Ashva Capital Management commentary for the first quarter ended March 31, 2018.
Dear Limited Partner
In his book, The Six Pillars of Self-Esteem, Nathaniel Branden states that “living consciously implies that my first loyalty is to truth, not to making myself right. All of us are wrong some of the time, all of us make mistakes, but if we have tied our self-esteem (or our pseudo self-esteem) to being above error, or if we have become over attached to our own positions, we are obliged to shrink consciousness in misguided self-protection. To find it humiliating to admit an error is a certain sign of flawed self-esteem.” Similarly, a fund manager’s performance should be measured against that of the broader market to ensure that he is prepared to assess his skills and abilities in an objective manner.
In my view, a fund manager must measure his performance in absolute terms. If I’ve generated positive returns over and above the rate of inflation, then I’ve done my job. However, as an investor you must be keenly aware of the next best alternative for your funds. For the vast majority of our limited partners the next best alternative would be a broad based Indian index fund. Even Buffett himself has advised that upon his death that the executors of his will place 90% of the funds given to his wife in an index fund and the remaining 10% in a bond fund. Ideally you invest with a fund manager who is capable of outperforming the market or the next best alternative is to invest in an index fund. Thus, as an investor you want to benchmark your fund manager’s performance to determine whether or not he’s adding value. I will add only one caveat that you should measure this performance over at least a three year and preferably over a five-year period before making the call that the fund manager has either outperformed or underperformed.
Ashva Capital Management - Which Benchmark to Use?
In the 2017 annual letter, I stated that the Nifty 50 index could be used as an acceptable benchmark. However, all our Limited Partners are based outside of India and the fund itself is denominated in USD. Since the Nifty 50 index is denominated in INR it’s not the most accurate benchmark because it will fail to account for changes in the USD/INR exchange rate. Thus, the appropriate benchmark should be denominated in USD. Additionally, the Nifty 50 index is comprised of solely large cap companies. The MSCI India index is a better benchmark since it was designed to capture both the performance of the large cap and mid cap space in India. With 79 constituents the MSCI India index covers approximately 85% of the Indian equity universe. Furthermore, the MSCI India Index has a version denominated in USD, which provides a more accurate performance comparison relative to the Ashva Capital LP fund.
Finally, an investor can’t actually purchase an index. If an investor wanted exposure to the MSCI India index they would have essentially three options: 1) Replicate the entire index in their personal portfolio, 2) Purchase an index fund or 3) Purchase an index ETF. Option 1 isn’t feasible due to the costs and complexities involved. Option 2 and 3 are perfectly viable alternatives and both are cost effective. For benchmarking purposes an ETF is traded on an exchange and thus pricing data is more easily available. The largest foreign India focused fund is the iShares MSCI India ETF, which had USD 4.9 bn in assets as of June 15, 2018. In my view, the appropriate benchmark for our Limited Partners is the iShares MSCI India ETF as it tracks the MSCI India index and is denominated in USD. The ETF also charges a management fee of 0.65%, which would be an apples to apples comparison relative to the net performance of the Ashva Capital LP fund.
As of March 31, 2018 the Ashva Capital LP fund is down (5.46%) year-to-date. In comparison, the iShares MSCI India ETF is down (5.38%) year-to-date. Thus, our performance in 1Q18 has been in-line with that of the broader market.
The Outlook Ahead
The downturn in the market has been driven by a number of fears that center around macro and political risks. On the macro front rising interest rates remain at the forefront of investor concerns. How many times the US Fed hikes interest rates in the remainder of 2018 is unknowable. However, the Fed has made abundantly clear that all decisions will be “data dependent.” The main risk investors fear is that an over-aggressive Fed hikes short-term rates above long-term rates and inverts the yield curve. The spread between the 2-year and 10-year treasury note is now 45 bps. Thus, the yield curve is now the flattest it’s been since the Fed began hiking rates in December 2015. An inverted yield curve is a trusted leading indicator of recession. Fortunately, the yield curve remains positive, which implies that the current nine-year expansion will continue. The time to become defensive will occur when the yield curve ultimately inverts.
In my view, the Indian market is attempting to digest the risk of an upset in the upcoming 2019 general elections. I expect the recent volatility to continue as we run-up to the elections. As a result, we’ll continue to maintain our strategy of owning high quality businesses that generate ample positive free cash flow. Finally, the recent short-term volatility shouldn’t detract from the positive long-term growth trends of the Indian economy.
Nathaniel Branden emphasizes that the first sign of becoming an adult is the ability to deal with objective reality. Benchmarking is the best way for a fund manager to determine his effectiveness. Following a high-quality investment strategy requires patience as the power of compounding works over time. I’m not thrilled with the fund’s 1Q18 performance, but I remain hopeful for the second half of the year.
Ashva Capital Management LLC