Currently, we like the consumption theme: Jinesh Gopani

The strength of a company and a portfolio is tested in a bear market, and the ongoing bearish phase has sure been giving investors the jitters. We speak to Jinesh Gopani of Axis Mutual Fund about the ongoing decline and what's causing it. He manages Axis Focused 25 Fund, which has assets of about Rs 8,000 crore.

The market has seen a steep decline lately. What is the outlook for the market going forward? Which sectors are you bullish about?
Markets have been negatively impacted as investors have lost their risk appetite due to a flurry of negative news. Weak GDP, rising credit costs and weak corporate governance have put off foreign investors. However, we believe that this is not likely to sustain for too long. Our channel checks indicate incrementally positive demand in the run up to the festival season. While demand is expected to revive slowly, this bodes well for corporate earnings as the trough seems to have been crossed.

Currently, we like the consumption theme. Consumption includes financiers (retail banks/NBFCs), durables, staples, auto and discretionary. Demographics and aspirations have been in favour of the consumption theme over the longer term. There can be periods where some segments slow down, but we need to tide over it through the business cycle. We also remain constantly vigilant about disruption, given the nature of these industries.

Today, there are many pockets of turbulence: housing finance, PSU banking, telecom, auto, etc. Where is the problem structural in nature and where is it just a passing phase?
India's economy has shown signs of slowdown over the last 12 months. The reasons for this could include: (1) tightening credit supply to SMEs due to NBFC issues; (2) continued high real interest rates for a long period; (3) weakening business sentiments due to tighter compliance/ regulatory environment on multiple fronts; (4) weaker investment cycle impacting job creation; (5) NPL pressures making banks risk averse in lending; and (6) slowing global growth. These have been the primary reason for the negative market tones. We see these as a near-term challenge for markets, but retain our positive long-term view on the markets given the structural transformation that the economy is currently going through.

Our rationale for this revolves around five possible positive trends that are likely to shape market consensus over the next few quarters: (1) continued low inflation enables more policy rate cuts and easier liquidity conditions drive rate transmission; (2) rewarding transparency and clean businesses, and clean-up of bad business practices; (3) potential conclusion of strategic deals in companies which have been the focus of the news, thus restoring investor risk appetite; (4) stable INR and benign global liquidity attract foreign capital to domestic markets; (5) normal monsoons and subsequent rural demand recovery during the festival season.

How do you select promising stocks? When do you exit a stock?
Our stock-selection process has always been bottom-up and we continue to do the same. The investment philosophy is centred on four pillars, viz., fundamental research, pricing power, strong management teams and risk management. The fund endeavours
to buy and hold high-growth secular businesses run by dynamic management with utmost integrity. We believe a fundamental investment approach focused on identifying such sustainable businesses while controlling risk is the best way to deliver returns in the Indian equity market over the long term. The fund has always focused on 'quality' companies that are able to sustain profitable growth and generate long-term returns for unitholders no matter which sector the investment has been made in.

Change in business fundamentals is the primary reason for selling a stock, which includes a change in competitive advantage, capital-allocation decision and corporate governance. We believe that instead of using absolute valuation as a metric, it's the relative risk-reward metric that matters more.

About 80 per cent of your portfolio is in large caps and 20 per cent in mid caps. You don't have any small caps. How do you see mid and small caps currently in terms of valuations and the opportunities available?
Mid caps have been underperforming large caps since the beginning of 2018. Over the last year, the midcap index showed 12-13 per cent underperformance against the large-cap index. We believe that the market is heavily polarised in favour of a few stocks. Over the last 18 months, only 15 out of 50 stocks drove the index return, while the remaining 35 stocks actually gave negative returns. Same was the case with the mid-cap index, where only 15 per cent of the stocks were up by a small quantum, while the rest 85 per cent were down by 20-30 per cent. Only 48 out of 150 mid-cap stocks have ROEs of more than 20 per cent in FY19. We believe that merely low valuations are not always attractive. Valuations should be seen in context of quality. A company's 'right to grow (moat)' and 'room to grow (penetration in market)' in an economic environment are the key determinants of valuation. At this juncture, evaluating a stock in terms of good or bad rather than large or small is more important.

We do believe that opportunities in the mid- and small-cap space have emerged post the steep corrections. While the broader market is likely to remain volatile, our focus will remain on companies with well-defined niches, and strong moats are likely to deliver above-average returns within the wider mid- and smallcap basket. Tactical investment opportunities can be looked at in the current market environment.

Experts often talk about the virtues of diversification. Star investors like Buffett and Munger preach about focusing. Which makes more sense: diversifying or focusing?
At Axis, we have always aimed for compact but high-conviction portfolios across our equity schemes. It also depends on the kinds of opportunities that markets offer at different times. Over the last nine-10 months, markets have been very narrow. Only a few stocks have
been able to perform. In the last few months, all the companies which couldn't justify their high valuations with underlying fundamentals crashed. We can see that the mid-cap index is back to where it was around three years back (pre-demonetisation, October 2016).
Since then, index returns show that large caps have outperformed mid and small caps. However, the dispersion of individual stock returns has been quite similar across market-cap buckets. The companies that have performed have higher weights in the Nifty 50 Index and hence the index returns look higher. In such an environment, we are more comfortable having a compact yet high-conviction portfolio comprising high-quality companies with high growth prospects.

Axis Focused 25 runs a concentrated portfolio. If an investor wants to create a focused portfolio of 15-25 stocks, what should he do to minimise risk and maximise performance?
At Axis, we have followed the same philosophy and stock-selection approach that we have been following since the inception of Axis Mutual Fund, irrespective of market cycles. Looking at companies from at least a two to three-year perspective and ensuring strong corporate governance and promoter pedigree, a secular growth rate, a strong business model, which demonstrates pricing power, and ultimately good ROEs and cash flows have helped us for a long time now. Our philosophy has got rewarded, especially when there is pain in the market.

We believe that protecting returns is equally important as protecting capital. Managing drawdowns and risk is the key to long-term success in investing. The key
factor driving performance should be the philosophy of buying fundamentally good-quality and high-earnings-growth stories rather than betting on short-term momentum. WI