"Preference today is towards mega caps and large caps"

Ihab Dalwai is a fund manager at ICICI Prudential Mutual Fund. In this exclusive interview, he shares insights into his distinctive investment style, the management of key mutual fund schemes at the fund house, and more.

Here is the edited transcript of the interview.

What sparked your interest in equity investing?
In academics, I pursued commerce and later completed Chartered Accountancy (CA). Typically, the conventional route for a CA is to either take up an audit assignment or venture into taxation. However, since my early days, I was inclined towards financial markets, given my personal investments in equities. That said, I did not have any understanding of how institutions invest in equities. At the CA institute (ICAI) campus placement program, I was shortlisted for an investment team role at ICICI Prudential Mutual Fund and at another large corporation for their treasury department. I found the ICICI Prudential role to be more interesting and opted for it - a decision which, in hindsight, turned out to be the best for me.

How was your career progression from research analyst at ICICI Pru to fund manager? What insights did you gain during your time as an analyst?
One of the biggest advantages of working on the buy side, especially in one of the largest domestic mutual funds, is access to vast information. It can be through sell-side brokers and even historical notes and knowledge databases that are built by the organisation (fund house). So, building up capabilities or understanding the sector is quite quick for any research analyst.

The significant takeaway as a research analyst is that when one takes up a new sector, the key aspect is to understand the industry structure of the sector. Apart from that, meeting with the company and other participants operating in that sector, be it a supplier or a customer, and assessing management quality through either historical corporate actions or historical capital allocation are all guiding factors when it comes to ultimately forming a view on a stock.

As a buy-side research analyst, once you form a view on a particular stock, it is also important to communicate and convince the fund management team. Seeing funds generate alpha based on your recommendation is the most satisfying experience for an analyst.

How are the responsibilities divided among multiple fund managers in schemes like ICICI Pru Balanced Advantage Fund and ICICI Pru Multi Asset Fund?
In case of ICICI Prudential Multi Asset Fund, we invest across multiple asset classes (equity, debt, commodities, etc.). A fund manager is assigned to each asset class. The CIO of the fund house is also involved, and his role is largely towards asset allocation and determining the net equity level and other asset class exposure levels in the fund. Then we have one person to solely look after derivatives, as these products are dynamically managed. So, the roles and responsibilities of each fund manager are clearly defined and assigned. All of the fund managers frequently meet to discuss the capital allocation to each asset class.

How do you navigate situations where multiple fund managers are part of a single fund, and you favour equities while your CIO prefers debt?
The ICICI Prudential Balanced Advantage Fund is purely based on an in-house model which helps determine the net equity allocation. But when it comes to the ICICI Prudential Multi Asset Fund, the fund manager determines the net equity level. In the multi-asset fund, I am responsible for equity allocation. Likewise, for the other asset class managers.

The thought process we have adopted for ICICI Prudential Multi Asset Fund is like that of ICICI Prudential Balanced Advantage Fund, which is to have a countercyclical approach to asset allocation. So, when the valuations are rich and earnings have been delivered, we would want to be at a lower equity level, and the inverse is true when valuations are cheap. Even when the earnings are suppressed, we would want to have a very high equity allocation in a multi-asset fund. This core philosophy is common across fund managers. As a result, we are largely in sync with each other. As mentioned earlier, we get into a discussion, agree upon a course of action and execute the same in the fund. Being the equity fund manager, my core responsibility is towards the equity portion of the fund and likewise for other designated fund managers. Once the net allocation is decided among each of these asset classes, it is up to the respective fund manager of each asset class to determine how he wants to manage that portion of capital and try to generate alpha.

How would you define your personal investment philosophy? What types of stocks, market conditions, or investment opportunities particularly resonate with you?
The core philosophy is to have a counter-cyclical approach. I believe it is an all-season or all-weather approach. There will always be some sectors under stress or out of favour. At most times, the market is divided into favoured and unfavoured sectors.

So, the underlying thesis of this investing philosophy is that market participants generally overestimate profits and overvalue a favoured sector, whereas for an out-of-favour sector, earnings estimates are low, and multiples are also suppressed. Hence, if the view on the out-of-favour sector goes right, stock returns generally benefit from two counts- rerating and earnings upgrades. For example, public sector undertaking (PSU) as a pack was one of the most unfavourable sectors three years ago since valuations were extremely cheap and dividend yield for a few of the stocks were greater than G-Sec. Today, this space has emerged as the most favourable pocket in the market. At the same time, we do not invest in a sector just because it is out of favour. To make an investment decision, the sector should have a positive internal research view because the market is right more often than not.

Given the performance of top holdings like ICICI Bank, HDFC Bank, and Infosys in the ICICI Pru Large & Midcap Fund over the past year, under what circumstances do you decide to exit a stock?
In terms of the top holding in the fund, there are mega caps, and from a capitalisation perspective, given the current market conditions, we prefer mega caps and large caps. Mid and small caps have done extremely well in the last two years. From here on, the potential return perspective looks better in large caps and hence the preferences towards large caps.

When it comes to selling discipline, most of the time, it is when a view has played out, and the outcome is desirable. Generally, sell occurs when the stock comes to fair value and moves above fair value, and we have a better switch idea to move to. Those are the ideal situations where one can look to sell and be comfortable with the decision made.

The tougher decision is when you have a stock that has not done well, and you want to sell that stock. Generally, we need to understand why the stock has not performed to begin with. Suppose leverage is a problem for the stock. In that case, it is very difficult for the company to come out because then it would need to raise equity, and this process significantly dilutes the existing equity holder. So, if leverage is a problem, one has to book the loss and exit. If leverage is not a problem, then you should accept that the thesis has gone wrong. However, one should not be in a hurry to sell as there can be instances of a short-term rally in the stock. And that is when one should look to sell because it does not make sense to sell in a hurry and impact the price if leverage is not a problem.

Finally, one needs to have a portfolio approach as certain stocks might not play out, and you may go wrong. But from a risk management and portfolio perspective, weights in that stock need to be capped so that they do not impact the overall performance of the portfolio. If you can restrict the weightage of the stocks where you think the view has gone wrong, the likely impact of that stock on the overall performance of the portfolio will be very limited.

ICICI Prudential Infrastructure Fund appears more weighted towards banks and less on construction compared to its category. What is the thinking behind this portfolio?
Infrastructure, as a theme, has to be viewed in a broader context because there will be several sub-sectors that one can invest in. The thought process we have adopted is that, on a medium-term basis, we try to switch from sectors that have done well to those that have not. The investment universe is quite broad. However, it cannot invest in IT, pharma, or auto sector companies. But most of the other parts of the market are quite open for investors to explore. Apart from construction, there are other segments as well, like power, which is also something that we have considered within infrastructure. There are companies in capital goods, ports, oil and gas, which also form a part of infrastructure. Then there is banking as well because banking ultimately lends to asset creation or lends to these EPC players to construct. So, the universe is quite broad. So, the aim is to take active calls on each segment, which we believe can deliver returns going ahead.

Also read: Interview with Venugopal Manghat of HSBC Mutual Fund