Marcellus

• Marcellus Investment Managers was founded in 2018 with the sole purpose of influencing efficient capital allocation in the Indian economy.

Key staff

• Our investment philosophy has been shaped over several years by legendary investors like the late Rob Kirby and by outstanding capital allocators like Harsh Mariwala (Chairman, Marico) and KS Dhingra (Chairman, Berger Paints).
• Our approach to portfolio management doesn’t just focus on delivering healthy returns to our investors but also aims to do so by taking relatively low risks.
• CCP’s investment strategy is to invest in a concentrated portfolio of heavily moated companies that can drive healthy earnings compounding over long periods with very little volatility.
• The PMS comes with attractive performance-based fee options which align our interests with that of the investor. Furthermore, it has one of the lowest cost structures in the PMS industry with no entry loads, no lock-in and no exit loads.
• Marcellus investment philosophy is based on the concept of consistent compounders, which says that the return on capital should be greater than the cost of capital, this should be sustainable for number of years in a row.
• Gap between return on capital and cost of capital is free cash flow that the firm generates, the wider the gap the more competition the firm attracts, intense competition narrows this gap.
• In the global landscape, competition that dominates their sector do not generate high ROE, which is far higher than cost of capital, therefore consistent compounders aren’t present.
• In Indian landscape their exists firms like Asianpaints, ITC ltd, Nestle, Pidilite, Jockey, HDFC dominate in their sectors and have ROE far higher than the cost of capital.
• The core challenge is understanding the sustainable competitive advantage.
• Research process includes:

1. Understanding that why is a company been able to generate consistent healthy fundamentals.
2. What has been the nature of competition, disruptions, evolutionary changes that these firms faced in the past and what is that their moats, because of which the return on capital as a result were not competed away.
3. High governance

• To understand the DNA of a company they watch the companies like a hawk for years.
• Their philosophy is based on Robert Kirby’s paper ‘ The coffee can portfolio’ , wherein he says to find a company and stay for 10 years , and don’t time the entry or exit and sit tight for a decade.
• They employ high quality of people to ensure proper delivery of the process and maintain highest level of transparency with the clients, they explain them about the investment philosophy, for them the trust is of at most importance.

Investment Strategy

https://marcellus.in/wp-content/uploads/2020/01/Marcellus_Creating_Consistent-Compounders_Jan-2020.pdf

1. Identify companies with clean accounts

2. Identify companies with track record of superior capital allocation

3. Amongst companies which pass steps 1 & 2, identify those with high barriers to entry.

Step 1: Identify companies with clean accounts

Ten forensic accounting checks used to identify naughty companies

Income statement checks:

• Cash flow from operations (CFO) as% of EBITDA
• Volatility in non-operating income
• Provisioning for doubtful debts as a proportion of debtors overdue for >6 months

Balance sheet checks:

• Yield on cash and cash equivalents
• Contingent liabilities as % of net worth (for the latest available year)
• Change in reserves explained by the profit/loss for the year and dividends

Auditor checks:

• Growth in auditor’s remuneration to growth in revenues

Cash theft checks:

•  Miscellaneous expenses as a proportion of total revenues
•  CWIP to gross block
•  Free cash flow (cash flow from operations + cash flow from investing) to median revenues

https://marcellus.in/newsletter/little-champs/the-importance-of-accounting-quality/

This checklist forms an essential part of the qualitative assessment of stocks:

Methodology:

• We look at over six years of consolidated financials for the universe of firms.
• We first rank stocks on each of the 10 ratios individually. These ranks are then cumulated across parameters to give a final pecking order on accounting quality for stocks.
• This framework draws upon Howard Schilit’s legendary text on forensic accounting, “Financial Shenanigans”.

Step2- Identify companies with track record of superior capital allocation

• We create a list of stocks using a twin-filter criteria of double digit YoY revenue growth and return on capital being in excess of cost of capital, each year for 10 years in a row.
• Next, we build a portfolio of such stocks each year and hold each of these annual iterations of portfolios for the subsequent 10 years (without any churn).

The bar chart on the right shows the back testing performance of such a filter based portfolio.

There are two conclusions from this exercise:

 • This filter based portfolio delivers returns of 20-30% p.a. (of INR returns) and 8-12% outperformance relative to the Sensex.

• The volatility of returns of such portfolios, for holding periods longer than 3 years, is similar to that of a Government of India Bond.

{Returns here (both for our portfolio and for the Sensex) are on a Total Shareholder Return basis i.e. all dividends are included in the returns.}

Step3: Amongst companies which pass steps 1 & 2, identify those with high barriers to entry

Perform in-depth bottom-up research of companies, which pass our filters to assess sustainable competitive moats and build a portfolio of 10-15 stocks which consistently compound earnings.

What do we look for in our research?

• Look for managements with an obsessive focus on the core franchise instead of being distracted by short-term gambles outside the core segment.
• Look for companies which relentlessly deepen their competitive moats over time

Look for promoters who are sensible about capital allocation, i.e. refrain from large bets (especially those outside core franchise) and return excess cash to shareholders.

Little Champ-  https://marcellus.in/newsletter/little-champs/introducing-little-champs-our-small-cap-pms/

Covers details about the little champ fund selection process.

https://www.rupeeiq.com/content/what-makes-marcellus-pms-little-champs-smallcap-strategy-worth-a-look/

The Little Champs portfolio as on January 16, 2020, had a total of 14 stocks with equity allocation of close to 88%. While its stock selection is purely bottom-focussed, no single sector constitutes >20% of invested corpus. The Little Champs portfolio went live on August 28, 2019.

The smallcap strategy intends to keep the portfolio churn low (not more than 25-30%) to reap the benefits of compounding as well as minimise the impact of trading costs.

Continuous monitoring and evaluation will also be key, even though Marcellus does not put much weightage on short-term factors like weak quarterly earnings. What it will watch out for is important structural change in the company like key management change, noteworthy capital allocation decisions or crucial corporate governance.

Performance of-

CCP– There are 13 stocks in the CCP.

Little Champ Portfolio-  https://marcellus.in/newsletter/little-champs/introducing-little-champs-marcellus-small-cap-pms/

Consistent compounder offshore fund