Widely read:
Having navigated numerous cycles of booms and busts over his 25-year tenure at UTI Mutual Fund, Ajay Tyagi knows when markets drift from fundamentals. The recent correction "represents a return to some sanity," observes the veteran fund manager, reflecting his seasoned understanding of market excesses.
Beginning his career tracking IT and Telecom sectors in 2000, Tyagi now heads the equity division at UTI, overseeing key funds like UTI Flexi Cap Fund and UTI Unit Linked Insurance Plan, with assets worth approximately Rs 33,300 crore. In this interview, he shares his scepticism about the recent market rally, particularly in mid and small caps since the latter half of 2023. He explains why the market needed a correction and discusses his preference for private sector banks and IT services companies. Below is the edited transcript of our discussion.
You have been managing the UTI Flexi Cap Fund since 2016; the eight-year period is quite a long time. How has your journey as an investor been, and how has your investment philosophy evolved over the years?
I began my journey with UTI in 2000, marking approximately 25 years at this fund house. I joined the team as an analyst, and my responsibilities included tracking sectors such as IT and telecom back then. The growth journey of the IT sector had a significant influence on me and my perspective on investing, even in the early days. For me, the focus was on businesses that were growing profitably, creating value and compounding that value year after year. This greatly influenced the philosophy I employ in managing my funds today.
As an investor, the most dependable way to select a business is to go for the one that effectively addresses customer problems, doing so in a profitable manner and entering the industry at an early stage to ensure sustained growth over an extended period. In essence, my philosophy revolves around businesses creating economic value, compounding that value, and ultimately leveraging this entire journey, leading to the compounding of market value for their stock prices.
As a fund manager during the Y2K period, how did that tech boom era and its narrow markets influence your investment philosophy?
The most significant insight I gained as an IT analyst was the application of the Pareto law to wealth creation--no more than 20 per cent of companies end up creating wealth in the long run. Back then, there were approximately two dozen IT companies, and we closely monitored each one of them. By 2003-04, it was evident that the ones still standing tall were just a handful. That was a great insight itself, which is that when the sunrise industries take shape, it doesn't mean that all the players participating in that industry would survive and create value for investors. Therefore, it is crucial to exercise extreme caution, and this approach has greatly benefited me.
This approach has also benefited UTI as a whole, given our scepticism towards anything that carries a narrative. We want to see structurally strong businesses with a winning business model and a path towards profitability. We are very conscious of the fact that profitability has to happen sooner rather than later, and the lessons learned during that Y2K phase, as you rightly put it, have been extremely important. Yes, sunrise industries and growth industries create a lot of value; however, within these industries, only a select few consistently generate value. Of course, these select few businesses have their own unique economic characteristics. While I cannot undervalue the softer aspects of management, vision, and commitment, they do possess certain quantifiable economic characteristics.
What is your fund's strategy, and why are you currently overweight in the financial and IT sectors?
Since we follow a bottom-up approach, we have a very high active share of 70 per cent, contributing significantly to our blockbuster years in terms of performance and equally disappointing years in terms of underperformance. Unlike those who maintain benchmark weights despite conviction, we believe in complete avoidance if we don't see value-creation potential. It is obvious that a high active share, which stems from a bottom-up philosophy, can lead to divergence.
Now, regarding our position in financial services and IT, let's put the facts straight. We are underweight in financial services. However, you are correct that financial services represent one of the largest exposures in the fund, accounting for about 20-23 per cent, and this exposure is limited to a small number of private sector banks. We don't have any public sector banks (PSU) in the portfolio. In our opinion, the banks that we hold will continue to show strong credit growth. They also have strong underwriting standards, so we've seen them performing well during adverse credit cycles over the last two and a half decades. These banks exhibit strong return on assets (ROAs), which makes us happy to own them. The good news is that most of these banks are currently trading at a significant discount to their long-term averages. So that's also one reason we continue to hold on to these positions.
We are slightly overweight in IT and IT services. IT services is a sector that experiences its own cycle. Sometimes, people are disappointed by the amount of demand in the US, and at other times, they get overly excited. As I mentioned earlier, my career began as an IT analyst. I've observed that these companies have excellent management teams, strong balance sheets and are highly cash-generating with a return on capital of 40-50 per cent. While the growth may not reach 20 per cent, our portfolio exhibits a slight bias towards mid-tier companies, which are experiencing growth in the mid to high teens. Further, each wave of new technology leads to more opportunities for the Indian IT services industry.
How do you balance the responsibilities of fund manager and head of equity?
As head of equity, I work closely with all the fund managers. For us, the core responsibility of stock selection and portfolio construction lies only with the portfolio manager. We offer a variety of strategies across the spectrum of value, blend, and growth, as well as large, mid, and small. My job as a head of equity along with Vetri, our CIO, is to ensure that each of these strategies are true to label and are being managed in adherence to their style. We have conversations with our fund managers about their key overweight and underweight positions, both at the sectoral level and stock level and try to gauge their level of conviction around these positions.
As the head of equity at UTI, how much time do you spend with your colleagues, and what does your routine look like?
We conduct formal quarterly reviews and thoroughly document them. We formulate a set of questions, which the portfolio managers respond to, and we meticulously document all responses. Every day at 9 in the morning, all portfolio managers and analysts participate in a 90-minute interaction with the entire team. This forum serves as our platform for discussing and debating a variety of topics, such as a new company, an established company, a sector review, or a results review.
Beyond that, every day, we speak to the team occasionally about something that could be of topical interest. Informal discussions continue throughout the day.
Given the current market uncertainty, what challenges do you anticipate? How are you navigating these times, and has the recent correction changed your thinking?
Actually, one of the things that we've been sceptical about over the last year has been the colour and texture of this rally. Until mid-2023, we were still fine with how the markets were moving up. But post-July-August 2023, we've been extremely cautious and wary of how the markets went up quickly. This is particularly true for certain market segments, such as the mid-cap or small-cap segments. More importantly, a narrative is being created around a few sectors, which has been worrying us. Perhaps we were concerned ahead of time, but despite our caution, the markets continued to rise for six to seven months.
What has happened in the market over the past one or two months represents a return to some sanity and rationality. We like to evaluate businesses based on their fundamental factors instead of simply fabricating stories and purchasing them at inflated prices. The environment over the last few months has made investors cautious, and they aren't endlessly bidding up the valuations of companies. So we're not doing anything materially different right now as the correction of the last couple of months, just about 5-7 per cent, is barely scratching the surface. As the tone of the market changes, we could have a much deeper correction. If you look at the performance of our funds over the last three and six months, you will see a massive improvement, and it is because the market is finally starting to move toward quality rather than just remaining stuck in that value and low P/E stocks.
Also read: Interview with Taher Badshah of Invesco Mutual Fund
New episodes every Friday
