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'We are at a tipping point where we could have higher-than-average inflation'

We speak with Daylynn Pinto, Senior Fund Manager - Equity, IDFC AMC, about his investment philosophy, view on volatile equity markets and the stock selection framework, among other things.

'We are at a tipping point where we could have higher-than-average inflation'

After a spectacular bull run, the recent volatility in the markets has worried investors. We speak with Daylynn Pinto, who manages IDFC Sterling Value Fund, IDFC Multi Cap Fund and IDFC Tax Advantage (ELSS) Fund, to understand the market scenario now. He also shares with us his investment approach, promising themes for the next 10-15 years and the reasons for the outperformance by his funds.

Can you please describe yourself as an investor? What early experiences or incidents have influenced your investment philosophy?
As an investor, my philosophy is deeply rooted in being patient and believing in the longer-term growth opportunity that equity investing presents. So, I'm someone who doesn't necessarily categorise companies as high-quality or low-quality, but I like to rather focus on the price I pay for a business, thus coining the term 'BARP' strategy, which is 'Buy At the Right Price'. So, I may buy any sort of business which might be out of favour or perceived to be a low-quality business by the market currently, but if the price is right and earnings growth opportunity exists over the medium term, then money can be made and that is what is important in equity investing. Similarly, there may be a very 'high-quality' business but at an irrationally high valuation and I would choose not to buy it, irrespective of how good that business is. So, BARP is really my inherent philosophy and I'm fairly patient and willing to wait three to five years for an investment to actually deliver above-average returns.

Also, for me, investing has been a continuous learning experience. I have been in the market for 17 odd years now, wherein I have witnessed three bear markets, in 2008, 2013 and the most recent 2019-20. So, the whole process has been one of learning with multiple experiences and incidents that have helped in shaping the way I think about investing. I would not like to say one particular stock or one particular event has really changed my thought process or influenced my learning curve. But the three bear markets and the overall 17 years of grind have helped my overall learning experience, thereby helping me develop my philosophy and keep adapting and changing as to what is required to stay relevant in the equity markets.

Markets are witnessing a sharp correction at the time of this interaction, led by global factors. What's your overall assessment of the markets? Which sectors or segments look particularly vulnerable to you?
When the market goes up or goes down, we usually try and figure out the reason for it in hindsight. It's really difficult for us to actually predict any of these short-term moves. There's obviously stuff that we're talking about today, e.g., the US Fed tightening, the geopolitical conflicts in Ukraine and the Middle East and of course inflation is the most talked-about word today and we're guessing whether we're going to be into a multi-year inflationary cycle or not. All these are very valid concerns and relevant to how the market would behave in the short term.

If you look at the last 10 years, we have primarily been in a low-growth deflationary cycle, where interest rates have kept declining and therefore, businesses which offered better visibility in cash flows (consumer and IT) were rewarded disproportionately and were popularly termed as 'growth companies' or 'quality companies'.

Now, we are at a tipping point where we could have higher-than-average inflation, considering the way the central bank's balance sheets have expanded and the way China is starting to react/think about pollution control and carbon emissions. These are new trends that are emerging that could signal a change from a deflationary to an inflationary regime over the next couple of years.

We're also seeing wage growth, especially in the western markets, where there are quite a few job openings and not sufficient people. In the last few months, wage inflation in the US has been the highest on record in the last 30 years. It's a tug of war between sustained higher inflation or not. I'm slightly more optimistic on inflation being higher than normal and as a value investor, that's the best thing that could happen.

So, with that view, sectors that could potentially do well with inflation over the next three to five years are cyclical such as financials, especially lenders, commodities, infrastructure and real estate. These are the sectors that have been large underperformers in the last several years and the tide could be changing for them. That would also mean that FMCG, IT and consumer-discretionary sectors, where inflation will restrict their earnings prospects, are the ones that could possibly struggle. Also, these sectors are trading at all-time high valuation multiples as well.

