"Relatively high market valuations limited our capital deployment avenues"

PPFAS Mutual Fund has recently garnered attention as a few of their bets have paid handsomely over the past few years. We had the opportunity to sit down with Rukun Tarachandani, a fund manager at the fund house, to discuss his investment strategies and delve into his journey in the world of equity markets. Below is the edited transcript of our interview, and you can watch the complete interview video above.

What got you interested in equity investing?
Honestly, I was just dabbling or trying to understand the stock market. So, it wasn't really a passion or something. But when I was doing my MBA at the Management Development Institute (MDI), Gurgaon, we had a course by Professor Sanjay Bakshi called Behavioral Finance and Business Valuation. As I went through that course, the entire process of investing and this entire field of behavioural finance just appealed to me and seemed extremely interesting. So that is what got me interested, and from there on, it has been a journey of learning and trying to discover myself as an analyst.

PPFAS has one large equity fund - Parag Parikh Flexi Cap Fund. How do the four fund managers divide the work?
The core investment philosophy for each of us is the same, and we believe in the same process, which is that we want to buy good-quality companies with a margin of safety. Having said that, each of us brings a different set of experiences that we have had over our investment careers and have looked at different segments of the market and different firms. Having all these different perspectives helps us while discussing an investment idea. So, it might happen that if somebody is making a mistake or someone is missing out on something while analysing an idea, there are other viewpoints that can be countered. So, having those different viewpoints helps quite a bit in the process.

What also helps is that, as an organisation, we are pretty open. We keep telling our research analysts to bring out the negatives of any stock we invest in. So, we want to know what is wrong. Typically, the process is that before any investment is made, a research analyst who's worked on the stocks will present their case, and then we'll deliberate on whether it should be a part of the portfolio. And then we decide whether, within the investment team, it makes sense or not.

So, what exactly is your role in managing the funds?
So, there are two sides to it. One is the fund management side, where, at any given point in time, we decide on a select group of stocks that we are looking to invest in or that we want exposure to. So, depending on the inflows and outflows in the fund, there will be daily trades that have to be given; there will be opportunities for cash futures, arbitrage, covered calls, and things like that. I would actively track and see if it makes sense from a portfolio perspective.

Now, in addition to fund management, there is the research side of things, wherein my focus is mostly on quantitative research. It involves building models that can identify opportunities or red flags with stocks, then updating those models and highlighting if something looks interesting to the rest of the team.

Has there been any situation when your CIO overrules your idea without any reason.
It happens, but it's rare. The reason is that our core investment philosophy is the same. Typically, I'm not going to take an investment idea which is completely 180 degrees opposite from our core investment philosophy. Having said that, yes, it has happened in the past, and that's fine. You will not agree on all of the decisions. But that is the advantage of having a group. If I've missed out on something or not taken a particular aspect into consideration, and the CIO feels that it is an important aspect, he can override it. At the end of the day, you also need one person to have a final say in the entire process. So, in this case, the CIO, Rajeev (Thakkar), is the final authority when buying or selling a particular stock.

How will you define yourself as an investor? What kind of stocks, context, ideas or opportunities excite you?
What are the kinds of ideas I would typically be most excited about? Good-quality companies are going through periods of temporary pain. Now, in the majority of these cases, you don't know how long that pain will last. You don't have a clear answer on whether that pain period will end - in one year, two years, or probably three years. But because of that uncertainty, you are getting that stock or that firm at a significant margin of safety. So, if you can be patient and if you're not looking for immediate gratification and near-term certainty, then you can take advantage of those kinds of opportunities in the market.

If you go back historically, for example, post-US FDA concern, many pharma companies got sold. Somewhere around 2018-19, a lot of corporate banks had these NPA issues come out in the open, and a lot of cleanups had started to happen, but you didn't know when it would get done. But on the flip side, you were getting many of these good-quality banks at about one-and-a-half or two times the price-to-book value. So those kinds of opportunities are ones that I would be excited about.

The other thing is the other set of opportunities that actively track special situations. So, demergers are one area where you have stocks getting listed in the market without an active bidding process. So typically, if you have an initial public offering (IPO), you have all the fund houses bidding and trying to get a share of that IPO. But in the case of a demerger, the listed stock is likely under-followed or under-researched. So you can have opportunities in those segments, or you can have special situations around changes in promoters or changes in management. So those are other avenues, because they tend to be under research.

For the previous few months, the flexi-cap fund has had a debt/cash allocation of roughly around 15 per cent. Is your investment universe shrinking as a result of high valuations?
Aggregate valuations in the market are certainly above average and not cheap. There are pockets of the market that are expensive. Having said that, some pockets in the market are still reasonably cheap. So, sectors like private sector banks, some of the utility companies that we've been adding, or the tech names that we've been adding. But yes, since the overall market levels or market valuations are relatively high, we have not been able to identify more avenues to deploy capital. So the cash range has been between 15 and 17 per cent.

