Midcap champion reveals success formula

Vihang Naik

Fund Manager

L&T Mutual Fund

  • L&T Midcap Fund has built up an enviable track record of topping the performance league tables across 3, 5 and 7 year horizons
  • Vihang says the fund’s 70:30 strategy (70% high quality, 30% deep value) across bull and bear phases has enabled the fund to maintain its outperformance over the years
  • A correction in midcaps coming after a 5 year bull phase could mean a longer time correction before the next rally takes root. The correction however has thrown up good bottom-up opportunities
  • Overpaying for growth stocks is a key risk in midcap investing today.
  • Hotels and hospitals could be significant long term wealth creators in the midcaps space.

WF: Your fund has an enviable record of being at the top of the performance league tables across 3, 5 and 7 years, and top quartile over 10 years. What in your view are the key factors that have enabled this consistent outperformance?

Vihang: We have followed our 70:30 strategy across bull and bear phases. 70% of the fund is invested in high quality stocks. 30% of the fund is invested in deep value stocks with a visible catalyst. High quality protects downside and provides compounding. Deep value stocks provide the fund with aggressive returns when value gets priced appropriately.

WF: The fund seems to have run into some near term performance challenges. What’s impacting current performance and what is your strategy to maintain your long term performance track record?

Vihang: We do not have large cap exposure in the fund. We predominantly invest in mid and small caps companies. The SEBI circular allows Midcap funds to invest 35% of the AUM in either large, mid or small cap stocks. We believe our investors have chosen this fund to get an exposure in companies other than the top 100 by market cap i.e. large cap companies. Hence we choose to invest in mid and small cap companies. Over the last 12 months, large caps have performed better than small caps, hence the near term issues. However we will continue to be true to label and invest in other than top 100 companies.

WF: Midcaps have corrected sharply in 2018, but midcap valuations continue to look high relative to historical averages. Your portfolio PE at 25, is reflective of this. Should we be bracing for more pain until valuations correct further or is the correction now behind us?

Vihang: We have to be cognizant of the fact that the midcap rally which started in 2013, lasted for 5 years. The correction also could last longer than just a few months. However, after significant broad based correction we believe midcap valuations are reasonable. We believe there could be a period of ‘time correction’ before the beginning of a new rally. That said, we find enough opportunities in the space at reasonable valuations.

WF: You are significantly underweight financials, auto and energy and overweight construction and engineering. Can you please take us through your rationale for these positions?

Vihang: Our thesis was that financials was a consensus favourite and one of the easier ways to buy growth. We have shied away from being overweight financials for most of the last two years. After an extended delay in capex recovery, we believe that with utilizations firming up, engineering and construction could see earnings perk up. That said, we focus on constructing a bottom up portfolio which may significantly deviate from the benchmark.

WF: What do you see as the key risks of investing in the midcaps space now?

Vihang: The key risk right now is over paying for growth stocks. If growth assumptions in these stocks get adjusted downwards, there may be significant de-rating in growth stocks.

WF: If you were to bet on 2-3 sectors that you believe can create significant wealth over the next 5 years, which would these be?

Vihang: From a 5 year basis, we would be positive on capex related plays, also positive on cyclical consumption at reasonable valuations. We like sectors which have gone through a significant investment phase, where positive operating leverage may lead to meaningful uptick in earnings and multiples like Hotels and Hospitals.


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