Fund manager, overseeing Rs 78,700 crore, defends Kotak Flexicap Fund's performance

Harsha Upadhyaya, Chief Investment Officer - Equity at Kotak Mahindra Asset Management Company, currently manages seven schemes with total assets of around Rs 78,704 crore. Among the various schemes he manages, Kotak Flexicap Fund has assets of over Rs 44,500 crore, the third highest in the flexi-cap category.

In this latest interview, he discusses his journey, investment philosophy, and the recent changes at the fund house.

Here is the edited transcript of the conversation.

How did you get started at UTI?

Well, my basic academic background is in engineering. Then, I did my MBA at IIM Lucknow. So, somewhere during that journey of completing engineering and starting out with a fresh MBA, I thought that I should make a career in capital markets.

What helped me was also my summer internship, which was in equity research. That gave me insights into what happens in equity research and how that helps construct a portfolio by selecting stocks. It was my basic knowledge about investments at that point in time.

Obviously, I was curious to know more and get into the investment field. And it so happened that I managed to get into UTI for equity research. At that point in time, there were very few companies offering equity research roles. And I managed to get through, and then the journey started. So, I spent about half of my career in equity research before starting as a fund manager. Even my second stint as a fund manager started at UTI MF. So that's how the whole journey has been.

In a recent interview with Value Research, Samir Arora mentioned that in the mid-90s, getting a bhaav (trading summary) copy from the broker was research. Can you paint us a picture of those times? How did it work as an equity analyst at UTI in 1996? And how different is it today?

You're trying to remind me of my age (laughs). It was a very nascent stage of the industry. I would say that we were probably one of the few teams formally doing research at that time. We were all allocated different sectors, and we covered different sectors depending on the complexity of the sector. And these were the days when we didn't have Google or any of the other digital platforms. All our research was done through reading, media interviews and annual reports. Basically, we read whatever was available about the industry and the company.

So, the way we used to go around seems very funny at this point in time. We had an attendant in our team, and all analysts used to mark the news items with different coloured markers that were relevant. Every day, we used to read the newspapers and mark them with different colours, and then the attendant, looking at the colours, used to cut those clips and then file them in relevant company or industry files. So, that used to be a reference point when we wanted to go back and see what was happening in the industry or what the management had communicated earlier.

Those were the initial days. Slowly, it became more formalised and easier to analyse the stocks.

You were a very successful arbitrage fund manager at UTI. With greater automation, how does this category work now?

Even today, the category is still giving very handsome returns to investors. I was managing a fund of about Rs 600 crore, which was the largest in the industry then. And we used to struggle to manage that amount of money. But today, look at the size of the industry and the kind of money the managers have been managing.

For example, our team manages over Rs 35,000 crore in a single arbitrage fund. And still, the returns are quite good, so it's an execution game. As long as you are able to focus on execution and get the best out of execution, you should be able to generate these returns.

Obviously, returns will depend on short-term interest rates, the speculative interest in the market, the number of positions you can take, the current assets under management in the industry, and so on. But clearly, this is one asset class that has provided excellent returns for our short-term investors without taking much risk in the market—almost zero kind of risk.

What has changed over the past two and a half decades in arbitrage funds?

Clearly, the size of arbitrage opportunities has seen an enormous change. Along with the derivatives market, the category has also grown. We have been using a lot of algorithms in the arbitrage trades. So, it's become that much easier in that sense because you get a lot of automated support.

But at the same time, the challenges are different. I mean, look at the size of the industry, and you can imagine what kind of positions that one would be looking at, the amount of churn that happens every month, etc. So, clearly, the challenges are with size, and you have to maintain the same kind of proficiency in execution even at much larger sizes.

How will you define yourself as an investor? What kind of stock or situation excites you?

We are a fundamentally driven fund house, and we look at three pillars, which are critical in terms of looking at and evaluating a particular business and the stock.

First and foremost, we look at the business and try to understand its competitive advantages, whether it's a scalable business, and whether it will grow at a reasonably strong growth rate. We also check if they have pricing power in their sector because that ultimately leads to profitability. So, generally, understand everything about the business in the first place.

