Despite good growth prospects, Avendus Olivo PMS does not have allocations in defence or railways due to high valuations, according to Tridib Pathak.
"We don't have direct exposure to defence or railways as the valuations have stretched out a lot," the executive director at Avendus told NDTV Profit in The Portfolio Manager show. Apart from that, the entire PSU sector has higher valuations than there was earlier, he said.
"We are not able to gauge good opportunities that are at attractive valuations. We may have missed these opportunities in the past and have been re-looking our portfolio," he said.
But Avendus is alright with not having them in its portfolio at this stage, according to the portfolio manager.
As the breadth and depth of the Indian market has expanded dramatically over the last few years, there are several opportunities across various sectors despite overall higher valuations in the markets.
Avendus is fundamentally focused on businesses that are capital-efficient and have sustainable growth. "We are more fundamentally driven and long-term-oriented and would invest in businesses, rather than investing in stocks," he said.
The fund manager is bullish on manufacturing companies. "Nearly 40% of our portfolio is focused on manufacturing companies, which derive their competitive advantage from improved infrastructure, and lower labour costs," he said. Apart from that, Pathak has a positive outlook on private banks, and insurance companies.
Within the banking sector, the focus remains on the larger and mid-private banks. "They (private banks) have underperformed, which is all the more reason to believe that there is a far more higher opportunity," Pathak said.
In the longer-term view, the large and mid-sized private banks will continue to gain market shares and will be able to manage asset quality and margins steadily, according to Pathak.
The fund manager is agnostic about market capital and focuses on the business side. "We are thus an all-cap/multi-cap strategy with a historical, typical and indicative exposure of 50% to large caps and 50% to mid and small cap."
Watch The Conversation here:
Edited Excerpts From The Interview:
Can you tell us a bit about the scheme and about yourself? What kind of portfolion manager are you?
Tridib Pathak: We're basically fundamental equity investors, more focused on businesses which are capital-efficient and which have sustainable growth. At the same time, we don't like to overpay for things. So you know, we're very cautious about what we pay for. So in a way, we have more fundamentally driven long-term oriented. We like to invest in businesses rather than investing in stocks, I would say and we very strongly believe that stock market returns are generated ultimately and finally, only through the underlying business growing and getting reflected over a period. In the meanwhile, there's always a lot of volatility and noise in the markets which we tend to ignore.
So, a particular index or a sector may find it difficult to have very substantially higher growth relative to maybe the economy, at least the economy linked sectors.
At the current juncture, with the global growth looking a bit fragile and Indian markets not necessarily cheap, are you getting a “the GARP valuation” or growth at reasonable price valuations within this Indian landscape when you're trying to choose stocks for the next 12-24-36 months?
Tridib Pathak: Certainly yes, surprisingly so. We find a number of opportunities even today. I guess the fundamental reason is, over the last 10 years, the depth and the breadth of the Indian market has expanded quite dramatically. So even today, we do find a number of opportunities across various sectors, where we find much higher growth possibilities. Some examples would be manufacturing. Nearly 40% of our portfolio is focused on manufacturing companies, which derive their competitive advantage from much improved infrastructure, lower labour costs and all that. So examples out here would be EMS (electronics manufacturing services) companies or textile companies or even auto ancillaries and we find them growing at a much faster pace. Other sectors, where we find much higher growth are obviously private banks and insurance companies—life insurance to be specific.
Now, with every investment comes this argument that there is always a way to look at it, a glass half full or glass half empty. So I'm going to try and probe a little bit into your portfolio and the psyche that you have when you're trying to choose some of these.
If I'm not wrong, banks and NBFCs constitute about 22.9% of your portfolio. Now this would make you, unless I'm very wrong, a relatively bit underweight to the index weightage that we have. And if so, is that because you believe that while there might be growth, supply side for may be global institutions who are selling some of these banks and are overweight there, a reason why the true valuations may not get captured in the next 12-24 months? Why is it that it has the weightage that it has, and what within this landscape do you like more because while the top tier banks have not performed as well, we have had idiosyncratic instances of mid-sized banks having done really well in the last 12 to 24 months?
Tridib Pathak: Fair enough. A 22.9 % weightage is definitely a little lower than what is represented in the benchmark. But as such our strategy involves independent individual stock selections. We don't really get to measure ourselves against a particular sector's weightage and all that. Having said that, our individual positions add up to a sector position, which is what you are able to see within the financial services space also. We also like life insurance, and I'll come to that later. But within the banking sector, our focus continues to remain on the larger private banks, including the mid-sized private banks. Both of them have equally good opportunities available. And you mentioned the fact that they have underperformed, which is all the more reason to believe that there is a far higher opportunity.
