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With over three decades of experience in the financial markets, Sanjay Chawla brings a seasoned perspective on the current investment landscape. The Chief Investment Officer (of equity) at Baroda BNP Paribas Mutual Fund notes that mid- and small-cap "valuations are facing challenges", and during global or domestic earnings slowdowns, "mid and small caps tend to decelerate much faster than the large caps," a trend being observed in the present market.
Having been associated with Baroda BNP since 2013, Chawla currently manages six schemes with total assets worth around Rs 11,500 crore, including the four-star-rated Baroda BNP Paribas Balanced Advantage Fund and Baroda BNP Paribas Focused Fund.
In this conversation, Chawla delves into his investment philosophy, centred around the BMV (business, management and valuation) approach. He also explains why valuations must align with growth expectations, particularly in mid and small caps, and advises investors to focus on the investment process rather than fixating on performance. Below is the edited transcript.
We've seen some corrections recently (in the broader indices). Do you see this as a buying opportunity, or are valuations still too high?
We have observed recent market corrections driven by global factors across market capitalisations. Global factors seem to impact earnings across the market curve, particularly in the mid- and small-cap segments. Large caps have been relatively less volatile. The corrections are also due to the slowdown in earnings growth in the first quarter of the current financial year. I anticipate a similar level of tepid growth in the second quarter.
While there has been a slight correction, I believe these corrections are temporary. In terms of the overall valuation, I think that markets are trading at the last 10-year average. So, are the earnings growth aligned to that 10-year average? Given the slower-than-expected first-half performance, we may see a bit of an earnings cut in the coming times.
How would you sum up your investment philosophy? Are there any stocks or situations that particularly excite you when evaluating potential buys?
The BMV (business, management, and valuation) principle forms the foundation of Baroda BNP's investment philosophy.
When we examine a company, we concentrate on its business, which refers to the market it serves. This market can be defined by factors such as brands, technology, or pricing power. I require a robust moat to ensure sustainability and predictability in earnings. The M stands for management, and in this context, we assess the management's competence by examining their ability to effectively manage both the business and its volatility. For instance, how did the management respond during the Covid-19 pandemic? How do they manage the supply chain effectively? How do they treat their suppliers? This essentially reveals their approach to handling minority investors, similar to how institutional investors are treated. Lastly, we concentrate on the valuation process. When discussing valuations, we adhere to the traditional method and continue to evaluate the company based on its cash flows. By and large, we are growth investors and look at growth at a reasonable valuation.
That said, I will not hesitate to invest in a company that is growing faster and trading at a relatively more expensive, higher multiple as long as the earnings are sustainable.
There's a lot of debate around mid- and small-cap stocks. Some say they're overvalued, while others see growth potential. How do you approach these segments and balance short-term volatility with long-term growth prospects?
The mid- and small-cap markets have experienced significant volatility recently, and the valuations are facing challenges. I firmly believe that valuations should align with the pace of growth. I would add another dimension by examining the profitability of the company's growth and tracking its various return ratios. We've recently seen a slowdown in earnings, which is more pronounced for the mid- and small-cap space. We have observed that during global events or domestic earnings slowdowns, the mid and small caps tend to decelerate much faster than the large caps, a trend we are currently witnessing. So whenever these external challenges are there, we see a slowdown in earnings, which could lead to volatility in the index performance. Hence, a large cap can be a very interesting option to explore now.
However, India is a growth market, and typically, when growth resumes, we see an acceleration in small-cap earnings growth, leading to a better rating or valuation for mid-cap stocks. Depending on your preferred time horizon, you should consider investing in large caps, mid caps, or small caps.
In a volatile market, how do you allocate large-cap, mid-cap, and small-cap stocks in your multi-cap fund?
This is a particularly intriguing question. The multi-cap fund requires us to allocate 25 per cent each to large-cap, mid-cap, and small-cap stocks. Therefore, the fund manager has limited flexibility in deciding where to allocate the remaining 25 per cent.
It's important to understand the fund house's philosophy regarding the allocation to each of these market caps. In the multi-cap fund, the allocation is made through a detailed analysis. We follow a strategy of 4-3-3, which means we invest 40 per cent in the large caps and 30 per cent each in the mid and small caps, respectively. If you follow soccer, this is the most effective attacking strategy. This has yielded excellent results for our funds. While there may be subtle differences and variations, our analysis of various indices revealed that a 4-3-3 formation is highly effective.
The large and midcap and the multi-cap funds seem to actively take sector calls with opportunistic buying and selling. In this regard, can you shed some light on both the fund's strategies?
As a fund house, we have performed well, with many of our funds outperforming their peers. Both the large and midcap, as well as the multi-cap fund, have outperformed their peers and the benchmark.
Let's focus on the Baroda BNP Paribas Large & Mid Cap Fund. At a broad level, the allocation towards the large and mid-cap has remained more or less static at about 40 per cent each. It's the judicious allocation of the remaining 20 per cent that has led to a significant outperformance. Undoubtedly, the bottom-up approach toward stock picking in the mid-cap has resulted in a good outcome. The allocation to the small-cap has also contributed to the outperformance.
In the case of the Barona BNP Paribas Multi Cap Fund, I discussed the 4-3-3 strategy, which allocates 40 per cent of the portfolio to the large cap, 30 per cent to the mid cap and small cap, respectively. Managing a multi-cap fund presents unique challenges, as it involves not only determining the appropriate market cap curve for our broad allocation but also deciding whether to allocate a small cap, which is inherently more volatile. We must decide if we want to increase the fund's volatility based on our market view. Therefore, the multi-cap fund's outperformance stems not only from the appropriate market cap allocation but also from this allocation to the sector and the specific stocks within that sector. Our focus is always to deliver the best returns while accounting for the risk we are taking in the fund.
Tell us about the sector call that has worked well for the funds.
The most significant factor, in my opinion, is the discipline we apply to our research. How we analyse the companies and how we act on the analysis makes a big difference.
In terms of the approach in the last 12 months, in particular, I think overweight calls in Industrials have worked very well. Our strategy of reducing expenditure on IT has also proven to be effective. We have maintained a neutral stance on Consumption, but our strategy of being underweight on Staples and overweight on Discretionary Consumption, such as Automobiles, has proven effective. These are the key sector-wise attributions that have proven to be effective. Of course, there have been stocks that have done extremely well for us.
Given the recent strong performance of some of your funds, is there a broader strategy to leverage this success and attract more investors?
It is our responsibility as investment managers to consistently deliver returns that align with the investor's interests. As a fund house, we always focus on risk-adjusted returns. Given their size, almost all our funds are in a very sweet spot where they are small enough to offer agility and large enough to attract attention. Our time-tested investment processes also support this, ensuring consistent performance. I would rather have the investors look at a process rather than focus on the performance. This is because performance is always an outcome. More desirable results are likely with consistent processes. So, what can the investors expect from us? We aim to deliver consistent returns that align with the investors' interests, driving a disciplined approach to investment across all our funds.
Also read: Interview with Ajay Tyagi of UTI Mutual Fund
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