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Carnelian Update – Completing 1st Year of our Journey

Updated: Oct 9, 2022

Dear Carnelian family

Trust you and your family are keeping well.

We are glad to share with you that we have completed the first year of our strategy and it’s time to thank, reflect back and plan forward.

Foremost, we would like to thank all our investors, channel partners and consultants for being with us throughout this journey. Remotely did we think at the beginning of the year that it will turn out to be so volatile/uncertain - so much so to witness once in many generations’ kind of an event! There is no hand book to handle an event of this nature. Current crisis has stress tested both our business operations as well as our portfolio stocks which has significantly increased our conviction on both. We believe that organisations which can withstand current crisis without much damage to their balance sheet and competitive moat will eventually flourish and gain market share.

We started our capital raise in the month of May 2019 amidst uncertainty of the Indian elections. A big thank you to all our friends & investors for supporting/believing in us, even though none of us had a formal track record of investing third party money; we admire your conviction & faith. Your support helped us keep our head high! We started investing on May 31, 2019 when the markets were cheering Modi’s victory. Unfortunately, the cheering short lived and the environment worsened due to the brewing banking sector crisis. Over the last one year, the environment has been far from being kind.

What gives us satisfaction –


Our portfolio stocks stood through the stress test (refer our last newsletter) in both pre Covid-19 and post Covid-19 scenario. We did not have to sell a single stock worrying about their survival. On the positive side, many of the companies in our portfolio have already started gaining market share in the current crisis which reinforces our hypothesis – big will become bigger. The crisis has given us an opportunity to add some of large potential compounder to our portfolio. We have grabbed the opportunity by swapping few of our mid-cap names to large-caps with better risk reward metrics – “opportunity comes to prepared mind”. In our last month’s note, we have shared the various dimensions of our stress test. We believe our portfolio is well positioned to “ride-the-tide” when the environment turns around for the better; at the same time protecting downside, should it turn worse for an extended period.

Investment Philosophy and MCO framework has served us well in identifying opportunities while keeping our eye on risk-reward metrics.

Forensic capability has helped us avoid any accident so far and shy away from companies which could have either a governance issue or leverage issue.


We have built a good team of professionals who are passionate about investing and capital markets. They do this not only as day job/to earn a living but as a passion which drives them to excel. Every day we endeavor to learn something new that helps us better ourselves from yesterday. We work for passion and we work long term.


We have built a good organisation, though a small one. While building the culture is an ongoing process for firms of our scale, we have beautifully created an ownership driven culture encouraging open discussion and focusing on what is right rather than who is right.

Client and Distributors

We are grateful and happy to share that we have built a diverse client profile ranging from large family offices to marquee HNI’s. We are also happy to have partnered with leading distributors and independent wealth advisors who have added to our credibility and confidence.

What we are still working on & our learnings along the journey

Unsaid, we too had our moments of pressure when the markets were collapsing earlier this year and we had to hold on to our nerves. It is one thing to lose your money, however very difficult to lose other’s money. For the first time we felt the weight of the later. Even though we are outperforming, we don’t like losing money.

We could surely have booked our early gains when we saw signs of worry emerging in January 2020; despite having a strong opinion, however we are glad that we have taken cash level of our portfolio up to 15% as well as happy to see inherent strength of our portfolio stocks to withheld current crisis.While we have our set of misses, we take every miss as an addition to our learning curve.

As we move into our second year, we would like to reiterate some of our core beliefs which we think have helped us so far.

We believe investing success is an outcome of making good decisions consistently over a long period of time. Good decisions are those which are made “Objectively, Free of any bias”, considering “Probability of outcome” and factoring “Risk reward”. We are creating a culture of making good decisions.

We will continue to look for good businesses run by great managements at fair valuation. We are constantly looking for Magic moments in our target businesses.

We will continue to use and improvise our forensic capabilities and learnings to stay away from companies which do not qualify through our “CLEAR” framework. We would rather have an error of omission than commission.

