'Markets are bullish despite being around fair value'

Bajaj Finserv Asset Management Company (AMC) is the new fund house that started its operations last year. We sat down with Nimesh Chandan, the fund house's chief investment officer (CIO), to understand his investment philosophy and stock selection process. Here is the edited transcript of the interview.

Indian markets have seen a significant rally in the last few months. Is there more steam left, or will we see a time correction?

On a fundamental basis, we create our own intrinsic value of equity, and Nifty is currently at a fair valuation. However, markets don't stop at fair value; they can either go up or down depending on various circumstances. At Bajaj Finserv AMC, we have created a behavioural indicator that considers how people express their opinions about bullishness or bearishness. We look at four different markets: commodity markets, currency markets, bond markets and equity markets.

In all these markets, we try to see what each investor is doing as an indicator. So, for example, in commodities, when investors are bullish on economies and businesses, they expect good capex. So, industrial metal prices start moving up, and gold, which is a more defensive allocation, goes down or doesn't do well. But, when people are worried about some crisis, corporates may not do well and there may be a cut in capex. In that scenario, investors sell industrial commodities and buy gold.

Similarly, there are indicators in each market. These indicators are combined with a proprietary formula to gauge the market mood. Typically, what happens in a bullish sentiment is that the market can remain above fair value. Our behavioural indicators currently show that we are on the bullish side despite being around fair value.

What is your fund house's investment philosophy?

Our aim is to generate alpha and create long-term wealth for investors. This is why we've created tools from our unique investment philosophy INQUBE (short for information edge, quantitative edge, and behavioural edge). We use these tools both for fixed income and for equities.

First, you have an information edge, which means superior information compared to the crowd and earlier than the crowd. This is not insider information but more knowledge about the business. In some pockets one can have an information edge.

These days Information gets you to the race but doesn't necessarily help you win the race. So, the second edge is how you process the data or the information better than the other. That's a quantitative edge. Suppose everybody has the same information, but you process that information better than the others through a better financial model, a better analytical model, or a better quantitative model. Then you can take better decisions than the crowd.

The third and most important is to have a behavioural edge, where you still make better decisions even if everybody has the same information and model. People are driven by short-term movements, by greed and fear. It is important that, as part of the behavioural edge, you put tools in place that stop you from swinging like a pendulum with the crowd. Otherwise, you will get average returns.

In the next stage, you identify where people are getting greedy and fearful and then take the opposite stance, which means you're using behaviour to take advantage of the crowd's overreaction.

How do you select stocks in the portfolio?

Top-down and bottom-up research is used to find stock ideas. It also entails analysing company cycles and trends, such as momentum and trend reversal patterns, to discover investment possibilities and their growth stages.

Additionally, a specific checklist is used to analyse the business, management, and value during idea analysis to guide stock selection. This checklist filters noise and focuses on key research areas, acting as a portfolio gatekeeper.

The checklist saves time and is consistent. The process also provides for scenario analysis (pre‐mortem) to assess the decision and assign appropriate probabilities while doing the valuation of a company. This approach involves travelling back from an imagined future, highlighting any weaknesses in the thesis, and reducing overconfidence.

To measure and organise allocation (of the investment), the business is screened by size, quality, valuation, growth prospects and risk. Investment decisions are supported by quantitative analysis. We design pre-commitments like stop losses to reduce human biases. Journaling investment decisions helps record decision-making quality, reduce result bias, and establish institutional memory and self-referring knowledge systems over time.

We also use a quant model like John Kelly's formula. Kelly used this in bet sizing in gambling. So, the Kelly criterion says that if you have a scenario analysis, how much money should you invest on a particular company? Since all our companies have scenarios, putting them into this formula tells us how much money we should bet on each company. So, basically, it guides us to see whether these companies have less risk on the downside and a higher upside. Conversely, many companies may have a good upside but may be at the bottom because they will have higher-risk calls.

How big is your investment team (analysts and fund managers), and how have you delegated the fund management responsibilities among them?

We have 15 of us and seven of them are involved in equity research. We have taken analysts who are generalists or who have experience in handling multiple sectors. We have not taken sector specialists, except for pharma, as pharma requires specific bottom-up skills. The idea behind hiring analysts who have covered multiple sectors is because we want some people in our hierarchy to grow within the company as fund managers going forward. We've taken a mix of people from the buy side (fund management industry), portfolio management services and hedge funds.

How do you manage Bajaj Finserv Balanced Advantage Fund? This category has not done well compared to other multi-asset allocation funds. Who do you feel is the target investor for this fund, and what expectations should they have while investing in it?
Let's look at balanced advantage funds across the industry. Many uses historical valuations like price-to-book (P/B) or price-to-earnings (P/E) to determine equity allocations in the funds.

However, markets work on both fundamentals and behavioural indicators. We just don't take the P/B or P/E ratio. We take many fundamental parameters and create an intrinsic value on a fundamental basis. Then, we pair it with the behavioural indicator of whether the market is bullish or bearish. Many times, if the market is undervalued or below its intrinsic value and moving up, we don't reduce our holding. We only reduce where we see the market has rallied and there is lot of greed. Basically, when our fundamentals and behavioural sentiments indicators change. I tell people that we buy when the market looks fearful and sell when the market is greedy.

BAFs are designed for conservative investors, and we try to help them enter and exit the market based on what we see as greed or fear in the market. However, the base portfolio is kept large (leaning towards large caps), so the volatility is reduced.

What kind of differentiated products are you planning to launch going forward?

Right now, we are telling the investor that this is the time to start looking at quality. Small caps are trading above average in terms of valuation. So, we are coming out with a large- and mid-cap fund, which will focus on high-quality companies with a competitive advantage. This would be a differentiator. We will share more details about the strategy at the time of launch.

Also read: Interview with Shreyash Devalkar of Axis Mutual Fund