Do you primarily focus on bottom-up investing for your flexi cap fund, or do you consider small, mid, and large caps? Do you think it's not worth your while investing in small caps for a Rs 42,000 crore fund?
When we are analysing the idea, rarely is the thought given to whether it is a large cap, mid cap, or small cap. So, while looking at a business or a stock, the focus is on the factors that I had earlier highlighted. Having said that, when we have to size the position, the stock's liquidity comes into play. So, with a large-cap stock, I can probably have a 5-6 per cent or even higher location. But for a small-cap stock, I might have a 1-2 per cent kind of allocation.

So, we are open to looking at small-cap companies, and we actively research them as well. In the last one-and-a-half years, the aggregate valuations in that segment of the market have materially moved higher. If we look at the valuation, then small caps are not really cheap versus large caps, both on a relative and an absolute basis. So, that is one factor that has contributed to not having a larger amount of portfolio allocated towards it.

How attractive do you think your top holdings are? In the past year, it has seen returns of just 2-5 per cent in the flexi-cap fund. Under what circumstances do you trim the holdings or exit the stock?
Typically, the price performance over the last year or one-and-a-half years plays no role in how we think of a position. The focus is on the business thesis, so if you look at the top holdings, the business is doing fine. There are near-term concerns with the merger, and so on. But then there are possibilities for longer-term improvement from the merger. So, as long as the business is improving and valuations are still attractive, we would want to remain invested. And if possible, depending on what the position size is, possibly add to that position. To answer the question of what makes us really relook at things, one is if the business starts to deteriorate versus our expectations, and second, if we come across management or promoter-level corporate governance issues that we were unaware of or foresee. And third, if the valuation is at a reasonably high and expensive rate. So, these are the three reasons why you would start to look at trimming or exiting a position.

Currently, only 17 per cent of the portfolio is in international stocks. Do you plan to increase it to 35 per cent once RBI opens up the limit of the investments?
We're fairly comfortable with our international holdings, and we think that these holdings are leveraging longer-term trends in the technology market. Trends like moving from linear television to streaming television, moving from brick-and-mortar retail to e-commerce, or moving from physical advertising to digital advertising, in our view, all these are longer-term trends. Even the valuations of our holding companies are quite reasonable. So, now, whether we decide to add to these or not depends on when the limits open up, what the valuations are in the rest of the market, and so on. So, at this point in time, we are fairly comfortable with our holdings.

If the limit is opened, would you like to increase your allocation to international equity? So, will there be a new particular set of stocks, or will you add on existing positions already?
Yeah, I would suppose so; we would want to increase the holdings. We can add on to existing positions; there are assets where the research on international stocks continues. But we like our existing holdings to be able to add to them, and as you mentioned, we have some cash in the portfolio that we can deploy. But again, this is a hypothetical scenario.

The flexi cap funds have seen some investments in public sector undertaking (PSU) stocks. What factors led you to opt for PSU stocks?
It was not a top-down thought process for PSU stocks themselves. It wasn't like we were going with the thought process that let's allocate 5 per cent or 10 per cent to the PSU. We have had a stock-specific reason for adding them. So, in one particular case, our view was that as renewables increase, you need more grid capacity. As that grid capacity increases, this stock will benefit. In one particular case, it was a demerger playing out. Each of these was an individual, stock-specific thing. Having said that, there have been a couple of things that have happened in the past four or five years.

One is the privatisation of Air India. In other cases, there have been movements towards the monetisation of assets. So capital efficiency, in some cases, has improved. The second is that, in this desire to invest in quality companies, the market, to some extent, took the valuation of quality companies to an extreme and the valuation of PSU companies to an absolutely other extreme. In one of our portfolio companies, it had almost a high single-digit, or a near-double-digit kind of dividend yield. So, you know, in those kinds of scenarios, the dividend yield was itself quite compelling to be able to take those opportunities.

What are your thoughts on new-age technology companies listed in India, given that you have been very interested in investing in Amazon, Meta Platforms, and Google for many years?
We can invest in new-age companies at various stages of their cycle. Some venture capitalists (VCs) would invest in the very early days. Private equity (PE) or late-stage PE would come later. We would prefer to invest in companies where we have good visibility on what the business model is, how they're going to earn revenues, and what kind of margins they can get at a certain scale. What are the kinds of cash flows that are visible in the near future? So, we would typically want to buy these companies at that stage.

Now, this might mean that you are late for the entire thing. There are people who would enter early and make money, but that's okay; we are willing to forego that opportunity. If you look at our holdings in the US-listed tech names, there would have been firms or people who invested way earlier. But even at a later stage, we had a significant opportunity to participate in the growth of those businesses. At this point, in many of these new-age tech companies, we don't have that kind of visibility, which is why we stayed away. We continue to track these businesses, and we continue to evaluate how the market position is shifting between the different firms, whether they're gaining market share, losing market share, or things like that. But to the extent that we don't have clarity, we'll stay away.

Also read: Interview with Ankit Jain of Mirae Asset