Interview with Aditya Shah, Founder and Cheif Investment Officer, JST Investments

Radhakrishnan Chonat: Ladies and gentlemen, welcome to another episode of Fund Manager Insights series. Today, I’m glad to introduce Aditya Shah, Founder and Chief Investment Officer of JST Investments and a renowned figure in distilling knowledge in the financial world. With a deep understanding of the BFSI sector and cyclical industries, Aditya began his investing journey during the 2008 financial crisis, making him well versed in navigating challenging market conditions. Known for his astute predictions, Aditya was among the first to raise the alarm about the impending crisis in institutions like YES Bank, DHFL, and cooperative banks. His ability to identify potential risks and opportunities truly sets him apart. Notably, Aditya’s strategic investments in the banking sector during the 2008 crisis have actually yielded substantial wealth showcasing his belief in the principles of capital preservation and sustainable returns.

Join us as we delve into Aditya Shah’s investment journey, try to gain some valuable knowledge from his experience, and uncover his unique investment strategies. Welcome to Fund Manager Insights, Aditya.

Aditya Shah: Thank you, Radhakrishnan, for having me and excited to share about my journey today.

Radhakrishnan Chonat: Excellent. To begin, Aditya, can you probably share some insights on your investment journey so far and how have you developed a deep understanding, let’s take BFSI sector and any other cyclical industry? So, walk us through your journey.

Aditya Shah: Yes. So, it’s been a very challenging couple of decades for me as in I have learnt everything that I know about the markets on my own. As they say, markets are the greatest teacher, market will encourage you, make you learn, and do crazy things and that’s what my journey has been. So I started at the peak of the 2008 crisis, somewhere in — somewhere just before the Lehman Brothers crisis and I saw a couple of my investments eroding by about 50%, 60%, 70% within a couple of months. In fact during that time even good company stocks were really down 50%, 60%, 70% and there was real crisis and nobody knew what was really going on. In fact people thought that the world is going to really end as was the case with COVID during March 2020.

But however, there were many mistakes. For example, let me take the example of one of my favorite banks, Kotak Mahindra Bank. The stock was down around 60% to 70% and the stock never recovered until 2011, which was a painful about 3, 3.5 years during that period of time. Bank did make a severe mistake in the lending side of it. But for a newbie to come in and see their capital erode like 50%, 60%, 70% is a very big thing and it really takes away that belief in the market that you can make money. That made me learn that you need to research properly where you need to understand businesses really well and from thereon started my journey of analysis of businesses.

So, I don’t feel this as ownership of — as stocks and trade stocks day in and day out. I view this as ownership of businesses and we are invested in very high class quality businesses and we want to create wealth for our investors. We don’t want to get 10%, 15%, 20% return. That’s our mantra. And we continue to talk to managements one on one and try to figure out which businesses to really invest, the first. Second point is right from thereon, I have been continuing to track the markets from 2009 or 2010. We went through the 2011 crisis. Then we went through the 2013 currency crisis. Then we went on to the 2018 ILFS crisis and then the 2020 COVID crisis.

So the first important thing to learn is that crisis is a time where great learners are very, very sharp and they try to learn maximum that they can learn about the markets. Everything that I learnt about the markets was from out of the crisis. Good times, they make you arrogant and you let your guard down, the second point. The third point is how did I learn my BFSI analysis. Today in the BFSI space, I track each and every company that is out there. Let me give you an example. In 2019 and ’20, somewhere in 2021 we started a positive coverage on banks when no one was covering banks and had a negative view on banks. Because we knew that the sector has been through such a bad cycle, that at some point in time the cycle will reverse and the banks will start to do really well.

Now when everybody’s very bullish on banks, all brokerages are coming out with excellent reports on banks, now we are negative on banks because we now understand that the base is high. They are doing really well and over a period of time NPAs when they start to come out, you will find that stock prices get a shock. So it’s always about being two steps ahead of the market and analyzing and predicting what goes on, what will go on 1, 1.5, 2 years down the road. If you’re able to really do that, then you can do really well. If you’re not able to really do this, then it is very, very difficult as a researcher and as a fund manager as well to try and make good amount of turns in the market.

So net net in my view, it’s about sustaining yourself 10 years in the market. If you are able to sustain 10 years in the market, you will find a lot of return in the market and you will also become a good fund manager if you are able to sustain in at least two to three bear markets. If you’re able to really do that, then you understand the market more holistically.