Looking forward to having your continued support, blessings and patronage. We will be eagerly waiting your feedbacks, comments and suggestions

We would be grateful if you can take a moment to give us your valuable feedback.

Thank you.


We are a team with different but complementary strengths. We have known each other for the last 25 years and worked together for over 15 years. Vikas brings a rich experience of building & managing leadership businesses in the capital markets and has a multi-dimensional macro perspective on any given topic. Manoj’s deep experience of building research platforms with many pioneering products, brings depth and details to table. Sachin has a wide experience of building technology, risk and a compliance driven culture to the organisation, besides bringing a balance approach to discussions. Swati brings along a strong relationship-oriented culture to the organisation and adds to the calm, care & intuition.

To sum us up,

  • We work for passion

  • We work for long term

  • We have a culture of open criticism and free opinion


  • We believe investing success is an outcome of making good decisions consistently over a long period of time. We strive to make Good decisions. Good decisions are those which are made “Objectively, Free of any bias”, considering “Probability of outcome” and factoring “Risk reward”. We are creating a culture of making good decision.

  • We believe in investing in good growth businesses, managed by great managements at fair valuation. We have built a proprietary quantitative and qualitative model to filter out ideas.

  • We believe margin of safety does not necessarily lie only in price, but can be sought in detailed work.

  • We believe one can never make money on borrowed conviction.

  • We are happy to be contrarian when risk reward is compelling: mimicking herd = regression to mean

  • We believe in being patient and long term. Investing is like watching grass grow.

  • We prefer definite returns over immediate returns.

  • We don’t mind sitting on cash if we can’t find a better use.


Carnelian Compounder Strategy is a long-only, multi-cap, sector agnostic strategy, with an objective to generate sustainable alpha and compound capital over a long period of time through our unique MCO framework. The Strategy offers a unique & unconventional blend of Magic (accelerated growth), Compounder (stable growth) & Opportunistic companies.

Magic Basket

The Magic Basket aims at capturing earnings growth and valuation rerating. Investing into companies through a catalytic/ change oriented approach.

While the literal meaning of Magic is having supernatural power/qualities, however, in the Carnelian investing world, Magic moments are change/catalysts in the life of a company - when the company gets into a new growth trajectory, but not recognized by Mr. Market. Mr. Market starts recognizing them as the change unfolds over a period of time, leading to a valuation re-rating, thereby creating a significant wealth generation opportunity (a twin effect of growth and re-rating).

The catalyst can be either one of or a combination of change of management”, “change of industry/business structure”, “change of business strategy”, “new business product or segment” or “simply long investment phase getting over”.

Through our decades of investing experience, we have found that post such an event, companies usually deliver superior returns over a long period of time. Of course, one has to put in lot of hard work to get it right if these catalysts are well placed.

During our study we found that successful magic events, have created significant wealth by the combined effect of earnings compounding and valuation rerating. We have deep dived universe of 250 companies to back test our magic hypothesis and found that average returns generated 14% CAGR during preceding 5 years (prior to magic event) vs 63% CAGR for the following 5 years (post magic event). Even after adjusting for the failed cases where the magic event didn’t play out, this number goes down to 56%. Of course, one would not be able to capture all the opportunities all the time and there could be some survivor bias, but this framework helps in capturing great opportunities.

Chart 1- Returns for pre-magic and post-magic period for “Magic Companies”

Let’s study the case of TCS. TCS went public in 2005 and was growing for more than 3 decades as an unlisted enterprise. It grew well under the visionary leadership of Mr. Ramadorai. However, when Mr. N Chandra took over as CEO, he restructured the company into 21 business verticals and outlined a strategy to grow at a faster pace, to create India’s largest IT service company. TCS delivered a negative return of 6% between 2005-2009, In the following 5 years, TCS’s profitability grew from Rs 5,300 Crs in FY2009 to 19,300 Crs in FY2014 and in the same period the market cap grew almost 8x. Price to Earnings (PE) ratio expanded from 10 times to 22 times. This is the classic example of how multiplier effect plays when both earnings growth and valuation expansion kicks in.

