'Economic output for FY21 is likely to be extremely muted'

The contra style of investing seeks to find ideas that have few takers in the present but which can get rerated later. The coronavirus pandemic has shaken many businesses, with the survival of a few coming at stake. Amid such a situation, the job of a contra fund manager has become all the more challenging. We speak to Taher Badshah who manages Invesco India Contra Fund, a five-star fund with assets upwards of Rs 4,000 crore. He fields questions on the impact of COVID- 19 on businesses and the economy, the emerging investment opportunities and how he has managed to contain the downside in his fund.

As a fund manager, is this the most challenging time you have faced in your career so far?
One can say that the circumstances surrounding today's market conditions are very different in that they do not have precedents, which makes rationalising the situation and taking portfolio decisions that much more complicated. However, one thing that runs commonly across most such market scenarios is investor psychology, which invariably responds with extreme reactions. As fund managers, it's critical to separate emotions from investing logic during such conditions.

It's becoming evident that this crisis may linger on for many months. What kind of implications do you see for the economy? Do you anticipate any structural changes in the economy or the way businesses are run?
On current reckoning, the sudden stop resulting from the lockdown will be devastating, to say the least. It will significantly crunch economic output during the current quarter and perhaps the next as well, even as some of the blow will likely be cushioned during the balance of the year as some parts of India gradually emerge from the lockdown.

The overall economic output for FY21 is likely to be extremely muted. Corporate earnings, which were estimated to grow at about 20 per cent during the year, will now likely end up being flat to marginally lower. Long-term structural impact on businesses will be a function of whether the world at large deals with this pandemic with an effective treatment or is able to overcome the same with a successful vaccine. In the case of the former, many businesses will have to contend with the challenges of social-distancing norms for a good time to come, which can meaningfully alter the economics of their business. The outcome may be less severe if a vaccine solution is in line of sight.

Meanwhile, consumer experiences and lifestyle changes of the past few months do suggest that technology-led disruptions and value migration resulting therefrom could permanently impair a few industries while benefiting a few others. Some trends such as social dining or personal hygiene, etc., are unclear at this stage and may be very slow to evolve as human behaviour also does not change as quickly as one would like to believe.

Which businesses are going to be hit the hardest in your opinion?
Very few pockets of the economy can escape the wrath of such events and it is fair to say that almost all businesses will see significant dislocation in the near to medium term. Non-essentials and high-end discretionary would be among the hardest hit. At first instance, technology- led disruptions and value migration will come into play for sectors such as airlines, travel and tourism. The issue of migrant labour will delay recovery for labour-intensive industries, such as construction and real estate. The path to stability of externally oriented sectors such as IT, commodities and parts of pharma and healthcare will likely be a function of the pace of recovery in the overseas markets.

In which sectors or pockets do you see some great contrarian opportunities emerging? What changes are you making to your Invesco Contra portfolio?
With a nearly 25 per cent cut in asset prices on average, large swathes of the market moved into the value or contra zone. Areas such as banking and financial services, parts of consumer discretionary and industrials could be interesting breeding grounds for contra ideas at this stage, whereas reasonable value may be emerging in sectors such as IT services and utilities. Invesco India Contra Fund typically runs with a positioning that benefits from a probable cyclical economic recovery and thus has a natural affinity for some of these presently unpopular segments of the market. However, in dealing with contra/value propositions - propositions which do not enjoy growth support - it is extremely important to avoid weak balance sheets or elements, which can impair franchise value. The recent market correction has allowed us to further move up the quality curve in individual sectors while maintaining the overall value proposition of the fund.

How do you ensure if a contra bet is indeed an opportunity and not a trap? Many of the turnaround stories which seemed to get back on their feet may now get crippled?
Value-oriented strategies or contra bets do run with the risk of delayed turnaround or value traps. Delays in turnarounds are easier to deal with by (a) buying at valuations that provide the necessary downside cushion in the event of such delays and (b) ensuring that one avoids taking balance-sheet risks of the investee companies, even while assuming P&L risks. By and large, value traps typically arise out of disruption forces affecting an industry and are identified and filtered at the stage of initial investment due diligence with the help of our investment process. However, one has to acknowledge that value traps can become evident at a later stage of ownership as well and the speed of response of fund managers in mitigating their impact on the portfolio is crucial under such circumstances.

We observe that your Contra and Multicap Funds have close to about 50 per cent overlap. What's the difference between their stock-selection strategies? How difficult is it for you to wear two hats simultaneously?
At the very outset, our proprietary investment process and stock-categorisation framework allows us to segregate investment ideas on the basis of whether they are growth or value opportunities. Invesco Multicap Fund has a growth-oriented bias, whereas Invesco Contra follows a value-focused strategy that has a greater preference for value/turnaround opportunities which may migrate to becoming growth stories over time. Hence, even though the two funds would have overlaps arising mainly out of the growth component of the two portfolios, the starting point for each of these funds is different. With our investment process clearly designed to demarcate growth and value opportunities at the time of ideation, it is then just a matter of matching the opportunities to the right strategy.

Which of these two funds would you recommend to which investor?
In a predominantly growth-dominated market, Invesco India Contra Fund provides investors the opportunity to have exposure to a value/contra strategy. Invesco India Multicap Fund, on the other hand, is a growth-oriented fund structured to provide a balanced exposure to large, mid and small caps at all points in time.

Your stock-holding patterns suggest that you generate alpha by making deft entry into and exits from your holdings and perhaps not so much from a buy-and-hold approach. What are your triggers for entry and exits?
Invesco India Contra Fund, as dictated by its very mandate, runs with a highly disciplined approach of identifying businesses that are head-winded, out of favour and because of which are also inexpensive on valuations. The fund exercises due patience for the pessimism to turn into optimism, as reflected in the valuations of that entity in the market. Hence, the fund doesn't follow a typical 'buy and hold' strategy but a very valuation-conscious strategy that tries to maximise returns and generate alpha through a combination of earnings recovery and re-rating. In doing this, the strategy also ensures that the value proposition of the fund is available to investors at all points in time.

Your Contra Fund has been able to contain the downside better than peers with great consistency whenever markets have hit a rough patch. Is there anything that you actively do to protect the downside?
Invesco India Contra Fund follows a value- conscious strategy that typically eschews excessive valuations. In identifying opportunities that are reasonable/ cheap as its starting point, it inherently tries to build enough margin of safety that acts as its downside cover. Over its 13-year history, the fund has generally ensured that its aggregate valuation is at a discount to that of the broad market at any point in time. Besides, a value/contra strategy has to adopt very high thresholds on portfolio quality, more so than even growth strategies. That's because unlike a growth-oriented strategy, the cushion of earnings growth is not available in the event the investment thesis does not play out in the desired manner.