Interview

Here's why Kotak fund manager Atul Bhole doesn't mind paying a premium for businesses

In this interview, Bhole discusses his investment philosophy in detail

dhanak हिंदी में भी पढ़ें read-in-hindi

Atul Bhole has around two decades of experience in the financial markets. A fund manager at Kotak Mahindra Mutual Fund, he took the helm of the Kotak Emerging Equity and Kotak Equity Hybrid funds just four months ago. With total assets worth Rs 48,100 crore, these funds are rated four stars by Value Research.

In this interview, Bhole discusses the strategic changes he's implementing in his portfolios and explains his preference for stocks with high P/E ratios. He also comments on the current market conditions, noting that while many stocks have performed well, their underlying fundamentals haven't necessarily improved. Below is the edited transcript of the interview.

What initially attracted you to the world of financial markets?

Actually, 'attracted' is not the right word because I landed in the equity markets through the elimination process. After completing my 10th standard, I chose the commerce stream because I didn't want to go into science. Later, while pursuing the Chartered Accountancy (CA) course, I realised that I could not do audits and taxation for the rest of my life. So, I ended up in B-school, and even there, while doing finance, I realised that I might not do a banking or finance officer kind of role in the future. While in business school, one of my professors was an investor in the equity markets, and that's how I started taking an interest in the equity markets and landed in the world of finance.

Could you describe your investment philosophy? What kinds of stocks or market conditions capture your interest?

My investment style and philosophy lean more towards investing in high-quality management. Many people focus on high business quality, but I focus on management. From the Indian context and after learning from the markets for over one-and-a-half decades, I think management or the promoters are very important. Promoters have the power to build or destroy a business, so staying with good promoters is crucial.

We also look at the business model and growth potential, but the starting point is management. Since this is my style, I have to pay a premium valuation for those businesses. Over time, I believe that this approach (high valuations) allows you to participate in the growth of these companies and also minimises the risk of accidents or drawdowns. Starting with good management and quality companies reduces the chances of significant losses. Capturing the upside and protecting the downside can create alpha in equity markets.

What factors do you consider while looking for good management?

It is subjective. We have extensive cumulative experience working in the mutual fund industry and have observed promoter groups and management's behaviour while managing the business. For example, when judging management, the first thing to consider is the business's capital allocation. This is critical to maintaining growth rate and return ratios and limiting drawdowns.

Next, I also look at how the management has managed during the cycle of greed and fear. We have repeatedly observed that during prosperous market or economic periods, management often makes mistakes such as poor capital allocation for acquisitions. So, they'll end up in trouble.

That said, we also need management that doesn't invest in businesses when the market or economy is not doing well. During such phases, many managers go into hibernation and do not invest. However, during recovery periods, their underinvestment prevents them from generating revenues. These are the fundamental criteria for effective management, along with other considerations such as integrity.

What key factors do you consider when identifying a stock as a compelling purchase?

Regarding specific stock selection, management, business, and growth are important parts of stock analysis. Apart from typical factors like cash generation, return on equity (ROE), and other financial parameters, I think the moat of the business in terms of market share is very crucial. Maintaining or increasing market share is key, as it creates value over a long time and markets reward such companies.

Additionally, growth potential and opportunity size are also essential. If the industry is only worth Rs 5,000-10,000 crore in the $3-4 trillion economy, then there is no point in considering such businesses.

Lastly, I will discuss the valuation factor, which comes last while selecting a stock. If a stock is good in terms of management and business growth prospects, I am willing to pay a slightly higher valuation to those companies. The quality of the business and the compounding of earnings will compensate for the high valuations I am paying.

What kind of markets or situations resonate with your investment style?

I like the normal market or the situation when there is volatility. During bullish markets, mistakes happen when chasing momentum, and the fundamentals are not up to par. I believe the current market is in a situation where many stocks have done well, but their fundamentals have not improved. Even if we maintain discipline and patience, some mistakes will happen in such markets. So, this kind of market is not something I enjoy because it ends in a concerning way, and drawdowns can be significant.

Markets with no major ups and downs are ideal for me, as they suit my framework of buying good-quality management. Many people love bear markets, but I would say that in such markets, it is very difficult to establish the business potential or how the businesses will come back. In many cases, we might just invest by looking at the valuations, but it could also be a value trap.

Having joined Kotak Mahindra Mutual Fund just four months ago, are there any changes or adjustments you're considering for the Kotak Emerging Equity and Kotak Equity Hybrid fund portfolios?

If you look at the portfolio managed by my predecessor, I think the style and framework are, to a large extent, very similar. Around 80-90 per cent of the portfolio style is very similar. Basically, what I can do is book profits in certain domestic sector stocks, which have done very well in the last two years and whose valuations are slightly high. These are not businesses where we can continue to extrapolate earnings or top-line growth. To some extent, these businesses are cyclical.

So, while I'm booking profit in some part of the portfolio, I am also deploying that money into sectors that have actually gone through a lot of time and price correction in the last two to three years. I'm adding names from pharmaceutical, IT, and hospital stocks because I believe they will be the structural theme over the next five-10 years. Apart from that, I am also looking to introduce some tactical ideas in 10-15 per cent of the portfolios. These can be stocks related to changes in the economy or the business environment. For example, we are seeing good traction in the power, railways, and infrastructure sectors. Some of the ideas in the portfolios were lacking. During 2010-20, these sectors did not work, but they made a comeback in 2022. So, I am also looking at such ideas, which can form 10-15 per cent of the portfolios, as they are available at a good valuation with high dividend yields.

Regarding stocks with high P/E ratios like Solar, Cummins India, Supreme, and Thermax, what's your take on paying such high multiples for growth stocks?

I will reiterate that I like good quality management and business; they invariably have a high P/E. As discussed earlier, valuations are not a starting point for me. So, when we buy stocks, some might have a high P/E. My experience is that investing in stocks that have a P/E of 40 or 50 needs a lot more deep research and study channel checks than buying a stock with a P/E of 10 or 15. This is due to the attractive valuation of stocks with a P/E of 10-15. Still, when I invest in higher multiple stocks, I must demonstrate the quality of the business and the management's ability to avoid serious mistakes. When buying high -P/E stocks, one must have conviction. If we look at history, they have delivered returns for the investors. There are names in private banks that have always traded at higher valuations. Still, by not making any major mistakes, they continue to deliver that 15-20 per cent earnings growth and these stocks have delivered strong returns over a long period of time.

Also read: Interview with Axis Mutual Fund's Head of Fixed Income Devang Shah


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