Our buy-and-hold strategy hasn't worked well in mid-cap fund: DSP MF's equity head

Vinit Sambre is a seasoned fund manager with over two decades of experience in the market. He joined DSP Mutual Fund in 2007 and is now the Head of Equity, overseeing the DSP Focus Fund, DSP Midcap Fund, and DSP Small Cap Fund, with a combined AUM (assets under management) of around Rs 38,700 crore.

Sambre is well-regarded for his expertise in identifying opportunities within the mid- and small-cap segments. However, the performance of the DSP Midcap and DSP Small Cap funds has dwindled lately. In a recent interview with us, Sambre addressed this underperformance, noting, "Post-covid, the sectoral rotations have been quite quick, so we could not capture well due to our buy-and-hold approach." He also elaborates on his investment philosophy and outlook on the current market during the nearly hour-long conversation. Below is the edited transcript.

As a chartered accountant (CA), you had the option to dive into auditing or taxation. What pulled you towards the equity markets? Was there a specific moment or experience that made you realise your calling?

You are right in a way, and the decision to come to the equity market has worked out well. I finished my Chartered Accountancy in 1997. Even my father was a CA. I did my articleship with him and did auditing and taxation work. After my articleship, I wanted to explore a different field, as the traditional work had become somewhat monotonous.

So, I embarked on a quest to explore something new. During the initial phase, I got an interesting opportunity to work for CRISIL in their research division on a retainership basis. Working there got me excited in the field of equity, as I learned something new every day. I was studying new companies and different sectors, which I found quite interesting intellectually. Along the way, my father was also investing in the equity markets, but his success was hindered by the reliance on 'tips' for investment decisions. Therefore, it was a challenge for me to determine what drives success in this field-tips or something else. All these factors combined prompted me to pursue equity research, which has panned out quite well for me.

The Indian markets seem to be on a relentless rally, even when global cues aren't exactly favourable. From your perspective, what's really driving this—investor sentiment, strong fundamentals, or a mix of both?

I feel there is a bit of a disconnect in the market right now. This kind of linear up move in the last eight years, without any single year being down, as far as Nifty is concerned, is quite unusual if you consider the long history of the equity markets, both in India and abroad.

Equity markets tend to remain volatile, characterised by periods of high performance followed by periods of correction and consolidation. In the long term, the direction of the markets is determined by the fundamentals. So, currently, if you're wondering whether the market is driven by fundamentals or sentiments, I would say it's a combination of both. Following the Covid crisis, fundamentals have improved considerably across the board, which has lifted sentiments and captured the interest of investors.

In recent years, we have also observed a sharp increase in retail investors beginning to trade in the equity markets. The sharp up move in the last two to three years is influencing investors' decision to invest in equity markets. The sharp rise in flows has meant that some parts of the markets seem to have entered frothy levels of valuations. Therefore, we recommend that investors adopt a cautious and long-term approach towards investing and refrain from assuming that just because the markets have produced these returns over the past three years, they will continue to produce similar returns in the future.

What's your investment philosophy and core approach when managing equity portfolios, especially in mid- and small-cap space?

I have adhered to a simple philosophy since I began managing money. I look at three important metrics: quality of business, quality of management, and reasonable valuation.

Our goal is to own good businesses for the long term. We are looking at businesses that have a long runway for growth and strong, sustainable moats. We periodically assess the relevance of the moats, which ensures the sustainability of premium valuations for the investee companies. Further we look at capital efficient companies with positive free cash flow. Our threshold for return on capital employed (ROCE) is 15-16 per cent.

On quality of management, we scrutinise the capital allocation decision in detail. We delve into the history-spanning a period of approximately five to 10 years-to examine the capital allocation decisions of the management. This is a crucial factor as it determines the future success or failure of any company.

When it comes to valuation, we like to own businesses at reasonable valuations, but sometimes, if the valuations look extended, we look for businesses in low to mid cycles with visible signs of recovery. These are some important metrics we follow as part of our investment philosophy.

The DSP Midcap Fund hasn't been able to outperform its peers since 2020. What has been holding it back, and how do you plan to make a turnaround?

Let me give some background on the overall fund performance. Most active fund managers who adhere to a strong philosophy have experienced high and low cycles depending upon the phase of the market. For us, the underperformance began at the end of 2020, which pulled down our long-term performance. Our philosophy of focusing on high-quality businesses, the buy-and-hold strategy and low churn have not worked so well in the last three years. Post-covid, the sectoral rotations have been quite quick, so we could not capture well due to our buy-and-hold approach.

Further, our exposure to defensive businesses like healthcare or specialty chemicals also hurt our performance. Some of our own misses, like not having adequate exposure to segments that were benefiting from the investment climate, contributed to our underperformance. These were the reasons that led to the underperformance of the DSP Midcap Fund.

Another notable point is that when we compared the DSP Midcap Fund to the Nifty mid-cap quality index (Nifty Midcap150 Quality 50), we were quite okay in terms of performance in the last three years. Therefore, we can take solace in the fact that, on quality factors, we have shown satisfactory outcomes. Our ultimate objective is to outperform our benchmark, the Nifty Midcap 150, and the past year or so has marked a period of improvement for us. We have been gradually recovering from the lows. We are seeing that some of the businesses that had underperformed or led to underperformance of our portfolios are recovering, like healthcare or companies within the materials category, for example, pipes, agri-inputs, etc., which is gradually helping our portfolio performance now.

In the long term, the markets will eventually follow the fundamentals, which gives us confidence in our ability to produce satisfactory outcomes for our investors. Some low-quality or narrative-based companies within the index should see correction; good-quality companies will bounce back, and we feel the performance gap will narrow.

The DSP Small Cap Fund hasn't had a great run, too, since 2022. What do you think went wrong, and are there any new strategies to improve its performance?

The underperformance of the DSP Small Cap Fund is broadly due to similar reasons. However, the underperformance here has not been as deep as the DSP Midcap Fund. DSP Small Cap Fund is more diversified or broad-based, benefiting from the broad-based rally in the market. Like our DSP Midcap Fund, some of our high conviction bets in the small-cap portfolios show signs of recovery, further giving us confidence about its performance going forward.

You've been bullish on sectors like consumer discretionary, chemicals, and materials in your mid- and small-cap portfolios, even though they've struggled over the last few years. What's the reasoning behind this confidence?

Given our demographics, we are believers in the long-term growth story for the consumer sector in India. However, within this sector, there are various subcategories like retail, QSR (quick service restaurant), building materials, autos, etc., with different factors affecting their growth cycles. We monitor these factors and optimise our exposures according to their growth cycles.

Over the last two years, we had sized up our exposure to the auto sector within the consumer discretionary space, which has proven to be effective as they recovered from their Covid lows. Similarly, we had reduced exposure to the QSR segment as they witnessed moderation in growth after the sharp growth seen during Covid times. Our effort is to identify these cycles so that we can adjust our exposures accordingly.

Further, when it comes to consumer non-discretionary or the FMCG sector, it has witnessed a slowdown post-covid due to stress among the lower-income group and rural population. The commentary from some of these companies' management suggests early signs of recovery, given better monsoons and controlled inflation. So, we are seeing a reversal in the trend now.

Within materials, our exposures are to companies catering to building materials and agri-sectors. The real estate sales over the last three years have seen remarkable improvement, which is likely to flow down to the building material companies as projects reach the delivery stage. Similarly, as mentioned earlier, the last two years were not so great for the agri-sector; even globally, things have been bad. We are seeing signs of recovery now due to better monsoons and lower inflation. Hence, we have continued with our positive stance on this sector.

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