Chart 2 – Market Capitalisation of TCS in post-Magic period

There are many such case studies. Another interesting case study regarding change in the Industry structure is that of Aarti Industries ltd (ARTO IN).

Around 2012-13, few years after the Global Financial Crisis (GFC) in 2008-09, China started rebalancing it’s economy on a slow pace by implementing stringent environmental regulations and increasing labor costs. This impacted a few industries in China and across the Globe as well. India’s chemical industry had always been at the mercy of Chinese counter parts and its policies. This move impacted the Indian chemical industry favorably. Not only companies like Aarti Industries who were already very well placed globally benefited, but the entire set of companies such as SRF, Navin Fluorochemicals, Atul, Vinati Organics and many others benefited.

Aarti industries profitability grew from 90 Crs in FY12, 133 Crs in FY13 to 504 Crs in FY19. PE ratio in the same period increased from 5x times to 27x, resulting into market cap multiplying by almost 25x. This does not happen overnight. It happens in a gradual manner as more and more players start believing in the theme, growth and potential.

Chart 3 – Market Capitalisation of Aarti Industries in pre-magic and post-magic period

Similar story is true for entire chemical industry.

Chart 4 – Market Capitalisation of Chemical Industry in pre-magic and post-magic period

History teaches us that no company is always great, no company always remains great. There are cycles in every company’s and every human’s life. Companies go through many changes, internally or externally, which ends up creating “Magic moments” even in the lifetime of companies with already good businesses. Our criterion of good business continues to remain the starting point. If one can rightly identify the catalytical moments, what we call “Magic moments” in the life cycle of a company or business, one can create significant wealth. Under the Magic Basket, our attempt is to constantly find such companies.

We will invest 50% - 60% of our portfolio in this Basket.

Compounder Basket (MRFG)

The Compounder Basket aims at capturing earnings growth over a long period of time. Many companies having created a significant moat around their businesses, managed by exceptionally talented managers, delivers a superior stable return over long period of time. (MRFG - a combination of Moat, High Return On Equity, Free Cash Flows, Growth & Governance profile). Such companies are usually well discovered, well owned and usually on the higher end of the valuation range. They are richly valued and remain so as long as MRFG characteristics are intact.

Often, companies have migrated or are migrating to this basket from the Magic Basket. For e.g. Pidilite Industries, PI Industries, Aarti Industries, etc. Aarti industries as we discussed above was once a Magic story and became compounder in 2018-19 period. Usually, we think it’s a period of 4-5 years of re-rating journey. Reason why such companies do well during Magic period is that they are acquiring MRFG characteristics. Once they have created scale and success, it creates a snowball impact, adds more moat to their position and they continue to deliver for long period of time. Post that, re-rating possibility might be limited, but earnings growth can be captured in the returns (usually 15-20%). For example, TCS still generated 15% CAGR return post Magic period, which is a good return for a company of that size given limited risk.

These companies entering this basket can remain here for a long period of time until they start losing their MRFG characteristics either due to internal reasons (complacency, hubris or greed) or external reasons (technology disruption, competition, industry growth).

The chart below shows the performance of the compounder portfolio vs BSE 200 returns and it shows how this portfolio has not only outperformed the BSE 200 returns every year but has also not delivered a sizable negative return in any of the last 10 years

Chart 5 – For last 10 years, Compounder basket aggregate returns has outperformed BSE 200

The compounder portfolio has witnessed robust PAT growth of 21% and average 10 year ROE of 26%. Due to the consistency in earnings growth and ROE, there has been a steady expansion in re-rating and thus this portfolio has delivered a 31% CAGR return over the last 10 years.

Chart 6 – Compounder basket aggregate financials remain solid

We look for companies who have been doing great since beginning of their journey (like ICICI Lombard, DMart, HDFC AMC) or have been migrating from Magic to Compounder due to one or many factors.

