Interview with Vinay Paharia of Union Asset Management | Value Research We speak to Vinay Paharia, CIO at Union Asset Management about prevailing market valuations and the research being carried out at the AMC among other things.

'Investors should not invest in any company with an expectation of quick gains'

We speak to Vinay Paharia, CIO at Union Asset Management about prevailing market valuations and the research being carried out at the AMC among other things.

The assets of Union AMC's equity funds have more than tripled since Vinay Paharia took over as the fund house's CIO. We speak with him about the equity franchise at Union, prevailing market valuations, and his journey in this industry.

With the markets getting jittery in recent months, do you see the Indian equity space as fairly valued now or do you see the markets to be volatile for a while?
We do expect an improvement in the macro outlook this year compared with the previous year, as we recover from the pandemic shock. The pandemic impacted both the demand and supply sides of the economy. While demand is improving, aided by easy monetary policy measures like low interest rates and abundant liquidity, supply-side bottlenecks continue to remain in place. This has resulted in sticky inflation, which is leading central banks of developed countries to change their accommodative and easy-monetary-policy stance.

Hence, the near-term situation remains very volatile and the macro environment is changing very fast. In fact, we have recently seen some consumer companies like an FMCG company, a rural retailer and automobile manufacturers signal concerns on demand weakness in rural markets.

In our view, the medium-term economic growth is likely to be moderate and revert to the historical rate of growth. We expect moderate growth in the fair value of Indian companies in the medium term. However, markets are trading at a valuation which is at a premium to its current fair value and we believe that we have borrowed some returns from the future. Hence, we remain cautious in the near term but are optimistic over the medium to long term for equity as an asset class.

During a recent media interaction, you talked about hidden risks in the market, with the biggest being the ability to make easy money. Can you elaborate on that? Also, what are the other major risks that investors could be oblivious to in the current scenario?
We think 2021 was a bumper year for equities, as the valuations swung from fair to moderate overvaluation. The fair-value growth in corporate India has been moderate in the year. We do not expect a repeat of such a re-rating of markets this year. In our assessment, small- and mid-cap companies are trading at a premium valuation compared with their large-cap peers and hence we would advise that investors should approach this segment of the market with caution.

Over the last 2.5 years, we have seen the number of investors (as indicated by the total demat accounts) surge by more than 100 per cent, from 36 million in March 2019 to 77 million in November 2021. These new investors have tasted success in the equity markets as soon as they invested. They have yet to get a taste of the volatility and drawdowns, which are a recurring feature of the market. Such investors need to be careful and not treat the returns made in 2021 as easy money and extrapolate such return expectations in the future. Another source of quick and easy money has been IPOs and the related frenzy. We think investors should not invest in any company with an expectation of quick gains, as that would be tantamount to speculation, which reduces the probability of success.

In our view, investors need to guard themselves against the risk of (a) compression in valuation multiples led by a rise in interest rates and (b) volatility in the macroeconomic environment.

Over the last few months, your fund house has come out with research literature on factor investing. Can you explain its importance in your overall investment strategy at Union?
We follow the quantamental-based (quantitative + fundamental) Fair Value approach to investing. Our investment philosophy has two parts: stock selection and portfolio construction.

In selecting stocks, we strongly believe in fundamental analysis and our core premise is that stock prices track intrinsic value over time. Hence, our focus is on identifying good-quality stocks with (a) growth in intrinsic value and (b) margin of safety in purchase price. When we are constructing a portfolio from such selected stocks, we believe in quantitative models guiding us in creating an optimal portfolio while strictly adhering to portfolio objectives, in both letter and spirit.

The highlight of the AMC is the strict adherence to its investment process to ensure that investing is scientific and outcomes are generally more repeatable. We want to ensure a healthy balance of science and art in the process of investment.

In one of your recent research titled 'Are active funds relevant in the Indian market?', you showed that most active funds lag in the large-cap segment. Why do you think that has been the case and do you see this trend percolate into other fund categories as Indian markets mature? Also, the absence of index funds in Union Mutual Fund's product offering makes it stand out.
In our view, some of the problems plaguing the large-cap category are (a) very low active share in some of the funds, which results in difficulty in generating enough alpha to meet or beat the expenses, (b) some funds taking meaningful exposures to mid-cap stocks and (c) some funds taking cash calls from time to time. Also, globally and locally, large caps are the most well-researched category of stocks and hence, beating the benchmark is relatively difficult in this category.

Please note that even in the large-cap category, around 44 to 49 per cent of the schemes have beaten the benchmark across time periods. Having said that, compared to all other categories, passive funds are most suitable for investors in this category. As of now, we do not see this challenge spreading to other categories.

We are building a strong, investment-process-driven, active-investing franchise at Union AMC, which we think can deliver significant value to investors over a period of time. We are not driven by any rigid legacy rules but by an endeavour to constantly improve our investment process based on the incoming data and research. Our research papers are a testimony to this endeavour. We may consider launching differentiated passive products if we think that they complement our active-investing strategies and add value to our investors' portfolios.

This is the first-part in the two-part story. You can read the second-part here.

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