Normalization - स्र्पष्टतर
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In our Apr 2025 letter – “Bottoming – पुनरुत्थान”, we mentioned that the markets are showing signs of bottoming and that the investors should use that opportunity to increase their equity exposure. Since then, the markets have recovered very well.
MARKET RECOVERY
The small-cap 250 index is rebased to 100 for various periods of correction
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Similar to the beginning of the year, multiple expansion is likely to be more measured from here given the high starting valuations, so future stock gains will rely on actual earnings growth delivery.
Data Source: Ace Equity. The percentage inside the bubbles represents the number of stocks in the particular style. Style classification is based on Vaikarya’s proprietary method, which combines several factors in addition to valuation.
PORTFOLIO STRATEGY AMIDST A VOLATILE GLOBAL ENVIRONMENT
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The global environment was extremely volatile over the last few months, marked by US tariffs, the Middle East conflict, and a brief war between India and Pakistan. The key event is the relative tariffs India receives from the US, as these tariff outcomes are expected to be settled over the next few weeks. The Indian macro and liquidity environment is much more benign now than at the start of 2025. Interest rates have come down, inflation is under control and the government’s continued focus is on infrastructure and manufacturing. Flows have been supportive, hence the Nifty is up ~7% for the year, showing resilience of the Indian markets. It provides exciting growth opportunities for nimble, smaller firms. We are approaching small caps with a quality bias within the “GARP” and “Value” styles.
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Over the last 3 months, we have deployed our cash and, given the prevailing global uncertainty, have skewed our portfolio towards businesses with domestic exposure. Notably, we have exited some of our IT positions and increased our exposure to tracked opportunities in BFSI, manufacturing, construction, and healthcare companies. Needless to say, we are closely monitoring global events and tracking a select group of companies for long-term opportunities
IMPACT ON PORTFOLIO
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The impact of all these uncertainties on our portfolio companies has been minimal since the US exposure for our companies was limited. Furthermore, we have restructured the portfolio to trim this exposure even more till further clarity emerges and we get conviction on industry cycles and companies that can benefit from any possible re-alignment of the global supply chains. As of the day of writing this letter, we remain overweight on companies anchored to domestic growth with a firm eye on the changing global economic indicators.
Portfolio Performance and Positioning
PORTFOLIO PERFORMANCE
Source: Fund returns are after management fees and other expenses.
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For the 1 & 3 months ending 30th June 2025, the fund delivered +120 & +50 bps relative to NIFTY500.
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The following factors have contributed positively.
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The financial sector and select small-cap stocks contributed materially on both an absolute and relative basis. As highlighted in prior letters, we acted upon building positions ahead of the credit cycle turn in select financial stocks, such as scaling up L&T Finance and IDFC, while taking fresh positions in Fedbank Financial, Aditya Birla Capital and RBL Bank.
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Select small caps, such as Interarch, performed well with strong quarterly results.
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The following factors dragged down the returns
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Healthcare/Pharma positions underperformed. While domestic ones (e.g. Windlas) had moderate quarterly results, one global pharma stock (Piramal Pharma) turned weak amid the US tariff narrative.
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Select small caps in the portfolio (e.g. Capacite) underperformed due to weaker results.
PORTFOLIO POSITIONING
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Over the last quarter, we have deployed cash (reducing from 27% to 7% levels) on tracked opportunities in Financials, Engineering, Healthcare/Pharma (domestic mainly), etc. We have made meaningful shifts to align the portfolio with evolving macro risks, like tactically reduced positions in IT Services and export-oriented companies. As a result, our core positioning has become more India-centric. Our largest sector allocation, Financials, benefits from improving trends in unsecured credit and regulatory easing under the new RBI governor.
Valuation data represents a weighted average across the fund’s positions. Forward P/E is used, except for turnaround stocks (approximately 5% of the fund), where a 24-month forward P/E is applied. Returns (ROE/ROIC) are incremental or based on a 12-month forward view. Growth rates are forward-looking, steady-state, and measured at the top-line level.
L&T Finance – Transformation-led re-rating in play
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L&T Finance represents a classic Vaikarya multi-bagger setup — a company with a legacy discount, mispriced due to short-term headwinds, yet executing a strategic transformation under new leadership to change its orbit towards Tier 1 NBFC. The company has transitioned into a retail-focused, cutting-edge tech-enabled lender with improving RoA, resilient asset quality, and high-conviction management.
Source: Trading Veiw
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As we highlighted in our December 2024 letter (see chart above), we closely tracked the MFI cycle, which was causing dislocations in stocks such as LTF – a potential multi-bagger over the years. We had a position under 2% in LTF at the beginning of 2025. We scaled up the position to 9+% by early April. With substantial gains over the last 3 months, we trimmed exposure due to SEBI’s 10% ceiling but continue to hold LTF as a core position for long-duration compounding.
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Beneath the near-term clouds of a microfinance credit cycle, we believe the market has been misunderstanding the speed and effectiveness of LTF’s transformation. The market? Still stuck on the lost decade till 2023 with the stock, followed by microfinance noise, and yesterday’s headlines.
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Meanwhile, the company has gone almost fully retail (97% of the loan book!), shut down its legacy wholesale business, and brought in a top-tier CEO from ICICI Bank who’s reshaping the house faster than anyone expected.
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The new LTF is using proprietary AI (tools called Cyclops and Nostradamus) to underwrite smarter and cut losses before they show up. In just one year, delinquency in two-wheelers has reduced by 120 bps, and high-risk loans were proactively flagged, and their share in new loans was reduced from 11% to 3%. Even farm indexed bounce rates improved from 159% to 38%. That’s not just cleanup — it’s a full-system upgrade. These outcomes, while not yet fully appreciated by the market, provide early evidence that LTF’s new tech-enabled approach is delivering tangible credit benefits. Regulatory tailwinds, such as the adoption of Account Aggregator frameworks, further strengthen LTF’s ability to compete effectively, even against many banks, given its low cost of funds (AAA rating).
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They're also entering high-ROA, low-risk products, such as gold loans (via a strategic acquisition), and launching micro-LAP. With 9 million active customers and growing, the cross-sell opportunity is massive and profitable. LTF isn’t just surviving the microfinance storm — it’s quietly becoming the last man standing with 3-lender cap. As weaker MFIs fade, LTF’s credit costs could fall fast, and what looks like a messy loan book today might be a great value in future.
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Here’s the kicker: even after delivering 2.44% RoA during peak MFI stress, the stock still trades at ~1.6x book and ~13x earnings — vs Tier 1 NBFCs trading at 3.5-4.5x book - not expensive for an NBFC, let alone one reinventing itself with tech, prime customer focus, and a shot at 3.0% RoA and nearly doubling the balance sheet over the next 3 years.
Source: Ace Equity. Stock prices indexed to 100 from respective turnaround years — Bajaj Finance (2011), Cholamandalam Finance (2014), L&T Finance (2023). Y-axis is in log scale.
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