Radhakrishnan Chonat: Interesting. Sticking to the BFSI itself, you mentioned as a third point that right now when everyone is gung ho about banking stocks, you’re actually turning negative because the — I mean right now net interest margins are at all-time highs, NPAs at all-time lows, but you see upcoming negative. So sticking to that theme as one of the first to figure out that there is something cooking in YES Bank or DHFL or even the cooperative banks from Mumbai, what kind of indicators or let me put it this way, what kind of factors do you observe that help you with this kind of early predictions?

Aditya Shah: Yes. I would say today you look at — let me take an example first off. So, let me give you a disclosure. I am a SEBI registered investment advisor and nothing that we discuss today here is an investment recommendation. We are just discussing here for educational purpose for our listeners to understand what’s going on. So, let me give you an example. Ujjivan Small Finance Bank eight months ago was available at 0.8 times price to book. Price to book is a valuation metric that we use to value financials. The bank was on the verge of a blow-up and nobody wanted to buy the stock. At that point in time the risk was very minimal because one thing is very clear, the RBI will not let any scheduled commercial bank really fail, be it a small finance bank or a universal bank.

So the point was that stock was available at 0.8 times price to book when the management had resigned, there was a microfinance down cycle that was really going on, anything that could go wrong really did go wrong. Now what is happening is the cycle has completely reversed out, microfinance sector is booming, credit costs are really low, and that valuation has expanded from about 0.8 times price to book to about 2 times price to book. Valuation not only across Ujjivan, but valuation across all smaller banks; IDFC First Bank, Federal Bank, you name the bank; all the PSU banks, they have expanded very, very sharply. So, the record high ROEs that we see on banks is already been now priced into the price. It is not as if it is not priced into the price.

So what going forward? Going forward, there are a couple of things that can really happen. As you know we are at a record high slip — record low slippage at this stage. The formation of new NPAs is very, very low for all banks not only for PSU banks, but for all banks. This will continue at least for the next 1, 1.5 year as the economy continues to upstage a recovery from its COVID problems. So 1, 1.5 year there will be a slippage that will start to come out. NPAs will start to shoot up for everybody and at that point in time, the ROEs will start to slip for most of these banks. Once the market has priced in the bears and the ROEs continue to keep coming down, you will see that there is a — the valuation rerating that was driving the stock price will work in the reverse direction and there will be a valuation rerating that will happen on all of these banks.

So, it takes a lot of insight and ability to think six to eight to 10 quarters down the line make huge amounts of return. And from that perspective, I see that today with small banks available at 2 times, 2.5 times price to book, you find that a lot of optimism is already now priced into these stocks. Now what you have to see is how long will the cycle continue. In our opinion, the cycle will continue for at least one and maximum two years. It will not sustain beyond two years. After two years, a lot of NPAs will start to come out and you will see a lot of –. Also you will have to see for triggers that come up. For example for the microfinance sector, 2016 demonetization was a very bad trigger for them, 2018 ILFS crisis was also not a great trigger for them, and COVID was a killer crisis where banks had NPAs rise from 1% to 10%.

So every two to three years there is a macro event which triggers off huge NPAs for banks, which is very unpredictable and you cannot work. So if somebody is sitting on 100% profit, I will not tell them I’m a small bank that don’t book profits. I will definitely tell them to book profits. Of course current cyclicals you can never predict a drop. You have to get out much before they drop and that’s what our whole premise is on that. Now we are negative on banks. That’s very, very important. And we are positive on other sectors, which are undergoing down cycle; pharma, chemicals, those things. But as a fund manager, our insights same.

Radhakrishnan Chonat: Excellent. Sticking to that theme, Aditya, how do you approach risk management in your investment strategies? Especially like what we discussed volatile or uncertain market conditions. So, give us a bird’s eye view of your risk management strategy?

