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The Value Hunter

Sandeep Kothari, fund manager at Fidelity, talks about his fundamentals-driven strategy…

With 17 years of experience, Kothari’s stock picking strategy is driven by fundamentals with a focus on risk-adjustment returns. After putting up an average show in 2007, his performance in the last two years proves that he can ride a bull market on his terms.

There seems to be duplication in your product basket. Fidelity Equity and Fidelity India Growth, both equity diversified funds falling in our ‘Equity: Large & Mid Cap’ category. Even their returns in 2010 were identical - so is the fund manager? Your comments.
I do manage the two funds differently. If you had to look at the contributors to the performance, you would have noticed that. It’s just that the outcome is similar.
Clearly, Fidelity India Growth is positioned as a more concentrated fund. The percentage ownership of a company, because it is more concentrated will be larger.
Now because it is concentrated and because I am taking larger bets, I focus on the liquidity parameter. As a result you would see a more prominent large-cap bias in the portfolio.
Normally one would think in a fund with a small asset base, the mid-cap allocation would be higher. Not so in this case. Here we have around 45-50 stocks in the portfolio with a large-cap bias. I am looking at a scalable model whereby if it scales the character of the fund will not change. So whether the fund is Rs100 crore or Rs1,000 crore, the essence of the portfolio will be the same, it will stay true to its mandate. I would not manage it differently. I would not pack the fund with mid caps simply because the asset base is very low.

Are all your portfolios so diversified in terms of stock holdings? Is that a mandate of the fund house?
Normally I have around 60-65 stocks in a portfolio. Around 10 of the stocks would be such that I am trying to build or exit a position. So it’s around 50-55 stocks that drives the portfolio. I have the flexibility to even go with 30 stocks, there are no restrictions. The way I look at it is not in terms of number of stocks, instead I look at my comfort level. Am I comfortable with the stocks in my portfolio? Do I have any serious risk and liquidity issues with this portfolio? The day I find my portfolio unmanageable or that there are stocks which I cannot give attention to, the number will be accordingly trimmed. But I certainly won’t be selling stocks just so that the number of holdings in my portfolio drops. But never will I put myself in a position where the portfolio is unwieldy and I am unsure of what is happening in certain areas. My thesis is very clear on the stocks in my portfolio. Why they are there and why that particular allocation to each stock.
There is no right or wrong about how many stocks there must be in a portfolio.

Fidelity India Value is a value-based fund managed by another fund manager. Does that mean you position yourself as a growth investor?
You can stylize certain investing patterns but I do not know if I can be categorised as either a value investor or a growth one. Some fund managers may have a value biased approach. I just follow a process. In doing so, I may be tilting towards a value approach in some picks and growth in others.
I do believe there must be value in what I buy. But if you ask me for a clear definition of value and growth in the market we are in, I would not be in a position to give a very clear-cut answer.
I look at scalable businesses, the quality of the business, execution track record and, relative to the cost I am paying, if there is value in it. So it need not be a low price earnings ratio (PE) or low book multiple, it just has to be a value buy. There is value approach to the stock picking rather than a fixation on certain ratios at certain levels.

In Fidelity International Opportunities what process do you follow when constructing the portfolio?
I took over this fund in August 2009.
Firstly, the mandate states that 65 per cent of the portfolio’s allocation is to Indian stocks. So only 35 per cent of the portfolio will be invested abroad.
From the portion that is to be invested abroad, the mandate restricts it to economies across Asia, not across the globe. There is a lot of growth in India and a lot of it complements what is happening is India.
I do the stock picking for both, the India and Asia allocations. I have worked in markets other than India and been a research analyst in various sectors, so I have had prior exposure. I pick stocks whose businesses I understand, where I see value and where there is scalable business. The same way I pick stocks for my domestic portfolio, I do so for the international portion too.
Of course, Fidelity’s research teams in countries across Asia helps. We have access to all the research on every company. But before I make the final call on which stock to pick, I too interact with the management of the company. The first-hand experience of what is happening in other geographies across similar sectors helps broaden the exposure on one’s domestic portfolio too.

In 2007, your domestic funds put up a very average performance and were pretty much trounced by the competition. How humbling an experience was that?
The market ensures that we don’t get arrogant. Every day is a humbling experience because you never know what the market has in store for you. It’s a lot of hard work on a daily basis.
While I do admit my funds were punished in 2007 and it was not easy to see that happen, I have never chased performance. I follow a process with the intention of favourable returns being the outcome. That year was a raging bull market with property companies showing some ridiculous valuations. Infrastructure was riding high. One cannot justify very high valuations because one does not know when they will collapse. So I preferred staying away. The funds did not perform for a while but that could not be helped. Such patches will always exist time and again.
End of the day, I am accountable for what is there in my portfolio. I have to be convinced of what I am doing and have an investment thesis to back it up.
My focus is consistent returns and I have not deviated from that. I cannot chase momentum because there is no way I can say where the market will be in the next quarter.
I am not saying that there is only one right way of managing money, all I am saying is that this is the way I have chosen.

You claim never to follow the benchmark in portfolio construction. So how do you measure performance?
Fidelity measure the performance against the peer group and against the benchmark.
The BSE 200 is the benchmark for all my equity funds, barring Fidelity International Opportunities. It’s a broader benchmark than the Sensex or Nifty. But the benchmark is no restriction for my portfolio. I will not limit my investment universe to what is there in the benchmark. I look for ideas across. The benchmark stocks are the second derivative. If I am not holding many stocks which have a significant weight in the benchmark, then I have to be very sure of why I choose not to do so. If I am not holding a company which is 5 per cent of the benchmark, then my thesis on that company has to be extremely strong otherwise if the stock moves up it will definitely hurt the returns on my portfolio.
So I look for the best ideas in my investment universe. If you take a look at our equity portfolios you will find many examples of stocks which are amongst the top 10 or 15 but are not benchmark compositions. But I do use the benchmark as a sort of risk measure and end of the day the performance of the funds is measured against it.

How do you manage liquidity in your portfolios?
Liquidity is a major part of the risk analysis of the portfolio. It is basically the number of days it takes to trade each stock. So tomorrow if I have to exit XYZ stock, I have to know what are the number of days of trade that would be required to do so. Depending on the average trading volume of that stock over a period of time, a number is arrived at. This is extremely important because end of the day we are trading stocks in the real market, it’s not just something on paper. So if the illiquid portion of the portfolio gets larger and larger, then it raises a red flag. I put a lot of emphasis on liquidity of the portfolio.
If I had to make a pick between a liquid and not-so-liquid name in a situation where the risk-reward is not significantly different, I would go for the liquid one.
Liquidity is a changing goal post. In a down market many liquid stocks become illiquid while illiquid stocks become very liquid in a rising market.

How do you manage risk in your portfolio and what risk management techniques do you have?
There are numerous ways by which risk is monitored in the portfolio. We have internal quantitative tools like the tracking error and the liquidity profile. The chief investment officer (CIO) and the risk managers can look it up at any point in time.
Every quarter we have fund reviews. We look at the long-term and short term performance of the fund. We analyse the contributors to it or those that have pulled it down. The why and what is intensively analysed and debated.
When making my stock selection, I am clear that I have to have a long-term perspective. And while the upside for certain stocks may be great, I have to also keep the downside in mind. I would try and avoid stocks which can blow-up. So quality and track record are important. If a management has blown up balance sheets before but now the company looks great, I would dig deeper to find out what brought about that change. Has the management changed? Can I trust them again? If yes, why?

Read second part of this interview on May 31, 2011