This fund manager handling Rs 8,600 crore wants time & price correction in small-caps

Ramesh Mantri, the chief investment officer at WhiteOak Capital Mutual Fund, helms 11 schemes (equity and hybrid) along with other fund managers and manages around Rs 8,600 crore of investor money.

Among the 11 funds he manages are WhiteOak Capital Mid Cap Fund and WhiteOak Capital ELSS Tax Saver, which rank eighth among 38 mid-cap funds and 36 tax-saving funds in the last 12 months.

During our interview, Mr Mantri spoke about the importance of corporate governance and how it is make-or-break for the best of businesses before highlighting the froth being whipped up in the small-cap universe. He also discussed the sectors where valuations seem comfortable for him.

Here is the edited excerpt of the interview.

Can you share what initially drew you to the world of equity investing after your journey through Chartered Accountant (CA), a Master of Business Administration (MBA), and becoming a Chartered Financial Analyst (CFA)?

The journey started even before I did my CA. My family comes from a business background. Being from a traditional Marwari family, kids tend to attend family businesses even before they pass the tenth grade. So, your summer vacations are devoted to your father's business.

But I had a lot of interest in reading, and I read newspapers, including the business section. My initial recall of the market was from the time of the 1992 Harshad Mehta scam. My father used to apply for initial public offerings (IPOs) at that time, which made money. Later, when I started college at St. Xavier's in Calcutta, we had a street known for its book market. There, I picked up a book called 'One Up on Wall Street' by Peter Lynch. That's when I fell in love with the stock markets.

Managing a diverse portfolio across 11 schemes at WhiteOak Capital sounds like a massive undertaking. Can you walk us through how you and your co-managers divide the workload? How do you keep such a broad perspective across all the strategies?

We at WhiteOak Capital are blessed with a very large research team of 33 people. There's not only a lot of breadth but also a tremendous amount of depth in terms of the research capabilities. Several sector leads (analysts) have more than 15 years of experience. The way we are structured is that we give a lot of responsibility to the sector leads.

Unlike a lot of other structures, where the fund manager is the key deciding factor, at WhiteOak, investment decision-making authority lies with the sector leads. It's a collective decision-making process with intense discussion and debate about any investment opportunity. We spend a few hours discussing even a single stock.

As we are a very bottom-up, research-driven team, the biggest part of my role is actually making sure that we have clearly defined risk management principles that are followed properly. Sometimes, I also exercise a negative veto. It's not like I myself decide to buy a stock in the portfolio; it's almost always with the concurrence of the sector leads that have to recommend the position.

I'm curious about the investment philosophy guiding you in equity management. Could you give us a snapshot of your approach?

Many people like to understand investment philosophies. But I would say that, in investing, the big differences are not about investment philosophies; the real deal about investing is the execution of investment philosophies.

The philosophy is that outsized returns are earned by investing in great businesses at an attractive price. Fundamentally, the combination of great business and attractive valuations have to come together. Our first filter, when we look at any investment opportunity, is not looking at the price but whether the business is great. We start with a funnel of about 1,000 companies in the market, which is typically the universe of companies with over Rs 1,000 crore market capitalisation.

We individually rank all these companies from one to five. The first-ranked companies are those we already own; in the second rank are companies we would like to own but are waiting to get them at an attractive valuation. The companies ranked five have corporate governance problems or absolutely unsustainable businesses. In the fourth rank are companies with a mix of corporate governance and business problems. Third-ranked companies are what we're not sure about. They might go up or fall to be a fourth-ranked company.

We do this exercise at least once a year, and around 400 stocks in our universe will be ranked from 1 to 3. That is where the team spends a disproportionate amount of time researching these great businesses.

Fundamentally, there are three key attributes (to finding a great business): First, the business needs to generate superior returns over incremental capital. Second, we want to see companies with growth potential. For example, you assume 6-7 per cent real growth in the economy and 5-6 per cent inflation. So, India's GDP is expected to grow by 11-12 per cent per annum in nominal terms. You want to invest in companies and sectors where we'll get better returns than the market over a longer period. So, you are constantly looking to invest in industries and companies that can outgrow the economy. And then the third factor of great business is that we are betting on companies that have a track record of execution.

You want the typical portfolio company to be either number one or number two in the industry in which it operates or have the potential to get there in the future through superior execution.

That said, even if you own these three elements but lack governance, you don't create value. Governance is very important.

The performance of mid- and small-cap stocks has been phenomenal lately. Is this momentum sustainable?

In the last 12 months, we have seen mid- and small-caps stocks do better, and micro-caps have done even better. As we speak today, the risk has gone up when we go down the market capitalisation curve.

For example, SMEs are riskier than micro-caps; micro-caps are more risky than small-caps, and small-caps are more risky than mid-caps. Even if we adjust for recent corrections in the mid-caps and small-caps, I don't think you can find broad-based opportunities in the small-caps and mid-caps today.

I think it's still a cautious environment, and valuations have to drop by at least 10-15 per cent for our investable universe to expand. By correction, I don't mean just price correction but time correction. And for stocks to become attractive in this space, you're a long way off.

Finding value in the mid- and small-cap space can be quite a task. Are there specific sectors or industries where you see potential value today?

The opportunity is across the board if we look at the longer period. But clearly some segments of the markets have heated up in themes and sectors such as manufacturing, power, and even real estate.

Currently, the area where we find opportunities is in the banking and financial services sector. The results of big companies have been good, but the overall sector has underperformed, particularly the private banks. For banks, the profitability in the short term has peaked, margins have peaked, and credit costs (will) inch up. But overall, the valuations of the sector are very attractive.

Another sector is pharmaceuticals and chemicals, which have gone through a fair amount of correction. We find their valuations to be more reasonable. Since both sectors are knowledge-intensive, it will depend on the capability of the fund managers to create alpha in the pharma and chemical sectors.

One space I am a lot more positive about in India is enterprise technology and software companies, which have started emerging in India. A lot of banks, the government and many other establishments are investing a lot more in tech, and this is one theme that can play out well.

When evaluating small-cap stocks, what three qualities will you not compromise on?

First, we would like a company to generate high returns on incremental capital. If we have to create alpha in small caps, there is no point in investing in slow-growing companies. So, you need to have the growth vector in a small cap that is in your favour.

Second, we have to look at the management's execution track record.

Finally, the non-negotiable factor is governance. If promoters are not aligned with the minority shareholders, then they are not going to create value for shareholders. So that's the real non-negotiable factor, but then you need all these boxes to be ticked to create value and not just look at one factor.

Also read: Interview with Neelesh Surana of Mirae Asset Mutual Fund