Ashmayu Quarterly Newsletter- Story of the year

Dear Investor,

For the past four years, it has become tradition for me to pick a ‘story of the financial year’ . The idea is to not simply take stock of the year but drown out the noise in order to identify the story that truly leads to a paradigm shift in our world. On March 31st 2019, I wrote:

“Narratives and stories drive investment outcomes in the short run. For the most part, they provide us with shock therapies with complete elasticity. The effect of the story is felt temporarily and over a period of time we are back to business as usual. Yet there are few stories that alter the course of business and cause a structural shift. As an investor with the intent of long term wealth creation, we need to ignore the stories with elasticity as noise and focus only on those few that create a change bringing about a new or an enlarged addressable opportunity. “

In March 2019, we picked the surge in Active Ingredient (AI) and Active Pharmaceutical Ingredient (API) manufacturing in India due to firms wanting to indigenise supply chains as well backward integration in pharmaceuticals, chemicals and agrochemicals as our story of the year. March 2020 sitting a week into the pandemic we chose the corporate tax cuts as the story of the year and not covid. March 2021 we gave a clarion call for advances in sciences- specifically in biology; just as the decades post World War II belonged to advances in physics.

Last year we cited a tie between India’s largest olympics contingent defining the aspirations of a nation and ability to pursue those on a global stage; and the return of Air India to the Tata fold symbolizing the ability our regulators have shown to bow out and let private enterprise flourish.

What happened in FY23?

The reversal of liquidity to the first photographs published from the James Webb telescope- there were quite a varied spectrum of headlines that were in contention for the story of the year.

Year of Tightening

From the perspective of global markets, it was the year of tightening. The Fed initiated a cycle of rate hikes starting with the 0.25% in March- the first hike in three years! What has followed has been the steepest tightening cycle by the Fed since the 1970s.

This sharp increase led to a steep inversion of the yield curve that has created a duration risk (short term deposits commanding a higher rate of return vs. the 10y treasuries in which money is parked) in many small/ regional banks in the US. The collapse of the Silicon Valley Bank caused panic around the world for it was the first case where investments in safe treasuries did the bank in.

The tightening cycle has caused a rationalization of valuation multiples across the board. Some may argue that this is a paradigm shift in investing as multiples compress and the era of ‘free money’ is over. Yet this is merely the nature of the economic cycle. Every tech boom sees multiples expanding that ends with inflation + recession leading to a correction in valuation multiples. Every cycle takes down with itself a financial institution or two. This merely proves the cycle and that over a long run, things always revert to a mean.

Floods in Pakistan

Another contender for the story of the year was the havoc wrecked upon our neighbors via devastating floods. 33,00,000 people were displaced. 9,00,000 homes were destroyed. 13,000 people were injured. 1,800 lost their lives. Economic damage worth over $15bn was endured. This has plunged Pakistan into a state of emergency. Some argue that an unstable Pakistan is dangerous for India, others argue the opposite citing the focus of the nation and its forces to be diverted. Both sides talk of a structural shift in our relations with the country when there is none. India- Pakistan have always been quarreling siblings. Interactions between citizens of the two countries in a foreign land are like a warm family hug. Yet at home we fight. While we hope peace prevails, and our neighbors tide over this calamity, it hardly impacts how we will interact with each other in the future. Siblings always have a way of getting back into their pattern.

James Webb Telescope

Zooming out of regional conflicts, NASA revealed the first full color images taken by the James Webb Telescope in space.

Seeing this vivid photograph of stars being born at the edge of the Nebula made it to my shortlist of stories for the year for it made me realize how inconsequential we are in the grand design of things. Yet I am overcome with the same thought every time I enter a bookstore- us and our knowledge is a tiny speck in the universe and there is so much more that we don’t know. No shift in thinking here either.

Passing Away of a Legend

Our limited time on the planet was further emphasized upon by the passing of India’s big bull- Rakesh JhunJhunwala. A home grown investor that demonstrated to us the power of conviction, of holding on and that instilled in domestic individual investors a passion for investing in India- the land of opportunities. In hindsight, I would herald the year he joined the markets as a point of paradigm shift for showing us the power of compounding. His passing immortalized his philosophy.

Role Reversal

‘Qismat ki hawa kabhi naram, kabhi garam’- if we were brought down by the passing away of a legend, there was an elation among us as a person of Indian origin became the Prime Minister of UK and as India overtook UK as the 5th largest economy in the world. This however wasn’t a structural change, simply a matter of time kind of story coming to fruition.

Story of Year Fy 23

If I cannot decree that an Indian ruling in the name of the British Sovereign is the story of the year, then what else can be so ‘power packed’? Energy Sovereignty.

In July 2022, the Nord Stream 1 pipeline, that carried natural gas from Russia to Europe was shut down for ‘maintenance’. European power is highly reliant on gas powered turbines which are in turn highly reliant on these imports from Russia. This supply shock in energy (and not ESG concerns) has forced everyone to consider heavy investments in alternative sources of power.

Germany was to phase out their 3 functioning nuclear power plants by the end of 2022. This was a decision signed into action by Angela Merkel in 2011 in the wake of the Fukushima crisis in Japan. Yet when met with this Russian supply shock, the German Chancellor extended the lives of these reactors.

A couple of weeks ago France voted in favor of a significant investment plan to grow its nuclear power base. The French will be investing up to 52bn euros to build 6 new reactors in France.

In India, solar installations are at an all time high and promises of scaling wind installations to 8GW every year as well as delivering hydrogen at $1 per kg seem to be shaping up. Combating our significant crude import bill as a nation, Indian 2W and PV has seen significant step up in EV volumes spurred by government incentives.

It is for this shift in mentality that our story of the year is, ‘Russia turns off gas flowing to Germany via Nord Stream1 undersea pipeline’. For years, ESG funds and environmentalists have tried to incentivise decarbonisation. Yet it took the powerful supply side shock to deliver the impetus to bring this mainstream. It is estimated that the annual energy investment globally will scale up to $5 trillion by 2030- adding 0.4 percentage points to global GDP growth. If the previous significant government expenditure by the west was done during the second world war and post the war in building physical infrastructure- especially highways, this time around it will be dominated by energy.

This significant investment opportunity brings with it a threat to many existing businesses. Businesses that do not comply with this desire for energy sovereignty, have products for example in India that put a levy on India’s crude import bill- will phase termination at some point. Many such companies may see their terminal value closer to zero now vs. what was previously estimated- a significant structural shift.

As we evaluate opportunities for investment, this has become an overarching reality that we want to represent in our portfolio- both by the companies we choose to include and those we choose not to despite how great the short term looks like.

As always, we thank you for putting your faith in us. Wish you a very happy and prosperous FY24!

Happy Investing!

Best,
Harini Dedhia
Head of Research and Portfolio Manager