Betting on Fundamentals

Fund manager Sandeep Kothari shares his view point & discusses his investing style

Do you replicate the benchmark closely when you construct your portfolios? We do not replicate the benchmark. In fact, 15-20 per cent of my portfolio will not comprise of benchmark stocks.

We have modelled 250 companies which we have met. I use this as my stock picking universe. But it is not static. We constantly update our database as we meet new companies.

If you do not use the benchmark as a portfolio construction tool, do you refer to it at all?

I use the benchmark to take a look at my underweight positions of certain stocks. For instance, a stock may have prominent weightage in the benchmark but is missing in my portfolio. I will periodically go back to check if my hypothesis is still correct and I am still convinced that the stock should not be in the portfolio. So I use the benchmark more as a risk management tool.

What do you keep in mind when constructing a portfolio?

When we construct a portfolio, we go for bottom-up stock picking. We look at the risk-reward ratio carefully. So we not only consider the potential upside, but even the potential downside.

I believe that whatever stock I have in my portfolio, I must be on top of it. I must know what is happening in that company, my valuation preferences and my investment thesis. I must be in complete control over what I own.

Despite Fidelity Mutual Fund's thrust on research, the funds don't show fabulous upside in a rising market.

We aim for consistency in performance over the long term. At Fidelity Mutual Fund, our portfolios are constructed with a long-term view in mind.

Since we are bottom-up stock pickers, we look at the businesses and the value we are paying for them. So even if a sector is on a momentum, we will not compromise on risk by getting into it just to show higher returns. I will always marry a concept to the relevant valuations and cash flows etc. Even if a stock is rising but I feel that the balance sheet is vulnerable or am not comfortable with it, I will avoid it. I may miss on the upside but I certainly do not want any blowups in my portfolio.

As I said earlier, at Fidelity we build portfolios bottom-up. Our sector overweights are not a result of sector allocations, rather the overweights are derived from our positions in individual stocks which reflect our conviction in those stocks.

In building a portfolio, we look for stocks with scalable businesses and good management that are available at reasonable valuations. Valuations are important as we tend to hold stocks over a longer term. When valuations are looking expensive, we consciously stay away from those stocks, possibly missing out on the last leg of the euphoria. At times, this can hurt the fund's short term returns, but it helps us deliver long term, consistent performance.

We believe that in the long term if we compound at a consistent level we can create value.

Do you not feel that your portfolios are too cluttered with too many stocks?

Diversification of my portfolio is an important parameter, both on the stock and sector level. If I am convinced about two stocks and view them to be great long term bets, then I would not bet, say, 10 per cent on any one of them, but probably 5 per cent on each, just to cite an example. Because I know that if I have too concentrated a portfolio, then it will be volatile. That is not what I want - sporadic highs. I look at consistency and outperformance over the long term. And I do believe that bottom up stock picking and staying true to your convictions will get you there.

As for the number of stocks, our portfolios have about 50-65 stocks. And there will always be a tail of 5-7 stocks, where you are trying to build a position or exit a position and the prices run against you. So those don't contribute much but it is a number which is there and we do not try to manage the number.

Having said that, yes, we do maintain a 50-60 stock portfolio and the point I would like to make is that, as long as we are comfortable with the stocks in our portfolio, as long as they are well-researched and we are on top of those businesses and understand their valuations and have a very clear thesis on why we own them or we know when to take corrective action when the theses go wrong - I think the number of stocks is not a constraint. Whether a 30-stock portfolio is the correct portfolio or whether a 60-stock portfolio is right, my belief is that as long as you know what you own, why you own and how well you know what you own, the number of stocks should not matter.

Don't you feel that the high large cap exposure hinders fund performance? Would you not be able to deliver higher returns if you took larger bets with smaller companies?

We buy stocks based on their risk/reward ratios, rather than buying small or large caps. I own a number of small caps like Rallis, Castrol and Whirlpool etc in my portfolios. When you buy a small cap, you do take an additional liquidity risk. So for small cap investing, I believe one has to take a fairly long-term view. We are not averse to small caps. If the risk/reward looks favourable and we believe that the management has the capability to scale the business, we are happy to invest.