Remarkable turnaround under new management
Sundaram Select Focus
Sundaram Select Focus has seen a remarkable turnaround in performance since Rahul Baijal took charge 20 months ago. Rahul takes us through the nuts and bolts of what went into turning this story around, his perspectives on why a focused strategy in large caps is better than a traditional diversified one and the sectors and stocks that he has positioned his fund in, to maintain its top quartile performance going forward.
WF: Your Select Focus fund is now in the 1st quartile among large caps over 1 and 3 year periods – quite a remarkable turnaround for a fund that was hitherto not seen as a serious contender in the large caps space. What’s the story behind this turnaround and how can you reassure your distributors that performance will be sustained in future as well?
Rahul: There are many things which have contributed to the turnaround in performance over the last 20 months. Initially, after taking over the fund in Oct-16, we did some streamlining in the investment process and strategy – that combined with some bottom up and top down calls taken have helped contribute to the improvement in performance ; more details on some aspects of the turnaround story below.
On investment process - I follow a bottom up approach in stock picking, use in house research as the key source of inputs, add to the conviction of the ideas by doing my due diligence as well and combine that with the top down perspectives while constructing the portfolio around key 3-4 core themes. Currently - the three themes dominating the portfolio are consumer discretionary, cyclical recovery and government reforms. While my investing style has a blended approach, the bias is towards GARP (growth at reasonable price) style and like to take a few contrarian calls as well, opportunistically.
On investment strategy – as you know, Select Focus is a large cap oriented fund and follows a concentrated/focused style of investing. From May 18 onwards, it comes under Focused fund category under new SEBI classification (now become a maximum 30 stock portfolio, earlier used to be a 30-35 stocks portfolio) while retaining its focus on large caps like earlier (>80% exposure in large caps )
While executing the above strategy, what has worked particularly well is the stock picking done during two critical time periods over the last 20 months – firstly during the demonetization –remonetisation phase in late 2016-early 17 and also secondly – portfolio risk reduction done in early 2018 . The portfolio adjustments done around these key inflection points has contributed a lot to the improvement in the performance. For example…
1) a lot of good quality consumer and financial stocks (egs. Kotak Bank, IndusInd Bank, Maruti, Crompton Consumer) were added in late 16-early 2017 in the remonetisation phase
2) reducing risk in sectors like metals, nbfcs and turning positive on IT sector has helped performance ytd in 2018
3) a contrarian bet on ITC and zero exposure in pharma also contributed to performance last year.
To summarize - I have used my learnings from earlier work experiences (17 years across equity research and fund mgmt ) to put in place a process and approach which has begun to yield results and am hopeful that it will continue to deliver in the future too– fingers crossed.
WF: What in your view are the pros and cons of a concentrated/focused style of investing?
Rahul: I believe that there are certain advantages of running a focussed style –especially in the large caps space.
Firstly - A “focused” portfolio with a consistent accuracy hit-rate can enhance the “reward” potential of a portfolio - the key of course is to make as few mistakes as possible. Under a diversified style - sometimes- buying more number of stocks for the sake of diversification can add to the “risk of diluting the return potential".
Secondly – now the investible universe for large caps has been redefined by SEBI as the top 100 names and it’s a level playing field for all large cap oriented funds with each of them mandated to have at least 80% of the fund amongst these names. Thus going forward - stock picking and sizing will play a even more critical role than ever before in creating alpha on a sustainable basis; in fact having too many stocks in the portfolio may lead to high overlaps with the benchmark and run the risk of hugging index returns as well.
Thirdly – the risk of running a focused style vs. a diversified style is much less in a large cap mandate since one is picking stocks amongst the top 100 stocks which are well established companies with long track records and with much reduced mgmt risk/financial risk/business risk/corporate governance vs small/midcaps. Also, in my view a 30 stock portfolio is a manageable number of stocks to track on a bottom up basis, develop conviction and therefore sizing and thus it captures the benefits of a concentrated style while at same time avoids the downside of being over diversified.