The biggest risk under this category to watch out for is de-rating possibilities, which usually happens when MRFG starts weakening. One has to be watchful.

We will invest 40% - 50% of our portfolio in this Basket.

Chart 7 – Snowball effect – Journey from Magic basket to Compounder basket

Opportunistic Basket

This basket is nothing but an opportunistic way of capturing opportunities offered by the market from time to time on a short-term basis (3-12 months). These may not meet all the conditions of the first two baskets so well to hold them for long term but we have a high conviction around the risk reward it offers. This could also include special situations including IPOs/merger/demerger/delisting, etc where we think ~18-20% return can be generated in 3-12 months’ time. Markets tend to offer such opportunities very often. This is an optional basket and if there are no opportunities, we will not invest.

We will deploy 0-10% of our portfolio in this Basket.

Chart 8 – Overall Portfolio Construction


In investing, avoiding an accident is equally important as getting the investment hypothesis right.

We come from Marwari families where our forefathers are used to seeing “where is our profit vs what is our profit”. We learnt our first lessons of ascertaining profits from the balance sheet and not the P&L from them. Our childhood learnings gathered through working with them coupled with professional qualification of Chartered Accountancy has immensely helped us.

This unique capability and rich experience of over 12 years on forensic research of the companies’ annual reports and seeing through some of the obvious accounting practices or frauds, helps us avoid accidents of investing in companies with dubious intent or misplaced objectives.

Our unique forensic framework deep dives into the following before investing, what we call “CLEAR”.

C – Cash flow Analysis & Capital Allocation: We assign zero value to profits without cash flow conversion. We deep dive into the source of cash flow instead of reported cash flow

L – Liability Analysis: True debt vs Reported debt, Contingent liability and likely impact on future earnings

E – Earning Analysis: True Economic Profit vs Reported Profit, Discretionary vs non-discretionary profit

A – Asset Quality Analysis: Some worrisome points -huge built up in loans and advances, large quantum of long duration inventories/receivables susceptible to value diminution, large payables supporting large receivables/inventory, profits getting re-deployed in non-core/expensive/uncertain inorganic growth, profits getting into intangible assets/goodwill – without visibility of commensurate profitability, subsidiaries/JVs which require consistent infusion of profit without any visibility of returns.

R – Related party transaction & Governance issues

“When you mix raisin and turds, you have still got turds” – Charlie T Munger.

Manoj Bahety has been doing forensic analysis on 100 plus companies over last 12 years. His observations have highlighted that Management Quality and Accounting issues have a very high degree of co-relation (inverse co-relation). Clean & honest managements are more likely to have conservative and right accounting policies. They will not resort to any financial shenanigans. So the quantitative & qualitative way of assessing quality of management is also through forensic analysis.

Aggressive accounting practices are followed either to mislead Equity investors or Bankers for credit. Management of many companies resort to such practices justifying in their mind, as temporary step, given a particular exceptional circumstance with an intent to correct at later stage. But that never happens. Once you resort to such practices, it’s a never-ending loop and temptation will keeps rising. Also, it shows one’s character. It will reflect in more than many ways. We give lot of importance to the history of promoters and their respect for minority shareholders. In India, almost 90% companies do not understand the difference between company’s and personal assets. They use this interchangeably. We have very low tolerance for such management.

There are certain businesses which are very prone to accounting frauds due to very nature of their business. Sectors like Jewelry, Retail Infrastructure where there is natural tendency and at times business needs to fudge accounts. We are extra cautious and stay away from them.

There are companies which have very low incidence of taxation (Low GST & Low-Income Tax). The incentive for manufacturing of books for such companies is very high. We have NO GO policy for such companies.

Table - Case studies on companies on which reports were issued

Chart 9 - Fall in Market Capitalization and Profit After Tax (PAT) of companies stated in the above table from the date of report

Pitfalls we avoid:

Learned Investment Guru Charlie Munger says, Invert, always invert. Tell me where I will die. I won’t go there.

