Vinay Paharia, Fund Manager, Religare Invesco Mutual Fund, shares his investment philosophy and the rationale behind his picks. He explains why the mid- and small-cap space is still attractive and how investors should approach in the current scenario.
Your funds Religare Invesco Mid Cap and Religare Invesco Mid N Small Cap have performed better than the category. Which stocks or strategy would you attribute to this and the rationale behind those picks?
Our strategy is consistent -- we follow a bottom-up investment approach. The returns are a function of the stocks we own but the identification of stocks and consistency is a result of the investment process. Using our investment process we identify companies with better growth trajectory and healthy capital return ratios. These form the core of the portfolio which has a growth bias.
What is your investment philosophy? Are there any sectors you prefer investing in and what do you generally avoid?
We only invest in companies that meet the stock selection principles as laid out in our investment process. We look at both qualitative and quantitative factors. A key quantitative parameter which we tend to follow is return on capital. We tend to buy into companies which have demonstrated long-term return on capital significantly higher than the cost of capital which we internally have set at 15 per cent. To that extent, we emphasise more on historical performance and less on forecasts. Of course, we do look at the future if we think that the future is going to be materially different than the past and there is potential for change. But our process and experience emphasise on the fact that history provides us valuable insight which further helps us avoid or reduce mistakes.
Secondly, a corollary of high returns to capital is that the company should have less leverage on its balance sheet. This scenario is an automatic result of high return on capital. If you have high returns on capital, the business would automatically generate high cash flow and as a result of that you would have lower leverage.
In case of the qualitative parameters, we tend to look at the management quality. We also look at a company’s business model and the competitive advantages that it possesses.
Moreover, we have a few set parameters that help us distinguish the quality management such as related party transactions and the accounting policies and level of disclosures in annual reports.
Finally, the most important factor is valuations of a company. Valuations are not just numbers but also have to be looked at from the prism of quality and potential growth. Growth, which is sustainable over the long-term and not just an extrapolation of what has been achieved in recent years. Companies that don’t meet our stock selection principles are automatically avoided. We don’t have any particular sector preference as such. Our whole approach is completely bottom-up stock selection for the mid-cap funds.
How important is it for you to go and meet the company management?
Meeting company management is an important component of the research process, but it is not the only one. We feel management meets are a great tool to understand business nuances, industry dynamics and key aspects of the company’s business model and its reported financial numbers. We believe that forming an opinion about a company solely from meetings without analysing the history can be misleading. So once again, we take stock of the annual reports, what the management has said in the past, about its future plans and how well have they executed those plans, etc.
We have an 11-member equity fund management team at RIAMC. This enables us to execute the rigorous investment process and also enables frequent interactions with companies. Last year, we almost had a 1,000 touch points with various company managements across the entire team.
So it’s not that we don’t think management meets are not important but what we think is that judging a company from just such meetings is not the correct way for investment decisions. Where these meets help you is that they either reinforce or weaken your investment argument on a factual basis rather than getting opinions from the management.
What advice would you give to an investor? Should they invest in the mid- and small-cap space right now?
I would say that for an investor who wants to invest in equity, the investment in case of mid-caps is always about asset allocation. If you were investing in equity, you would enter into the asset with the expectation that over a long period of time this asset class should deliver returns in line with the nominal GDP growth rate. Now within equity, depending on the investor’s risk appetite one tends to allocate some portion in the mid-caps and some in large-caps. If he is a young investor, he would invest in mid-caps more aggressively than large-caps as compared to an investor who is close to the end of his earnings cycle.
The current scenario especially from the markets point of view is that we are trading at a valuation which is slightly below the long-term averages on a one year forward basis. In fact, we would be closer to 10 per cent discount to long-term averages and the mid-cap averages are trading at a discount to large-caps which are similar to their respective long-term averages. So in that sense, mid-caps are also as attractive as large-caps. I would say that investment in this particular segment of the market should always be viewed from an asset allocation point of view and not be used to play the market from a beta point of view.