Quest Investment CIO On Key Elements Of Its Portfolio Construction Strategy

Aniruddha Sarkar: After the way the markets have moved in the last one year, one thing is very clear that you need to definitely protect what you have made in the last one year. So, what I am focusing on in our portfolio is ... earnings are going to be much higher than the industry or the broader market because at the end of the day, earnings is what will justify the price.

Any place where the stocks would have moved much faster than the basic fundamentals is where we are booking profits. In fact, we have been very aggressive in booking profits in the last couple of months, and that would be our advice also to investors... So, I am looking at profits into companies and sectors which have moved ahead of fundamentals and parking the money into sectors and companies where earnings are going to be much, much higher than the broader industry average.

With regard to the market cap allocation as of now, we are almost equally between the large cap and mid cap and small cap, roughly around 40% would be into the large cap and around 40% into the small caps, and rest would be to the mid caps. Cash level would be roughly around 4-5%. So, that is the broad market cap allocation, which I am keeping at this point of time.

Aniruddha Sarkar: So, the basic philosophy, which we follow in our portfolio construct is following the concept of sector rotation and in that you will find a way we try to allocate bulk of our money is where the highest conviction is there and where the highest earnings growth is there.

At the same time, what you would have observed in our portfolio is there are sectors which we completely avoid. Now, talking about industrials and the whole capex cycle, which we are trying to play, that makes a large portion of our portfolio as you rightly mentioned—around 26% of our portfolio would be into the industrials, where we are trying to play the capital goods, industrials, defence, cement is in a larger allocation over there compared to the index.

Our thought process there is that, that is one part of the economy which is doing very well and our outlook is over the next five years, this is one part which will contribute significantly to the whole valuation in the economy.

Now, valuation is a concern because we have a couple of names wherein in the capital goods space, mostly where the valuations could be a bit on the higher side, but the type of growth opportunity which is unfolding across industries... earlier it used to be a concept that most of the capital goods companies used to deal with the government. Now, what we are seeing is a lot of private engagement of these companies is also happening.

In fact, many of the capital goods companies we own, a lot of demand is coming from the smaller towns which is very unheard of. So, there's a broad-based kind of growth happening in the economy and that is where we are trying to play the whole capex cycle via these industries.

We also have energy as a part of our allocation... It goes without saying if you're bullish on economic, you have to be bullish on the whole energy space and we have taken allocation within the energy space also.

Aniruddha Sarkar: Within the portfolio construct, in fact, we just have an overview of a portfolio. It gives you an image that we are betting on India.

Everything in our portfolio is about India and that is where you will find we are not taking any bets on what is happening outside India, because if we are talking about a slowdown in the U.S., a slowdown in Europe, we don't want that portfolio to be exposed to any risks over there. We are bullish on India, the world is bullish on India. So, why should not the portfolio also be kind of bullish on India?

Within India, I would say the whole India opportunity. I think consumption is a very large component where household income is increasing, disposable income is increasing and that is where the debate happens between urban consumption and rural consumption.

...There's still time for the rural consumption to pick up. There is some kind of pain over there with a lot of the demand picking up on the agri side of the economy and hence, we are betting completely on the urban side.

Now, if you ask me the allocation within the urban consumption basket, I need to just look at any consumer like you and me, and see where does the money go and that is where the allocation is.

Bulk of our money goes into real estate, autos and apparels and also the hospitality (sector) which is your holidays, your hotels and also eating out. So, this is the whole spectrum of urban consumption allocation, which is there in my portfolio, which is auto and auto ancillary, the real estate and the home improvement, consumer discretionary and hospitality.

In fact, we have our larger allocation, almost 6-7% into hospitality, which is your hotel industry and both the names we have in our portfolio have done exceptionally well. Valuations in the whole consumption space is a big debate, which keep happening. But if the earnings are going to justify the growth, valuation is something which the market will keep giving it higher and higher.

