Arthveda STAR Fund – Follows Value Investing Principle To Provide High Returns

There is no dearth of investment philosophies and their followers. However, one philosophy that has stood the test of times is “Value Investing”. This method of investment that was pioneered by Benjamin Graham, the father of securities analysis, way back in 1930’s has been followed, modified and enhanced by several legendary investors such as Warren Buffett and Peter Lynch. Lynch believed in the term ‘Know what you own’ and once quoted “Investing without research is like playing stud poker and never looking at the cards”. According to Value Investing, the asset prices cannot sustain at unreasonably high or low levels over a long period of time and return to their economic values eventually.

Arthveda Fund Management (AVFM) predominantly follows this principle as a bible in all its investment decisions across asset classes. Arthveda STAR Fund which is a real estate centric fund does not believe in taking significant risks, thereby aiming to provide “superior risk-adjusted returns” as compared to its peers. It focuses on identifying such “pockets of inefficiencies” with significantly reduced risk and hence, “high margin of safety”. The team at AVFM has a unique advantage because of its close ties with the extensive network of Dewan Housing Finance Corporation Ltd (DHFL) across India. This in turn exposes them to the ground realities of those locations in addition to close interactions with the developers, lawyers among other people.

Value Investing – The Principle

It essentially consists of three elements namely:
Analysis – This includes deriving the intrinsic value of the asset by thorough analysis.
Safety of principal – To make sure that the initial investment (capital) remains intact thereby focusing on ALPHA.
Adequate returns – A satisfactory return which the investor is willing to accept provided he acts with reasonable intelligence.

It is a given that “Value Investing” is the reason why the Buffets and the Grahams of this world have built their extraordinary track records and have had a growing coterie of modern day value investors follow their path. All these principles revolve around the basic objective of “margin of safety”. This is the foundation of Value Investing philosophy and ties all the aforementioned principles. No matter how the intrinsic value is arrived at, Value Investing is not complete without adding a reasonable cushion i.e. “margin of safety” to provide for the possibility of intrinsic value being lower than the estimated value. What it clearly means is that, for example in a Discounted Cash Flow (DCF) analysis, the volatility could be caused by variations in the cost of capital, leading to a change in the Net Present Value (NPV). Hence one needs to consider the “margin of safety” so as to mitigate such unprecedented risks.

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Arthveda STAR Value Investment Methodology

AVFM has applied the above principle to the real estate industry that exhibits into the Arthveda STAR Fund. The fund estimated the economic values in different cities based on affordability levels of middle-income population in those cities. Using this data, the fund shortlisted cities where the supply for this group of society was not met or/and the market price was lower than the economic value. This opened up a possibility of appreciation in price when adequate supply came into the market.

While cities such as Mumbai seem like obvious investment targets, AVFM estimates show that actual demand by house-dwellers (i.e. NOT speculative demand) has either been satisfied or unfeasible at current prices in such cities. It is estimated that around 2.25- 2.50 Lakh households (i.e. 5% of the total 40-45 lakhs households) earn over INR 20 Lakh p.a. However, data from PropEquity shows that around 2.2 Lakh housing units have been sold for an average price of nearly INR 1 Crore per unit over the period 2007-11 in Mumbai (including suburbs). Beyond this, around 20% of the population earns INR 5-10 Lakh p.a. whose buying capability is to the tune of INR 15-50 Lakh but there is no viable supply for their affordability levels. Moreover, the region is also sitting on an inventory of over 89,000 units. Due to lack of ‘high-quality’, sustainable demand by actual house-dwellers, AVFM chose to leave out Mumbai and similar cities from its investment sample. Also, small cities with very low populations were also left out as they pose liquidity risk i.e. there might not be enough customers to form a reasonably sized target group. Hence, AVFM eliminated that risk by picking cities with population of over 8.5 lakhs.

ArthVeda STAR Value Investment Model

The Rationale Of Choosing Tier II/III Cities

AVFM chose the cities where DHFL already had branches with experienced professionals equipped with an in-depth knowledge of the local markets. This extensive network of DHFL in Tier II/III cities helped DHFL grow despite all odds also proved by the fact that DHFL’s loan book during the 2008-09 crisis grew by 30%.

On the back of RBI data and with some leads from DHFL, AVFM estimated market saturation on housing loans dispersed over the past few years. This helped in delineating the cities with insufficient supply of modern housing units for middle income households and consequently, facilitating mitigation of exit risk. The exercise involved identification of cities in which population was growing at a rate higher than the normal rate i.e. due to migration. Hence, AVFM ensured that there would be enough growth in demand over the investment period and there would be adequate profit maximization opportunity. Considering a demand slump in Tier-I cities such as Mumbai, it was imperative that smaller cities posted a much higher growth. This, in turn, goes to show the strong resilience of housing demand during the 2008-09 crises in Tier-II/III cities. They had essentially decoupled from sluggish national demand during that period. During the course of this exercise, AVFM introduced ample margin of safety while ensuring adequate returns in its Arthveda STAR Fund.

Arthveda STAR Fund is an INR 129 Crore fund which invested in greenfield residential projects. The investment were spread across 17 projects in Tier II/III cities across India with ticket size between INR 4 Crore and INR 20 Crore.