The second is management evaluation. Here, we try to look at how aligned the management is with the minority shareholders. This is easier said than done because no hard-coded number or hard-coded fact is available. Only through the experience of our research team and our own experience are we able to see whether the management is in line with minority shareholders or not. We also look at the management's capital allocation decisions in the past because, as the company grows, we check how efficiently they have used the capital. Capital allocation is very, very important to us.

Then, we move on to the valuation pillar, wherein, depending on the industry segment, different valuation metrics will be relevant. When it comes to valuation, we look at various other aspects of financial performance and then determine whether there is merit in investing in that stock or not. Clearly, our decisions are driven by fundamentals rather than betting on any events.

So as long as our investors are putting money into our funds, even when we are not so positive about certain valuations in a market or certain macro-factors in the market, we tend to still invest in what we, at that point in time, visualise as relatively safe or better sectors and businesses.

In that sense, I'll say that the flow of our funds influences all of our decisions.
But generally, the real challenge is to identify scalable businesses at the right valuation. After that, the compounding characteristics of those businesses will take care of the fund returns.

Having said that, there will always be some mistakes. And that's the reason why we have a diversified portfolio.

When and what kind of stock becomes a compelling buy for you?

I will not be able to speak about individual stocks. But clearly, the thread we are looking at in terms of identifying good stocks should have compounding characteristics, as I explained earlier.

Generally, we have followed the principle of growth at a reasonable price (GARP). This is more like a middle path, I would say, in an emerging market like India, where growth is always favoured. So, to that extent, even if you go wrong in terms of assessing the cycle or the impact of future growth, your returns are probably going to be slightly diminished as compared to your expectations. However, you're still likely to make money if that is the growth-oriented process.

We believe tilting a bit towards growth is definitely good in the Indian context. And at the same time, one also has to keep valuations in mind. So, you cannot pay any price for the higher growth you aspire for. Valuations have to be, more or less, in line with the pay range of valuations. So, if you're investing in growth stocks at a reasonable valuation, then hopefully, over a period of time, you should be able to outperform the market.

We understand that some fund managers quit recently, and there's more on your plate now. (Since October 2023, you have started co-managing six schemes.) How do you co-manage 11 funds?

This is more of an interim management position. New fund managers have already come on board, and you will shortly see the addendum that will be released, giving out the fund management details.

Similarly, you will see that the two most experienced fund managers who have joined us also have fund management responsibilities. In the near future, you will see the funds' transition. After that, I'll be left with whatever I used to manage before all these exits. So, to that extent, my bandwidth remains the same. And I'll continue to focus on the ones that I am managing.

There is no consistency in terms of returns in Kotak Flexicap Fund. What are the reasons, and how do you plan to improve the performance?

When you say there is no consistency, you are probably referring to the benchmark. And unfortunately, at this point in time, we have no control over the benchmarks; the regulator decides the benchmarks.

The fund has been in existence for 14 years now, and the benchmarks have changed three times. Initially, it was Nifty 50, then it became an NSE 200, and post-December 1, 2021, it's become an NSE 500. So, whenever you're looking at today's benchmark and comparing past performance, you will see all these anomalies.

Now, probably, it is happening in various other categories too. While some of the newer funds obviously will not have this kind of issue, all the older funds will. But setting aside this issue, if you look at the rolling returns of 5-10 years of investment horizon, you will see that across time periods, our funds—not just Kotak Flexicap, but almost all of our funds—have outperformed even the revised benchmarks in a consistent manner.

That said, every fund will have phases where it could underperform due to various reasons. It could be external to the portfolio; it could be internal. But those are the challenges. I mean, if you're in the market and have managed funds for 15 years or so, you will definitely have some of these cycles coming and challenging you. And that's what has happened even in this case. But we are quite confident that if you can stick to our investment philosophy and continue with our disciplined approach, we will continue to deliver returns to the investors.

Also read: Interview with Nimesh Chandan of Bajaj Finserv Asset Management Company