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The market keeps teaching us new lessons

Mahesh Patil Co-CIO - Equity, Aditya Birla Sun Life AMC says, it is important to generate sustainable returns

The market keeps teaching us new lessons

Known among investors as Mr Consistent, Mahesh Patil, Co-CIO - Equity, Aditya Birla Sun Life AMC, oversees over 20 funds that hold Rs 85,000 crore in assets. As a seasoned investor who manages other people's money, Patil is extremely calm and composed. In an interview with Kumar Shankar Roy, the man behind the fund house's equity prowess shares his views on what to do when a stock goes up fast, how to react when a good company faces bad times and why valuations can be ignored at times if everything else in an investment is sound. Read on to know more such fascinating nuggets.

When did you get interested in the markets?
I have had interest in the stock market right from the time I was studying management (at Jamnalal Bajaj Institute of Management Sciences) in the early 90s. I got early exposure to equity research (at Parag Parikh Financial Advisory Services). I liked equity research because it gave me an understanding of companies. Being an analytical person, I got a lot of food for thought from that. Slowly, as I progressed and had a good knowledge of different sectors, my aspiration turned to managing money. That's when I got an opportunity to work in Aditya Birla around 12 years back and it's been an exciting journey for different reasons. The nature of this job always keeps you on your toes and there are new things to learn. Then, there is a passion to generate returns and when I see how we are able to make a difference to the lives of investors, it brings a sense of responsibility.

How has your thinking changed ever since you began your investment-management role?
You have seen different market cycles from a very close quarter.

There are a lot of changes that happen as one matures. The market keeps teaching us new lessons. The lessons taught during large crises are extremely important. The first big lesson is that we need to respect the markets.

Secondly, we have to try and become more process oriented towards investing. This has to continue even as we devote time to finding winners.

Thirdly, as a portfolio manager, discipline is everything. Discipline ensures consistency. Rather than being too flamboyant, it's important to generate sustainable returns.

Also, not depending on individuals and instead trying to work as a team brings greater dividends. Put together, there are about 27 people in the equity team. It is important to delegate, empower, and share information within the team.

What have been the biggest successes and setbacks in your investment journey?
That we were able to pick certain funds has been a source of big success. The Frontline Equity Fund, for example, which we acquired 10 years back, and the way we were able to shape it up have been very encouraging. The way we are able to achieve scale and size has been the biggest success.

The disappointment in this journey would be around the times after the global financial crisis. There were some funds that we were managing very aggressively. Then we had a very tough period in some of these funds. Our balance in those portfolios in terms of risks taken was not good. That was a setback for us. Then again, we quickly came out of that period also. Our first objective then was to beat the benchmark. Once you do that, you start assuming more risk. It is important to objectively look at your mistakes. That can only happen if there is a strong review and control mechanism.

How do you identify multi-bagger opportunities?
What appeals to us is a set of key drivers. The opportunity of the business is very important. We should be able to see longer-term sustainable growth in the business. This can happen if the penetration levels of the business can be raised or the company is trying to do things differently or has a very strong competitive advantage - a moat. A moat not only allows a company to gain market share but also protects it. Obviously, the management has to have a vision and the capability to execute it properly. We have seen our biggest gains in stocks from all these situations. Of course, we like to spot them before others in the market, which means valuations are better early on. The ability to sit on such stocks for long is equally important. There should be conviction to stay put. Or else, there will be temptation to sell if the stock price reaches the target price.

Rarely does it happen that you have a company trading at cheap valuations when the business opportunity is great, management is of top quality and there is a durable moat. What do you compromise on in this kind of situation?
Clearly, you can compromise on the valuations a bit. These have to be clear drivers of growth. Good companies have a sustainable moat. From a longer perspective, strong and good return on capital, free cash flow, etc., are very important.

When a stock performs very well, many investors often sell it. But you are saying you don't. Why is that?
In such a situation, it's important to go back and see your investment hypothesis of that stock. Are there incremental drivers that can take the stock higher? There need to be somethings that will sustain the performance and take it beyond that level. For that, you will need a deeper understanding of the company. Of course, your understanding of a company grows with time. If all the analysis convinces you, you hold onto the stock despite it having touched your initial target price.

I have seen you hold onto stocks, like Nestle, when they were going through crises. At such times, when there is so much noise and headline risk, how do you manage that investment?
Short-term noise will always happen. Truthfully, we cannot ignore it as well. What you have to do is continuously question the investment hypothesis. Any company can go through short-term pain. Find out whether an event is short-term or will impact the business materially. Meanwhile, you will have to ride the short-term volatility. Hold onto your position. Defining what is short-term and what is long-term is very important as well.

Can you tell us how you construct portfolios? How do you assign different weights to different stocks?
We first shortlist stocks. Then, we look at those stocks where we have the highest conviction. This is where we take inputs from the analyst team also. As fund managers, we have to understand what our expectations from that stock are. Once that's done, we ensure we take enough active bet on the stock. Active bet is vis-a-vis the benchmark. We also have to do some top-down work to find out which sectors are doing well. You can say it's a mix of top-down and bottom-up approaches. As an investor, we have to decide how much risk we want to take at the stock level. The level of risk will decide the maximum underweight or overweight position. Once you set up a portfolio under risk-management framework, your job is not over. A continuous monitoring needs to happen. This monitoring tells us which stock bet is contributing and which is not. Once you know that, you can take necessary steps to add or correct positions.

Vast amounts of money always chase good stocks. But in India, over the past couple of years, liquidity has been plentiful. In such a scenario, how do you remain focused because others are buying and continuously pushing the stock prices up?
One has to understand the fundamentals of a stock. At the end of the day, we are relative managers. So, it is important to stick to companies with strong fundamentals. Even if the stock is slightly expensive, you should be assured of good growth. At times when markets are awash with liquidity, it is important not to get carried away.

You may miss certain opportunities. I am okay letting them go. In a market which is highly liquidity-driven, we are okay if we are not the best fund or investor. Our endeavour is to be in the top quartile, but during such times we are okay to be in the second quartile. I can't chase stocks irrationally. We also maintain some liquidity in the portfolio. When there is huge liquidity, there will also be shocks. We have to take advantage of them.

What is the margin of safety you look in stocks? Do you have your own way of calculating it?
There is no simple formula. It depends on different factors. Margin of safety depends on the characteristic of a particular stock. For a high-quality but low-volatility stock, we are okay giving away some margin of safety.