions.)

Q & A

On the importance of infrastructure

Investment in infrastructure is a must for global competitiveness. India’s manufacturing sector (especially when compared to China) has struggled due to the high costs of capital, power and transportation. While the cost of capital has come down in recent years, significant investments running into hundreds of billions of dollars are needed in areas like rail, roads, and power. A major part of this investment may come in the form of FDIs. But foreign investors may also have opportunities to acquire existing infrastructure assets in the current asset monetization program of the government. These assets can be managed more efficiently, and a lot of value unlocked. All these investments will also lead to substantial job generation.

On dealing with income inequality

Mr. Shah felt that the main problem is the large section of the Indian population engaged in agriculture and earning low incomes. The farm sector accounts for about 50-60% of the population but only 15-18% of the GDP. The per capita income of people in agriculture is thus substantially below the average per capita income of $ 2000. Moreover, with growing literacy and awareness, the younger generation may not like to work in the farms.

All this means that we have to manage and enable the shift of people from agriculture to manufacturing but without reducing the production of crops. We must try to improve agricultural productivity using science and technology. The use of better seeds will enhance good production while greater mechanization will free up people currently working in the farms. If our manufacturing sector keeps growing and provides livelihood for these people, income inequalities will come down significantly.

On fixed income vs equity

In case of fixed income instruments, the upside is completely defined and there is no downside. These are safe investments with guaranteed returns and investment decisions are made with basic information. The returns for such instruments will in general cover inflation.

Equity is risk capital with no clearly defined upside. The purpose of equity is to beat inflation. Publicly traded shares tend to be volatile. This can create fear and panic in the minds of investors. But we must learn to draw a distinction between volatility and risk. Volatility refers to short term fluctuations in prices. Risk is the possibility of a permanent damage to capital. Even though equity looks risky, over a long period of time, it is rewarding. Investors who have longer time horizons of say 5 years and beyond have generally benefited from stock market investments.

On gold

Mr Shah made it clear that he is not an active supporter of investing in gold. Not only are investments in gold speculative but gold as a commodity has no economic value. India is heavily dependent on imports for its gold requirements. We buy gold from foreigners and pay them in dollars. These dollars come back to the country in the form of FII and generate much higher rate of returns in the equity markets. In a manner of speaking, we are subsidizing foreign investors. Gold is at best, a store of value. Financial assets are far superior to gold.

On fear and greed

To be successful investors, we need the information edge, analytical edge and behavioral edge. We should have all the information we need and also know how to process it. But without the right behaviors, we cannot succeed as investors. To make sure that our biases don’t lead us in the wrong direction and emotions do not overpower economic logic, we can try the following approaches:

• Put in place a well thought out asset allocation plan, ie the mix between equity and fixed income.
• Follow a systematic investment plan that protects us against fluctuations in the market.
• Diversification: Avoid concentration and spread the investment across companies and sectors.

On the pricing of IPOs

Are our IPOs overpriced? Mr Shah explained that valuation is both science and perception. It would be wrong to say that every IPO is overpriced. At the same time, it is true that among the various IPOs which we are seeing these days, some have a moat with a clear value proposition while others are also ran. The market is trying to differentiate between companies which will remain relevant in the long run from the others. For those companies which will have a competitive advantage in the long run, the markets are prepared to pay a premium.

We must also remember that it is difficult to value the tech companies using the traditional lens and metrics such as P/E. These companies are focused on growth and onboarding customers rather than generating profits. If for old age businesses, the focus was on using the balance sheet to create capacity, for the new age businesses, it is about using the P&L to acquire new customers.

On identifying investment opportunities

We must be clear about our investment horizon. Multibaggers (stocks that give several times returns over their investments) are a short to medium term phenomenon. Compounders (steady returns year after year) are a long-term phenomenon. Over the long term, as their returns compound, such companies turn into multibaggers. A steady 25% rate of return year after year will lead to 100X over 20 years.

Digital is both a creator of new businesses and destroyer of existing businesses. We must ask the question whether the business will be able to survive and preserve value in the long run, especially against the backdrop of digital disruption. We must examine the growth potential. We must check whether there are large and underserved, market opportunities. The ambition, agility and ability of management should also be key considerations while making investments.

On REITs

Real Estate Investment Trusts represent an additional investment opportunity. They are like high yield bonds. Till recently, these instruments have been traded in markets which lacked depth. But over the next 5-10 years, the markets will become deeper and wider. It may be worth participating.

On crypto

Equity and fixed income will remain the asset classes. Crypto can at best hope to become another asset class. It cannot supplant fixed income and equities. For crypto to become a preferred asset class, regulation is necessary. Unregulated markets are not good for the investors and the economy.

On risk assessment

Risk refers to the permanent loss of capital. Our ability to assess risk improves with experience. While risk assessment is both an art and a science, asking some basic questions can help:

• How vulnerable is the business to regulation, technology, consumer behavior? How good is the management?
• Are high standards of corporate governance being followed?
• How is the balance sheet? Is it leveraged or cash rich?
• How is the valuation? Are we overpaying for the asset? It is important to understand the difference between the value of the business and how much we are actually paying to acquire it.

On timing the market

Mr Shah is not a believer in timing the market. For a good asset, any time is a good time. More than timing the market, what is important is the time we spend in the market. In the short term there will be volatility, but if we remain invested for long periods of time we can benefit. We should be bottom up investors looking at the merits of the specific instrument. We should think macro but act micro.

On the ARIMA model

ARIMA is an analytics (machine learning) tool based on time series forecasting. While such tools are useful, they cannot be used to predict prices with complete accuracy. Investment is both art and science. The behavioral dimensions are difficult to incorporate in AI based models. Even successful tech startups like Zerodha realize the limitations of AI.

We thank Dr. Vedpuriswar for bringing out the highlights in the form of this note