Though the equity funds of Axis AMC are fairly new, Chandresh Nigam, Head – Investments, Axis AMC is an old hand at this business. He hunts for companies that have the ability to exploit opportunities in their sector and then analyses whether they possess sustaining power. Not least is the fact that he is overtly proud of the risk management systems in place at the AMC.
Can you tell us how you build your portfolio?
Our objective is to build portfolios with stocks that have significant upside potential. So the investment process is to narrow down on a good business and analyse it to see if it has the potential to make meaningful amounts of money. We have a bottom-up, universe-based approach. We continuously track over 300 companies which we believe have the necessary attributes and strengths to succeed and grow over the next few years.
How do you define next few years?
Around two to three years.
How do you narrow down on this universe?
We then look at these stocks individually. We look at where they are in terms of the business cycle and how they are valued from a two to three year perspective. So our approach starts by looking at businesses which we track and then take a call on the size of the opportunity. Does this company have the competitive advantage to exploit opportunity in its sector? If yes, can they do it profitably – in an effective and efficient way? We spend most of our time doing this.
At any given time, how many make for good ideas?
Around 40 to 60. And depending on the individual portfolio manager, these ideas find representation in the funds.
Tell me about your risk management.
We pride ourselves on having integrated a sophisticated risk management system with the investment process. We look at risk very holistically. We don’t just look to our compliance and the risk management team to tell us what risks we are facing. We don’t believe it should be relegated to the mid-office. The investment manager himself is very aware of the risk he is taking because risk management is intrinsic in our investment process. The risk management strategies are built to ensure that all the pre-identified risks are managed in the investment process itself. These five risks are classified as: Quality, price, liquidity, volatility and event risks.
What this process allows us to do is to buy inherent quality at a good price. We want all our portfolios to be of high quality, hold stocks which are reasonably valued and have appropriate liquidity. All our funds have a quantitative liquidity target, which means a maximum number of days to sell a minimum percentage of the portfolio.
Some of our funds carry specific volatility targets. So a multi-cap fund cannot exceed a particular mid-cap allocation because of its volatility target.
After doing all this, we look at potential events which can affect portfolios negatively. Then we evaluate probability of the event occurring and the impact of it on our portfolios.
In this hunt for great businesses, how do you manage your benchmark exposure?
Ideally, I would like very few of our products to be index linked. This is a personal preference. Of course we have our benchmarks but the key to long-term outperformance is to make the fund manager independent of trying to out-perform benchmarks over short term periods. This really helps him focus on the job at hand – which is to identify good businesses and buy it at good prices.
Further, each of our funds has an investment policy document which lays out the portfolio objectives and all risk limits to be maintained by the portfolio manager. So while there is significant flexibility for the manager to run the fund, there are limits on cash positions, sector exposures etc. to ensure that the portfolio objectives are met.
On the portfolio management strategy side, we believe there are two ways to make money sustainably.
One is to find great businesses which will grow shareholder value. In other words, invest in businesses which compound value.
The second is to invest in great stocks which are available at prices significantly below inherent value and wait for the undervaluation to correct.
Both strategies are good. If you can find the stock which combines both: available at great value as well as will compound its business value over a period of time, then that is a potential multi-bagger.
How do you value a good business? You have been vocal in your distaste for PE multiples.
What are we ultimately buying when we buy a business? End of the day we are buying cash flows. Future cash flows. We are firm believers that the “business” of business is to generate cash. Since it is difficult to work out these values way out into the future, a short cut is to look at the PE. On its own a PE will tell you nothing. A 40 PE stock may be cheap because the next few years’ growth is may be very high.
Whenever we look at a company, we say, if this company was not listed, how much would we pay for it? Then there is no quoted P/E. You are ultimately just paying for cash generation. The strategy is to invest in growth-oriented companies. I am a firm believer of growth investing where you put your money into businesses having sustainable growth.
So PE has no value at all?
If you are comparing comparable businesses then you can have a PE comparison. Then PE can be used along with PB and sustainable RoE. But a PE comparison of disparate businesses makes no sense.
Years ago, I remember looking at two very well established companies, each growing at that time at 20 per cent. However, a big difference was that one had a pay-out of 80 per cent of its profits, the other, only 20 per cent. So it should not have been a surprise that the company with a higher pay-out had a PE that was thrice that of the other. So the EPS was the same, EPS growth was the same. The difference was the dividend payout. And the PE is vastly different.
Also, businesses do not grow continuously. You have to look at cyclicality and volatility. You can say that these are my estimates but what is the band between the best case scenario and the worst? If the band is too wide, then there has to be some factor of safety. In such a case, generally speaking, the PE that you are willing to pay would have to be lower.
