Riding on Growth Ideas | Value Research Sadanand Shetty, fund manager, Taurus Discovery, talks about his fund's blockbuster run in 2012...

Riding on Growth Ideas

Sadanand Shetty, fund manager, Taurus Discovery, talks about his fund's blockbuster run in 2012...

Taurus Discovery had a blockbuster run in 2012. Sadanand Shetty, fund manager, Taurus AMC, speaks to Varun Chabba on the tactics and strategy adopted for the fund's successful run.

To what factors do you attribute the blockbuster performance of Taurus Discovery in 2012?
In 2012, the BSE Sensex was up 25.7 per cent but the real story was told across mid-cap companies. The CNX Midcap index delivered 39.16 per cent and 42 per cent of the CNX midcap companies delivered more than 50 per cent and up to 173 per cent returns. At least 50 per cent of these are of high quality, well managed mid-cap companies with good institutional presence and track record. Taurus Discovery has been able to identify and hold many of these high quality companies in its portfolio in a turbulent market. Our team's ability to spot winners in difficult market situations has helped Discovery reach the top slot. These are all absolute bottom up ideas and one can characterise them as re-rating stories, earnings surprises, distress valuations, turnaround stories, reforms and policy beneficiaries.

What factors do you keep in mind when selecting a stock for this fund?
Our identification of mid-cap ideas is entirely dependent on where we stand in a cycle of economic growth, and what that means for the mid-cap cycle. It is never an isolated effort. We do not indentify bottom-up stories without taking cognisance of the underlying cycle of larger economy and themes that can be played in the cycle. While in 2011, our focus was to protect the capital and generate absolute return in a falling market, we changed that strategy in the latter part of 2012. We were able to indentify growth stocks in falling markets, re-rating stories on the back of specific reform initiatives; we looked at companies with sound business but at stressed valuations. We also took many short-term opportunistic calls in a volatile market.

It is extremely important to understand the underlying cycle in the case of mid-cap companies, because all market rallies do not result in outperformance for mid-caps. There were three instances in 2005, 2006 and 2011, when the CNX Mid Cap significantly underperformed the Sensex in the past 9 years. Periods of slowdown not only cause damage to earnings but also inflict far greater damage to valuations of mid-cap companies as allocation of assets moves towards relatively safer large-cap companies and also weaken the exits from these companies. Such market dynamics cause substantial damage to stock prices, even for the most well managed companies. This gets exactly reversed in a recovery or growth market. We take cognisance of many such historical trends while building the mid-cap portfolio. Identification of the underlying economic cycle helps us decide about the portfolio composition; whether it should be concentrated or diversified. We decided to take a relatively concentrated bet in 2012 as we thought high conviction and higher weights will generate greater return to the portfolio compared to diversified holding in period of economic slowdown.

We looked at multiple investment themes and used it to build the Discovery portfolio. Last year, we played media for its game changing-digitisation, BFSI companies for low valuation, besides airlines for their stressed valuation. We also focused on realty themes within Mumbai and the southern market for their strong balance sheets and high earnings visibility. We prefer investing in companies with demonstrated track record. We bet tactically on stocks that come under pressure due to short-term volatility in the market. Some part of asset is allocated for multi-bagger ideas with long-term holding. It requires bottom-up research and high conviction. Our investment style does not allow us to chase stock prices; we avoid doing block and bulk deals unless it is unavoidable. Volatility in the market helps you to build the portfolio at your price.

What do you generally avoid?
Performances of mutual fund schemes are evaluated at regular intervals with respect to the benchmark and peers. We are conscious of this fact and avoid very long term private equity kind of investments in our mutual fund schemes as our focus remains on companies with sustainable equity returns. In general, we avoid heavy exposure to small-cap companies. Although it is true that many small cap companies have generated significant wealth in the long run. At the same time, large number of such companies have caused collateral damages to the portfolios as well. Absence of good governance, lack of long public history and proprietary nature of the management does not infuse enough confidence to invest public money into them.

We also avoid companies that have a tendency to sugarcoat the guidance and underplay the stress in their analyst or fund manager interactions. Our experience in dealing with such companies over the decades comes to good use. We do avoid momentum stocks, in general, fancied by HNIs and operators. While they offer large alpha in a short period, more often these stocks induce huge risk and volatility in the portfolio. You can also find many of these stocks in derivatives trade and with very thin delivery volumes in cash market. We do not chase breaking news, events and rumours in our portfolios.

On what hypothesis did the winners emerge in 2012?
For us, our strategy of buy and hold across many companies has done well. We took advantage of attractive valuations of the largest South-Indian real estate company, when the stock was hammered by the exit of a large investor. This was the same stock in which the IPO was oversubscribed significantly at 2x price point. We took advantage of that and it still remains one of our leading portfolio stocks. We looked at the company's ability to generate substantial amount of lease rental in a slowing real estate market and its premium positioning in South India. It was trading at a substantial discount to fair value.

Our bet on a pure play insurance company has also done well. We kept accumulating the stock in a range bound market for its excellent product mix and healthy balance sheet and its ability to unlock value through strategic placements. We also found substantial gap in valuations between its private and public market. Positive regulatory changes and noise of reform push has further provided the fillip to the stock.

Our investments in one of the mid-cap consumer companies has also done well equally. Its ability to absorb the similar size company without much of a financial stress was considered the next big step for this company. Also, our trust in a leading consumer products company owned by an MNC has done well for us when price discovery of the stock happened at substantial premium by its parent company. Most of these companies are still remain part of our holdings.