Thus, I'm not so obsessed about what levels the markets are at currently but keener to see whether there is a large sector rotation that is going to happen from those that are favoured and loved sectors of growth style investing into more traditional cyclical or value style of investing.

What are the three big investment themes you would like to bet on over the next 10-15 years?
I wish I had a crystal ball. But one of the most talked-about themes today is clearly the electrification of vehicles. After almost 100 years, we would be moving away from internal combustion engines (ICE) engines to electric or green fuels such as hydrogen. That's something that would easily last for a few decades.

The second theme is on bringing down the global carbon footprint that is going to unfold over the next 10-20 years, moving to cleaner forms of energy like solar or wind or hydro or newer cleaner fuel sources. These are the areas that a lot of us are going to spend a lot of time trying to understand.

The third thing that still has huge potential is just continuous growth of infrastructure. India is clearly very underinvested. But even if you look at the western world, a lot of the infrastructure is about 60-70-year-old and they need to revamp and build some new infrastructure as well. We've already seen the US president talking a lot about pushing for an infrastructure revamp which is really focused on this theme.

Which attributes are non-negotiable for you when picking a stock? Are there any sectors or industries you completely stay away from?
A lot of time, the non-negotiable attributes are known in hindsight. Just to give you an example, before 2018, nobody really focused on how much a promoter pledged his shares. After 2018-19, we have all started to look at the promoter-pledged holding with a magnifying glass. Different market cycles result in different factors that investors need to focus on. There are a bunch of basic hygiene factors commonly talked about such as accounting practices, governance, leverage, pledges, etc. I don't think anything is a dampener for me. These are just a set of factors that the people articulate based on learnings over their investing journey and keep fine-tuning over time.

To answer the second part, if you're following my philosophy of BARP, then being sector- or industry-agnostic is the first principle. This, along with the price that you are paying for the quality of the business, the quality of earnings and the quality of the management, is more relevant.

What are your triggers to exit a stock in your value fund? We have observed you cutting positions swiftly in a rising stock. In hindsight, do you regret exiting some of them too early?
What we did with the portfolio is something that is portfolio-specific and not a trend. Our value fund is a predominantly mid- and small-cap-focused fund. We have almost 60 per cent of our holdings in mid and small caps. In 2019, mid and small caps were almost 85 per cent of our portfolio and extremely cheap relative to the market and they witnessed a huge amount of underperformance. That's why I refer to 2019-20 as the bear market because while the Nifty didn't appear to be in a bear market, the underlying market was in one. So, at the time, we added more money where we had more conviction and we just held on because we really believed that at that point there was no point in selling many of these businesses at the prices that they were trading. That really helped us a lot in 2020 and 2021 when the markets rebounded and the earnings of these companies started to normalise

So, that whole momentum in 2020-21 helped us do two things. It helped us prune some positions where our conviction was low and that's where you see a lot of selling. Additionally, a lot of stocks where we completely exited were marginal positions and in doing this, we have rejigged the portfolio. It had more to do with improving the overall portfolio structure and usually, it is advisable to do that in a bull market rather than a bear market.

Also, if a stock really does well and its weight increases beyond a certain proportion, then I automatically cut down its position by following the sell discipline. So, this sometimes leads to booking profits in your winners slightly earlier than you anticipated. But we've seen that the markets turn very quickly. Just look at the last one month (January 2022), the way the market has swayed.

How important is portfolio valuation while managing your funds and does it play any role in terms of your stock selection?
The overall portfolio construction is not really dependent on what the outcome of the portfolio P/E will be. The construction of the portfolio has to depend on the overall macro factors, views on various sectors and then finally the stocks within those sectors that you would like to buy or not buy. Portfolio P/E is just an outcome of this process.

The investment philosophy that one follows would automatically determine the portfolio P/E. We don't start with the aim of having our portfolio P/E lower than that of Nifty just because we think that it would be an expensive portfolio. So, there's no such predisposed notion as far as stock selection is concerned.

This is the first part of the story. You can read the second and the final part here.

This interview was conducted in January, 2022.