• Team Carnelian

Credit Flow – Vital Lynchpin

Dear Investors,


Welcome to the Carnelian Family!


First of all, we team Carnelian would like to express our gratitude for your participation in our first fund. Your contribution in our first initiative means a lot to us, and we are grateful to you for the trust and faith reposed in us.


We are in an unusually difficult macroeconomic environment. The good news is that such times are best times for investing and building a portfolio. However, such an environment makes it incredibly hard to convince people and raise capital amid pervasive pessimism. We, at Carnelian, view the onset of our journey in these incredibly difficult times as more of a positive. Before we give you our view on the markets, let me first share the status of our portfolio—which must be of great concern to you, particularly given the mushy market conditions. We are happy to let you know that our portfolio has done reasonably well in the face of macroeconomic headwinds.


We started raising capital in May this year and did our first close on 31 May. The election mandate was historic and market expectations from the budget were high too. Markets spiked after the election outcome. At that time too, our view was very cautious as we believed some structural problems in the economy must be addressed. In light of our negative view in the context of macro headwinds, we have largely preferred staying liquid in our portfolio.


As highlighted during our initial interactions, we look for investment opportunities in three broad baskets:

Magic Basket - comprises stocks with the potential to capture both “Earnings Growth and Valuation Re-rating”.

Compounder Basket - comprises stocks with the potential to capture sustainable earnings growth over a long period of time without expectations of a valuation re-rating.

Opportunistic Basket – comprises deep value stocks with cash flow or benefit from special situation but facing temporary headwinds and stocks which do not fall in the other two baskets.


We invested in ten stocks, deploying only 50% of the total amount called; the balance is lying in liquid funds. Our three largest holdings are Reliance Nippon Asset Management and Fortis Healthcare in the Magic Bucket and Max Financials in the Compounder Bucket—all three have performed reasonably well during the current meltdown. Other stocks in the Magic Bucket are Axis Bank, Kolte Patil and Mahindra Lifespaces. We believe that the current scenario offers many a great business that are scalable and run by good management teams at interesting valuations. While we see great value in pockets, we are watching the liquidity situation and will gradually increase equity allocation to our portfolio. All the stocks that we have invested in have the potential to deliver 2.5–3x returns over a five-year period with limited downside over the medium term.


We are confident of the portfolio we are building from a five-year perspective. Even so, we are mindful of the potential downside in the medium term. The current market environment demands sharp focus on risk management, and we are fully aware of it. We do not want to lose focus amid current challenges while looking at the long term. We will gradually build our portfolio, which we think can help us deliver on our promise.


We will be more than happy to speak to you in person to discuss the investment rationale, should you desire.

Now turning to our view on the current market…

The most-awaited event of the year – general elections – is behind us and the outcome has been favorable to market expectations. The budget is also over, but the markets seem to be far from happy.

Most investors we have been meeting are utterly confused about how to decipher the current economy, markets and – thereby – investments. Clearly, there are macro positives, but at the same time many micro negatives are playing out too.


-Some positives are:

-Stable government – reforms in progress, aggressive infra spending planned

-Global rate easing, local interest rates coming down too

-Benign inflation

-Crude and commodity prices in check

-Monsoon seems to be getting normal


Some clear negatives are:

-Deteriorating consumer sentiment

-Auto sales de-growth

-GST collection stagnating

-Credit growth muted

-Banking NPA resolution getting delayed

-Job growth missing; in fact cases of job losses

-Gross capital formation still far from desired

-Broad based earnings growth missing

-Expensive headline valuations, serious wealth destruction in mid/small caps

-Regular negative news flows around corporate governance

Our view is unavailability of credit/funds is the SINGLE BIGGEST reason for the current slowdown across the economy and meltdown in the markets.

Post the IL&FS crisis last year, credit supply in the economy has dropped and risk perception has gone up sharply. Out of three major suppliers of credit, namely private banks, PSBs and NBFCs (including HFCs), the latter two account for almost 70% and are almost out of action. Only private banks are growing at 25%. But if you observe from the table below, NBFCs and HFCs were growing almost 25% and they were disbursing INR4–5 lakh crores every year. This amount was largely going towards purchase of houses, vehicles, personal loans, business loans to SME and structured loans, which were not available from the banking system. This amount was going into the economy to builders, product companies, workers and the entire value chain. This was also boosting income and consumption. This amount along with velocity of money was creating good economic momentum. However, over the last one year, post-IL&FS crisis, this segment is almost out of action; in fact, this segment is pulling out money to meet their liabilities. This is much like taking fuel out of a running car!

SME’s, considered as the backbone of economic growth, are struggling for working capital. With these two large suppliers of capital missing, business growth is significantly hindered; infact, many of them are struggling to keep their business going, which is creating a huge systemic stress.

This has a cascading effect on businesses and economic demand in the economy. Note that an SME facing a credit squeeze is also a consumer, and this has led to people cutting back on discretionary spends, thereby compounding the problem.

This vicious cycle has only one root cause – reduced supply of money and heightened risk perception. Whenever such environment gets created, huge counter-cyclical steps are needed to kick-start the economy.

The reason economies across the globe recovered sharply from the 2008 crisis was co-ordinated monetary stimuli in the system. Post-IL&FS crisis (our miniature equivalent of the Lehman crisis), which eventually snowballed into an NBFC and MFs crisis, there have been hardly any measures to get credit back on track (certainly not along the lines of the Global Financial Crisis).

This means we are going to get a U shaped recovery rather than a V shape. Once it is clear, then the only answer one needs to have is which slope of U are we in - are we still in downward slope of deterioration or consolidation bottom or upward recovery slope. We think it’s the time to clearly watch out for the course of action before taking a call on an upward recovery in markets. We see a few big risk events like the resolution of Dewan Housing (with almost INR 1 lakh crores outstanding) can have a severe impact on the system. If not handled well (like the Jet Airways episode), we could be staring at another systemic risk. We don’t rule out that probability yet and, hence, would advise investors to be cautious.

Even if the Dewan case is handled well, it is unlikely that credit will gather any meaningful steam in a hurry. Then why jump the gun until clarity arises? We believe there is no other way to revive the economy other than get the credit flowing in the system. Of course, we do believe a coordinated action from the government can solve this problem quickly, but that requires political will. We will keep close tabs on every development in this regard while we are evaluating opportunities.

All in all, we believe a bottom on the market is quite likely over the next 3–4 months and the best time to build the portfolio is when everyone is fearful. We are seeing hard-core bulls in markets turning negative, and many people we interact with – despite sitting on large piles of cash, are still fearful of allocating corpuses to equities. To me, that’s the clear sign of the beginning of the end of this bear phase.


I am reminded of John Templeton’s quote, which is very relevant in the current context:

Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” .“The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

A note on the Changes in Income Tax:

We have received several queries on the recent announcement in the annual budget regarding higher taxation on trusts and its implications on CAT III AIFs, for assessees having income above INR 2 crores and INR 5 crores - AIFs will be subject to an increase in the surcharge, which will be paid by the fund. As regards most of our investors, it shouldn’t impact them as it is same rate at which they would be taxed in their individual capacity. We shall be happy to answer any further queries, you may have.





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