'We look at the company level'

Janakiraman R, Fund Manager, Franklin India Smaller Companies Fund, says, quality compounders account for a large part of the portfolio

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What is your investment universe?
Small and mid-caps form the investment universe for the fund.

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What attributes should a stock have for it to become a part of your portfolio?
The fund focusses on investing in businesses with an acceptable level of quality, growth and sustainability. These are businesses that are characterised by an attractive return on capital, relatively lower capital intensity, ability to generate free cash flow, attractive growth potential and capable management. The list is not exhaustive but illustrates the idea adequately. The attraction of such businesses is that they compound their earnings steadily over a long period of time at a relatively lower degree of risk. Exceptions to this preference happens on a tactical basis in general, the 'quality compounders' account for a large part of the portfolio.

It is our view that such companies tend to compound their earnings better than their peers through a business cycle. Importantly, for investors, such businesses are also characterized by a lower degree of volatility in business metrics.

What kind of stocks never enter your portfolio?
Businesses that do not have the ability to generate free cash-flow over a business cycle are the ones we try to avoid. Such businesses tend to be very capital intensive, generate poor return on capital, are very cyclical and have limited entry barriers. We reiterate that we look at the company level and not at the industry level; even in challenging industries, there have been companies that have managed to generate shareholder value, though the number of such outlier cases has been quite limited.

What will you attribute the relatively superior performance of your fund to in recent years?
Our approach is to construct a well-diversified portfolio of small and mid-cap stocks that have an attractive business with sound fundamentals. Significant amount of effort goes into identifying such good quality businesses. These businesses have the ability to compound earnings at an attractive rate over a long period of time. Identifying such companies and remaining invested in them for a long time has been the key reason for the fund's performance. Patience in terms of giving good businesses adequate time to perform and compound has played a key role over the past five years.

Is there any tactical miss you regret (for instance, not owning a stock or not owning enough of it)?
The mid and small-cap universe being quite big, there are quite a few stocks that we have missed out over the past 5 years. Inability to visualise the scope in case of exceptional growth opportunities has played a role in such misses.

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