Meet the Manager. ‘We look for firms that have a sustainable moat’

At BNP, we have a fairly detailed research process. Our investment philosophy is based on BMV — business, management and valuation — whenever we construct a portfolio or select stocks. Our endeavour is to identify businesses that are growing faster than the economy and the industry, and look at the sustainable (economic) moat of the business. We also look at profitability, growth levers, any adjacent areas that they can expand into, and also how well they are able to address the changes in their own areas of operation.

On the management side, we emphasise on the competency and the ability to drive market share gains over the long run. Because it is the topline and the ability to grow the business that will effectively decide a company’s competitiveness in the long run. In addition, we look at corporate governance — how they treat various stakeholders and how they allocate capital.

Balance sheet and cash flow are very central to our analysis of companies and managements. Thus, on the valuation front, we look at valuations from a cash flow perspective, not from a PE perspective. We look for growth at a reasonable price.

But I would not say that for companies that are very good — we will keep owning it at any level. We will probably reduce the weightages if it keeps re-rating to a different level where the valuation metrics are not justified either by a discounted cash flow model or some other terminal growth rates we work with.

I would say we emphasise 70 per cent on business, 20 per cent on management and 10 per cent on valuation. The reason we do so is, if one gives too much emphasis to valuation, the universe of companies that we may start out with will be very large. If you actually look at the data across economies, in every economy, you will find that a select few companies drive the performance and they stand as examples for others to follow. Based on our BMV process, a set of such companies, to start with, would be between 200-250 odd companies in India.

From time to time, there will be a clean-out of stocks. For example, you might have got interested in a company for a reason.

If the moat is gone and if the firm is not able to develop new moats or bring in new competencies, the reason to own that particular stock over a period of time reduces. At the same time, new stocks get added to the universe. We have got reasonably good IPOs in the past 24-36 months.

Some very large companies — be it in retail, insurance or manufacturing — have got listed. So it is an ongoing process. There is 2-5 per cent clean-up in the universe, from time to time. At the same time, may be in the last few years, we would have added 3-4 per cent to the universe.

The Dynamic Equity Fund invests in equities, arbitrage and debt. At any point, equity and arbitrage will always be more than 65 per cent, so the fund will be taxed as an equity fund.

The way it functions is that when the markets are expensive — we use the metric trailing 12-month PE — the equity allocation goes down, and vice-versa. There are funds in the market that use forward earnings, price-to-book value, dividend yield, earnings yield vs bond yield, etc. Some use a combination of these.

The Dynamic Equity Fund is an asset allocation fund. It is more like a balanced product. The only thing is that the allocation is decided by the model instead of the subjectivity of a fund manager. Because of the way the product is structured, you will have lower volatility. The PE benchmark that we will be using is the trailing Nifty 50 PE. On the debt side, we are using the CRISIL 65:35 Aggressive Equity Index as the benchmark. On the equity side, it has a provision to follow a multi-cap style of investing. On the debt side, it will predominantly be certificate of deposit, commercial paper and AAA rated bonds.

We, as a house, are focussed more towards B2C companies. And the reason is that 60 per cent of the GDP is consumption-focussed. Over the long term, volatility in earnings tends to be slightly lower for consumer companies.

Today, if you look at consumption companies, yes, the headline numbers are expensive not only from a PE perspective but even from a cash flow perspective.

But the reinvestment required to bring growth is far lower in consumption companies because they inherently have a certain moat in the form of brand or distribution, which is more sustainable. And, they are not capital intensive.

In general, markets tend to reward companies that treat capital very well. So, sometimes capital can be a big moat in itself.

However, for consumer cyclicals, the call is more nuanced. At present, we are underweight in consumer cyclicals.

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