Aditya Shah: Yeah. So for us, price is the biggest risk management point that is there. We try to buy stocks not at too much expensive valuations. Let me give you an example. Today we bought a company called Indian Rail Finance Corporation at 0.6 times price to book. Nobody wanted to buy the stock at that point in time because the point was that it was out of favor. When a stock is out of favor, you find that the valuations are extremely cheap and once the valuations are extremely cheap, that’s the risk management that you take. Our biggest mantra is we cannot lose capital permanently. We can lose capital temporarily when the market becomes volatile, but valuation is one of our biggest…

Today our biggest position continues to be in a company called HDFC Bank, which is the largest private sector bank in this country. Today it trades at about 2.8 times price to book, which is the lowest it has got in the last 20 years. The bank is growing excellently at 20% loan growth, 20% 20% deposit growth, and they have doubled our profits in the last three years. But the stock price is not really reflecting that because of simple reasons that merger is going on and there are short-term pain – there’s a short-term pain point. So for us, price is one of the biggest risk management tools that we have got. Then we don’t invest in poor quality companies. Even if we invest in poor quality companies, we make sure that the valuation there is very high. Point number two.

Point number three is we try to invest in companies which have heavy moat in their business. For example they will garner 50%, 55% 60% market share and where they control market share, it is imperative that during bad times they will be the ones who will suffer less. So these are three, four, five techniques that we really do. But we tell our investors if you don’t have the ability to invest minimum for three to five years, don’t come and invest with us. We are not somebody who can deliver returns overnight, but definitely over a period of five to seven years, we will deliver very high returns.

Radhakrishnan Chonat: Excellent. On that note, Aditya, talk us about your company JST Investments and I believe you have a smallcase. So if you can give us an idea about what kind of funds do you manage and stuff, it’ll be nice.

Aditya Shah: So, I am a SEBI registered investment advisor and what we do is we manage client portfolios. Now we manage all client portfolios through smallcase itself. And what we really do is we build a very diversified portfolio across financials, pharma, chemicals, autos, FMCG. The idea is to build a very diversified portfolio and then take advantage of the India theme –the India growing team. That’s called the high conviction portfolio where we are doing exceptionally well over the period of last five, six months since we have launched, completely revamped our organization.

Then we try to play the cyclical theme where we feel that once a sector is down, we need to take complete advantage of the sector and that’s how we really operate. So net net what really happens is now our financial services smallcase is closed and now we are concentrating on getting a smallcase for chemicals and speciality chemicals and pharma sector because we believe that the down cycle is there and we need to take proper advantage of what’s really going on. So, we have a diversified portfolio offering as well as a sectoral portfolio offering. On the sectoral portfolio offering, the risk is much, much higher because when the sector there was a downturn, all stocks in the sector don’t do really well and in the near term we will face challenges.

But as the sector continues to move up, you make a lot of it. We’ve seen already in financials, small PSU banks and small private sector banks have given tremendous growth. So we are looking for investors who are wanting to invest three to five years, who don’t keep telling us every day that you are not beating the market. But over a longer period of time, we are able to generate sustained and high quality returns without churning the portfolio too much and that’s how we really tend to operate in our offerings. We don’t brag about what is our AUM or what is our return in the short term. But definitely we want to churn less, we want to invest in high quality companies, and offer good quality service to our clients. That’s really our aim.

Radhakrishnan Chonat: Excellent. So sticking to the two industries that you have identified are actually good investments, pharma and chemicals. Walk us through your role in terms of how do you research or analyze an industry and how do you identify the potential risk/reward benefit or opportunities in the market? So if you can walk us through an example, that will be nice.

Aditya Shah: See, market moves in a cycle so every sector will have an up cycle and a down cycle. No sector in the market is 100% long-term wealth creator. All of them will undergo up cycle and down cycle. So the first job that we do is we identify which sector is in up cycle, which sector is in a down cycle. For example financials are in up cycle right now so we don’t touch them. Whatever the investments we made, we continue to hold. The chemical sector, many stocks have fallen 50%, 60%, 70%. They are undergoing a big down cycle business-wise as well as topline. Pharma, let me give you an interesting trivia. Pharma sector in the Index – NIFTY 50 Index had got a portfolio weight of 2%. It is the lowest in the last 15 years since the NIFTY’s been formed at the pharma index, pharma has a 2% weight on the index. So what really is happening here is nobody wants to buy pharma at this stage because pharma stocks have taken a big hit of 40%, 50%, to 60% and as the cycle will continue to keep turning, you will find pharma sector will lead the bull market.

