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'BUILD POSITIONS'

This year will be a period of consolidation for the market and should provide a base for a meaningful rally from a long-term perspective, says Mahesh Patil of Birla Sun Life Mutual Fund...



Mahesh Patil, Co-Chief Investment Officer of Birla Sun Life Mutual Fund continues to remain focused on stock picking to gain outperformance.

Given the current situation, what is your outlook for the market? What factors can help it grow from here?
In the current fiscal year, we expect earnings growth to be better (about 12 per cent) compared to the single digit growth seen in the last couple of years. This year will be a period of consolidation for the market and should provide a base for a meaningful rally from a long-term perspective. We expect market returns to be at least in line with corporate earnings growth given valuations are near their long-term mean.

From a portfolio perspective we have been cautious and very selective in the companies we want to invest into; focusing where there is visibility of the earnings growth. For investors our advice will be to remain invested and build positions in any market corrections.

In such a situation, what would be your overall investment approach?
Our investment approach during the last year was essentially bottom-up stock picking and avoiding any aggressive sector calls, as sector rotation was very swift and in short cycles. For example, in the IT sector which was an underperformer last year, despite running a neutral weight on sector, we gained significantly through stock selections by being overweight on stocks such as HCL Technologies, Satyam and TCS.

We will continue to adopt this strategy going forward and remain focused on stock picking to gain outperformance.

I don't think any major theme is playing out in the current environment. As the markets move out from the current range and start trending, there should be a lot more scope to play sectoral themes. In the current scenario when the markets are narrowly focused, companies having earnings stability and predictability are coming at a high premium as we are seeing in case of the consumer sector. But such high valuations make us little uncomfortable and we will be looking at companies where valuations are not at such an extreme end.

At the same time, some of the sectors where we are positive are pharma, media and private sector banks. We find pharma to be a better defensive play compared to consumer sector given the better growth and valuation tradeoff. Media has tailwinds because of the digitisation rollout and a more secular growth being an indirect consumption play. Private sector banks, especially the retail focused ones, have been able to mange asset quality much better and have grown at a significantly higher rate than the industry average.

As interest rates start to come down and pace of economic recovery gathers momentum, we would like to be more inclined towards rate sensitive sectors such as banking and consumer discretionary.

How do stocks make inroads into your portfolio?
For stocks to be part of our portfolios they have to fulfill three fundamental requirements. First, decent return on capital employed; second, competent management; and lastly, reasonable valuations. So there are three aspects we look at before zeroing in on a particular stock and selecting it in the portfolio. First, our analysts have to put in the target price which is calculated after factoring in the fundamentals, valuations, earnings and future growth. This target price is then compared with the current market price and if it looks attractive we then look at management quality.

Then we have a management score card which includes various parameters (like corporate governance and disclosures in the balance sheet) and the company is rated accordingly. Companies having high score rate could be at advantage as we would be ready to pay higher premium or higher multiple. Third, it's the risk and volatility as there are certain stocks which are highly volatile and the downside could be also high which needs to be compensated. So we capture a volatility score of the companies. These factors are followed religiously to identify which stock looks attractive in the mid-cap segment.

What kind of stocks never find a place any equity fund of your portfolio and why?
Here also there are three factors that determine stock rejection. First, its the business, if we don't understand the business we stay away from it.

Second, if a company is not likely to generate return on capital above its cost of capital over a business cycle, we would not look at it as a core of our portfolio. Last, we also look at the management quality and if there are serious corporate governance issues then we avoid such companies irrespective of valuations.

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