marcellus Investment Managers

At Marcellus, their purpose is to make wealth creation simple and accessible by being trustworthy & transparent capital allocators. Marcellus has evolved from the ideas of Kirby and Thiel, which they have refined further. Their investing approach has 3 pillars: Clean Accounts , Capital Allocation, Competitive Advantage They look for companies with superior track record of capital allocation and love companies that generate free cash flows and reinvest them in the business to fuel further growth.Their experienced investment team through its in-depth primary research constructs a portfolio of companies with deep competitive moats.Their quantitative frameworks which use a combination of forensic accounting and capital allocation assessment define Their investible universe

THE SOLUTION : MARCELLUS ‘CONSISTENT COMPOUNDERS’ PORTFOLIO

Marcellus’ experienced investment management and research team led by its Chief Investment Officer, Mr. Saurabh Mukherjea, uses a combination of a filter based approach and indepth bottom- up research of companies to build a portfolio that delivers such outperformance through compounding over long periods of time.

The power of a filter based portfolio: We create a list of stocks using a twin-filter criteria of double digit YoY revenue growth and return on capital being in excess of cost of capital, each year for 10 years in a row. Next, we build a portfolio of such stocks each year and hold each of these annual iterations of portfolios for the subsequent 10 years (without any churn). The bar chart below shows the backtesting performance of such a filter based portfolio.

Source: Bloomberg. Note: Only the Consistent Compounder Portfolios which have finished their 10 year run have been shown. Note: These are total shareholder returns.

There are two conclusions from this exercise

This filter based portfolio delivers returns of 20-30% p.a. and 8-12% outperformance relative to the Sensex*.
The volatility of returns of such portfolios, for holding periods longer than 3 years, is similar to that of a Government Bond

THE POWER OF A FILTER BASED APPROACH

Unique DNA of these companies: By “filtering in” companies with a history of very consistent fundamentals over very long time periods, the portfolio is skewed towards companies with a DNA built around relentlessly deepening their competitive moats despite disruptive changes taking place both inside as well as outside the organization. More often than not, such DNA sustains over the subsequent 5-10 years’ investment horizon of the filter based approach.
Power of compounding: Holding a portfolio of stocks untouched for 10 years allows the power of compounding to play out, such that the portfolio becomes dominated by the winning stocks while losing stocks keep declining to eventually become inconsequential.
Avoiding the pitfalls of psychology and reducing transaction costs: Being patient with a portfolio helps cut out ‘noise’ of trying to time entry / exit With no churn, this filter based approach also reduces transaction costs. Consider two data points: (a) In a portfolio with 70% churn (average churn of large cap mutual funds), 20bps broking cost and 30bps impact cost, churn reduces the terminal value of the portfolio (after 10 years) by 10% (i.e. a drag of 120bps on the 10-year CAGR); and (b) deferring the 10% long term capital gains tax payable on the portfolio by 10 years enhances the terminal value of the portfolio by 8% (i.e. 100bps increase in the 10-year CAGR) vs a portfolio where capital gains are paid each year.

HOW DOES THE FUND MANAGER ADD VALUE ?

The Consistent Compounders Portfolio combines our deep-dive stock-specific research with the benefits of the filter-based approach explained above, to help generate outperformance of 2-5% per annum over and above these filter-based portfolios. This is achieved via three different types of interventions:

Portfolio concentration: The filters might give a longer list of stocks (sometimes as high as 20) which dilutes the reliance of the portfolio on outstanding companies. We use manual intervention to produce a more concentrated
Excusable blips in historical fundamentals are forgiven: For example, Nestlé’s Maggi episode ensured that revenue growth of Nestle India dropped below 10% in FY15. Similarly, the fall in crude oil prices to below US$30 per barrel caused a 6% product price cut by Asian Paints in FY17 which led to its revenue growth dropping below 10% YoY in FY17. Manual intervention in portfolio construction analyses the nature of these blips and might include such stocks in the portfolio
Ignorable consistency in historical fundamentals: Many housing finance companies (HFCs) which form part of the filter-based portfolios, are examples of 10 years of consistent fundamentals delivered due to unsustainable macro tailwinds for the HFCs from low cost money market funding and a booming real estate market in the country – neither of which to our mind is sustainable