Important to balance strategic and tactical calls in a fund portfolio
Co-Head of Equities
DSP Investment Managers
WF: Do you expect the current market correction to evolve into a much larger mean reverting correction that will align us with the overall bearishness in the Emerging Market basket?
Rohit: It may not be appropriate to look at the market trend over the past 2-3 weeks. There is a need to look at them from a medium term perspective. Emerging markets have been driven by some of the macro factors like depreciation of domestic currency against the US dollar, the type of Government intervention in currency markets and liquidity issues arising from outflow of foreign capital.
In the Indian context, currency depreciation has been quite steep, but we have sort of peaked. It is unlikely, that we could see any further sharp depreciation in currency over the medium term. Global factors will continue to weigh on the market sentiment. Meanwhile, there are signs of good earnings growth pick up. While the expectation was 17% - 18%, they have come up a little less, but the recovery has been broad-based. This gives us a fair picture of where we are headed. The Government has been focused on other aspects such as trade deficit and inflation, they have a clear outlook on where they would want to see these parameters. Hence, the macros of India should look slightly better than what they are at currently.
That said, FIIs have a significant holding in the Indian markets and any major sell-off by them could take a toll on the market’s trend. The pressure from global factors could continue in the near term. If the global cues start improving then the market trend could also reflect some strength, as underlying fundamentals show signs of improvement.
WF: What steps are you taking to protect on the downside even as you continue your quest for alpha?
Rohit: There is often quite a gap between expectations and reality – and when we talk about global factors pulling markets down, it is more on expectations. When we look at generating alpha, we are however talking company specific – and the businesses of many companies are not substantially impacted by global macro concerns. It is when we think that earnings trajectory might get impacted by macros that we need to act decisively.
Historically, in such market scenarios, defensive sectors are preferred. In line with this rationale, the exposure of Equity Opportunities Fund has been increased towards IT, pharma and cut down NBFCs. Basically; we have restricted our exposure to those sectors which can see a big draw-down due to existing macro factors.
We have to keep in mind that these adjustments are done at the margin, which means that portfolio shuffling will be to the extent of say 10-15%. The core of the portfolio will remain the same so long as the fundamentals of those companies continue to look healthy. So, from a portfolio strategy perspective, one wouldn’t go entirely defensive because of possible macro scenarios playing out one way or another. We try to limit portfolio volatility to some extent, but avoid drastic overhauls based solely on macro possibilities.
WF: The fund has seen a bout of underperformance over the past 6 months and 1 year. What would you attribute this to and what are the corrective measures you have undertaken to bring back the fund to its previous glory?
Rohit: The key reason for the underperformance CYTD is primarily due to the fact that we have been underweight on IT sector and overweight on oil and gas companies, corporate banks and metals. At the beginning of the year, we were still not very convinced about the IT growth story from a fundamental perspective. The reason IT stocks earnings have done well primarily due to the rupee depreciation. While there was anticipation that currency would depreciate, we did not foresee this kind of a correction. As the currency depreciation set in, we increased our weight in IT stocks. But the fact that we were underweight earlier, impacted our performance.
It is important to strike a balance between tactical and strategic calls. The core of the portfolio should always be strategic calls on stocks you have high conviction in from a long term perspective. Sometimes these may drag performance for a couple of quarters, but if the fundamentals are in place, they ultimately deliver alpha. We are very positive with the way our portfolio is currently positioned and believe it will help drive fund performance going forward.
WF: One of the core investment principles identified for the fund is to hold tactical weight allocation across all stocks / sectors – How do you manage to ensure that your portfolio is not overdiversified whilst you try and achieve a tactical allocation across all sectors / stocks?
Rohit: Tactical calls in the portfolio are based on a few fundamental principles. First is that even when stocks are held in the portfolio with a long-term investment thesis, the weights could be altered at different points of time. These calls are taken depending on individual corporate cycles.
The fund does not take big calls just based on tactical triggers especially when it is not backed by improvement in fundamentals / earnings. For example being overweight on IT could have been a tactical call since the month of January, 2018. However, it was not backed by a bullish fundamental view of significant improvement in earnings outlook, we maintained a big underweight position
Weight in the sector / stock (especially illiquid names) has to be such that it can be easily managed incase the outcome from the sector / stock does not pan out as per expectation.
WF: Which are the sectors you are significantly overweight on and why?
Rohit: It is important to understand the pockets within the sector that the fund is overweight on, this provides a better view of the quality of portfolio of the fund.
Financials we are ~120 bps overweight against the benchmark. However, within this sector, we are significantly overweight on private banks vs. other segments.
Within consumer discretionary, the basket is significantly wider. We are under weight on auto /auto ancillaries, but overweight on consumer electrical names & textiles. We are overweight on materials & healthcare & construction space
WF: Some experts believe that despite the correction in the midcap space (where you are overweight – 40.34% vs. benchmark 17.15%), quality stocks continue to be expensive. Do you subscribe to this view?
Rohit: Basis on SEBI mandate, we had classified Equity Opportunities Fund as Large and Midcap fund. Hence, as per the mandate, there is a need to have an exposure of at least 35% in large cap and at least 35% in midcap. The current benchmark may not be an ideal representation of the portfolio mandate.
With regard to the valuation of midcap and quality, we need to categorize stocks into buckets. In CY 2017, a lot of ‘junk’ stocks across market cap saw big price appreciations which now have been reversed. The price movement last year was more on account of valuation multiples expanding, rather than being earnings driven. Now the market is looking for earnings growth to come in, if the earnings continue to grow and the stock may continue to trade expensive. However, if there is a disappointment in earnings growth, we should expect multiple de-ratings.
If we were to compare the largecap index as a whole to midcap index, then it would be safe to conclude that the midcap space continues to look expensive. In the midcap space, it is more important to ensure that there is earnings stability & visibility. However, if in a mid/small cap if we see sustainable earnings growth momentum and clarity of future cash flows and are confident of business model, then we would invest in the stock.
WF: What were the changes that have been made in the fund’s mandate pursuant to implementation of product categorization norms?
Rohit: Until last year, we had a 65% - 70% large cap exposure in the fund, with the change in the mandate, this has come down to ~ 55% and exposure in midcap space has gone up to ~37%. In terms of investment philosophy & process there has been no change. We continue to hold a large cap bias.
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