Mutual Funds

‘For us, balance-sheet is more important than profit & loss’

Bhavana Acharya | Updated on November 23, 2013


The component in judging value and growth is fair value in discounted cash flows, not the price to book.

Religare’s Mid-N-Smallcap fund ranks in the top quartile among funds in its category, while also scoring on consistency.

A diversified portfolio and a long-term view has helped, says the fund’s manager Vinay Paharia. Edited excerpts from an interview:

Your mid-cap and mid-and-small cap funds have a very unusual set of stocks.

We follow a bottom-up stock selection method so we don’t chase momentum stocks. Attention is more on historical performance, annual reports, and what has been done rather than what is going to happen. The entire analysis revolves around understanding the quality of the underlying business, judging the management quality, and valuation on a dispassionate basis. We consider the balance sheet more important than the profit and loss account.

When you talk of valuation, what parameter are you using? Is it price-to-earnings, or price-to-book?

Neither. This may sound theoretical, but the discounted cash flows concept is crucial. It involves judging the key drivers of the business. You can find out, for example, some key factor such as negative working capital— it can push up the fair value of a stock quite significantly —that may otherwise be ignored. So, it might be at odds with the current consensus, which is almost always based on the P&L account.

What’s the difference between your Mid-cap fund and Mid-N-Small cap fund, especially since there’s a performance divergence between them?

The mid-cap fund is slightly more value-oriented compared with the mid-and-small cap fund, which has a growth bias. The latter also has a small-cap contribution of close to 15-20 per cent.

Stocks in the mid-cap fund could not be over Rs 10,000 crore in market capitalisation. The mid-and-small cap fund could, on the other hand, go right up to Rs 50,000 crore. So there were stocks which were larger in size that delivered significant returns for this fund, which could not be invested in for the mid-cap fund.

We are taking calls on larger companies in the mid-cap fund now, up to 35 per cent of the portfolio. But broadly, the mid-n-small cap fund will have close to 60-70 per cent in growth companies with the remaining in value. For the mid-cap fund, 55-60 per cent goes towards growth with the rest in value.

Value isn’t a theme that’s working well currently.

Broadly, the observation is correct, but it depends on the lens with which it’s being viewed. The classic theory is that those with a high price-to-earnings and price-to-book are classified as growth stocks and vice versa. But the component in judging value and growth is fair value in discounted cash flows.That is the best way to judge whether a company is a growth or value one, and not the price to book. What we’ve seen is that companies we bought at a discount to our own fair value have done very well.

Your funds are very consistent in terms of performance. With the volatility in mid- and small-cap stocks, how do you manage this?

We have a highly diversified portfolio, and we’re not concentrated in a single stock. We tend to have allocations towards those companies, which, on a relative basis, have lower risk and slightly lower return. It’s also the company in which we invest.

We’ve also seen that, in the last five years, investors have recognised companies which are of good quality. Poor quality companies have done poorly. And since we are in the good quality basket, we’re doing well. It could well be possible that in the next five years, the poor quality companies could do well!

We’re trying to introduce mid-cap investments suitable for an investor from a long term point of view.

We hold stocks for a longer period of time. On an average each company stays in the portfolio for two years. Our portfolio turn is low, closer to 0.5. That’s the reason we’re also able to buy into companies that are illiquid or small, which others may find difficult since they need liquidity. Our objective is to gain from gain from intrinsic value than PE re-rating. Purely relying on re-rating means that churn will go up.

How long will you hold a stock waiting for it to go up?

One way of allowing a wait is not over-exposing to a stock – as said earlier, we have a very diverse set of stocks. Well, what is long term is a definition that keeps on changing. The rule of thumb we use is based on the core investment thesis— that is, in the business and not the stock price.

If it hasn’t held true for three years, then, it’s time to re-evaluate the investment. This is the long term. Three years have already passed and the business has not performed according to your thesis.

That said, we aren’t worried too much about stock prices. This is because stock prices have to respond to the underlying business. There may be a lag of one to two years, but it cannot be forever.


Published on November 23, 2013

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