Aniruddha Sarkar: There is a big change in the way the hotel industry has evolved in the last couple of years, especially post-pandemic. ...the hotel industry is a very cyclical business and anything to do with the cycles you have to play it right, you have to exit at the right time because otherwise typically, bulk of the capex happens at the peak of the cycle and then you're sitting with an overleveraged book and you go through the pain of the down cycle.

Unlike that, what has happened now is that the whole hotel industry is expanding in a different zone. A lot of new destinations are being made and this is unlike the past where in most of the new room additions used to happen mostly in the metros of Delhi, Bombay, Bangalore, Calcutta, etc.

Unlike what we are seeing this time around, a lot of new destinations are being created in which we see that both the large players, your Oberoi, Indian Hotel, both of them are building destinations. They are coming up with hotels in some new properties in some new areas where there have been no hotels in the past.

Now, this is something which is a very, very big change. With regard to the ARRs, if you look at the ARRs which are there in India and the ARRs which are there in comparable kinds of countries and anywhere outside India, I think there's a huge scope of ARR improvement even as of now.

Historically, the ARRs used to go up, occupancies used to get impacted. This time around, as an investor, I am very happy but obviously as a customer, I won't be very happy because ARRs continue to rise. But yes, I think occupancies are not getting impacted, even with the rising ARRs and with the new destinations being built. That is something which is getting more and more Indian domestic consumers over there.

Aniruddha Sarkar: Within the consumer discretionary, you have rightly pointed out that conditions of consumer discretionary has changed a lot. Earlier what used to come under it used to be very different compared to what comes now.

Within the consumer discretionary, we will have names like consumer retail like Trent on which we are very bullish. We have been an early investor over there and it has done exceptionally well for our investors. We are also betting on eating out or ordering food at home wherein you will see a large allocation towards Zomato. We have again been an early investor in Zomato. We continue to like the business exceptionally well. Also something like I would say Tata Consumer, wherever you go to Starbucks and things like that. So, this is the consumer discretion where we are betting on, which is the retail in the form of Trent, eating out and ordering food and also something like Tata Consumer. So, these are the consumer discretion needs which we will be having in our portfolio.

Aniruddha Sarkar: Any of these companies, when we look at these businesses, what we try to identify is that if a company is suppressed from a price point or a valuation point in the market, what are the factors which is leading to the suppuration in the valuation or the price in a particular company.

Now, since you mentioned Zomato and Blinkit, if you look at the way the stock reacted, post the announcement of acquisition of Blinkit after its listing, that is something which got our attention. We felt that the market was overreacting and that is where we look beyond the short-term reaction. We looked at what Blinkit can do to it in the next four to five years and if it's able to kind of leverage its brand, its net worth, it's on the ground reach. Can it complement its existing food business and also add to the top line and the bottom line? So, these are things which as an investor, one should look at any short-term event which is happening in the company, is it an opportunity for the next couple of years...

Now, you also mentioned about Trent. We were bullish on Trent, mainly because of the way Zudio was growing. Initially, there were many people who were apprehensive about Zudio, they were saying there have been many competitions like that in the market. You also had your big names who were at a similar price point. But what we learned from being an actual visitor to a couple of their outlets, I would say the comprehensive experience as a consumer which you get when you enter one of their stores is very different. The price point at which they're offering, top notch quality is very different and that can attract a lot of the mass consumers into their stores and that is exactly what has happened. So, sometimes on the ground check, visiting the stores also gives you a good feel about the businesses in which you're entering into.

Aniruddha Sarkar: Yes. Absolutely. In fact, over the last 18 months, we have been quite bullish on PSUs, and for most part of the last 18 months, we will be having on an average anywhere between 7% to 10% allocation towards PSUs. At this point of time where we stand, this allocation would be roughly around 14% to 15%. So, we are pretty high on the PSU opportunity.

A lot of debate happens with regard to the froth which has built up in some of the companies which would have moved very fast. But one thing which I keep debating on the PSU opportunity is that we don't need to look at PSUs, what they have done in the last 10 years or 18 years or 20 years.