WF: In your portfolio, you are neutral the BFSI space – which is the largest component of the large cap index. What is your view on this bell-weather sector going forward?
Rahul: While the stance on BFSI is neutralish – the fund is OW private sector retail banks and underweight corporate lenders and NBFCs in its current positioning. I am very bullish on the private retail sector focused banks like Indus Ind & HDFC Bank. I think they are very strongly placed for good quality growth over next 2 years vs competition. PSU banks and some other corporate lenders are still struggling to cope with the aftereffects of the NPA resolution and new RBI norms while many NBFCs will find it tough to compete with banks in some products in a rising rate environment in the medium term, in my view.
WF: You are underweight pharma even as some managers are eyeing the sector as a value play. How do you read the medium term prospects of the sector?
Rahul: Having almost zero exposure in the pharma sector for the last 12 mths has been a high conviction call which has worked well for the fund. I still remain cautious of the large caps in the sector which derive a reasonable amount of business from the US generics space and while many of them corrected a lot – my sense is that the earnings downgrade cycle is not over yet – so have not built exposure in the stocks, yet. In the medium term – companies that focus on scaling up the specialty products and complex generics will do well in my view – but that will take time ; many others will find it tough to scale up in the US generics space.
WF: In which sectors do you see strong earnings momentum and how comfortable are you with current valuations in these?
Rahul: I think the sectors which would fit the bucket above are private sector banks, select consumer discretionary (cars, white goods) and the IT sector. The fund has many stocks from above sectors where valuations are more reasonable.
WF: Markets have been a corrective phase in recent months, with international as well as domestic news flow turning a little negative. What is your prognosis for markets going forward over the next 12-18 months and what will be the key drivers now?
Rahul: Over the medium term – what will be most important would be how the pace of broad based earnings recovery occurs in Indian markets. While there have been hopes of a sharp pick up at beginning of every fiscal over the recent years ; as the year rolls out , the expectations get muted with reality . More recently – 3q and 4qfy18 earnings season has seen steady performance by many companies and the chances of a more broad based earnings recovery ahead have increased. On domestic macro – while GDP growth outlook has clearly improved for FY19 vs FY18 , oil prices and fiscal deficit concerns will continue to be an overhang on India macro in coming months. What kind of a government we get in the next general elections will also be a big sentiment driver in the markets over the next 12 mths.
Globally, the overall economy seems to be on a better footing than a few yrs back. The US economy is clearly on an upswing and the Chinese economic outlook seems stable. Some pockets of emerging markets are under stress. Going forward two important macro monitorables and drivers for the global equity markets over next 12-18 mths in my view are – 1) How the rising interest rates globally impact valuations in equities –especially in the high PE growth stocks 2) Are pace of US Fed rate hikes in line with market expectation?
WF: Large caps are seen as the best place to be in during volatile times, while mid caps are seen as creating the most long term value. Should investors today be more concerned about protecting capital in volatile times, or go for growth in midcaps despite the huge volatility we are seeing in that space?
Rahul: Large caps and midcaps – are like apples and oranges – both are different in characteristics but both are very important to be part of a balanced equities portfolio of a long term investor. Large caps offer exposure to well established businesses which have achieved a certain scale and are run by experienced managements with an established track record in the respective industries. Thus the level of risk that an investor is exposed on 3 key metrics – management, financial and business – is much lower in large caps than in mid/small caps. On the other hand - many mid and small caps offer higher growth potential and trajectory over long term , many new sectors and sub-sectors emerge (eg. Small finance banks, microfinance), new themes emerge (eg. Healthcare) within the space and many of those companies also get listed on the stock market during IPOS and thus offer exposure to niche industries and sub sectors which one may not find traditionally in the large cap space.
Thus in my view – one should build a portfolio with an optimal mix of both large caps and mid/small caps funds and keep rebalancing the percentage mix based on 1) risk reward on valuations 2) the individual investors investing goals and risk appetite.
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