What is the thought process behind having focused portfolios?
Being focused has an impact on investors and on how portfolios are managed as well. Talking about the investors first; we don’t know what is there in their overall portfolios—that is opaque for us. It may be guided by media or intermediaries, but we really have no view on their end portfolios.
However, by experience I can say that an average investor has about 8-10 funds in her portfolio and each of these is likely to have 50-60 stocks. In the end client’s portfolio, there could potentially be 500-odd stocks and if you remove the overlaps, you end up with around 250-300 stocks.
I did this as an experiment; make an equal-weighted portfolio of the top 10 largest equity funds by assets under management, and do an analysis of 5-year performance against a broad-based benchmark like CNX 500.
You will find that the outperformance is limited. The reason is the funds have few unique stocks. In my experience, if you buy the market, you can’t beat the market.
Focused portfolios, in that sense, do add value to the clients’ portfolio.
I have noticed that most funds are managed either for their own performance, or for the narrow objective of beating the index or being number one or two and so on.
We need to think about how we impact client portfolios. Being widely diversified, when the client is already over-diversified, is not going to help.
From a fund management aspect, our philosophy is market agnostic. We are not driven by macros and the overall market environment. We are strictly bottom-up. Then it makes sense to be reasonably focused.
This doesn’t mean 8-10 stocks but rather around 20 stocks that could be the sweet spot.
The strategy has worked in the current market and performance can be seen in the last 1.5 years or so. What happens to a concentrated portfolio when the market turns sour?
Theoretically speaking, in the current market I can even run a portfolio of information technology, healthcare and public sector banking stocks; but it won’t work.
There is a lot of attention given to the word ‘focus’ but by itself it means little.
The key is what you focus on. The portfolio must be bottom up, where you understand the business.
In a down cycle can it get hit? If you are invested in high-quality high-growth businesses, there is an inherent floor to your downside. When the market hits a bad patch, there are some companies where earnings may fluctuate but they are resilient and more sustainable compared to some others. Focus can backfire but it is a function of what you own. You must own companies that have sustainable and resilient earnings and are not overvalued on price.
Because of this strategy, many segments in the market get eliminated from portfolios, such as global commodities and companies that are exposed to exchange rates. The focus should not backfire; the locus of control of the company one invests in should be with the company management, rather than in macro changes (external factors).
How well is this strategy communicated to your investors—the quality of portfolio versus risk of concentration?
There are challenges. My biggest fear is whether our funds only get looked at thanks to past performance. I hope that is not the case. We work hard on communicating the strategy.
Earlier, our communication was only about Buy Right Sit Tight. But now we also elaborate that this is about high-quality and high-growth stocks. We make our best attempts to educate people on process and philosophy.
Our TV campaigns never promote products. Our advertisements tell people to ask for processes.
We are telling people about this. Any product provider should influence the client to ask the right question. In our fact sheets, we never talk about the market moving up or down and we don’t give a market call.
How do you manage the conflict between the mutual funds and portfolio management services (PMS) platform, given that the underlying asset is the same?
Let us first understand why people even consider PMS. First, there is a huge base of clients who are already holding equity, a large part through stock options. There is already a legacy, since Reliance listed in the late 1970s. There is a case for all those people to appoint a professional to manage the equity.
Second, high net worth individuals (HNIs) who are more experienced in this asset class, and possibly more aware, can take higher risk. Risk controls like maximum exposure to a stock, the true labelling of a portfolio and so on are slightly more relaxed as compared to a mutual fund scheme.
By running slightly concentrated positions and the fund manager having more flexibility in stock selection, there is a potential to outperform mutual fund performance. In my personal experience, this does happen and there is data to back it.
On the commercial front, compared to mutual funds there is more freedom in PMS. This is a good outcome. There are some clients, for example, who pay us a variable fee (for PMS) and a negligible fixed fee. There are others who invest larger sums of money and the fee is accordingly calibrated.
It’s not true that a PMS is necessarily more expensive than a mutual fund. In a profit-share arrangement, for example, we must perform first. Another experience is that people tend to stay invested longer in a PMS as they hold the stock in their demat account.
As opposed to this, in case of a mutual fund, one can redeem simply with the press of a button online. The communication is also more intense as PMS clients reach out to me personally.
There are many reasons why one may prefer PMS; commercials aren’t the only factor.
Your multi-cap fund contributes 64% of the overall assets under management for your AMC.
Do you think that is focusing too much on one product?
I work hard on diversifying this, but I leave it to the intermediaries and clients. It is also a quirk of our market. In the industry however, the largest category of funds is a go-anywhere fund.
Some of the largest mid-cap funds have around 40% in large-cap, and most large-cap funds have 30-40% in mid-cap. Our offer documents define the investment universe for each scheme very precisely. It is an industry quirk that people put money in these kinds of diversified multi-cap funds.
When I go and communicate to people and talk about pure large-cap funds, there is some traction that is building up now. This also makes me think that investments are happening only based on past performance, which is not the right way. One must focus on the other factors as well.
How do you approach product development? What was the thought behind launching Dynamic Asset Allocation Fund?
My first reaction to new products is: ‘No’. Also, I feel with every new product in our basket we are opening a window and inviting more risk. I am wary of launching new products. Second, I question whether the new product will dilute what we set out to do. The mandate from our promoters is that we will be a niche equity company. I don’t have any targets around assets under management and market share.
Coming to the Dynamic Asset Allocation Fund, my view was that people do their own asset allocation. Hence, what is the need for a mixed product. However, I realized this is more a theoretical view. People who invest in equity do look for a fund that curbs volatility. Even if we do a good job with investing in equity, we do need to manage volatility better. This product is one deviation for us. Another deviation is the ETF business, although we are not growing it. As of now, we have no offer document pending. The only remote possibility is maybe a small-cap fund, which is a gap in our offering. But now is not the right time. Volatility management funds are also an area we may look at.