Alpha champion bounces back
Head – Investments & Deputy CEO
BNP Paribas MF
WF: Fund performance across your flagship schemes seems to be coming back after a disappointing run. What changes to strategy have you made to enable this performance turnaround?
Anand: Few large cap stocks drove the index performance for the large part of the 2018 narrowing the market breadth. Also, correction in mid and small caps due to change in long-term tax in the union budget 2018 coupled with profit booking added to the market woes. This also led to underperformance of active funds against their respective benchmark. In order to address this situation we pruned our exposure to mid and small capitalisation companies and added large capitalisation names our portfolio. We reassessed our large underweights and have been sticking to quality and growth names.
We have faced these kinds of bouts earlier as well. But we remain confident of the recovery as our portfolios are closely knitted by our investment philosophy, BMV – Business, Management and Valuations. This focuses on businesses that grow faster than the economy and the industry growth rates. Once a business filters through this, we focus on the management leadership to see if they are gaining market share, how they are building moats around a business or protecting it, how they allocate capital, plan for succession, respond to disruption etc. Once a business filters through these two filters, we focus on valuations. We never go the reverse by owning businesses that are cheap. This strategy has helped us well across cycles and should hold us good in the longer term.
WF: CY 2016 and 2018 seem to have been challenging for your funds, while all other years over this decade have seen your funds perform much stronger. Are there any similarities between 2016 and 2018 which dragged down your fund performance? What lessons has your team drawn from Mr. Market from 2016 and 2018?
Anand: In capital markets “ignorance is never a bliss” and as a good student you always pick up learnings. Although there is not much similarity between 2016 and 2018 events, except both were challenging years. In the year 2016, our overweight telecom sector hurt the performance (new entrant with deep pockets and superior technology) and demonetisation led to underperformance, which swiftly recovered in the first quarter of 2017. Lesson learnt: a) technological disruption, it is not too far b) if fundamentals are intact, structural and secular growth stories continue do well even if there is a temporary demand destruction
In 2018, as explained earlier, market dynamics narrowed the breadth leading underperformance of broader market. Lessons learnt: Pay respect to trough valuations especially for the large benchmark names.
WF: Prolonged sluggishness in earnings at a broad market level has led to excessive demand for stocks exhibiting strong earnings visibility, consequently raising PE levels to historic highs. What happens when there is a broad based cyclical earnings recovery – is there a risk of these quality stocks getting de-rated as alternatives finally emerge
Anand: We have seen such episodes in past when broad-based cyclical recovery emerges leading to de-rating in select stocks/sectors where the valuations have been frothy. However, what prevails, quality and growth companies continue to defend their high valuations or worthiness. We believe the consumer facing companies will continue to trade high due to their superior and sustainable earnings potential backed by superior cash flows. As investors, we are cognizant about what price we pay and have been building that margin of safety in our portfolios and also have been cognizant of how the cash flows have moved for the names we own.
WF: How are you balancing your portfolios between high quality consumption oriented stocks which have remained in your portfolios over the years, and cyclical stocks which have the potential to grow earnings strongly as the cycle strengthens?
Anand: We have been proponents of growth and consumption oriented companies over the years and would continued to do so. Majority of our portfolios are positioned to benefit from the domestic side of economy with consumption theme being at the fulcrum. We believe the general elections and recent interim budget announcement were focused towards rural and low/middle income population and should act as quasi stimulus for consumption, particularly the low-ticket consumption. We have seen some green shoots in investment capex but very sporadic in nature with much of the heavy lifting still being done by public side. Our exposure to cyclical stocks is pure bottom-up play and we are participating through selected industrial capital goods and engineering companies. We believe the investment cycle is on the upturn and hence manufacturing and industrial companies will have a role to play.
WF: Which sectors/themes do you see creating significant wealth over the next 3 years?
Anand: Even while the macro environment stays at the cusp of uncertainty, we expect the underlying micro economy to continue to be in recovery mode. Over the last four years, several policy initiatives and implementation of “framework” reforms have disrupted the economy in the short term but have set the foundation for the longer term in the form of a likely improvement in growth and consumption. We believe that these initiatives will now begin to fructify, smoothening variations in demand and driving micro-level growth. Additionally, the continued thrust from the governments (both state and central) on infrastructure will give further impetus to the domestic economy, having a positive impact on the overall consumption and growth in the country.
We are more focused towards domestic consumption stories, B2C businesses and around financials. B2C oriented NBFCs are where we are finding some value now as they were very expensive 6-12 months ago. Consumer staples led by rural consumption recovery, consumer discretionary due to GST and a pickup in the urban spending. We are finding more opportunities in earnings growth stories in the domestic side of the market and that is where we are focusing.
One of the other focus areas is the cement sector. Affordable rural housing is very cement incentive and that is one sector which we are keenly watching for. However, cement is also impacted by urban housing slowdown. While Affordable Housing is a good tailwind, we will have to identify individual sectors and within that, individual companies which have more exposure to rural India.
WF: How do you see markets playing out over the next 12-18 months and what are likely to be key drivers going forward?
Anand: The dovish commentary by the US Federal Reserve has been cheered by emerging markets. As a result, we believe foreign investors may look at emerging markets more seriously in 2019 benefitting India as well. Back home, given that it is going to be an election year, we cannot wish away the volatility; however, we believe that earnings recovery, albeit delayed, will take centre stage post elections. The second half of the calendar year is likely to be driven by earnings delivery. In some sense, a move from the single digit earnings growth seen in the past few years, towards the long term average levels (two-decade average of 13%), is likely to result in the multiples trading at a premium compared to average to reflect the improved growth. In this context, we see a reasonable outlook for equities amidst the volatility. In such an environment, stock selection is likely to be crucial and can make a large difference to equity portfolios.
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