Big calls during cyclical turning points can be 'rewarding'

Interview with ICICI Prudential MF's Anish Tawakley, one of those few managers who oversees a large- and small-cap fund at the same time

dhanak हिंदी में भी पढ़ें read-in-hindi

Transitioning from a role as a management consultant to one in equity research may seem daunting, but for Anish Tawakley, Deputy CIO-Equity at ICICI Prudential Mutual Fund, it was a seamless shift fueled by his innate passion for business analysis.

An economist at heart, Tawakley currently oversees six wide-ranging funds, spanning from large-cap to thematic and small-cap funds.

The large-cap fund - ICICI Prudential Bluechip Fund, overseen by Tawakley - has assets of around Rs 53,500 crore and is the second largest fund at ICICI Prudential MF.

In this interview, he delves into many topics, including his skepticism towards the widely-adopted investing strategy known as GARP (Growth at a Reasonable Price), his affinity for cyclical turning points in the economy and being underweight on banks.

Here's the edited transcripts.

What brought you to equity investing?
I started my career as a management consultant. This position involves helping companies develop business strategies. However, as you become more senior, management consulting becomes more about client service and less about problem-solving. Since I used to enjoy problem-solving, I thought capital markets would be the right place. That's how I got into equity analysis.

Consulting is all about developing strategies from the inside, and investing is about evaluating those strategies and their execution ability from the outside. So, I see them as two sides of a coin.

Why did you decide to transition from equity research to fund management?
I have always enjoyed analysing businesses, and I'm a passionate economist. In my opinion, equity analysis is about business analysis from an economic perspective. I'm still a very research-based person. (But) over time, as you become more experienced in equity analysis, it's a natural transition to move into fund management while retaining your interest in equity analysis. I still spend a lot of time with analysts, understanding how they are thinking about things and try to guide them on how they could improve the research process, apart from doing fund management.

Looking back on your lengthy equity research career at Barclays, Credit Suisse, Alliance Bernstein and McKinsey, what lessons have proven most valuable now that you manage funds?
As far as equity analysis is concerned, I have realised that having a good foundation in economic theory is very helpful. Understanding economic theory helps you predict how industries will evolve. Second, respect history, as history repeats itself in industries and markets in terms of euphoria and pessimism. So, once you study economic history and the history of industries, you are in a very good position to form a view of what will happen in the future and the risk-return trade-offs.

You manage a pretty diverse range of funds, from the Bluechip Fund to a small-cap one. What's your thought process when taking on such a breadth of strategies?
Although the difference between large and small caps appears stark at first glance, when you eventually get to stock picking, the approach is the same. This is because the characteristics of a strong company don't change whether you are looking at a large cap or a small cap. A strong company with a good competitive moat is typically one that is a market leader and has a demonstrated track record of profitability. Those characteristics don't change whether it's a large-cap or a small-cap company.

Now, some industries are large, and market leaders end up being large caps, and some industries are small, and market leaders are small caps. For example, the auto original equipment manufacturers (OEM) industry is a large industry and market leaders are large caps. But individual auto component industries are small (tyres, batteries, lighting etc) and in these industries market leaders remain small caps. So, the stock-picking approach does not change.

Can you describe your overall investment philosophy? What kinds of stocks or market conditions get you excited?
One part of the investment philosophy is a top-down approach, which basically means sector selection based on economic cycles.

The second is the bottom-up strategy, in which I can choose value stocks or growth and quality stocks. I don't invest in the middle, which is called growth at reasonable price (GARP) stocks.

In my view, companies that fall into the middle category are neither strong enough to be market leaders nor cheap, where there is comfort in valuations.

I like quality and growth companies because they are market leaders with a strong track record of profitability and compounding potential. So, even if I pay a bit more on valuations, it will be fine as that company will continue to deliver on earnings.

To answer the second point, I like cyclical turning points in the economy,when either the economy is bottoming out or people are still pessimistic. Or where capacity utilisation across industries has peaked and, from here, earnings are more likely to be downgraded. That's the turning point for me. You can make big cyclical calls, and if you're right, you're rewarded for them.

Two and a half years ago, there was a turning point when real estate in the country started picking up. There were a lot of naysayers. But I realised that monetary policy is now easy and real estate is turning, which will benefit the overall economy. In my opinion, real estate drives everything in the economy. Once real estate picks up, demand for jobs is created, and demand for other goods also goes up. So, such cyclical turning points are very interesting to me.

I noticed the ICICI Pru Bluechip Fund and ICICI Pru Focused Fund are underweight in the financial sector. Could you explain the strategy behind this positioning?
We realised early that the banking system would struggle with deposits because of the consolidation activity in the sector. As a result, there would also be pressure on income ratios and net interest margins (NIMs). Consequently, we ended up being underweight in banks. While we are underweight on banks, we are overweight on mutual funds and insurance companies. So, to play the financial theme at this point in time, we decided to invest in asset management and insurance companies.

Despite strong returns from the small-cap index in recent years, the ICICI Pru Smallcap Fund has faced challenges. What strategies are you implementing to improve its performance since you took over?
At ICICI Prudential, we believe that there are times when markets will be irrational. In that situation, as a fund manager, you can be rational, or you can outperform. But logically speaking, in an irrational market, you cannot stay rational and outperform.

So, as a fund house, we believe there is a froth in the small-cap space, and we are being cautious. If the small caps continue to run up for some time, our fund will continue to underperform, but that's a conscious strategy.

It may turn out that the rally does last for a while, and we are wrong; we will live with that. But right now, our call is that small-cap allocation should be limited.

Since you co-manage the ICICI Pru Bluechip, a large-cap fund, do you believe active funds can still generate alpha in this segment?
There is evidence that active large-cap funds have been able to generate alpha. Let me explain why I believe that large-cap (funds) can create outperformance.

Our fundamental view, or premise, while buying stocks is that if you like something at Rs 100, you should like it less at Rs 200. If you like or dislike something at Rs 200, you should like it more at Rs 100. Logically, as things go up, you should like them less. But the index fund does exactly the opposite. As the stock price moves up, the weight of that stock in the index also increases, and every incremental inflow (of investor money) will be allocated more to the stock that has gone up. So, by definition, it is momentum. Effectively, you're buying more at Rs 200 than you did at Rs 100.

In other words, in passive, you are buying after it has performed. That is exactly the opposite of what we recommend at ICICI Prudential Mutual Fund. One should buy after underperformance and not after it has performed well.

What can spoil the party for mid- and small-cap stocks? Do the current valuations make sense?
We've seen in the past that it's not unusual for investors to get drawn into stocks based on narratives or on one or two quarters of strong performance, particularly when the economic outlook is positive. I don't know what can spoil the party, whether the liquidity dries up or the euphoria fizzles out. Some of the companies in the mid- and small-cap segments don't have strong moats. So I think there is that risk; the risk-return trade-off in small and mid-caps is not attractive. In our view, large caps offer a much better risk-return trade-off.

Among large caps, which sectors or themes offer good value for a buck?
Nothing is cheap at the moment. But our argument is that the economy is in good shape, so the earnings outlook is good. When the economy does well, cyclical sectors tend to do well. So, we like domestic cyclicals. Then there are the Automobiles, Capital Goods and Financials sectors. Currently, I'm less positive about FMCG space and metals.

Also read: TRUST MF CEO Sandeep Bagla on launching flexi-cap fund

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