Marcellus PMS Funds are underperforming because market is undervaluing longevity of great businesses

Saurabh Mukherjea has been facing heat from investors due to the underperformance of the various schemes in the Marcellus PMS Funds.

Some contemptuously claimed that he has been able to collect large sums for his PMS Funds due to his "amazing vocational ability" which has "absolutely nothing to do with performance".



However, many did come forward in defense and argued that his performance cannot be measured in short time frames but require a full cycle to be completed.

In his latest newsletter, Saurabh has fairly admitted that his PMS Funds are underperforming the Benchmarks.



He has explained that these are "quality companies" i.e., companies with clean accounts, sensible capital allocation across long periods of time and dominant franchises (which can charge product prices 20-40% higher than the competition without any loss of market share). These companies have, over the past 12 months, produced healthy results. However, their share prices have corrected as investors, especially FPIs, have taken fright at the scary macro situation in the West, the never-ending lockdown in China alongside the war being waged by Russia.

He has emphasized that (a) the competitive advantages of these investee companies have not been impacted either by the Federal Reserve’s rate hikes or by Russia’s war in Ukraine or by Xi Jinping’s policies; and (b) simple calculations show that investors will make more money from staying invested in these outstanding franchises (than from investing in other stocks which optically look cheap).

Saurabh has given specific examples of specific stocks such as HDFC Bank, Dr Lal PathLabs, GMM Pfaulder and Amrutanjan from the Marcellus portfolios.



He explained that because of the competitive advantages, the investee companies are able to grow their revenues and profits consistently faster than the broader market. The share prices reflect, in part (and only in part), this superiority.

Saurabh cited the example of Divis Laboratories which has been trading at ~40x earnings in 2018/19 thus reflecting market’s view that Divis’ high growth period of 20%+ would last only for the next 5-6 years (and fade-off thereafter). However, given the kind of extended growth runaway available to the company from its dominant position in the pharma API segment and given the immense growth opportunities available from API manufacturing shifting out of China, the share price quoted underestimates the potential length of high growth period available to Divis. Increasing the length of high growth (20%+) period to just 10 years (vs the 5-6 years expected by market) implies an intrinsic fair value P/E for Divis which is ~50% higher than what the stock is trading at, he says.

"Therefore, the reason we are able to buy these great companies without paying share prices which FULLY REFLECT THEIR SUPERIOR COMPETITIVE ADVANTAGES is because the conventional three stage DCF employed by most investors tends to undervalue the longevity of a great business. Given the depth of research and conviction required to hold such a view (regarding an extended high growth period), most investors seek comfort within a narrow band of P/E multiples. We thank them for doing so because that gives us the opportunity to continue compounding our clients’ wealth at a brisk rate," he has concluded.