What is your investment universe?
The fund aims to invest in mid and small-cap businesses. Within this, the intent is to have a higher exposure to mid-caps. Given the structure of Indian stock market, this approach opens up a reasonably large number of businesses for investment consideration.
What attributes should a stock have for it to become a part of your portfolio?
Our objective is to invest in good quality businesses for long term growth. Some of the attributes we seek in businesses are attractive levels in return on capital, free cash flow, moderate capital intensity, etc. Longer and larger growth opportunity adds to the attraction of a business. This needs to be supplemented by competent and disciplined management and a reasonably alert board of directors. A combination of an attractive growth opportunity and a business with a competitive advantage, in most cases, generates good value for long term investors.
The above illustrates a general framework used to build bulk of the portfolio. Besides this, the portfolio may contain stocks that may not fully fit in this framework, examples are restructuring opportunities, an attractive business passing through a temporary weak phase, etc.
What kind of stocks never enter your portfolio?
Businesses that do not have the ability to generate free cash flow over a business cycle are the ones we try to avoid. Such businesses tend to be very capital intensive and are likely to generate less attractive return on capital. We also tend to be careful about businesses that are very cyclical and have a low degree of visibility. We reiterate that our focus is on the company and not on the industry. Even in challenging sectors, there have been companies that have managed to generate shareholder value through internal efficiencies and differentiated business models.
What will you attribute the relatively superior performance of your fund to in recent years?
Our approach is to construct a well-diversified portfolio of mid-cap stocks that have an attractive business with sound fundamentals. Significant amount of effort goes into identifying such good quality businesses. These businesses have the ability to compound earnings at an attractive rate over a long period of time. Identifying such companies and remaining invested in them for a long time has been the key reason for the fund's performance. Patience in terms of giving good businesses adequate time to perform and compounding of earnings has played a key role in delivering returns over the past five years.
Is there any tactical miss you regret (for instance, not owning a stock or not owning enough of it)?
Quite a few. But the attraction of mid-cap universe is that its large size offers the ability to generate attractive returns despite having missed out on a few successful opportunities. Over the long term, the ability to limit mistakes or capital losses is probably a more powerful driver of portfolio returns in the mid-cap segment.