Stewardship of Capital

Compounding of Wealth

___ 2013

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Introducing River Valley Asset Management Our investment philosophy Our investment strategy and approach Our investment process

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An investment management house targeted at creating steady long term compounding of wealth for our investors Our solution is bespoke and fully transparent to our investors The people behind RVAM
Homiyar Vasania, CEO, Fund Manager:
Mar 2000- Sep 2012: A very senior member of the Emerging Market team of Morgan Stanley Investment Management (MSIM); the last 5 years as a Managing Director MSIM EM team manages about USD 25 bln of assets and has been in the business since 1987 A total of 18 years in the investment business with extensive coverage of Asian markets In his last role he directly managed a portfolio of over USD 5 bln. and his Asian team managed a total of USD 12 bln. Over 5 years as a member of the Emerging Market team of Rexiter Capital Management (a part of State Street). Rexiters EM team managed USD 4 bln of assets Jamshed has 19 years of experience in investment management

Jamshed Desai, Fund Manager:

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Introducing River Valley Asset Management Our investment philosophy Our investment strategy and approach Our investment process

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Most market participants do not have duration on their side Most market intermediaries make money on higher flows, not necessarily higher return for clients.
Investment advisors interest not fully aligned to investors Multiple levels of separation between investment advisor and investor portfolio Access to products is skewed by conflict of interest

Investment process often does not combine clear-sighted top down and bottom up analyses These create opportunities for return-focused entities with longer investment horizons

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Invest in businesses we understand and that are generating a high, sustainable and growing pool of economic value Ensure a high seniority on claim to this value Management integrity is as important as their ability Willing to wait to buy it at the right price An understanding of long term macro economic cycles is the foundation on which the businesses are analyzed Sell when the first five points weaken
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Introducing River Valley Asset Management Our investment philosophy Our investment strategy and approach Our investment process

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Use leverage judiciously - remain an investment manager, dont be forced to become a volatility manager Look for businesses giving steady total returns above 10%. The higher the cash component of this the better.
Higher cash return reduces vulnerability to the price discovery mechanism of the market

Within this growth

Steadiness and predictability of business should be valued more, not just growth requirement, look for as high a seniority in the capital structure as possible
Debt and Equity are just labels

This is the pool of businesses to create our portfolio from

Beware of business volatility, not stock volatility. Stock volatility is NOT risk

In the past 3 decades

Growth was artificially boosted
Helped by a strong drop in interest rates. US 10y T-bill rates fell from 14% to 1.8% over ___?? Inflation never came up because of the inclusion of new capacity in labour, land and capital from the inclusion of the EM countries like China. Technology-led improvement in productivity also helped.

Going forward
Will be a low growth, low interest rate environment
As the tail wind from a drop in interest rates is gone World still has spare capacity in both EM and DM

Going forward

Our opportunity set

In this environment of low growth, the hidden source of growth is corporate cash flow

Dividend will form a larger part of total return

Dividend returns reduce volatility of total return Growing opportunity set to invest in stocks with improving cash generation.

Asian growth will remain robust though lower than in the past

Today, cost of money is at a multi-century low

Over the last 30 years, we have had the largest drop in the cost of money which has led to one of the longest and quickest leveraging cycles the world has ever seen

US total debt (% of GDP) 250% 200% 150% 100% 50% 0%

Oct-49 Oct-52 Oct-55 Oct-58 Oct-61 Oct-64 Oct-67 Oct-70 Oct-73 Oct-76 Oct-79 Oct-82 Oct-85 Oct-88 Oct-91 Oct-94 Oct-97 Oct-00 Oct-03 Oct-06 Oct-09

year

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This had created a strong tailwind for high growth unsustainable, unprecedented and probably un-replicable
Bond and equity returns in the 1980-2000 period were way off the charts compared to long term (50yr) returns. Bond returns have remained high since then, but equity returns have started normalizing. Bond returns in the period 1940-1980, when rates went up from a bottom similar to todays, were very poor both in absolute terms and relative to equity returns. We believe that the world could be going into a similar phase. Hence we believe that it will be difficult to continue achieving these returns, particularly from the bond markets
Global Total Returns in USD (%p.a.)
Time Period Last 100 years Last 50 years 1940-49 1950-59 1960-69 1970-79 1980-89 1990-1999 2000-2009 2010-now US Equity 9.5 9.7 9.0 19.3 7.8 5.8 17.5 18.2 -0.9 9.3 Bonds 7.4 8.0 2.7 0.4 2.8 6.1 12.8 8.0 6.6 9.5 Equity 8.5 10.4 5.2 17.2 6.7 9.3 20.0 14.9 1.6 3.9 UK Bonds 5.1 7.5 -0.2 3.4 3.4 8.6 10.4 10.2 5.4 5.4 Japan Equity Bonds 9.2 -25.6 33.9 13.0 16.9 27.7 -0.9 -4.1 0.7 2.5 10.0 -32.3 6.0 12.3 11.2 14.9 11.0 2.8 8.5 Germany Equity Bonds 6.2 9.2 9.1 -10.8 -21.5 25.9 5.9 7.3 7.1 10.3 16.7 16.1 8.4 10.5 5.4 2.7 9.6 -0.1 3.0