Right now financials are leading the bull market. You will find that the market leadership changes every year. IT led in 2021, financials are leading in 2022 and 2023, and then some other sector will lead which we don’t know right now the market. So basically what you have to first do is identify the sector. Once you’ve identified the sector, then you can identify good quality companies with clean balance sheet, with market leadership, with good quality products. All of those things if you’re really able to do, then you are able to identify five, six, seven, eight, 10 companies within the sector, which when the sector will turn will give very high quality superior returns. So that’s what our framework is and that’s what we really look at at this stage about how to build a sectoral analysis and how to grow.

Radhakrishnan Chonat: Excellent. You mentioned that you’re very straightforward when it comes to your clients telling them not to expect returns on a daily basis and stuff. So, how has been your experience dealing with your clients or customers who don’t keep track of this theme? So from a psychology point of view, how do you prep them up for the expectations?

Aditya Shah: A very difficult question. Very good question and a very difficult decision. Everybody wants to return in the market yesterday so if you actually will not beat the market, they will — many investors will scream about it. In my opinion in my 10 years of market, I have learnt this. No fund manager beats the market every year. If a fund manager beats the market every year, it means he’s taking extraordinary kind of risk in your portfolio. He’s churning way too much inside your portfolio because no stock will outperform every year because sectors undergo up cycle and down cycle. In my opinion, what we tend to do is we tend to see ourselves as owners of businesses. We don’t want to make 10%, 15%, 20% return. We want to make 10, 15, 20x kind of returns.

In our funds stocks per data, we have made 10x returns over a period of three years. So, that kind of returns that we are looking at. So, what then really happen is there are two sets of clients. Those clients who want to join yesterday. Those clients, if you look at my Twitter handle as well, I don’t promote those kind of posts as well and I do promote those kind of followers as well. I don’t entertain them as such. I am very clear about it. I will share very high quality content and very high quality material with people and those who can — who resonate with my philosophy can come on board and then be with us for a period of three to five years, we will deliver high quality. For all those clients who want return every year, I tell them that it is better that you don’t look at us and you get some other fund managers.

There are many ways to make returns in the market. People do technical analysis, people do fundamental analysis, and I don’t say any one of them is right or wrong. But when I say this is our philosophy where we want our hearts to live freely and not worry about what is the stock price today, tomorrow, or day after tomorrow. Rather I will spend my time talking to the managements one on one and figuring out what is good and what is bad. So in my opinion, I don’t worry too much because it is hard to get such high class quality clients. But when you have them, it’s a pleasure to work with them. So I have some very high quality clients with whom my relationship is not just client and advisor. It’s like a family, they are family to me and they will ask me everything about their money, which not many advisors do and which not many PMSes really are. So it’s a very fantastic relationship that I offer. But yes, the downside is you don’t get too many clients every day. It’s a journey that you go through.

Radhakrishnan Chonat: Very, very insightful. So Aditya, if I were to ask you what keeps you awake at night when it comes to the macro factors in India, what would it be?

Aditya Shah: I am very extremely inspired by an ace investor called Mr. Rakesh Jhunjhunwala. A bunch of time my stocks have been down 50% also. As a disclosure, one of my stock Biocon was down 50%. Do I worry too much? No, I don’t really worry too much. I have risk management techniques already in place. No stock is more than 5% to 7.5% of my portfolio. It’s completely diversified. All of those things. But in the bull market that is India, I want to say this famous quote that Mr. Rakesh Jhunjhunwala says.

In the bull market, a train from Mumbai to Delhi will only reach Borivali, which is about 50 kilometers from Bombay. This country is changing massively. This country is embracing manufacturing. This country is embracing infrastructure. This country is coming up to its true potential over the next 10 to 15 years. Of course nothing in this country is really very easy. It’s hard, it’s difficult. At some point in time you will want to not be in India because of the challenges, but the opportunities. So on the macro side of it, there’s nothing as such that tempts me because I’m not an investor looking for next two to three years. I’m an investor who wants to build a portfolio for the next 20, 25, 30 years. And I know if I’m able to do that, I will compound at the rate of double digits.

So, I’m not worried too much about that. But there hundreds of macro factors, what will happen to government, what will happen in 2024 elections, what will happen if crude oil crude prices move up, what will happen to the current account deficit. All of those after some point in time as a fund manager spending 15 years in the market tell you that look, India is on an upturn, which it was never from 2010 to 2020. Apple is going to manufacture $5 billion worth of iPhone by 2025. This never happened any time in the last 60 years of our India. So, India is on an up cycle. I don’t worry too much about what happened with the US belt or the RBI because I know we are now a very well managed team.

