Get the Big Picture | Value Research Dhimant Shah, Fund Manager, Principal Mutual Fund, tells us how his fund has delivered spectacular performance in 2012...

Get the Big Picture

Dhimant Shah, Fund Manager, Principal Mutual Fund, tells us how his fund has delivered spectacular performance in 2012...

Principal Emerging Bluechip, the fund you manage, is up 52 per cent year to date so far, the best among the mid- and small-cap funds. What reasons do you attribute to this success?
There are a few reasons; firstly, we focused on stock picking, we built our position in stocks where we had conviction and held on to them. This also meant that we reduced the number of stocks in the fund and made it a more focused portfolio. While picking stocks we were focused on those companies that had growth, free cash flows and sensible cash allocation policy from the company’s management. We also got certain themes right, for instance, we were early into media, cement, etc. We remain fully invested through the year and did not have any cash call, this also helped in our performance.

Can you please explain the process part of it?
There are a couple of processes that have helped us. Firstly, the use of our in-house stock screening model which flags off companies for further analysis. Then, there is a rigorous follow up for companies that we invest in – be it quarterly updates or interaction with the management to ensure that things are on track. Last but not the least, we are always on the lookout for new ideas especially in the mid-cap portfolio, these can make a difference to the performance. I think these processes that we follow, apart from the regular screening of companies that meet our defined criteria have aided in portfolio decisions to a great extent.

How do you select you stock universe? What factors do you keep in mind while making the stock selection?
The first thing that we do is to get the macro picture right and then graft a micro understanding of the companies on to the big picture. For example, a few months ago our exposure to financials was below the scheme’s benchmark and as we got into an environment where we perceived that we are almost close to the peak of the interest rate cycle. So we reversed our position and today our financials are slightly overweight compared to the benchmark. As a corollary, we increased weightages in other rate sensitive sectors such as auto and construction. Besides having a macro view, we got the micro picture right using our analysts’ views on stock selection. In terms of the stock universe the in-house stock screening tool that we use covers nearly 400 stocks. Once you have identified the stocks, you just wait for an appropriate level to increase your weightages in the identified stocks.

What do you avoid while building a portfolio?
While building a portfolio, we are not biased against any sectors. You can say that we are kind of sector agnostic. Our entire thesis is driven by getting the expected absolute and relative returns right. What we try internally is to get the valuation metrics right because valuations are the cornerstone and stock price will follow the earnings power of the company. For example, if something of a value of `100 is available at `50 and if we believe that the journey from `50 to `100 is likely to transpire in a reasonable period of time then we certainly would like to ride that journey. So it is critical to get the valuations of the defined universe as stock prices will always follow the earnings power of the company. Lastly, we try to avoid great exposure to themes not amenable to valuation. Techniques or something we can’t justify in terms of appropriate value.

What is your view on mid- and small-cap universe over the next 6 months?
I think most of the times it is an alternating cycle where the large-caps lead and mid-caps follow. Typically the large-caps lead the valuations and mid- and small-caps usually follow suit. This time around too it shouldn’t be different. We are in an environment where because of the global liquidity we have seen some amount of allocations happening to emerging markets as well. India has got a decent portion of the same. What will help will be continued momentum from the Government on the reforms steps that they have taken. If these reforms and policies continue, then I think there will be a case of good performance from the mid- and small-cap space. There are many examples where today’s large size companies were yesteryear’s mid- and small-caps companies like Titan or Crompton Greaves. With valuations still being fair we feel optimistic for the mid- and small-cap space.

Do you think the market has the potential to go further up from here?
I would say yes, with measured optimism. We have seen reform moves from the Government and if it takes the right steps the rising trend in the market will continue. I think there is scope for re-rating especially because in the past two years the earnings have not been to the full potential. Post-Lehman crisis, most of the companies were working to get their leverage right, and more recently were grappling with the currency volatility besides dealing with cost pressures owing to raw material and high labour costs etc., The favourable part is that in general, corporate balance sheets are not too leveraged. Further the valuations currently are not euphoric and growth and the underlying return on equity support valuations. We are broadly trading at mean valuations for the last couple of years and with other asset classes offering limited upside, equity should be able to outperform.

Are you anticipating anything from the Union Budget?
The budget exercise will be constrained by the high level of spending and weak revenue growth that we have been seeing. Hence fiscal consolidation is one key area that one would need to watch. We hope the budget is growth oriented and offers a path to the next level of reforms, like the GST. We need to have government policies that make India an attractive investment destination that attracts foreign capital.

What should investors look for while investing? If someone invests in the fund right now, how long will it take to get rewarded?
I think in terms of getting rewards, it would be extremely important for the investor to be exposed to equity as an asset class because elsewhere in fixed income instrument you are getting around 8 per cent. The last 15 years have seen the profits of corporate India grow at 15 per cent CAGR and finally the returns follow the earnings power and hence I am looking at returns which should be certainly better than returns that you earn in debt instruments.

You also manage Principal Dividend Yield. How do you strike a balance between these two fairly different funds which require different strategies?
Yes, the characteristic of this fund is quite different from the mid-cap fund that I manage. The procedure of investing remains same. Only the choices and the way you allocate money in this fund are different.

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