Market Microstructure in India – A stock picker’s market

In a market like today, as we stand in December 2020, one of the often-asked questions revolve around the ‘market’ and whether we are in an overheated environment as far as sentiment goes. While the genesis of the question is understandable, in an environment when the ‘market’ (proxy for this in India is Nifty or the Sensex), is at all-time highs, its important to take a step back to understand what has happened over the last 2.5 years and explain the same with data.

It may not be intuitive, but the Nifty has been at the same level as of August 2018 and as of October 2020 (around 11,600). So while the headline market has broadly been at the same level for a little over 2.25 years, there has been underlying growth in many companies and sectors. It’s important to understand that while the levels seen in the market between these years has been between 7,500 and 12,000 – the more important aspect for us as a fund manager studying individual companies is to understand the performance across sectors and market caps.

In this exercise, we restrict our analysis to the top 500 stocks in India, by market cap and look at the growth across sectors and specific companies in the same period where the market was volatile but the market levels were the same between the two periods (meaning, the index generated 0% return on an absolute basis, but we want to be translating the same into single stocks and see how portfolios could or may have performed.)

1. Pharma

We start our analysis with the most talked-about sector, Pharma. It’s interesting to look at the dichotomy and variance of returns across pharma between the various segments of the market. The below table shows that understanding the company and the business played a key role in the performance of the underlying companies rather than a generic statement that all pharma companies did well.

2. Auto

While Auto has had a hard 3 years as a sector, select companies in the ancillary space have managed to show growth even during these times, which comes through in the performance of the companies across market caps. Within Auto, there continues to be a significant divergence in shareholder returns due to the growth in underlying businesses not coming through.

3. Chemicals & Speciality Manufacturing

The manufacturing-based chemical businesses have had a solid growth over the last 2 years predominantly coming from prudent capital allocation and a demand led growth. What’s interesting here again is the choice of company in the portfolio has driven bottom-line shareholder returns.

4. Consumer Goods

While the growth from a revenue and PAT perspective was prominent in consumer goods, there was a wide dispersion in the returns for the shareholder across companies, depending on the bucket one analyses. Most of the gains came from large and mid companies which showed steady revenue and cash flow growth in this sector too, rather than returns across the board.

5. Financial Services

The importance of risk management and stock selection cannot be more emphasized than when one studies the financial sector. Across the market caps, we saw value accretive and value-destroying companies to the shareholder, which reemphasizes the promoter integrity and capital allocation importance in this sector

6. IT / Technology

The tech stocks in India had a good performance more skewed towards the large and mid-cap companies. There were consolidation and growth in market share in specific pockets within the tech sector that reflected in the performance.

While the index (Nifty) was flat over 2+ years, individual securities had significant outperformance across sectors and market caps. The performance was not limited to a narrow range of 5-10 stocks either. As we move ahead, the important question to ask for investors continues to be, how your portfolio is constituted rather than where the ‘market’ is going, or where the index is?

Increasingly the role of a fund manager in constructing a good quality portfolio will become more relevant in the next few years.

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