Saurabh Mukherjea's Bold Move: Will it Deliver?

No other fund manager has attracted as much scrutiny as Saurabh Mukherjea in recent times.

And as the stock market pendulum has swung wildly from the depths of the Coronavirus crisis to one all-time high after another, so have Mukherjea's fortunes.

Surprisingly though, his fortunes have moved in the opposite direction to those of the stock market.

Mukherjea took the fund management industry by storm when he launched his Marcellus fund more than half a decade back.

His interesting narratives backed by in-depth research and solid due diligence, endeared him to his investors and the fund was off to a great start.

The fact that he had already authored some best-selling investment books, also boosted his credentials.

Hoping that his deep wisdom and his sharp insights would translate into an outperformance of a significant magnitude, investors made a beeline for his fund.

The first few years went as per the script. Consistent Compounders or CCP as it is popularly known as, was the fund house's very first offering. Within 3 years, it had outperformed the benchmark index by a significant margin.

To put things in perspective, the CCP had racked up an impressive CAGR of 27% vs the 17% earned by the comparable benchmark Nifty, at the end of the three-year period. This is indeed a huge outperformance whichever way you look at it.

However, things started going downhill since then and as they stand today, CCP's 16.6% CAGR since inception is in fact neck and neck with Nifty's 16.63% returns.

Put differently, Nifty has covered all the lost ground in the period since December 2021 and has effectively turned the tables on Saurabh Mukherjea's flagship fund.

And if this wasn't disappointing enough, Marcellus' two other funds viz. Little Champs and Rising Giants, are also gasping for breath.

Little Champs, which invests primarily in Smallcaps, has found the going tough against the BSE 500 index. Its 17% CAGR in a little under 5 years, lags the 22% earned by the benchmark.

Rising Giants, the fund that specialises in investing in mid-sized companies, is no giant in terms of performance so far.

Just 2.5 years old, the fund has given a negative return of 1.8% since inception in December 2021 versus 20% CAGR earned by the comparable benchmark. The fund has found it hard to even put up a positive performance so far.

So, that's a below par performance across all the three funds if you ask me.

In a recent interview with Mint, Mukherjea has thrown some light on the reasons behind this underperformance.

• Having lived through events like the 2G scam, coal-gate scam, IL&FS and the 2020 covid crash, perhaps we had gotten too defensive.
  
  We focused too much on companies that had a high ROCE even if they weren't growing very fast. Since covid, however, a set of smaller 'challenger' companies have outperformed.

Hmm...although I haven't looked at all the stocks that Marcellus has held over the years, I did look at a few of them. And here's my general impression.

Mukherjea argues that the performance was not as per expectations because the portfolio companies did not grow fast enough.

I believe that the fund's below par performance has to do with buying good stocks instead of good investments.

Let me repeat that. Marcellus focused more on buying good stocks instead of good investments.

You see, even an average quality stock can be a good investment if you buy it at the right price.

However, even the best quality stock can turn into a bad investment if you do not insist on an adequate margin of safety.

Now, margin of safety is one of the most important concepts in investing and also the most misunderstood in my view.

You see, we humans are prone to making mistakes, especially when it comes to predicting the future. Also, the future itself is uncertain and can throw up nasty surprises.

The concept of margin of safety is to protect us from our own errors and from the uncertain future.

So, if we have a big margin of safety net, then a miscalculation on our part or a negative surprise in the future, may not cause a big dent in our portfolio. It saves us from big losses.

Now, a lot of investors do not believe in having a sufficient margin of safety. They argue that their superior judgement and deep analysis are in themselves a margin of safety.

They believe that the future will turn out exactly as they have predicted. Hence, they will earn market beating returns.

In other words, they focus only on the upside potential and forget to minimise the downside.

However, as we have often seen, the future does disappoint us from time to time.

Our skill and talent fall short, and the companies in our portfolio don't grow their profits as expected. This leads to declines fall in the stock prices, creating a strong possibility of underperformance.

When I looked at some of the stocks that Marcellus had bought, I did see a lack of a sufficient margin of safety.

It was as if Marcellus was relying on superior skill and judgement and did not worry too much about the consequences of a lower-than-expected growth.

Well, as per Mukherjea's own admission, the growth did come lower than expected and as a result, most of the funds ended up underperforming the benchmark index.

Therefore, not overpaying for growth and insisting on a sufficient margin of safety is one big lesson that one can learn from the underperformance of Marcellus.

Now, coming back to the present, it looks like Saurabh Mukherjea and Marcellus are on a mission to turn around the performance of their funds.

They undertook a massive data crunching analysis recently, and from which emerged a few surprising insights.

As per moneycontrol.com, when financial information on 30,000 listed and unlisted entities were fed to the computers, it emerged that the smaller companies or 'challengers' emerged as the fastest growing segment of the 10-year period between FY12 and FY22.

In fact, by snatching market share away from small unorganised players, they even raced ahead of their larger counterparts.

Well, I won't go into the details but suffice to say that the insight from this study, seems to have forced a shift in the investment strategy at Marcellus.

In fact, if the May 2024 update from Marcellus is anything to go by, the shift has already happened.

Here's an excerpt from the update...

• Over the last 12 months, CCP underwent a significant increase in allocation to companies (from 10% previously to over 50% currently) which have seeded new business optionalities through capital allocation decisions over the last 3-5 years.
  
  These new business optionalities are expected to add incremental revenue growth drivers over the next 2-3 years, thereby helping accelerate the overall company's earnings growth to well above 20% CAGR (in some cases, even higher than 25% CAGR).

CCP, the flagship fund of Marcellus, has undergone a significant shift.

Allocation to companies that have launched new 'challenger' businesses has gone up from 10% to 50%. These businesses are expected to grow significantly going forward as per Marcellus and this will then translate into rising share prices of these companies.

Trent Ltd, which has launched Zudio is a great example of this.

As per Mukherjea's study and channel checks, Zudio has snatched market share away from the unorganised sector and is growing at a much faster pace than some of the large companies like Page Industries in this space.

Thus, the idea is to buy businesses that have started these new divisions, which are helping the overall business to grow at a faster pace.

Well, this does seem like an interesting strategy and certainly there is data to back it up.

Hence, the million-dollar question is whether Mukherjea and Marcellus would be able to turn the ship around and bring it into a higher growth path? Will the new strategy work wonders?

If I were to look at the kind of companies that the fund has added in recent times, it seems to be again a case of trying to look into the rear-view mirror instead of the windshield.

Companies like Trent, Astral, Cholamandalam, and Eicher Motors, are all great quality companies no doubt but I don't get a strong feeling that they're also good investments.

Put differently, these stocks again seem to have very little to no margin of safety. This is not to say their price won't go up from here. They certainly can. However, any negative surprises and the downside could be significant.

Please note that I'm not saying that the funds of Marcellus are not worth investing in or may continue to underperform. Who knows? The change in strategy could work wonders for them.

What I'm trying to arrive is that as a value investor, I'm uncomfortable paying such high PE multiples, and as a result, settle for very low margin of safety, no matter how good the quality or how strong the growth prospects.

I'm more a believer that one should insist on a certain margin of safety. And this limit should not be breached. This habit keeps you from overpaying, which is one of the major reasons why a lot of investors underperform.

Even in the case of Marcellus, overpaying and keeping a low margin of safety, proved to be their waterloo.

It remains to be seen whether they course correct or continue to ignore valuations in favour of quality and growth.

Happy Investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)