‘Low quality stocks are first to run up’

The forthright Anoop Bhaskar, Group President and Head of Equity at UTI Mutual Fund, talks about why cash flows are the primary filter that he uses to select stocks and why a preference for quality hurts short-term performance but pays off in the long run.

Retail investors seem to be back, with equity mutual funds receiving large inflows last month. Have you seen a similar trend at UTI Mutual Fund?

Yes, we have received some inflows, not record inflows though. Our older investors have stayed with us through this cycle.

UTI’s equity funds have not been top performers in the recent rally and investors typically look at most recent performance to make their decisions.

Point-to-point performance over one, three and five years is what they look at. Investors should look at performance from the previous market top to capture a fund’s returns over an entire market cycle.

If you look at the performance of our funds from December 2010, when the market last peaked, till date, we would be in the first quartile with most of our funds.

But if you look at the last eight months, we would be in the fourth quartile.

This year, we have stayed with quality stocks in our portfolio and in the initial months of the year, didn’t have large exposure to cyclicals such as capital goods.

When a market turns, low quality stocks with the most depressed valuations are the first to be re-rated. But eventually, the focus shifts to the ability to deliver earnings performance.

What has been your approach to stock selection?

We believe that a company should be able to fund its sales growth without resorting to borrowings or equity infusion. In India, we often find that companies tend to overbook their sales each quarter, which adds to the receivables and exaggerates profits.

You circumvent this problem by going through their cash flow statements and see if they are generating operating cash flows.

Given that we have had a slowdown over the last five years, only the best companies would have been able to generate operating cash flows in each of the five years.

Based on these criteria, we rated over 600 companies which have been part of the BSE 500 (over different periods of time) and classified them into four quadrants.

We found that only 167 of these companies (which we termed evergreen companies) were able to meet this criterion in all the five years, while another 108 managed it in four out of five years.

About 209 companies were ‘fair weather’ companies, which did well for three out of five years in the up-cycle.

About 50 companies generated negative cash flows in the majority of the years and we avoid them.

UTI Focussed Equity Fund will use this strategy to select stocks. But why make it a closed-ended fund?

Running a concentrated fund in an open-end structure is difficult. If the fund does well, inflows flood in and you are forced to diversify the portfolio.

We felt that a fixed corpus will allow us to run a 25- or 30-stock portfolio. Plus, we wanted investors to stay with the fund to reap the rewards of the strategy.

If you look at the investors who come in through the bank or wealth distribution channel, their average stay in equity funds is 24-26 months.

So, until we reach a situation where direct inflows are 50-60 per cent, I think this will remain the investment horizon, unless you lock in the money.

Do cyclical sectors still excite you? Recent earnings from infrastructure and capital goods have been rather disappointing.

No, we are in the other camp which thinks that an urban-led recovery is going to drive earnings in the first 15-18 months. So, we are betting on consumer discretionary — automobiles, auto components, consumer durables and banks to some extent.

We are also betting on road operators — the asset owners. We see that this Government has cleaned up the road sector and can kick-start projects within the next 9-12 months. I think doing the same for power will be difficult. Getting the coal and putting in place the logistics will take a few years.

Power is a four-year story. It will not be an easy climb for cyclicals. However, not that we take no exposures to infrastructure or capital goods, we remain underweight relative to peers. In the January to June upmove, our funds lost out because we did not bet on these sectors.

So are you still betting on export-oriented companies rather than domestic plays?

Yes, in the case of a few sectors. For instance, we believe that Indian auto component companies are today in the same position as pharma companies were a decade earlier.

Ten years ago, the average Indian pharma company then had 70 per cent of revenues coming from India and 30 per cent from overseas; today, it is the opposite. I think auto component companies can at least earn 40 per cent of revenues from exports, making the revenues and profits more balanced.

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