In fact, the private bank sector is one area where we find stock opportunities which are at a lower valuation than their past averages. Ironically, whenever the market is at a higher valuation than average valuations have been in the past. So we do find a bargain out there. We are quite patient and from a longer term point of view, the larger private banks as well as the mid-private banks will continue to gain market share as we go forward. They're growing quite well and they'll be able to manage, we believe, their overall asset quality as well as their net interest margins quite stably. From a bottom-up basis, we find very interesting opportunities in the life insurance space. In most of these companies, the share prices are telling you—if I do a reverse VCF—the premium growth in this industry is going to be only in the region of 2-3 % or 4% max, which is not the case. So we do find a lot of opportunities which are attractive from a valuation perspective as well.
You could have made a similar argument around life insurance 12 months ago as well, maybe, wherein they looked attractive then or they looked attractive even 24 months ago.
But I was looking at either the private ones since 2017, Circa 2017, when they listed or the PSUs. They haven't quite generated wealth. Now you could argue that because they have underperformed, they could outperform but that could extend itself for another one year as well. What is ailing these businesses or the stock prices, if you will?
Tridib Pathak: Well, I guess there has been a correction in the valuations. I agree with you. Maybe partly, there were too much expectations, probably 2-3 years back. There has been some regulatory interventions of late, about the surrender value thing.
But if I want to just look at a little longer term in terms of the prospects for the sector, in terms of the fact that there is a lot more to go on penetration. And more importantly, I think the overall product mix slowly as you go forward, will keep shifting towards the protection policies, which have much higher margins, per se, within the basket. So we find that the whole sector is moving towards more protection over a period and certainly it can be able to take advantage of the underpenetration as well. And when the valuations tell you that the embedded growth in the share price is 2-3-4%, when the actual growth possibility could be anywhere in the region of 10-15%, then it is basically up to you to say that from a longer term perspective, there is definitely a good amount of ability to gain from this scenario.
Moving from something that has been a large portion of your portfolio, or is a large portion of your portfolio. and yes, because I mean 22.9 on banks and NBFCs and about 9% on life insurance. So that's collectively a fairly large, reasonable allocation to both lending and non-lending financials.
What I found absent, again, I may be wrong, but based on the sectoral breakup that I see, some of the high flying sectors have been the likes of defence and railways, in the last 12 odd months. They don't find a place in your portfolio. Do they?
Tridib Pathak: They don't directly. There are a couple of businesses which do benefit from the railways’ capital expenditure. You know, we have a business which is a part of the Vande Bharat train system. But specifically, what it says, we don't have direct exposure to defence and railways… We find valuations have stretched out quite a lot now. In fact, in most of the PSU sector I'm thinking of, there are a lot of higher valuations now in the industry than it was earlier. And we probably are not able to gauge good opportunities, opportunities that are at attractive valuations. I think that will be the fundamental reason that we went up if we may have missed a couple of these opportunities in the past, when we have been re-looking our whole portfolio strategy and we think we are okay with not having them in our portfolio at this stage.
The last few days there's been a lot of talk around the caution that SEBI brought out around mid caps and small caps and how they have advised fund managers to take care of ensuring that people don't get caught.
And I've been on the record saying that it is a warning like many others that have come, that needed to be careful when you choose small-cap stocks. It doesn't make them a no no. If anything, there are a bunch of small-cap sectors and stocks out there which potentially have far greater and far better growth rates than most other spaces.
And the beautiful part about the Avendus portfolio is that they have a sizeable exposure in this unless I am very wrong, to the broader end of the spectrum.
Does this worry you? There is so much chatter around how small caps have become completely avoidable, untouchable, what have you. And here I have a portfolio which has got a refreshing mix of large caps and mid caps as well and small caps too.
Tridib Pathak: Fair point and it is an interesting question too in the right context. But let me step back and explain our thought process. We are market cap agnostic in a way. In the sense that we think and investors also should not fall into what we call as the definition trap. A lot of people use the words large cap, mid cap and small cap. And they invest according to the size of the market cap.
We think what matters in investing, again, fundamentally is the underlying business. It doesn't matter what is the size of the business or the size of the market cap per se. But there is herd mentality, which happens when an allocation happens towards market cap sizes and all that. We are aware of that.
But our whole way of working has been that look, we're going to look at the underlying business because you know no two mid-cap companies are the same. If you compare two mid-cap companies or two small-cap companies, they're not the same. It is just that they belong to a certain size categorisation. But their businesses could be completely different with very different horizons, in terms of growth, in terms of prospects and all that. So we would rather focus on the prospects. That is why, from a liquidity management point of view, obviously, it's important to have a balance. So we've always maintained our stance that we are a multi-cap offering, which in a way because it is multi cap, it is also market cap agnostic. And if I were to go into the historical ranges, our large-cap exposure has ranged from 40-60% and the mid and small cap also in the same way 40-60% but it is more focused towards the choice of the businesses, rather than the choice of their size.
