Ever since its launch in Nov-2005, Principal Large Cap Fund has stayed a reasonably small fund but has managed to deliver relative out-performance across different time periods. Kumar Shankar Roy caught up with Rajat Jain, Chief Investment Officer, Principal PNB AMC to find out more about the fund's investment strategy, and beliefs behind managing the scheme. Jain, who has over 25 years of experience in the capital markets, says that he doesn't want to overpay for quality. The market is forgiving so long as a company delivers earnings growth, he quips.
What is the investment strategy for Principal Large Cap Fund?
We use a bottom up stock selection process focusing on stocks with improving fundamentals (improving earnings, rising return ratios etc.) and attractive relative valuations. We do not take market timing calls and usually have low levels of cash in the portfolio.
In implementing the strategy we are benchmark aware, though not benchmark constrained, in that we construct the portfolio with risk limits for stocks and sectors, but with good flexibility to the fund manager in terms of deviating from the benchmark.
On average, the share of active positions (i.e. stock positions different from the benchmark) is about 45%-50%. However, it being a large cap fund, most of the stocks are well research and tracked in the market. Occasionally however, extreme swings in the market towards pessimism/ optimism also give opportunities to add/ reduce holdings which the fund also takes advantage of.
What is included in the portfolio and what is avoided?
We prefer companies with improving fundamentals and looking good on relative valuations. The fund has no biases in terms of what we avoid relating to specific sectors etc. We have seen that the market is forgiving so long as a company delivers earnings growth. We would however generally avoid companies where there have been issues of corporate governance relating to accounting, fair treatment of minority shareholders etc.
What are the stand-out features of your fund that differentiate itself from other large-cap schemes?
A certain percentage of our portfolio names would be similar to those in other large cap funds given that there are only so many large cap names in the market. However, we may at times be ahead of the market in identifying stock ideas which we have successfully done in certain stocks in the auto/ auto ancillaries and the cement sector.
Besides, where we would differ is in our portfolio approach, which is to make money using multiple small bets, rather than bet big on few names which may or may not work. This helps in managing volatility in the portfolio.
What will you attribute the relative consistent performance of your fund in recent years?
Portfolio construction is as important as stock selection. This portfolio construction being aware of risk limits has helped in the consistent performance.
In addition, the strong focus on stock selection and periodic revalidation of our hypothesis of investment helps limit volatility.
Any tactical miss you regret (not having, or not having enough or holding something) in your portfolio?
There have been a few. In the recent past, we missed (or substantially missed) the rally in metals last year as we weren't so sure of the fundamental improvement there.
Also, while we had identified the improvement in business fundamentals of NBFCs, we didn't take a large enough position there.
Also, generally, our portfolios would avoid overpaying for quality, i.e. stocks with very high valuations but with perceived quality and safety. We would have missed on those.
How do you decide to increase exposure to a holding? What are the factors that play a role in such a move?
We add to our positions as we see anything that enhances the business outlook for the company and has a positive impact on earnings.
You have about 40 stocks in your portfolio. Compared to some of your peer large-cap funds, this is a bit lower. Has it always been the fund strategy to keep this limit on holdings, or there is a reason for changing the same?
It is not a hard and fast rule, but we think 40-45 names give adequate diversification, especially in the large cap space, as these stocks are inherently less volatile. However, we wouldn't like to have a long tail, as these stocks wouldn't usually contribute much to the performance of the fund while monitoring them would take out time.
You have a major telecom stock in your portfolio. Given the weak operating environment for telcos, why do you have that stock?
The number of telecom operators, which at the peak was nearly 13-14, has gradually shrunk and the market continues to see consolidation. While a stable equilibrium is still some time away, this could be a precursor to sustainable improvement in fundamentals.
Further, as things become more 'digital', and the mobile device becomes more central to transactions, entertainment, social media, there is a value that the telecom operators should derive from being a key link in the value chain. However, our portfolio exposure is limited on account of the near term uncertainty.
Experts say that a sharp rise in oil price rise in imminent. How have you positioned yourself to take advantage of the situation?
The consensus view on crude oil prices is of them being in the range of USD 55- 60/ barrel over the next few quarters. We haven't made changes to our portfolio depending upon our view of oil prices. This is a macro call which we do not usually take, focusing more on bottom up stock picking.
You hold quite a few construction project linked names. What kind of opportunity to do you see in them?
We think that things at the margin are improving for order flows for civil construction, though private capex remains weak. At the micro level however, companies in the space are focused on improving return ratios which has been their weak spot in the past.
Some interesting IPOs came in recent times. How do you assess an IPO stock for your portfolio? What are the parameters and are they different from listed entities?
Broadly the process of evaluating the IPO is same as that for a listed entity. However, we may additionally take a tactical position in the IPOs. However, with the strong subscription numbers the good ones have been seeing, their contribution to fund performance has been minimal.
Talking about the stock market in general, how do you see the year panning out for equities?
The most important determinants for equity returns are future earnings growth and initial valuations. The current valuations are at slight premium to long term historical valuations, though after a number of quarters when earnings have not met expectations, the earnings cycle seems to be looking up going forward.
We expect that the impact of demonetization would be transient and shouldn't show in numbers beyond Q4, FY17. However, there could be volatility around GST implementation, the elections in the Euro zone, interest rate actions in US etc. A smooth roll out of GST is expected to be taken positively by the markets.
Are there any interesting spaces in terms of sector which looked unappealing earlier, but are beginning to look attractive?
We think that telecom and aviation could be sectors which have had challenges in the past and could do well going forward.
When there is corporate governance matter in one of your holdings, how do you evaluate the situation? Is a positive interaction with concerned management an important factor in your decision framework?
We would see the impact on the sustainable earnings trajectory on the company. While we realize that business results can be unpredictable, we would like companies to be predictable in their approach to situations, which is an important facet of corporate governance.
The recent guideline of SEBI asking companies to declare their dividend policy is a step towards this. We would like to engage the management of the company is such a situation arises, and we find companies are more open to hearing the viewpoints of minority shareholders than in the past.
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