IIFL Focused Equity Fund manager Mayur Patel recently sat down with us to explain their stock-selection criteria and long-term outlook
28-Mar-2023
Mayur Patel took over the reins of IIFL Focused Equity Fund in 2018, and has ensured it remains one of the best performing funds in its category. A few days back, he took some time out to chat with Chirag Madia and Omkar Bhat and share the fund house's investment framework, philosophy and his top sector picks. Here is the edited transcript...
Do you see the US banking crisis impacting the Indian equity market?
The banking sector has not been materially impacted by the banking crisis. They are on a healthy growth trajectory, with low credit costs, although margins may normalise.
We do not expect the US banking crisis to significantly impact the Indian equity market. Nonetheless, the narrowing interest rate differential between the US and India is a concern in the short term.
Given that both countries currently face different challenges, do you see RBI's interest rate policy deviating from the US Fed soon?
Interest rate differential between US and India has narrowed to a seventeen-year low. This is the key concern for us in the short term.
RBI would have to continue with rate hikes in the near term. I say this because our currency will depreciate considerably if the RBI does not keep up with the Fed.
The interest rate increase of around 250 bps (2.5 per cent) in this cycle has not yet derailed the economic recovery and there could be room to absorb another 25-50 bps.
However, there will be a cascading effect across sectors if we see (rates increase by) another 200 basis points (2 per cent) in India.
Can you provide insight into your stock selection process for the funds you manage?
I joined this fund house in September 2018 and our team's priority was to establish a robust investment philosophy and stock selection framework. During our team discussions, we discovered our preference to have long term growth companies in our core portfolio while not missing out on alpha ideas in other segments of the market.
Thus, our funds' core portfolio stays in long-term, quality stocks while creating satellites around the main portfolio to boost alpha and reduce volatility. We follow SCDV (Secular, Cyclical, Defensives, and Value Trap) investment framework.
Secular segment is the core. It consists of companies whose ROEs (return on equity) and profits have been extremely good for six of the past 10 years and are likely to maintain that momentum in the next three to five years. Our main portfolio has 33 per cent of the money invested in such names. We will always be overweight on this quadrant. As per our analysis, the BSE 500 has around 21 per cent allocation, whereas we have around 33 per cent.
Let's look at the cyclical quadrant. It has sectors which move with the economic cycle. Examples would be industrials, corporate banks, cement, and infrastructure.
ROEs (return on equity) tend to be lower but these sectors witness strong growth in cycles. We look for firms that are well positioned to benefit from the economic cycle. Currently, we are overweight on cyclical stocks as the domestic recovery is looking promising.
We go overweight on defensives when markets are weak and the risk-reward here is attractive.
Finally, we come to value traps that have low profit growth and ROEs. We usually have an underweight on this segment. But we find companies that can catalyse its ROEs and profits over a few years. In short, our investment strategy is a mix of bottom-up stock picking, which is our strength, and managing risks through our SCDV framework.
What are the red flags while evaluating your fund portfolios, and what do you do when you encounter these warning signs?
We have a forensic score for every company in our research universe (there are around 275 stocks at the moment). It's a forensic model that considers historical data and gives a combined score based on nine parameters.
We avoid investing in a company if the total score is poor, even if we see upside potential in it.
We are also working on the ESG scores of a company.
Also, if we have a stock in our portfolio and the operating performance is poor, we will interact with the management of that company. If we find the problem to be structural in nature, we do a course correction.
Your fund has been a top-quartile performer. What do you think has worked well?
One, the portfolio which we inherited was good but did not fully reflect our investment philosophy. At that point, we made changes and incorporated our views and the SCDV framework.
Two, the significant part of performance came from solid bottom-up picks over the last few years. We bet on a few mid-caps and small-cap names that were not widely owned across our peers. These stocks ran up and created good alpha. Even now, we have a few interesting names that are not widely owned.
Three, our collaborative approach of investing. Our weekly investment team sessions and our homegrown research management system have enabled us to create a culture of transparency.
But what went wrong last year because the fund delivered slightly muted returns? How is the fund positioned to deal with the intense volatility in the Indian markets this year?
Last calendar year, we went through a phase of underperformance versus benchmark. That's because we did not have a conglomerate in our portfolio which had a strong run in 2022.
Also some of our IT bets which created good value earlier corrected sharply due to the sell-offs in the developed market. This dragged our performance in the short term because we had a sizable weight in this sector.
However, looking at our portfolio, we have made limited mistakes and are quite happy with the current portfolio mix.
Which sectors would you bet your money on for 2023? If you had to pick the top three themes, what would they be?
We are optimistic about the investment cycle, and thus, domestic cyclicals such as Financials, Autos, and Industrials are well-positioned in this environment. We are quite bullish on the electric vehicle (EV) theme and have been investing in companies that can benefit from it.
This interview was conducted in March 2023
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