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The balancing factor on leverage-led growth is normally an increase in inflation. However, in the 1980-2012 period, inflation kept surprising on the downside. This was because of:
Inclusion of China, India and Asean in the global supply equation. These markets dramatically increased the global supply of labour, land and capital Productivity gains lead by technological changes in the developed world

We believe inflation remains only a low level concern in the medium term because:
The impact of the above deflationary factors still persists, though at a weaker level. In addition, there exists cyclical spare capacity from the developed world, especially in terms of labour and land.

Therefore central banks will continue to have leeway to further increase leverage and keep cost of funds low

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Nominal GDP growth in Asia and Emerging Markets (EM) has been strong in the past decade We believe that:
This will definitely slow down but will continue to be a relatively strong number Demographics are still very much in favour of continued growth Hence, though reliable growth will be more difficult to find, it will be valuable once found

Very strong growth higher in USD

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Corporate sales and earnings growth will continue to slow down but so will capital expenditure and therefore leverage Operating margins are expected to remain stable
MSCI Asia ex JP: Sales growth
MSCI Asia ex JP: FCF / Sales

40 30 20 10 0 (10) (20) (30)

(%)

Sales growth

20.0 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0

(x)

Op cashflow/Sales

97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F
MSCI Asia ex JP: Sales (US$bn) 25.0 20.0 15.0 10.0 5.0 0.0 (5.0) (10.0) 97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F (%)
Capex/Sales FCF/Sales

97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F

MSCI Asia ex JP: Net debt to equity 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F (%)
Net debt to equity

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Corporates are becoming more cash generative across the world. Free cash flow across the world now exceeds dividend payouts an unprecedented situation Hence dividend will be a large source of value, more so in the current environment
MSCI Asia ex JP: Free cash flow (US$bn) 250 200 150 100 50 0 (50) 97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F MSCI Asia ex JP: Dividends (US$bn) 140 120 100 80 60 40 20 0 97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F (US$bn)
Dividends (US$bn)

MSCI Asia ex JP: Free cash flow yield 8 (%)

FCF yield

(US$bn)

Free cash flow

7 6 5 4 3 2 1 0 (1) 97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F

MSCI Asia ex JP: Dividend yield 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 97A 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F 13F (%)
Div yield

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Dividend contribution to total return since 2000 has been nearly 40%. All the rest was from EPS growth. In the expected lower growth environment, this contribution will further increase This means over 40% of total return will not be susceptible to the market pricing mechanism Currency moves and change in valuation have had a negligible contribution PE, which is the strongest driver of short term price moves and volatility, is irrelevant in the long term The high yield portfolio naturally has a lower beta than the market as the yield acts like an anchor around which the capital value needs to fluctuate The Asian high yield basket has outperformed other high yield baskets handsomely

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We believe that the universe of stocks with strong cash flow, dividend and moderate but stable growth is growing. It represents an better opportunity than investment grade bonds for investors with a longer duration

Also, dividend yields have only been higher than long bond yields in rare crisis situations. Today we have a similar situation without a major crisis a huge source of opportunity.

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This strategy beats market returns in the long term. More importantly it does it with a much lower volatility. DPS volatility is much less than EPS and CEPS volatility (though higher than BPS volatility). Current 3.2% DY for AsiaXJ in in a 3 sigma event would fall to 2.4%.

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Agnostic to asset class i.e. to invest across the capital structure in both equity and debt securities Agnostic to geographic exposure but we expect a higher exposure to Asia (ex- Japan) because of better opportunity set and higher familiarity with businesses in that region The three asset pools we would focus on:
A. Steady sustainable cash generators with moderate growth THIS IS THE CORE OF OUR STRATEGY
They also payout good dividend yields. This is a growing pool of companies. They are a source of relatively non-volatile double digit total returns. Here the total returns seem to be moderate but they beat long term equity returns and, importantly, they give a higher level of predictability.

