'Choosing business with less variability in earnings outlook'

With over 18 years of experience in the financial services industry, Ashwani Kumar manages three popular funds with assets of over Rs 12,500 crore at Reliance Nippon Life Asset Management. Reserved in his approach but to-the-point with answers, the experienced fund manager, in an interview with Kumar Shankar Roy, talks about how he has given extra importance to three sectors in Reliance Vision Fund, why sustainable competitive advantage is the guiding factor for his investment strategy across schemes, and how Reliance Top 200 Fund chases companies that grow without external need for equity.

Edited excerpts:

For your Reliance Tax Saver Fund, what are the reasons behind the out-performance vis-a-vis category and also many peers in the one-year, 3-year and 5-year period?
In a 1-3-5 year period, stocks in Automotive and Auto parts, Industrial Capital Goods and Metals sectors have lead to outperformance. These were high quality differentiated MNC and domestic companies which outperformed the indices.

You have earlier said that the ELSS keeps around 20 to 30% of the portfolio to MNC stocks. How has that bet worked?
Certainly, the MNC bets have worked reasonably well in last 3 years. They would do well in long term because of superior capability. These companies have advantages of technology, R&D, superior and relevant product offerings.

How do you measure superior growth potential? What are the ratios/parameters that you use to project future growth potential?
There’s no formula for this. The idea is to scan the environment and understand specific industry dynamics over next 2 years. The process involves investing in companies which possess a sustainable competitive advantage.

Your biggest holding is an automobile company, at a time when most of the peers and equity funds, in general, have banks as their top holding. Can you take us through your top 5 holdings and why they exist in your ELSS portfolio? 
Our top holdings have strong growth opportunities from 2-3 years view and would benefit from domestic recovery and improvement in earning profit. The companies in the portfolio have quality management and relevant product offerings.

For the ELSS, what are your other high conviction ideas at present?
The high conviction bets are part of the portfolio. In India, earnings will be driven by domestic demand. The fund has exposure to high quality differentiated companies across various sectors which should do well in next few years.

There are around 80 schemes in the ELSS category. What sets Reliance Tax Saver Fund apart from the rest of the pack?
I can only say that our scheme offers 3-5 years growth potential and has exposure to high-quality companies. Many of these companies are in MNC category and have potential to scale in revenue and profits in next few years.

Coming to Reliance Vision Fund, you have maintained tactical exposure to mid caps. In fact, your mid-cap stocks exposure (about 18%) is much higher than peers. Can you tell us why?
The idea behind holding midcap is to provide alpha to the portfolio. These companies have niche positioning and would grow strongly in 3 years timeframe. These are differentiated companies with strong product portfolio and potential for growth.

In the last one year period, Reliance Vision Fund's performance has just been average. Your fund has given 22% gain versus S&P 100's 21.89%. But you have done well in the 3-year period. What happened in the last one year?
Last year, some of the Industrial Capital Goods companies have underperformed on account of delay in execution. This would catch-up in due course.

Some experts feel the rally in small and midcap funds is going to be over, and it will be now large-caps that will out-perform. What is your view?
Certainly large-cap stocks are more attractively valued versus Small & Mid-cap stocks. However, on a case-specific basis there are always stock specific opportunities in small & mid-cap segment for the long term investor.

What is your take on the macro situation today? How have you distilled the broad view to micros?
The impact of recent Government initiatives on Real Estate (Housing) sector, lower interest rates and increased spend on Infrastructure would help the core economy sectors. The portfolio of Reliance Vision Fund has exposure to sectors like Banking, Automobiles, Capital Goods and Metals which would benefit from improvement in consumption and Investment/infrastructure demand. The recent landslide victory of BJP in Uttar Pradesh will help them take more tough decisions which will help the economy.

Since your investment strategy focuses on investing in market leaders and potential leaders, what do you do when the company faces stumbling blocks? How long do you wait before you change your track?
It depends on the situation if the problem is temporary one may use opportunity to add and if it is permanent one will do the course correction. There is no specific time frame for a complete reversal of stance. It is a very stock specific decision.

Your current portfolio seems positioned to gain significantly from domestic revival. How long do you before this elusive revival will happen and what are the key triggers for this to play out?
In my view revival would be visible in second half of 2018 (Oct – Mar). The resolution to banking NPA issues, acceleration of investment demand and consumer demand are key to growth revival. The triggers are higher incomes with rural households and urban households and low interest rate and general aspiration among households to improve their lifestyle. 

For Reliance Vision Fund, can you give us examples of large sector deviation that you have taken? What are the reasons for those deviations?
Sector deviations are in Auto and Auto parts and Industrial Capital Goods as I see them doing well in next 12-18 months. These sectors would benefit from lower interest rates, rising income and faster expectation.

What has been the impact of demonetization on Reliance Vision Fund stock holdings in terms of earnings? Was the fear of impact more than the actual impact?
The companies which had exposure to rural India suffered some volume growth during the period of demonetisation. We can only say actual earnings turned out to be more resilient. However, one must not forget that first 39 days (Oct 1 – Nov 8) pre demonetization were very strong in case of consumer demand in India. 

Coming to Reliance Top 200 Fund, what are the factors behind the scheme's consistent out-performance? How do you consistently generate alpha while owning best of the index companies?
Reliance Top200 focus has been on delivering low risk alpha in the large cap category. Buying growth companies at reasonable valuations has been the operating framework of the fund. Sector and Stock selection framework is based on relative attractiveness in large cap universe, which generally comprises large sustainable businesses, with good track records. Among mid cap investments, which are generally about 20% of the fund, companies which are leaders in smaller industries or have some sustainable advantage are preferred.

Reliance Top200 has generated alpha from both sector allocation and stock selection strategies. Focus on “sustainable profitable growth” companies having leadership characteristics has been the Investment approach for the fund.

What is included in the Reliance Top 200 Fund and also what is avoided? What are the reasons behind inclusion and exclusion?
Reliance Top200 being a large cap fund is focused on the largest 100 companies in India. Investment in these companies accounts for close to 80% of the portfolio. Emphasis is on businesses with sustainable characteristics in sales and profits, with right valuations being the key ingredient for taking decisions. Within Mid caps the focus in on companies which have “large cap capabilities” but might have a lower market cap as industry is small in size today or in a bad cycle.

What is the reason behind the fund's focus on selecting companies with high return on equity?
Reliance Top200’s philosophy is to focus on businesses which deliver high return on equity, which provides cash flows for growth without any dilution. Companies which grow without the external need for equity (by internal cash generation) create significant shareholder value as all the returns are retained by existing shareholders.

What are the memorable hits and misses of the fund over the past few years? Please give some examples.
Over the years we have consistently followed a focused approach to choosing businesses with less variability in earnings outlook unless there is a huge valuation discount in those companies. Exposure to the Auto sector and Oil and Gas sector at right valuations and lower weights in Technology and Healthcare supported returns, while Underweight in Metals sector did not work as anticipated in the last 12 months.