Radhakrishnan Chonat: Excellent. So Aditya, apart from analyzing companies threadbare, how do you chill? What are your hobbies apart from reading annual reports or earnings transcripts?

Aditya Shah: Analyzing businesses. So analyzing businesses, trying to see what new trends are coming into the world. Talking to — I don’t talk to — I generally don’t tend to talk to news channels. What I love to do is talk to managements, love to get their insights about businesses, how to create businesses. That’s my favorite go to thing that is there. So net net they say to be very good at something, you need to be very obsessed with it. And I’m decently okay, I’m not very good, but I’ve done decently well for myself, for my clients. It’s because analyzing businesses really amazes and now we’re starting to go to larger companies, which is some fantastic insight that I really get. So, that is one.

Then reading books is another one. Reading financial books and understanding what’s going on in the markets. That’s another one that’s really of huge interest. So those three, four couple of things that are there. But as such analyzing businesses not analyzing stock prices because that’s something that I don’t really know, but analyzing businesses per se is something I do.

Radhakrishnan Chonat: Nice. So, apart from quantitative analysis, you’re also talking about qualitative factors, management quality and stuff. So, are there any filters? How do you filter the noise and try to get signals? Is there any framework that you follow?

Aditya Shah: So, you’re asking 12, 13 years of the system within two minutes. Analyzing management is 90% of our business. Mediocre company with a good management can go places. A good company with a third class management will not do really well. Let me give an example. Two banks got the license in 2003, Kotak Mahindra Bank and Yes Bank. Yes Bank was far superior in technology all through 2000s, but look at where Yes Bank is and look at where Kotak Mahindra Bank is. The only difference Uday Kotak had run it. So no stock recommendations, but this is the fact. Managements make huge difference in running the business.

And there are several factors; we look for honesty, straightforwardness, truthfulness amongst managements. We try to read between the lines about what the managements are really saying and that comes really with time. It comes five, seven, 10 years down the line when you are trying to — you have gone through periods of bad luck and good luck with managements, you have seen bad managements and good managements, you have seen stock price erode because managements did not live up to their expectations. So net net, these are all things that we can talk about right now. But you know what, as Rakesh Jhunjhunwala said, cooking in markets is not something that can be taught through books. They have to be really experienced in the market and once you really experience it, you will frame a more proper trademark about is going on.

Radhakrishnan Chonat: Excellent. It comes with experience. So, it’s been a pleasure. Now before I let you go, I know you said you do read books. So, for the listeners if you can recommend any three books that — not just sticking to investment, but in general. If you were to get one month free of no responsibilities, what would be three books that you would pick again to read?

Aditya Shah: So, I’ll just recommend. So, there are some great investors who shaped up my life. One of them is Howard Marks. He’s a fantastic investor who’s written a lot of newsletters regarding how to master market cycles. So, mastering market cycles by Howard Marks is an excellent couple of newsletters as well hundreds of newsletters that you should really read and understand how he is able to master market cycles. The first one. The second point is I don’t know it’s very generic or not, but I find one of the best books that has been written is the Intelligent Investor. Really framed up my investment journey because I applied most of what Intelligent Investor really is, right, in terms of how I look at valuation, how I look at businesses. I never call them stocks, I call them businesses. That’s a marked difference that you will have when somebody is wanting to invest in businesses and stocks.

The third book that I will recommend is one of the best investors in Wall Street, Peter Lynch. His book is one up on Wall Street. Fantastic book, fantastic experiences. That is point number one. So, those are the three books. Since you say entrepreneurship and since you say something to motivate, there are two books that I really love. One of them is from Ronnie Screwvala of how he shares his journey that he came from nothing and became this big. So one of the books from Ronnie Screwvala, I forget the name; but from Ronnie Screwvala, that’s the book. And the other book is from our great former President APJ. Abdul Kalam, the Wings of Fire, where he writes about his motivational story and how you can come from nothing and do everything. So, net net those four, five books are really something that have shaped up me.

Radhakrishnan Chonat: Excellent. It’s been a pleasure catching up with you, Aditya, and I look forward to many more sessions where we nitpick on industries and companies. And it’s been a wonderful experience talking to you for half an hour. Looking forward to more such sessions.

Aditya Shah: Thank you. Thanks a lot for having me.

Radhakrishnan Chonat: Bye. Take care.