If you had two stocks in the same sector, one a mid cap and the other a large cap, would you analyse each differently?
Generally, it will not be very different in terms of stock picking. But all the parameters I mentioned earlier will come into play. Liquidity of the stock will play an important factor. So will volatility.
We generally do not play large cap versus mid cap. Whatever is more attractive, taking into account all the parameters, will find its way into the portfolio. Then individual portfolio exposures will come into play. Depending on the portfolio, whether it is large or mid cap, the stock will get an exposure.
You have been in the business for over a decade. What has been your biggest learning, especially post 2008?
The biggest learning is that you just cannot get too sure about anything. There is a lot of uncertainty out there. While that is there, the sustainable businesses will eventually make a mark. We live in uncertain times. But if you have real value – which is sustainable competitive advantage – then you will make money.
What shaped my investment philosophy was the period during 1994-96. At that time I really understood the value of sustainability of businesses. At that point in time the economy slowed down and interest rates were high. So many companies were folding up. And I was left wondering why is it that some of the stocks I had bought had lost significant amount of value: in some cases over 80-90 per cent. The reason was that these companies were not able to sustain in a difficult environment. That is why I keep coming back to risk management and sustainability.
What would make a business sustainable?
Lots of factors: Management, past track record, balance sheet strength, products, competitive advantage in distribution and technology and so on. It is different for different industries, but innovation is at the heart; it is a must. It stretches across industries. The business has to keep innovating through more creative and radical ways on keeping the customer and drawing new ones.
If you were looking at banking, what would you look for in innovation?
How they reach out to their customers. There are new ways to do things. There are two aspects. How the company appeals to customers and how it delivers its product. Now we have commoditisation of technology. Internationally huge amounts of money have been spent by banks to build customised solutions which they thought would give them a competitive advantage.
There is no question of survival if you cannot differentiate. It is important to see if the innovation exists in the DNA of the organisation.
How important is meeting management in your hunt for good stocks?
It is good to meet them to understand the business. But it may not be a good idea to depend solely on their guidance and projections.
In your earlier stint in the alternative investment space, how different was it?
That was very different. The fund was a long-biased, long-short fund. The focus of the fund was on generating positive return. The expectation was that if we would catch 70 per cent of the upside and limit falls to just 30 per cent of the market fall, we would do well....... So the kind of companies we looked at were different. The idea was not to deliver “blow-the-lights-out” kind of performance; the focus was more on risk management.
That was a good learning. Am I being adequately compensated for the risk I am taking?
In the long-only space, if I were to say that I delivered 20 per cent, the next question would probably be: What did the index deliver? But in my stint in the alternative investment space, if I said that I delivered a 20 per cent return, the question would be: What risk did you take to achieve that?
Axis Long Term Equity has been the best tax saving fund over the past two years. What has been the reason for its success?
This fund, being an ELSS, has a three-year lock in so the investment strategy is aligned accordingly. To put it simply, the strategy is to identify a good business and hold on.
We are not too bothered if a stock performs or not for six months. We buy quality businesses with strong growth visibility over the next two to three years at a reasonable value. We are not too bothered if a stock performs or not for six months.. So the idea is to buy something that is so good on a three-year basis that that we can take some short term volatility in our stride.
Besides your ELSS, you have a large-cap and mid-cap fund. Does that mean Axis Long Term Equity has a multi-cap strategy? Yes it does but the maximum limit it can invest in mid caps is 50 per cent.
In which sectors are you finding value right now?
We are finding value everywhere. We were little ahead of the curve in November 2010. We were clear that inflation numbers would spike up and thought that the RBI would accordingly move. Now we feel that the cycle is kind of over but do not see a sharp decline in rates. But the negatives are discounted in the prices so the downside seems to be limited. We are now finding significant opportunities all across sectors. In some sectors like real estate we may have no exposure. Or in some like infrastructure, we have exposure but would be underweight from a top-down basis. Not because we are monitoring the index exposure but because we have not got good stocks that we want to invest in.
How big is your equity team?
We launched our first equity fund in December 2009. We had a six-member team then and the same now. So we have had a full team with a lot of experience from day one itself. The way I laid out the process was that we knew how many people we would need and that decision was made and recruitments were done even before the first product hit the market.
Apart from me there are three equity portfolio managers, an analyst and a dealer.
ELSS: Equity Linked Savings Scheme / PE: Price to Earnings ratio / PB: Price to Book / RoE: Return on Equity / FMCG: Fast Moving Consumer Goods / EPS: Earnings Per Share / RBI: Reserve Bank of India