Here is some useful market wisdom from some key names in the Indian mutual fund industry
09-Mar-2018 •Aarati Krishnan
Tired of reading investment quotes from Warren Buffett, John Templeton, Peter Lynch and other global gurus? Well, while these global greats do offer timeless wisdom to stock market investors, we decided to present some distilled wisdom from our desi Buffetts and Lynches that are more apt for the Indian scenario. Here are some key investing nuggets that were our major take away from the 2017 fund manager profiles that we ran through the year (the quotes are paraphrased). They are worth reiterating because these are seasoned managers who have survived many market cycles and came out winners.
In equities, patience is more important than intelligence
Prashant Jain, CIO, HDFC Mutual Fund
When we met up with Prashant Jain in January, HDFC Mutual Fund's schemes had just made a strong comeback from a spell of underperformance. Asked how he coped with the pressure when his funds lagged behind the market, Prashant explained that being prepared to underperform the market for short periods is essential to creating wealth over the long-term. Indian stocks, he pointed out, have typically displayed six to eight year cycles. In each cycle, most of the wealth is created by a narrow set of companies and sectors. Between 1993 and 2000, it was IT stocks. From 2001 to 2007, capital goods and infra firms were in vogue. Between 2007 and 2015, it was the turn of pharma and FMCG. But he took a call that from 2015, falling inflation, an appreciating rupee and better macros in India would lead to a capex revival.
To make money from such cycles, he argued, you have to get out of overheated themes before they top out and position yourself in the beaten down themes much ahead of others in the market. This phase entails pain and requires a great deal of patience as you wait for the cycle to turn. This bet seems to have played out to a tee with HDFC Mutual Fund's bets on PSU banks, metals and infra stocks delivering big gains in the last two years. Going against the market tide can be painful in the short run, but when it pays off, the rewards are obviously sweet.
When the starting point on valuations is wrong, long-term returns will suffer
Neelesh Surana, CIO - Equities, Mirae Asset Investment
Many mid-cap managers struggled this past year to keep up with their rapidly rising benchmarks. But not Mirae's Neelesh Surana whose Emerging Bluechip Fund has held strong at a five-star rating and kept up with the changing preferences of the market. One key element of the fund's strategy is to avoid the real tiny-caps and look mainly at mid-caps with Rs 80 crore to Rs 100 crore operating profit. The whole idea in mid-cap investing, Neelesh said in April, is to identify businesses that can make the journey from small to mid to large-caps and very tiny companies really struggle to make that journey. When companies reach a reasonable size, say Rs 100 crore in operating profit, scalability becomes much easier.
For a mid-cap maven, Neelesh is also quite valuation conscious and books profits if he finds the valuation of any stock he owns shooting through the roof. He explained that there are three aspects of a good mid-cap strategy: look for stocks with an extraordinary business, extraordinary management and reasonable valuation. In 2016, Neelesh felt that the third piece went for a toss - many investors were not looking too closely at valuation if they found a great business. In effect, they were unwilling to take business or financial risk, but in the process ended up taking on a lot of valuation risk. The same 'quality' stock cannot be a good investment at a 30 P/E and also at a 60 P/E. That's a good quote for all equity investors to remember as the Nifty 50's P/E soars well beyond 25 today.
Ownership patterns don't matter
Vinit Sambre, Vice President, DSP Blackrock Investment Managers
In this bull market, there are a number of websites, Whatsapp forums and chat groups that have sprung up around discussing the investing strategies of the rich and the famous and coat-tailing their investment moves. Many investors today pay greater attention to the influential shareholders in the company they are researching than the company's balance sheet. But Vinit Sambre, who steers the top of mind DSP BlackRock Microcap Fund, says that ownership patterns really don't matter when you are sifting for good quality stocks. He says that the shareholding pattern doesn't figure on his radar when he studies companies.
'Even if we find a stock with no institutional holdings at all but with a good business, we buy it. Similarly, if we find a good company, but the shareholding shows a few big market names owning it already, we don't get bogged down by worries about the large investors dumping the stock. If they dump it, good for us, we can buy more of it!' he said. Even operator driven activity, he argued, has an impact on a stock's price only for the short run. In the long run, it is always earnings that drive performance. An operator can sustain a stock for three months, six months or nine months. But ultimately it requires the backing of earnings. He reminded us that during the 2000 tech boom, one or two big operators were highly influential and could single-handedly drive stock prices. Today, the market is much more diversified and no single jockey can propel prices. 'Put fundamentals first and don't get distracted by extraneous factors' is the message.
The big mistakes in small-cap investing happen in copycat ideas
R Janakiraman, Vice President, Franklin Templeton Investments India
Franklin Templeton's Smaller Companies Fund has beaten its benchmark like clockwork over the last eight years and a driving force behind that fund and many other mid-cap schemes is R Janakiraman. When we met up with him in July, we asked him how he came across small and mid-cap ideas that turned multi-baggers, Janakiraman admitted that it was a combination of word of mouth, research and sometimes sheer luck! But the most important thing was to stay away from the flash in pan ideas that spring up by the dozens in bull markets.
Experience over one or two market cycles helps to eliminate mistakes in mid-cap investing, he said. Many a time, because of a favourable cycle, a small-cap company delivers high growth rates and people immediately extrapolate it. This results in high valuation on cyclically high earnings. When earnings revert to mean, the valuation can also collapse and lead to big losses. He has learnt to put all his ideas through the filters of quality, growth and sustainability, he said. He offered a warning on me too ideas, also. In a bull market, there are often clear leaders in every sector which create a lot of wealth. But this spawns a lot of copycat ideas from the same sector, where people pick up second rung or third rung players, hoping to follow the leader. That's when mistakes happen, says Janakiraman.
Sustainable ROE matters more than P/E
Chandresh Nigam, CEO, Axis Mutual Fund
As we wound up the year with a profile of Chandresh Nigam, he raised the risk of disruptions that could upset the best-laid investment plans. Business cycles are shortening and every business today is vulnerable to disruptions. To deal with it, he said, Axis' fund managers are focusing more than ever on business quality. By high quality, they mean businesses with sustainable pricing power, customer loyalty and strong brands.
The one financial metric that Chandresh relies on to shortlist stocks is whether they are capable of generating and sustaining a reasonable return on equity (ROE). While that may seem obvious, a surprisingly large number of businesses don't manage it! Globally, market gains are narrowing. In the US, just 12 companies in the S&P 500 contributed 90 per cent of the index gains in recent years. This is being mirrored in India, too, where, according to Chandresh, only about 25 per cent of the businesses earn returns higher than their cost of capital. They have created 100 per cent of the market wealth over the long term, he said.
In the next few years, Axis believes, some companies from this select club will also slip and fail to create wealth. Chandresh, therefore, believes that the top 25 per cent companies by ROE are the place to be in, in the face of disruption as they will be the ones to survive. 'If we are fairly sure that a company can deliver 20 to 25 per cent growth with healthy ROE, we would rather hold it than a value stock that trades at half the P/E without any visibility on ROE' was his sentiment.
If worried about disruption, don't lose sight of ROE is the message.