The biggest multiplier effect shall come from revival in corporate capex
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Ajay Tyagi has been part of UTI AMC's equity investment team for 17 years. Along with managing UTI's offshore funds, he took over the management of the AMC's flagship UTI Equity Fund in February 2016. Overall he manages assets worth around Rs11,000 crore. UTI Equity Fund with assets under management of around Rs 5,300 crore has seen a bout of underperformance last year. Tyagi spoke to Mint about performance, fund strategy changes and how the portfolio is positioned in the current market scenario. Edited excerpts:
How has the strategy for UTI Equity Fund evolved since you took over last year?
The fund follows a strategy of investing in high-quality companies that operate at very strong return on capital employed (RoCE) through the cycle. The objective is to identify businesses that generate strong RoCEs, which leads to strong free cash flow generation, which in turn can be reinvested into the business for future growth. Such businesses are typically not too many in any economy and therefore when we identify such businesses, we invest in them for the long term and try and be patient with them. Within this small set of high quality (high-RoCE companies) we like to look for long-term secular growth so that economic value can compound year after year.
Some changes were made in the portfolio last year to incorporate this strategy when I took over. Post that we have been sticking with this and it would continue to be the guiding force for portfolio construction.
Going by the market capitalization in the fund, this seems to be primarily a large-cap oriented fund. How is it distinguished from UTI’s other large-cap strategy— UTI Opportunities Fund?
UTI Equity continues to be positioned in the large-cap category. UTI Opportunities has now been positioned in large- and mid-category. Further, in terms of style, UTI Equity is a bottom-up driven scheme while UTI Opportunities is a mix of top-down and bottom-up. And lastly, UTI Equity is very clearly positioned in the growth part of the grid whereas UTI Opportunities is a blend.
Was there a need to change the stocks and sector allocation when you took over?
Yes, there have been some changes that were made in the January-March quarter of the previous year. This was to realign the portfolio to the strategy that I have explained above. Some of the noteworthy changes that were made last year are: increase in the banking and financial services exposure from about 20% to about 32%, increase in consumer goods from about 8% to about 14% and increase in pharma sector from about 8% to about 13%. Likewise, the energy sector was reduced from about 10% to 2% and telecom sector was completely sold out. Since then, the strategy has been followed very rigorously and without making any exceptions.
Given the level of market valuation currently, how is the fund portfolio positioned in terms of P-E (price to earning) relative to the market?
As mentioned above, the fund is focused on high-quality companies that have a secular growth outlook. Such companies are inevitably more expensive as their RoE (return on equity) profiles are better than the market. For instance, RoE of the fund is 24.4% as against the RoE of the index at 19.85%. Consequently, the trailing P-E of the fund is 26.5 as against 22.2 for the market
Despite the low interest rate environment, corporate earnings are not turning around decisively. Would you say this is an extraordinary economic cycle?
While low interest rates help in priming the pump but that alone cannot lead to a turnaround in the economy. The biggest multiplier effect in the economy shall come from revival in corporate or private sector capex. However, for that to start, the capacity utilisation levels in the economy shall have to get closer to 80% or even cross 80%. This number has been stubbornly stuck around the 70% range. While the hope is that a good monsoon would lead to better consumption demand, which would feed into better capacity utilization across industries, we shall have to wait and watch. So, unlike the previous up cycle that we witnessed in 2003-10, where the demand revival was sudden, this time the revival has been more gradual.
Which sectors and businesses do you think will sustain earnings growth in the current economic environment?
Domestic driven sectors should continue to do well in the near term. So private sector banks, consumer staples and consumer discretionary including auto should continue to do well. In particular if the monsoon turns out to be good both in terms of spatial and temporal distribution, the above sectors should get a good rub of the green. GST is also going to be a strong medium-term driver for many businesses in the above sectors.
What type of businesses would you avoid investing in due to either lack of earnings growth visibility or valuation?
The rally in the last 1 year has been strong and many businesses with weak balance sheets and lack of strong cash flow generation have been bid up under the hope of a strong economic revival, helping these businesses in terms of operating and financial leverage. One has to be extremely selective in such cases as valuations have already reached to a level where any slight delay or disappointment in turnaround can lead to steep corrections.
Top 10 stocks in the fund are primarily from the benchmark indices and 35% are in financial services. This is more or less trailing the market index. What are the active alpha contributors for the fund?
The fund follows a bottom-up strategy and therefore the source of alpha generation usually comes from securities selection rather than sector selection. So while our weightage in the banking and financial services sector could be similar to that of the benchmark and also many stocks could be from the benchmark itself but the weightages of these stocks are materially different and that is the source of alpha generation. For instance, over the last year the fact that we were significantly overweight on Yes Bank Ltd and IndusInd Bank Ltd has helped us generate alpha.
Similarly, bottom-up ideas like Motherson Sumi Systems Ltd, Shree Cements Ltd and Eicher Motors Ltd have also helped the fund generate alpha.
What do you attribute the underperformance seen in the last year to?
The underperformance of the last year is mainly attributable to the overweight position of the fund in pharma sector. The pharma sector last year suffered in all its key markets: US generics, India business and also exports to emerging markets. In the US generics business growth has been impacted on account of pricing-led competition, channel consolidation and also lack of launches due to manufacturing plants being under FDA (US Food and Drug Administration) observations. We feel that there should be a gradual improvement in these factors over the next few quarters. The overall demand outlook in India continues to remain strong on account of poor penetration of healthcare, although there could be some GST-related disruptions in the near term.
On an overall basis, pharma remains a highly scalable business opportunity with strong RoCEs and cash flows and the fund can continue to remain overweight on this sector, notwithstanding the near-term challenges.