During a relaxed two-hour meeting over lunch in Chennai recently, Balaji Vaidyanath, CEO and CIO of NAFA Asset Managers explains his investment approach and philosophy. NAFA runs three PMS schemes currently. He manages assets in excess of ₹1,150 crore. Edited excerpts from the conversation:


Your latest PMS offering on the clean tech theme looks interesting. What is the thought process here? 

The fund was started in September 2021, focusing on new and clean technologies. This fund has a concentrated portfolio of 10-12 stocks. We hold companies such as Linde, KEI, Hitachi, PowergridInvIT, Amara Raja, Fiem Industries, KPIT Technologies.  While EV (electric vehicle) is a theme to focus on, when EVs ramp up, you have to automatically upgrade your power infrastructure – the transmission lines, cables.

Besides, when power starts to flow in more directions than one, you need smart meters, transformers, switch gears which Hitachi is making. Linde is becoming a multi-product, multi-industry company from being predominantly an oxygen supplier. It is finding uses for gases such as like argon, nitrogen, which are now in demand for welding (in the manufacturing process), food preservation and arguably for semiconductors. We also have KSB pumps in our funds as a play on nuclear power.

Ultimately, I have to give good risk-adjusted returns beating the benchmark, to clients. One way to do this is to focus on such sectors that are growing faster than GDP, with some cognisance to valuations. This is where wealth creation happens.


At a time when small-cap as a segment has done well, why has your small-cap fund underperformed the benchmark – the BSE 500 TRI – on a one- and two-year basis?

Our stock selection is based on the premise that there should be some distress ie some P&L issue in the company in the short term. It is at these times you get the valuation in your favour and you must be willing to sit on it. Clients in our small-cap fund have 5-7 years’ window.  For us, our top weight in this fund is Greenpanel Industries which has not done well. There is realisation pressure because of imports and local capacity additions. There is also raw material price pressures leading to margin issues. But we are very positive on the theme. We are seeing a behavioural change in furniture buying where the current generation doesn’t look for heavy, long-lasting, carpenter-made ones but light, short-life, store-bought ones. MDF (which Greenpanel uses) is growing faster than plywood.

Wherever there is this kind of shift happening, wealth creation takes place. Earlier, pipes used to be galvanised iron and copper, and then it shifted to PVC and CPVC. We saw wealth creation in Astral, for example. Shift from compact car to SUV is one more trend. Value-added dairy is another, where we hold Heritage Foods.

So, while short-term returns may take a hit, we don’t want to run the risk of overpaying for a business. If you have certainty, valuations are not in your favour; if you have uncertainty, valuations are in your favour. So essentially, it is buy and hold strategy and buy during a bit of uncertainty. Over a period of time, market share gain, alongside changes in taste and preference, creates a very strong wealth creation opportunity in stocks.


The same segments that did well in 2023 be it market capitalisation-wise or in terms of sectoral performance continue to do so into 2024. When do you expect a rotation to take place? SEBI has been talking of a bubble in the mid and small-cap space…

The market capitalisation ratio between the Sensex and the broader markets used to oscillate in a range between 38 and 52 per cent. At 38, it indicates you go to large-caps and at 52 per cent it means large-caps have performed really well, so you go back to mid- and small-caps. Now the ratio has come down to 36, indicating a move to large-caps, but then, the continuation of the mid and small-cap rally shows that there is no permanent indicator to rely on as far as markets are concerned.

One interesting study that we did shows that Nifty’s current underperformance can be of its own making. There is 35 per cent weight in financials. In developed economies such as Germany, France, the UK, the US (on the premise that India is aspiring to move from the ‘developing’ to the ‘developed’ stage) the weight of the financial sector in their bellwether indices has trended downwards. In India, in the Nifty, there are 10 stocks from the financials space out of which only two are non-lenders — SBI Life and HDFC Life. Mutual funds, wealth management, depositories, registrars — all non-lenders where there is better growth than lending are listed today. So, new leaders will have to come into the Nifty as growth industries are not in the Nifty. Why blame the mid and small-caps when Banks, FMCG and IT, which have good weights in the Nifty, have underperformed?

Sector rotation will happen. We are going to have companies do well for a few quarters then take a pause. There could be a catch-up rally in private sector banks. Chemicals have been in bear markets for 6-12 months; some can make a comeback. There are pockets of bubble — such as defence — where the market has priced these companies very high. This has to be followed up with numbers. The only thing we can do is to do our homework and minimise our errors on the valuation side.


How closely do you track macros such as geopolitical events, Fed commentary, US data releases, etc., for your investment decisions?

Historically, any geo-political event has been a great time to buy — 2010 saw PIIGS crisis where there was threat of default on sovereign debt; the MENA crisis followed in 2011; 2013 was the taper tantrum; elections drove 2014; 2016 was demonetisation, 2017 saw GST implementation, 2018 witnessed US-China trade war as well as the IL&FS and DHFL crisis locally. 2020 was hit by Covid, followed by Russia-Ukraine, Israel–Hamas and it goes on. That said, the moment you become a macro observer, a lot of uncontrollables come in. The noise value increases. Rather, spend time understanding companies, their P&L, margins, industry, commentary, etc.

We track 100-150 international stocks. We used to hold Varun Beverages. Pepsi globally used to report numbers 7-8 trading sessions before Varun reports in India. Pepsi always has 2-3 lines on how emerging markets, including India, have performed. So, we get a hint (and it’s perfectly legal!). Similarly, we have held Whirlpool which we decided to sell at a point because Whirlpool globally gave bad results for the APAC business and India was 75 per cent of its APAC business. What more clue do you want? We bought Carborundum Universal because, in 2021, machine tools companies gave a strong guidance and CUMI is the abrasive supplier for all these companies. The rest is history. This is how you get the additional edge.

If a company is deleveraging, for example, how does it matter what Fed is doing ? In India, if a mid-cap company deleverages and its debt becomes, say, zero, the market tends to assign a higher EV multiple. The market capitalisation (which becomes the equivalent of Enterprise Value with zero debt, assuming no cash) goes up by 1.5–3 times the debt in mid-cap stocks. It is much higher as we go down the market-cap curve. I would rather spend my time on these. Some of my best ideas have happened by talking to people with feet on the ground, people down the value chain — the plumbers, carpenters, for example. I have no disrespect for macros, but I prefer this style.


How do you read and interpret quarterly numbers?

On a quarterly basis, we see which companies are showing top line growth and margin expansion. We especially look forcompanies that outperform in a beaten down sector. The best quartile to be in is where the companies show both top line growth and margin expansion. The second best is top line growth alone but no margin expansion. Third comes no top line growth but margin expansion. And the fourth is neither top line growth nor margin expansion.

We keep looking closely at companies in the first two quartiles. However, we don’t ignore the fourth. If the first quartile player is trading at 50 PE and the fourth quartile player is trading at 10 PE, you can still buy the latter. This was what happened to PSU banks as at some point, the valuation gap had to narrow. The lesson is that nothing should be ignored. We should approach stock picking with an open mind. Corporate action is key. Promoter intention is key. Even if the company is deep down in the business cycle, if the valuation we are paying is reasonable, we go ahead.