Below illustrated are companies / managements we will not invest with:

  • Companies with aggressive accounting practices

  • Companies with high financial leverage

  • Companies with low tax incidence

  • Companies with the management having no skin in the game or misaligned objective

  • Managements with consistent poor governance track record

  • Managements in a hurry to create value

Investment Process and Portfolio Construction:

Our Investment Process:


We have multiple sources of idea generation around our strategy. We have meticulously built several automated alerts/screeners inhouse which throw up potential ideas, in addition to connecting the dots through our reading/research of newspapers, magazines, research papers and interaction with partners/industry experts. For example, we picked up one of the biggest themes for starting our research in the chemical sector out of a general conversation with a Chinese friend, leading to investment in several many multi-baggers.

We have different alerts, filters and screeners for each of our baskets - Magic, Compounder and Opportunistic.

Automated Quality check

Once we have shortlisted the ideas, they are subjected to automated quality checks built in-house by our team. By inserting the stock ticker, the screen is populated with last 10 years of data required to analyse the company, including all the red flags – this helps us decide if we should pursue the investment opportunity further.

Deep Dive

Having cleared our automated quality checks stage, we assign a research team member to deep dive into the business and management which usually takes anywhere between 2 weeks to 2 months depending on the company, business and our level of competence. Once we have understood the business and company and it fits our criterion of progressing further, we seek deep interaction with management. Our interactions are usually at the multiple levels of the organisation, both formally and informally. We like delving deep into

softer aspects of the management and culture. We lay emphasis on all past management commentary and their follow through.

Forensic Analysis

Using our core expertise, we subject every idea to CLEAR framework for forensic checks.

Research Note:

All our above findings are captured in our Research note which is in a prescribed format and a checklist. We follow the checklist to avoid any kind of bias and to operate out of pre-conceived notions. Checklist Manifesto by Dr Atul Gawande is a great guide on the subject where he says that most senior professionals make judgement errors when they operate out of instincts rather than a checklist. He assigns a large number of medical errors due to non-adherence of checklists by surgeons including something as basic as washing hands. We would like to wash our hands before we start any operation. A checklist will help us in doing so.

Investment Committee

Our Investment Committee (IC) deliberates along with the research team. The IC may accept/reject the idea or may direct further investigation if certain aspects are not covered/well covered or in light of emergence of a new aspect out of discussion. The IC scrutinizes various risks involved including hypothesis failure, liquidity risk, market risk etc.

If the stock is approved by the IC, it also discusses the investment size and price range. The final decision on timing of the purchase is left to the Portfolio Manager.

Portfolio Construction

Chart 10: Overall Portfolio allocation

Risk Management

Our risk management policy focuses on two aspects:

1. Business Risk : Focus here is on identifying and managing risks concerning business of the firm including Reputation Risk, Compliance Risk, People Risk and Process Risk. We have built in a reasonable risk conscious culture and systems/processes for identifying and addressing each of them at an early stage.

2. Portfolio Risk : This is a very important aspect of our Risk Management Framework. We cover following areas under this

a) Liquidity Risk

b) Concentration Risk

c) Price Risk

d) Stock Selection Risk

e) Governance & Process Risk

a) Liquidity Risk

We constantly monitor the liquidity at the portfolio level and analyse its sensitivity to change in market condition. We ensure adequate portfolio level liquidity – at any point of time ~30% of portfolio can be liquidated within 5 days. Our Current portfolio level liquidity is less than 2 days. We also focus a lot on getting a right set of investors who understand our style and objectives; and discourage them from taking short term (exit/entry) calls.

b) Concentration Risk

We shall always endeavor to have adequate guard against portfolio concentration and ensure that it is in line with portfolio tolerance limits and guidance.

Our sector and stock limits are:

  • Sector limit: 40%

  • Stock limit 1: 10%

  • Stock limit 2: 5% (In stocks with less than INR 5,000 Crs of market cap or less than 25% free float)

c) Price Risk

We monitor stock and portfolio price/market risk both on absolute terms and relative to market. We analyse the sensitivity of our portfolio against possible market and stock price scenarios. Though we love our chosen stocks at lower prices, we have put adequate safeguards against human bias.