What are the things that did not play out as expected?
Few calls did go wrong. We were disappointment with one of the best managed companies in fasteners industry from the South. The stock was never able to recover from its lacklustre performance, much against our wishes, and we had to book losses after holding for long. In another case, for a very long period our investment in the largest motion picture company has not yielded any return, we ascribe market's under appreciation for the business model of the company. A leading IT education company in our portfolio disappointed us for a long period of time. Our objective of generating alpha through a construction company with average management also disappointed us. Similarly, our faith in air-conditioner cum minimum energy performance standards (MEP) arm of one of the largest groups in India with overseas exposure belied our expectation. We went wrong at few places in judging the potential underperformance of the business. Fortunately, the hits were significantly higher than the misses during 2012.

How did you bring about the change in the portfolio through 2011 and 2012?
The Indian economy was sliding down from its 2010 peak, besieged by the multiple headwinds of high interest rate, inflation, crude oil and with multiple scams and governance issues. Global crisis was at its peak and the domestic policy paralysis did not help either. We focused on protecting the portfolio from the slide and that required relatively large dose of cash and a defensive portfolio. Our cash levels have remained relatively high and we did take exposure to few large caps within our mandate. Our large holdings had large percentage of defensive weight from FMCG, pharma and regulated business and with relatively diversified portfolio. Market volatility during the year provided many opportunities of generating absolute return to the portfolio in a falling market. There was decisive shift in this strategy adopted for 2012 for growth and absolute ideas.

What drives your optimism for big positions in media and entertainment stocks – Zee Entertainment Network, Dish TV and Balaji Telefilms constitute almost 14 per cent of the net assets.

Yes, all these investment are in general clubbed as part of media and entertainment but a close observation of business models will reveal that they are driven by advertising, subscription and ticket sales (consumption story) and also export revenue. Most of these are positions considered post digitisation and weights in the positions do change as we monetise gains in these stocks. 2012, we believe, ushered a new era for the sector. Phased digitisation will have unprecedented impact on the sector and will bring in a new ecosystem. We expect this new ecosystem to catalyse substantial investments: expansion and new launches and consolidation and meaningful ROI for the sector. This is already beginning to reflect in underlying stock prices and we expect more to come.

Which are the most promising positions in your portfolio?
All our portfolio stocks are promising. They are absolute ideas or thematic ones. We are optimistic on the mid-cap oil and gas sector due to the significant recent reforms in the sector. There is also substantial under ownership of this sector in the mid-cap space. We have bullish view on power, media, IT, realty, private sector banks in the mid cap space. We also build tactical positions in many companies by taking advantage of volatile market conditions.

What are the stocks that you discovered first, ahead of the curve?
Public listing of the stocks itself is the first level of discovery in market. Where we make a difference is our team's ability to build future scenario and outlook and historical understanding of the business and stocks. Most of these are not generally written in a report or discussed in public domain. We also look at historical cycles of the market and approach of the management and behaviour of stocks in such cycles. Many a time our team's insights into the industry and bottom up approach help us to get such large upside in the portfolio.

Our investment in the largest multiplex chain is one such example. We looked at the industry structure and found that basic raw material, movie content, that is feeding into this chain has already gone through structural shift and visibility of pipelines up to nearly 18 months forward. This was uneven and unpredictable till few years back. Occupancy level is now not only limited to traditional A-list stars as many new talents have shown huge potential in box office collections. New genres of movie making and scripts are being accepted by the markets; thus brining additional footfalls to the theatres. Having convinced about the business we have narrowed this largest chain of multiplexes for its excellent brand image, healthy balance sheet, good vision and management. This was the only company that was demonstrating its confidence on the future while most competitors were shrinking with their broken balance sheet. We were convinced that the stock would re-rate as earnings flow surprise the market. It was our smallest capitalised stock when we bought it and it delivered us the largest return.

Our decision to board early on in one of the mid-cap consumer companies also paid us rich dividends. We looked at the company's product portfolio and its expanded roaster of product profile due to its new acquisition. We compared valuations in public and private market and found there was a vast gap. We looked at the strategic valuations and were willing to hold it for a long time and eventually, our patience did pay off.

In general, we are averse to investing in airlines due to lack of sustained profitability and wealth creation. Our investment in a leading domestic airlines was due to attractive valuation and changing dynamics of the industry and also due to the near collapse of its large rival. Rising yield and benign crude oil has provided the comfort and news of strategic investment has added further kicker to the stock price.

What is your outlook of the market?
We are convinced that equity market will deliver in the coming period. When we look back we see the market has consolidated for nearly 5 years in the same range whereas corporate profitability has doubled. The de-rating that was caused by worst of the unprecedented twin global financial crisis in the US and EU is also behind us. Global leadership has shown tremendous maturity in tackling the crisis with its synchronised actions. While green shoots are visible in US, Europe seems to be stabilising. China is also showing recovery. Abundant liquidity, including new entrant Japan, coupled with insipid growth in global economy, means flow of money for the emerging markets and most importantly, India. Global risk factor that has been one of the biggest bugbears for Indian equities seems to be easing off. This is good for flow of money, trade, finance, export and will have positive impact on Indian economy and stock market. What is uplifting the India story again is the domestic reforms push through the finance ministry. The path of fiscal prudence and subsequent measures to boost the economy have lifted the sentiments. We expect the budget to maintain the momentum and give further fillip to the sentiments. We are positive on BFSI, oil and gas, power infrastructure, capital goods, IT and infrastructure and large number of ideas from mid-cap sector.

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