We need to see that how the whole PSU basket is evolving with the government, the mindset which has changed in the government with regard to what they want to do with the PSUs. If you go back, we always used to hear that the government wants to sell the loss-making PSUs. So, that used to be the main factor that why would one want to buy the PSUs because that could be a disinvestment opportunity. Some private company could acquire it...

Now, what has changed is the government focus has changed that we need to bring up these PSUs at par with the private companies, bring in the strategic investors and grow the businesses. That is a very big change in mindset and that is what is unfolding in most of the PSUs across the spectrum, could be oil and gas, energy, defence, the railways, even the NBFCs which are there in the PSU space.

This is a whole opportunity which we have been trying to capture and we have been participating in different, I would say, sub-sectors within PSUs from time to time, including the banks. In fact, we were one of the early investors into some of the PSU banks as well in our portfolio.

Aniruddha Sarkar: In fact, in the defence space, we would have booked profit in most of them and because valuation comfort is something which we are not getting in some of the defence names.

As I mentioned early on, many of the companies which would have run up much faster than our expectation, it is better to take profits off. It's always good to leave something on the table for others to also earn.

But I would say defence is one space where... if one has a four-five year horizon, opportunity is there. But if we have a kind of a limited number of stocks, which we need to own in our portfolio, that made us take a call to exit defence from there.

With regard to the industrials, we are betting on companies which are there on the railway side, which are there on the energy side with a lot of power transmission or maybe the power generation. So, both the generation, transmission, the railways, that is where we are betting on the industrial side with regard to PSUs.

Aniruddha Sarkar: IT is one sector we have been, I would say underweight for almost the last 15 months, as some part of it we went wrong with regard to the price of moving, but if I look beyond the price action, fundamentals have not improved.

We were heavily overweight on IT for most part of Covid, but almost for the last 15 months, we have been heavily underweight and in the last one year, we are completely absent from IT. Now, the reason for that is the valuations.

I would break it into two parts. One is the large-cap IT and one is a mid-cap IT. Now, mid-cap IT companies have been doing well, compared to the larger players and that is where the valuations of the mid-cap IT is pretty high.

On the other hand, the large-cap IT is where the earnings are not as they were in the past and that is the reason your valuations are cheap. Now, it's a very difficult choice. Do you buy the mid-cap IT at a high price where growth is there or do you buy the large-cap IT companies where growth is not there and valuations are cheap?

The second part is that if you talk to the management of any of the IT companies, they're still concerned about the margin improvement, about the deal pipeline, and that is yet to improve. So, we continue to be negative with regard to the outlook over there. But as of now we have some of the IT companies on our watch list. We are evaluating them because maybe in a couple of quarters, they will be out of the woods, margin would have bottomed out and also the deal pipeline will improve because the biggest impact happened when the slowdown emerged in Europe and America.

That is where a large part of the deal wins which were happening were not happening. So, with improvement in the outlook on the economy in those regions, we could see the sector also picking up.

Aniruddha Sarkar: I think in the first half, we should be looking at adding.

Aniruddha Sarkar: That is the whole confusion which as an investor we also have that: do you buy something like that at a very high price? Tata Elxsi because you mentioned, we were very early investors over there during Covid and we exited completely, roughly at around 8,000 plus levels and the multiples which were there almost like 60-70 P/E is something which we could not justify.

As you rightly mentioned, the valuations at this point or something which doesn't give us the comfort to make a fresh entry. So, one needs to be very careful at what price we are entering because valuation is one part and second part is the PEG ratio...

If the PEG ratio is going to be anything more than two times, you're slightly taking a bigger risk because if there is a contraction in the earnings, you will see the multiples also contracting. If you look at the market in the last couple of years, only those companies have underperformed which were very, very expensive with regard to the PEG ratio.

So, that is a big kind of doubt in our mind also that should you pay such a high multiple for that type of earnings. Since there is no shortage of ideas in the market, we are completely avoiding entering into those parts of the market.