“This positioning has insulated us from the recent drawdown and volatility. The megacaps, including not only the big tech names but also companies like Eli Lilly and Costco, have been bid up to extremely high valuations due to their certainty around growth and earnings delivery in near term,” says Arindam Mandal, Portfolio Manager at Marcellus Investment Managers.
Edited excerpts from a chat:
How has been the performance of your Global Compounders fund amid all the turmoil being seen globally?
The past month has been volatile for global equities. The turbulence began with a momentum reversal in U.S. markets in mid-July, where megacap stocks saw a pullback while laggards gained, leading the Russell 2000 (Small Cap) to outperform the S&P 500 by approximately 12% over 12 trading days—a rare event in the past 25 years. Following this, weaker-than-expected U.S. job data further dampened the broad market. Weak demand signals, particularly from China, led to lower oil prices despite rising tensions in the Middle East. The Federal Reserve’s hint at a potential rate cut in September provided some relief, but the Bank of Japan’s unexpected rate hike disrupted the “yen carry trade.”Despite the market choppiness since early July, the Global Compounders portfolio has held up relatively well, remaining flat compared to the S&P 500’s decline of over 4% and the Nasdaq’s drop of more than 8%. It’s reassuring to see that the portfolio not only withstood this recent volatility but has also outperformed our benchmark, the S&P 500, by approximately 900 basis points since its launch—achieving this without holding some of the most popular stocks, like Nvidia.How are you dealing with the stress in megacaps on Wall Street? Will the likes of Nvidia bounce back?Our exposure to megacaps is limited. The Global Compounders portfolio is more heavily weighted towards “non-megacap” stocks. If we define megacaps as those with a market cap above $250 billion, the S&P 500’s allocation to these stocks is around 55-60%, whereas ours is below 30%. This positioning has insulated us from the recent drawdown and volatility. The megacaps, including not only the big tech names but also companies like Eli Lilly and Costco, have been bid up to extremely high valuations due to their certainty around growth and earnings delivery in near term.
Interestingly, the valuation discount of the S&P Midcap Index compared to the S&P 500 is similar to what it was in the early 2000s—a period after which midcaps outperformed large caps (S&P 500) for the next 12-24 months. While history may not repeat itself, it often rhymes, and in such a scenario, Global Compounders is well-positioned due to its significant allocation outside of megacaps.
As for Nvidia, it’s difficult to predict whether it will bounce back, but it will likely remain highly volatile. Nvidia’s long-term thesis is compelling, but at its recent peak share price (~135/140), it was trading at a ~20x FY26 EV/Sales multiple. Paying such a premium for a cyclical, though secular, growth business that might be at “peak growth” and “peak margin” offers limited margin of safety. In a narrow market driven by momentum, stocks can reach unbelievable prices, but sustaining those levels is challenging. It’s possible that some future growth is already priced.
A section of the market is calling AI stocks, Nvidia in particular, to be in a stage of bubble. Would you agree that the pick and shovel opportunity was overhyped?
We might be at a stage where the companies that are putting investments in “pick and shovels” for AI need to demonstrate their ability to monetize the hundreds of billions of dollars spent on building the infrastructure. This monetization could come in the form of revenue generation, cost savings, or productivity improvements. The pace of this monetization will likely dictate where we are in the cycle, or what Gartner refers to as the “Hype Cycle.”
While AI’s application will undoubtedly be widespread (similar to the Internet in the late 1990s/early 2000s), the adoption of enterprise uses at scale will likely take time, and there will be cycles. That said, today’s Nvidia is very different from Cisco in the 2000s, but it wouldn’t be surprising to see the adoption process go through some lull periods compared to the current exuberance. This isn’t a denial of AI’s role in the future—it is indeed the future, much like the Internet was 25-30 years ago. However, a profitable monetization engine needs to be built over time to justify the current investments, which will likely happen, but not overnight.
Do you think that the impact of the reverse carry trade is mostly over? JPMorgan said 75% of the carry trade has been unwound
It’s challenging to know for certain. Various broker houses have their estimates, but in reality, it’s tough to quantify or “know” definitively. The estimates of the “yen carry trade size” being circulated are in the range of hundreds of billions to a trillion dollars. There was undoubtedly some leverage created due to this trade, and it’s likely that most of it has been unwound by now.
What is your base case scenario as far as Fed rate cuts are concerned?
It’s likely a matter of “when,” not “if.” Real-time inflation data is gradually declining. However, one surprising aspect of this rate hike cycle has been the resilience of U.S. home prices, which have held up much better than expected. This resilience has likely provided some comfort. The magnitude of rate cuts will depend on unemployment data as the Fed continues to make data-dependent decisions. We expect a 25-50 basis point rate cut in September, which aligns with the consensus unless there’s significant weakness in the data.
Tweaks in Budget has made overseas investing more attractive from a capital gains tax perspective. Do you expect global investing to become more popular in India?
Global investing is likely to gain traction. As Indians become wealthier and more successful, their investment approach will likely evolve to consider the impact of diversification—geographic and thematic—as well as asset allocation and volatility in long-term wealth generation. GIFT City was a major step forward in making India a Global Financial Hub. Enabling two-way traffic – both inbound and outbound – is the best way to do it. The recent changes, which simplify and align long-term capital gains tax with domestic equities and allow resident Indians to open foreign bank accounts in GIFT City, significantly reduce friction. We are grateful to the regulators and the finance ministry for these changes.
In your opinion, is a 10% allocation to international equity good enough for someone with an aggressive profile and long-term horizon?
A 10% allocation would likely be on the lower side. I would suggest somewhere between 20-30% as more appropriate. One interesting point to consider is that, over the long term, U.S. market returns, which are the primary component of global markets, are very similar to those of the Indian markets. However, these returns come with much lower volatility and drawdowns. Additionally, during global crises, the INR tends to depreciate against the USD, as the USD is considered a safe haven. Investors who regularly deploy fresh money will benefit more from investing in similar return but lower volatility assets. A 10% allocation might not significantly move the needle in terms of diversification, whereas a larger allocation would better capture the value proposition.
