What has resulted in the outperformance by IDFC Focused Equity Fund in the last one year?
The investment philosophy of the fund revolves around constructing a concentrated portfolio which has adequate diversification across sectors. Identifying the right stocks and having an allocation which is sufficient enough to drive the portfolio level returns has helped the fund to a great extent. Another key attribute of the fund is also to have an eye for 'buy and sell' rather than only a 'buy and hold'. As a result, our ability to get out of stocks at the right time has also helped in alpha generation.
How do you pick stocks for this fund?
Our stock selection philosophy is driven by a bottom-up research process, which seeks to identify businesses on the twin factors of quality and growth. The key is to identify businesses which are transitioning to high quality and/or high growth, which could result in higher alpha opportunities. The tactical part of the portfolio is allocated towards such business, while the core comprises high-quality and high-growth business, providing steadiness to the overall portfolio.
Do you have any special safeguards for mid and small caps?
This is a segment which is typically exposed to the highest mortality risk and higher draw-downs. Over the years, only a few companies successfully transition to mid-caps and a further few to large-caps. The key is to avoid temptations and invest only on the basis of the merits of the individual businesses. Typically, good quality of management is a key driver behind such successful transitions, even if the business growth is lagging for the time being.
When do you exit a stock?
The fund runs a limited 30 stocks portfolio. So, only the best ideas tend to remain in the portfolio and the rest get weeded out as the more promising stocks make an entry. Fundamentally, the exits are driven by two factors: a very low margin of safety and deteriorating business fundamentals.
How do you determine allocations across large, mid and small caps?
The fund has a multi-cap mandate and the resultant market-cap mix is an outcome of our stock selection as well as allocation to those ideas based on our conviction levels. As of now, more than half of the fund comprises large-cap stocks, while the rest is broadly divided equally in mid and small caps.
How do you see the current overvaluation in the market? What are you doing to deal with it?
The headline PE looks elevated in the absence of any material earnings growth in the past few years. Going forward, aided by a low base, we expect BSE 200 earnings to move to the 12 to 14 per cent for FY19, setting the stage for a much stronger growth in FY20. This would be primarily driven by NPA resolution, which should lead to a lower provisioning from the second half of FY19 and a low teen growth in credit. In addition, our analysis suggests a comeback of earnings growth in some other cyclical sectors as well. These give us relatively higher confidence on the earnings-growth delivery over the next two to three years.
Which sectors are you bullish on?
We remain structurally bullish on the entire financial-services space. In addition, we are bullish on the broader consumption space (including housing, automobiles and services sectors). These sectors offer multi-year growth opportunities.
What is the outlook for equities in 2018?
We remain optimistic on the market in the medium term. Driven by cyclical sectors, broad market earnings are going to witness a comeback over the next couple of years and we see valuations catching up to this. Moderating return expectations and keeping equity allocation at levels which correspond to one's temperament will be the key for investors in 2018.