Strong start for new fund with 500 bps alpha over 3 months
Head – Investments & Deputy CEO
BNP Paribas MF
WF: Its still early days, but your India Consumption Fund has got off to a sound start, with a 500 bps alpha over benchmark over the last 3 months. What portfolio construction strategy has enabled you to begin the fund’s journey on a strong footing?
Anand: We focus on companies that are predominantly in B2C (Business to Consumer) businesses and not just on FMCG and Consumer discretionary sectors. B2C companies include Staples, Durables, Retail, Media, Retail Financials, Cement, Building materials, Autos, Consumer oriented Gas utilities, India-focused Pharma and Hospitals.
The B2C companies have brand strength providing them a connect with the end customer. Our analysis of the last decade and a half showed that the B2C companies generally tend to have higher return ratios than non-B2C companies and have outperformed through the cycles. India’s demographic dividend of a young population, growing urbanisation, falling dependency ratio and increasing per capita income bode well for consumption. Even GST should help many of the consumption categories as market shares move from informal to formal sector. Many of our portfolio companies have a long history of existence and leadership providing them the much required experience and expertise to benefit from the current opportunities.
WF: The portfolio composition of your Consumption Fund underscores one of the significant challenges for fund managers today – on how to perceive value when valuations are high. The FMCG stocks you own are quoting at 40-70 PE, banks at 30-70 PE, even cement at 50-60 PE. Given that this was a fresh portfolio cast post an NFO, what factors drove your investment thesis when historical valuations appear so demanding?
Anand: While some of the companies especially in Staples are trading at high valuations, we intend to focus on companies with higher and sustainable earnings and cashflow growth. The sustainability of the earnings growth depends on the Moat or strength of the company, category penetration levels and sector growth potential while the cashflow generation is dependent on the capital and competitive intensity of the business. Our intention has been to build a portfolio with growth and relatively better margin of safety compared to the rest of the pack on valuations front as it could be difficult to get good businesses at normal valuations. We are willing to pay a premium as long as the earnings growth justifies it from a 3-5 year perspective.
WF: Your Substantial Equity Hybrid Fund (erstwhile Balanced Fund) is also now a top quartile performer over 3 mth, 6 mth and 1 year time horizons. Is this also on the back of your stock picks in the consumption space?
Anand: We have been following the BMV framework (Business-Management-Valuation) model of identifying sustainable high earnings growth businesses which has helped our performance through the years. We are overweight consumers and financials and have exposure to companies with higher earnings growth and free cashflows. Our fund has predominantly focused on large caps considering the risk profile of the fund, with reasonable exposure to high growth mid and small cap companies across sectors.
WF: Given that domestic macro challenges are easing off now, is it time to bet significantly on cyclicals or would you remain overweight consumption – which is generally seen as cycle-resistant?
Anand: While the industry utilisation rates have crossed 75% which is positive from the capex cycle perspective, we believe the Central and State government capex contribute to majority of the spending and private capex may take few more quarters and could see more gradual pick up. However, unlike the previous cycle, we don’t expect big bang capex from metals and power this time around.
Having said that, there are select companies we like in the cyclical side which have proven track record, technology edge and ability to grow profitably. Cement as a sector is more B2C due to majority sales being retail in nature but it also benefits from a capex cycle revival. Housing and Infrastructure being two other key demand segments for the sector. We like some large cement companies which are gaining market share. Also we like corporate banks for their liability franchise, retail advances and end of asset quality issues, as these could stand to benefit in terms of higher growth in their corporate book should the capex cycle revive.
WF: What is your market outlook as we begin 2019? Are the best money-making opportunities of this market cycle behind us or still ahead of us?
Anand: Looking ahead into CY19, we believe it will be a tale of two halves with macro dominating the first half in the form of trade war developments, fed rate movement, and then the big general elections in May. Post this, the focus will move towards micro factors, primarily the earnings recovery (Bloomberg consensus earnings around 15% in FY19E and 26% in FY20E) led. To this earnings recovery theme, we would add four themes that are over-arching and are likely to decide how the various companies stack up on their execution i.e., (a) preparedness to benefit from framework reforms that are in place for sustainable growth in for medium to long term, (b) economic recovery being led by consumption, (c) gradual revival of manufacturing/investment capex, (d) embracing and accelerating digital disruption.
In that sense, we believe that this year Stock Selection across sectors and market capitalisation may be a key for outperformance amidst such volatility.
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