What has resulted in the outperformance by your fund in the last one year?
It has been our endeavour to select companies at reasonable valuations. In the correction seen in January-February 2016, and post the demonetisation exercise in November 2016, we used the volatility in the markets to pick good-quality franchises across all sectors which had corrected.
While the fund manager predominantly follows a bottom-up process for stock selection, if one wants to look at the top-down allocation, there has been a tilt towards broad-based themes such as auto, auto-ancillary, building materials and some select sectors like housing finance, insurance, including select NBFCs. The outperformance by the fund could be attributed to these sectors.
How do you select stocks for this fund?
We aim to invest in fundamentally strong businesses and usually refrain from investing in highly leveraged companies, companies with a questionable management record on governance or companies solely dependent on outcome of events to drive growth. Our team analyses the fundamental attributes, historical business performance, recent developments in operating environment and future expectations.
Because it's a mid- and small-cap fund, we follow a bottom-up approach for stock selection to identify strong businesses. The fund manager uses GARP (growth at reasonable price) investing, while avoiding companies that have very high valuations.
When do you sell a stock?
The team constantly checks for any changes in the fundamentals of the companies bought or a downgrade of the outlook of a sector. Other reasons for the sale of a stock could be the realisation of the target price or an unprecedentedly high valuation.
What do you do to contain volatility in the fund?
Despite being a fund with bottom-up stock-selection process, the stocks included in the portfolio are selected in a manner to achieve diversification across sectors. Efforts are also taken to ensure that the portfolio is rebalanced on a regular interval. This helps curtail volatility to a certain extent. Similarly, we also monitor single stock exposures and ensure they stay within our internal limits.
Do you have any special safeguards for small caps?
Since small caps are less researched and relatively illiquid, our endeavour is to select companies which are fundamentally strong and have a strong business model. Over-leveraged companies and companies which are operating in a sector which has a bleak outlook are generally avoided.
The number of stocks in your portfolio stands at 72. Is there any reason why you prefer such a high number?
While the fund specialises in selecting companies based on bottom-up picking, there is no restriction on the number of stocks the fund can hold. The endeavour of the fund is to invest in companies with high earning potential and hence the fund currently has exposure to quality companies. With regards to diversification, the higher number of stocks reduces the concentration risk in the portfolio.
How do you see mid-cap valuations in general?
The stock markets have seen a massive rally since 2014. But despite the run up, the valuations of the overall markets are only slightly above the historical averages. However, this must be put in perspective with bond yields which have seen a secular decline over the past three years. Hence, if one were to look at equity valuations in conjunction with bond valuations, the expansion of P/E multiples is justifiable. Mid-cap valuations typically are at a premium to the broad market during bull markets and vice-versa. We believe that the markets are in a secular bull market and hence valuations appear high.
What sectors are you bullish on and why?
Considering the current macro environment, we are bullish on auto, auto ancillaries, consumer themes, transportation and logistics, and financials.
This article was originally published on October 24, 2017.
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