“At times it is difficult to distinguish between conviction and human bias”

Any stock with price erosion of > 20% relative to benchmark is subjected to review by Investment Committee (IC). Any fresh buying in the stock is suspended till clearance by IC. There is a critical review to see if there is a change in the investment hypothesis.

Portfolio Manager has to present detailed investment note covering:

  • Deviation to original investment arguments – what has not worked and why it has not worked. Are the reasons of underperformance temporary and self-correcting?

  • What can go wrong analysis – includes detailed sensitivity analysis.

  • How much money is at risk in worst case scenario - Instead of analysing scenarios on normal distribution curve we focus on risk of capital loss on the happening of extreme probable scenario. If any event can take significant portion of investor wealth on a permanent basis, we will pass that opportunity.

The proposal has to be unanimously agreed by all the members of IC.

Needless to mention we are OK with temporary MTM losses to our portfolio considering “biggest investment opportunity comes during extreme pessimism”

d) Stock selection/earning quality risk

We shall focus a lot on selecting right stock after clearing all internal filters and framework. We shall protect against any kind of style drift to the temptation of capturing any short-term gains.

We take pride in our governance framework which at times leads to error of omission however safeguards our investors against error of commission. When we have to choose between errors of commission vs error of omission our unanimous vote goes to the later. Breaching governance framework has “ZERO TOLERANCE “in Carnelian world of investing

We have a detailed checklist which includes in-depth forensic analysis to safeguard against governance risk.

e) Process Risk

“Biggest risk to any process is non-adherence”

  • We understand that all of above will be theory only unless we put adequate independent process.

  • We shall ensure that all processes are followed and implemented in true spirit.

  • We have strict policy on not seeking any kind of inside information in the process of our investing.

  • We will have zero tolerance on such things which are against letter and spirit of investing.


Please read this information carefully. Access to this Newsletter is confirmation that you understand and agree to be bound by all terms and conditions. We are registered Portfolio Manager with SEBI vide registration no. INP000006387. Investments in the securities markets, and especially in options, are speculative and involve substantial risk. The information we provide or that is derived from our Newsletter / email/ or any other communication should not be construe as a substitute for any professional investment advice that can be render by a Portfolio Manager. We wrote the reports in the Carnelian Asset Advisors LLP (“the Firm” or “We” or “Us”) ourselves and it expresses our own opinions. The Firm has no business relationship with any company nor receives any compensation from any company whose stock is mentioned in the articles. The information included in may include inaccuracies or typographical errors.

This material is for your private information only and is not intended as an offer or solicitation to buy or sell securities.

The information may contain discussions of, or provide access to, certain positions and recommendations as of a specific date. Due to various factors, including, but not limited to, changing market conditions, such discussions and positions/recommendations may no longer be reflective of current discussions and positions/recommendations.

Performance Figures

Performance figures are actual, we cannot guarantee that subscribers will mirror the performance stated on our track records. Past results are not necessarily indicative of future performance.

Therefore, no subscriber or potential subscriber should assume or expect that future performance of any investment or strategy will be profitable or equal historical or anticipated performance levels.

Limitation on the Firms liability

To the extent not prohibited by law, each subscriber and potential subscriber agrees, prior to accessing or using the information provided herein or receiving information provided by the Firm, to release and hold harmless the Firm and its Partners, officers, employees and agents from any and all liability in connection with accessing or using the Firms information provided by the Firm. In all other cases, our liability to a subscriber, whether in contract, tort, negligence, or otherwise, shall be limited in the aggregate to direct and actual damages of the subscriber, not to exceed the fees received by Us from the subscriber. The Firm will not be liable for any consequential, incidental, punitive, special, exemplary or indirect damages resulting directly or indirectly from the use of or reliance upon any material provided by the Firm.

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