"We prefer businesses that have large reinvestment opportunities compared to their current size, says Harshad Patwardhan of JP Morgan India Mid and Small Cap Fund
28-Oct-2016
What is your investment universe?
The investment universe available to us is very wide for this fund. Our research focus for this fund is on the bottom quartile of the market capitalization. I will elaborate what we mean by that. Take all the stocks listed on BSE/NSE and sort them in a descending order of market capitalization. Now, start adding market capitalization from the top till you reach 75% of the total market capitalization on a cumulative basis. Whatever remain (stocks accounting for the bottom 25% of the total market capitalization) is our investment universe for this fund. The reason why we have kept this limit floating (as opposed to a fixed limit of say a few hundred or thousand crores INR market cap) is to keep it relevant in the long term at different absolute levels of the market. As per the mandate of this fund, at least 65% of its capital needs to be invested in the bottom quartile of the market capitalization. Generally, we are at a level higher than this limit.
What attributes should a stock have for it to become a part of your portfolio?
While considering a company for our portfolio, a key attribute we look for is whether its business is compounding in nature. We prefer businesses that have large reinvestment opportunities compared to their current size. This way a business can potentially grow to a scale multiples of what it is today; over the medium to long term. Ideally, this growth should be realized without any need for additional external equity funding. Along with compounding stories, during cyclical upturns (we believe we are in the middle of one) we also consider businesses that are well-levered to economic growth.
What kind of stocks never enter your portfolio?
Typically, we do not prefer businesses where we cannot see large re-investment opportunities. Also, we try to avoid businesses where we have doubts about managements regarding rational capital allocation decisions and treatment of minority shareholders.
What will you attribute the relatively superior performance of your fund to in recent years?
We believe stock selection is a primary way we add value for our investors. Our focus in this fund has been to identify- early on- quality mid and small cap businesses which can grow their earnings faster than average. This way, our investors benefit both from faster underlying earnings growth as well as valuation re-rating over medium to long term. Our overall active bet in the portfolio has been consistently high- averaging about 65% over last 5 years which has also contributed to the superior performance.
Is there any tactical miss you regret (for instance, not owning a stock or not owning enough of it)?
Yes, we do sometimes regret missing out on an opportunity or not taking adequate bet in the one we did identify. However hard we might try, it is almost impossible to avoid this error of missing out on a good business. We also focus a lot on avoiding another type of error - buying into a wrong business.