When I look at the sectoral break-up and we discuss the two ends, but now I'm talking about something in between. So I could argue that maybe textiles, maybe select pockets of real estate, etc., or maybe auto ancillary would certainly be the mid cap, small cap flavour.
What forms a part of the mid-cap, small-cap space? I know you're not investing by market cap, but if you're choosing to invest in a small-cap company in a particular sector, it'd be interesting to know.
Tridib Pathak: So I referred to manufacturing, you know and refer to quite a lot of opportunities within manufacturing, the EMS part, the textiles part, the auto ancillaries part. And then there is another part, which is housing finance. So that forms a part of our mid-cap strategy.
Interestingly, our entire portfolio is focused on consumer discretionary. And we find a lot of consumer discretionary ideas in the mid-cap and small-cap space as opposed to consumer staples, which is largely in the large-cap range. We feel that the consumer discretionary sectors would do far better, simply because there is a rise in per capita incomes. What was considered discretionary consumption, very soon and very fast, is turning into non-discretionary, I would think. So we find a lot of opportunities, some examples of which will be QSR (quick service restaurants), even real estate for that matter and so on and so forth.
Auto and auto ancillaries. I would love to talk a bit about that, considering that here's one pocket wherein I have heard completely chalk and cheese commentary post Q3. If Baba Kalyani’s comments around what could happen to demand was one and some of the others that we spoke to a Sona Comstar and RK Forging, what have you. They're all citing that they are not seeing any issues thereof. What is your view on autos and auto ancillary in particular?
Tridib Pathak: So again, in autos, of course, we are focused more on the premium side. There has been a premiumisation and as a consumer discretionary part, we've seen that consumption at the low-ticket item level has not been growing much. But at the premium end, there has been a good amount of growth. So within auto, our focus is more on the premium end. Coming to your question about auto ancillaries, I think it's more company and business specific. I think it's quite a large sector and a lot of auto ancillary companies are export-oriented as well.
So it all depends on what chain they belong to and you know, what is the competition out there, in terms of the product categories. So it would be difficult to really paint with one brush, but we are focused on businesses within that which are more futuristic, in terms of, technology, where they are able to or rather they have already taken strides in terms of competitive advantage through their technological edge and are into the new sunrise applications and sectors. So I would think it is more business and company specific.
You do have an exposure to information technology as well. Is this ER&D, is it IT services, is it large, is it small and why is it here when discretionary demand in the words of the companies isn't quite turning around the corner anytime soon?
Tridib Pathak: Interesting. So, within that space, we have an exposure to the ad tech space and also to product companies in the banking platform. We don't have much exposure to IT services by choice. It's more towards platform companies within the technology side be it the advertisement technology platform or the banking products platform.
So this is more the platform companies which got derated for a bit and have just suddenly found resurgence, save for a fintech player, which is under the eye of the storm. Most others seem to have done reasonably okay. So I think it falls under that bucket.
Tridib Pathak: Not exactly. I would think, in the sense that not in that loss making so-called new generation companies, per se, but highly profitable companies in the technology and platform space, with a return on equity of more than 20% and that is where our focus has been.
Do you guys buy and hold for a really long period of time or if there is no such framework, you may take the gains when they come and it's not necessarily held for a long period?
Tridib Pathak: So our investment horizon—the way we look at things, expectation wise and all that—has been anywhere from 3-5 years. But the holding period could be different. We may have to book profits in case our position really does well and we need to size the position per se. So we do take action when we have to size it. But typically, our horizon is definitely 3-4 years. Not less than that. Our holding period could vary, depending on what is happening with the stock or with our position within the portfolio and the size and all that.
You told us about a few pockets like defence, railways, etc. and some of them that you now don't find the risk-reward to be favourable. Where is it aside of that, that you are negative on, wherein you believe that either the valuations or the growth prospects are firmly stacked up against the fortunes of the sector or the companies?
Tridib Pathak: If you look at the large vast majority of the kind of businesses which we don't have in our portfolio, they would belong to the IT services space—I am talking about the whole services space. They would belong to the overall commodity, the global commodity space if you normally like to avoid it because we don't have much knowledge or the ability sitting here in India to get a gauge on how the commodity prices are going to move. So I would think metals, commodities, IT service businesses out there, we don't have any exposure, I would think, in our portfolios at this stage because of the reasons that you pointed out.
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