Candid discussion on fund performance
Co Head – Equities
DSP Investment Managers
WF: While the DSP Tax Saver Fund has demonstrated strong top quartile long term performance, the last one year seems to have been quite challenging. Besides market volatility which has impacted all funds, what other factors in your view have contributed to your relatively weak near term performance vs peers and what steps are you taking to get the fund back to a strong performance zone?
Rohit: I think there were two things that worked against our fund’s performance in C.Y. 2018 . The first was our call on Information Technology. At the beginning of 2018, we had a big underweight in IT – this was on the back of our assessment that the fundamentals of this sector were not really exciting, nor was the guidance from the companies. What we did not anticipate was the sharp rupee depreciation during the year – from 63-64 levels to almost 73-74 levels, and the resultant boost to IT companies’ earnings and therefore their stock performance. We reduced our underweight in IT during the course of the year (CY18) 2018, but frankly, being underweight IT stocks in the first half had a material impact on our 2018 performance numbers.
The second detractor to fund performance was also linked to rupee depreciation – albeit a little more indirectly. We were significantly overweight energy – especially the oil marketing companies (‘OMC’), in the beginning of 2018. Our view then was that the action of the Government after the Gujarat elections, in terms of allowing market driven fuel prices, would set the stage for a sustained period of market driven economics for OMCs, which could then cause a substantial re-rating of these stocks. However, as our currency depreciated coinciding with sharp rise in crude (due to geopolitical concerns), domestic prices of oil started climbing much too fast. This forced the Government to abandon free market price discovery caused significant fall in these stocks.
Our underweight IT, overweight energy & metals accounted for most of our underperformance in CY2018. While we have taken corrective action, there are also some lessons we have taken away from the events of 2018. One takeaway is the recognition of just how strong and quick unexpected macro developments can be, and their impact on the investment thesis of our key positions. Given this recognition, we believe it makes sense to temper some of our high conviction bets a bit – so, if I am significantly overweight on a key position, should I think of reducing it by 15-20% - this will demonstrates conviction adequately, but also safeguards a bit more against unexpected macro headwinds which are always so difficult to predict.
WF: What fund strategy do you use in managing this fund? How have market cap allocations moved in the last 12 months?
Rohit: This is a multicap fund. In practice, our large cap position has remained in the 60-65% range. That said, we are very bottom-up focused -so if I find a great small cap stock, I will add it even if it means I may go a little higher than my historical range of allocations to small caps.
The other aspect of fund strategy is that we don’t run this fund as a 3 year closed ended fund. We have many investors who are remaining invested in this fund well beyond the 3 year lock-in, so for them, this is an open ended fund. We typically tend to look at our mid and small cap holdings as 3 year horizon bets while in the large caps space, we can be quite nimble and opportunistic.
WF: Concerns are running high as another quarter of disappointing earnings numbers tests the market’s patience – just as it has over most part of this decade. What is your prognosis for markets going forward, especially in the context of continuing weakness in broad market earnings momentum?
Rohit: Discussions on headline earnings growth numbers – which typically refer to Nifty or Sensex earnings aggregates – are very misleading as there is wide divergence within sectors and companies within it. We have seen a prolonged slump in earnings of corporate banks, which has supressed Nifty earnings numbers – but it is most likely this sector that is going to lead earnings growth in FY20. A good part of the 16-20% earnings growth projections for FY20 are in fact on the back of expectations of a surge in corporate banks’ profits. In this year, we saw a surge and now a plateauing of earnings numbers from metal companies – largely due to movement in international commodity prices. These variations too impact aggregate earnings numbers.
Amidst all this, we have seen a good number of companies continue to grow profits in the mid teens year after year – these companies have attracted market attention, for the right reasons. So yes, we don’t have a big cyclical upswing that is lifting overall earnings numbers – that may still be some time away – but if you go bottom up, you do find good companies with strong earnings growth visibility.
Market earnings and market PE are therefore only talking points, but not the only actionable data for fund managers.
WF: In recent years, few quality stocks which have demonstrated strong earnings growth have been bid up to very high PE levels, due to paucity of alternatives. What do you think will happen to these high PE stocks as and when we finally see a broad market earnings recovery? Is there a risk of de-rating in these quality stocks?
Rohit: I agree and share this concern, and in fact have taken cognizance of this when casting the portfolio of our Tax Saver Fund. So when we do see a broad-based cyclical recovery, I believe there is a risk of these high valuation stocks – whether they are high PE or high PB or high EBIDTA/EV – underperforming the markets for a considerable period. That’s one reason you won’t find big exposures to such stocks in the portfolio of our Tax Saver Fund. In the near term, this stance is impacting performance negatively, but I believe its better to be circumspect on high valuations, as mean reversion can happen anytime.
WF: Which sectors are you overweight on in your Tax Saver Fund and why?
Rohit: We are overweight financials, and within that, corporate banks. We believe the worst of the NPA cycle is behind us, which should allow for strong earnings growth. Coupled with an expected cyclical recovery, we could see strong earnings momentum for some time in this segment. Then we are overweight pharma – especially some of the mid-sized ones. We are also overweight on materials and industrials. We are significantly underweight consumer staples and consumer discretionary – largely on account of very rich valuations, as we have already discussed.
WF: Considering the 3 year lock-in for this fund, does it make sense for you to go aggressively into small and midcaps now, considering the significant correction we have seen in this space?
Rohit: For us, the focus is purely individual stock focused. A stock which has corrected 35% without a significant dent to fundamentals is clearly interesting. But one that has fallen 35% amidst weakening fundamentals is not worth considering, unless there is strong reason to believe that the weak fundamentals are now behind the company. I would therefore say we go aggressively where we see good value – that could be in any segment of the market and in any sector.
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