B. High quality growth companies with strong sustainable franchises

Franchises in the form of brands, distribution networks, technology, government monopolies, etc.
This opportunity pool is the outcome of the double digit nominal GDP growths in Asian markets like China, India, Indonesia, etc. Also increasing exposure of global companies to growth markets has created a pool of well managed companies with a new source of growth. The current inability to raise money from the equity market and banks has created an increasing pool of high yield bonds. These are quasi-equity but with a finite duration. They have fixed, equity like returns. The priority on claim on the cash flow is higher though the businesss strength is moderate compared to categories A and B This is an asset class only to park spare liquidity. The intention is to keep a low duration and not necessarily hold to maturity The long term returns here could be unexciting.

C. High yield bonds

Investment grade bonds.

In a sustained low interest rate environment, growth businesses where the risk perception is better understood will rerate upwards

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Introducing River Valley Asset Management Our investment philosophy Our investment strategy and approach Our investment process

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Provides steady long term returns Portfolio managed directly by professionals with long investment management history (over 35 years combined) and large network of corporate contacts Portfolio managers interests aligned with investors Minimizes use of investors time dealing with multiple intermediaries Clear calibration and statement of risk Concise and consolidated reporting Analysis and control of direct and indirect costs. Our scale economies will reduce transaction costs substantially Creates a financial think tank to bounce off and whet ideas related to tactical investments
No product pushing Skin in the game in terms of own money and performance incentive Returns give optionality on upside compared to a bond heavy portfolio, but with similar risk

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Sector and geography agnostic as long as the securities fit our initial investment philosophy and the defined pools. In practice, could have a about 70% exposure to Asia Exposure to about 40 businesses (either through the debt or the equity route) Maximum exposure of 8% to a particular security At any point of time identifying and having an exposure to 2-3 broad themes. This becomes the medium-term bedrock on which the portfolio is created A strong analytical process that will include
An initial investment report on each security purchased. Quarterly maintenance write-ups Target entry and exit price - action/ review when these are hit Quantification of sector and country exposure

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We recommend a maximum leverage of 50% on the overall portfolio. The normal leverage would be in the 20% range Cash is an investment option. We will exercise judgment in maintaining tactical cash balances. Short duration IG bonds will be used as cash proxies Ability to short the market tactically when views are strongly negative and markets are euphoric. To only use index shorts. Shorts limited to 50% of the portfolio

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A. B.

Stick to the principles stated earlier. Company analysis based on :

A. B. C. D. Growth potential Pricing power Look for companies with moats (in terms of brands, technology, distribution network, government monopolies, etc.) Analyze market stability in terms of competitive, technological and regulatory disruptions Cost structure and movement on that. Operating and financial leverage Tax regime and changes in that. Unit profitability Capital intensity and capital efficiency Liability analyses Cash generation and use of cash Hierarchy of claim in the capital structure and where to enter

B
Buy/Ignore

C E

E. F. G. H. I. J. K. L.

Initiation process

C.

Valuation :
A. B. C. Based on intrinsic value and market comps Have clear buy and sell triggers. Review/action at that trigger point Pure valuation a very strong trigger but only at extreme situations

Regular

D.

Idea generation from :

A. B. C. Running regular data screens Whetting of ideas being generated by other intermediaries multiple company meetings

E
Buy/Sell/Hold

Valuation
Triggers

E. F.

Documentation
A. B. Documentation of complete thought process when initiating a position Regular review documentation

Sell trigger :
A. B. C. Business thesis breaking down Management becomes suspect Target valuation

Maintenance

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Business volatility
Differentiate between risk related to business volatility and stock volatility. The former is clearly more important than the latter Business deterioration is a red flag for further review and/or action During extreme stock price dislocation strong, intensive business review will be the bedrock of risk management. The corrective mechanism will be based more on this than on price movement. Stock volatility is important from the perspective of the leverage taken. Manage margin call, refinancing and interest rate risks for the leverage. Carry out Low exposure to the stock markets price discovery mechanism. The bond portfolio is less volatile and the dividend income portfolio has lower beta (volatility) than the market Also, half the expected return comes from the payouts (dividend and interest), which do not carry market risk. Here the risk is only at the business and management level. Regular portfolio rebalancing is an integral part of the risk management process. Manage market beta by the judicious and infrequent use of index shorts. The maximum short exposure to be limited to 50% of the portfolio.

Stock/ portfolio volatility

regular sensitivity analysis and stress test of the portfolio.

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