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The US Federal Reserve seems to be softening its stance on interest rate hikes. Fed chair Jerome Powell said recently that interest rate hikes could slow down from December. This could have serious implications for both the Indian and global markets.

Mint caught up with Shridatta Bhandwaldar, who oversees more than 50,000 crore of equity assets as head-equity at Canara Robeco Mutual Fund (MF), for his views on what the Fed move means for the equity markets. Canara Robeco is the 16th largest fund house in the MF industry and its schemes have been doing well recently. Take the case of Canara Robeco Small Cap Fund—managed by Bhandwaldar and Ajay Khandelwal. The scheme has delivered 40% compounded annual growth rate (CAGR) returns in just three years. In an interview, Bhandwaldar reveals the factors responsible for the fund’s outstanding performance. Edited excerpts.

What did you make of the Fed’s guidance that rate hikes could slow down from December?

The stance on rate hikes has clearly softened because of the data points around inflation that came in last month. Yet, the Fed is likely to keep rates elevated long enough to focus on reducing inflation. At the margin, it is positive because the Fed Chair’s comments suggest that further sharp hikes may not be needed and terminal rate could be around 5%, rather than the higher trajectory that was expected earlier. This will bring some stability as investors will, instead of being worried over incremental rate hikes, now look out for signals on how fast they can get off the rate-hike cycle. And this will solely depend on how the monthly inflation prints shape up.

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Your small-cap fund has been among the best-performing funds in the 3-year period, with 40% CAGR returns. What has worked for this fund?

Different funds tend to do well at different points in time. There was a period in 2017-18 when our emerging equities fund, which is a large- and mid-cap fund, did quite well. We also had a flexi-cap and hybrid fund, which was among the best-performing funds on a 3-year basis. In 2020-21, our bluechip fund was among the best-performing fund. This shows our team’s stock-selection abilities, which reflected in different schemes at different points in time.

We don’t tag ourselves as a fund house having strength in just one particular segment of the market.

Stock selection is very important in a small-cap fund, given the wide universe of companies that a fund manager can choose from in this space. In our small-cap fund, several sectors have contributed to its performance. These are chemicals, capital goods, textile companies, mid-cap and small -cap IT names, industrial names, market infrastructure plays, etc. which today are not doing well, but have been impressive if you look from the last three-year perspective.

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What is your overall investment strategy?

Our investment objective is to focus on robust growth-oriented businesses which are run by competent management at a reasonable valuation. Ultimately, for the creation of wealth, you essentially need a capital efficient business, which is run by a promoter who has both business acumen and integrity. Business acumen, because he has to run the business well, and integrity, as otherwise he will not share profits in a fair manner with minority shareholders. We also look for businesses or industry that is scalable. If the industry size itself is scalable and the company is gaining market share, this will improve its earnings.

We also like to play turnaround stories. So, we look for long-term compounding stories, as well as alpha-generators. Alpha-generators are companies that can see potential earning upgrades due to certain triggers—change in management, change in competitive landscape, change in capital allocation by the promoters or the operating leverage playing out.

The second part of the investment process —filtering—is probably the most important part of alpha-creation, in my belief. Several investors make a lot of errors of commissions, which is why the filtering stage is so important. Error of commission happens when people make investments just because there is lot of buzz or a lot of interest in a particular sector or stock.

So, at the filtering stage, we try to avoid that. We have created a model with various financial business parameters and then test whether a stock meets all these parameters. This brings in objectivity in the process and avoids bad apples— whether it is challenged balance-sheets, weak managements or poor business quality—from entering into our coverage universe.

What has been your single most successful stock pick?

There was a company that ran hospital chains which earlier never qualified for our purposes because its capital efficiency was very low. But, over the last two-three years, the promoters realized that they needed to focus on their core business and move away from the non-core. Earlier, they operated with asset-heavy books like real estate companies, even though their core business was hospital chains. What has changed in the last three years is that most managements have realized that they can just take property on rent and keep their books asset-light. This was also seen in hotel chains, where we also had made a successful pick. We have also made successful picks in industrials.

Does the small size of the schemes help your fund house to be more nimble-footed than others?

Now, we also have a few large-sized schemes. Yes, there are still quite a number of smaller-sized schemes, and small size does help to an extent. So, what I tell our investors is that if the scheme size is below 1,000-2,000 crore, I can participate in small opportunities which come by. For example, a company with a market cap of 5,000-7,000 crore would have an acceptable business model and can be included in a small scheme’s portfolio.

At the same time, it won’t be possible to add such companies in large-sized scheme’s portfolio.

However, a large size can be a blessing sometimes. When you are managing a small-sized scheme, you may be less patient. For instance, we had bought stake in a company that provided explosives to industries, as well as the defence sector. But for a long time, the defence side was not playing out, despite the company deploying capital there.

Finally, at the start of 2021, we sold our position in that stock for around 1,300 per share. Today, it is trading at over 4,000 apiece. Had it been in a larger-sized scheme, I would have probably been more patient with the performance of the company and kept it in our portfolio. Since it was in a smaller-sized scheme, we exited as we thought we had waited long enough. The stock was held by the fund house for a long time.

Why did industrials do well?

Manufacturing, in general, has seen a good turnaround, and we are bullish on this space.

We picked up on this trend quite early. Even through the Covid pandemic, their order intake was far more superior. Covid has in a perverse way improved balance-sheets, whether it has to do with industrials, commodities or banks.

When commodity prices rose, the cash flows of the commodity companies improved. Real estate managements were worried during the pandemic, so they quickly liquidated their inventory. As for construction companies, the government started clearing off their outstanding receivables quickly. So, in all these sectors, energy, commodity, cement, construction, real estate, etc, the cash flows improved for one reason or the other. So, they could deleverage balance-sheets faster. Private corporate balance-sheets have dramatically changed through 2020-21. I have not seen such balance-sheets in my career, except during 2006-08.

So, when balance-sheets are in place, the promoters think of committing to operational expenditure (short-term expenses for plant and machinery), even if they do not support capital expenditure (capex). But when promoters see their plant capacity utilization inch-up close to 70%, they even start thinking of fresh capex.

Also, a rejig of supply chain is underway, as globally several companies want to move away from China. So, companies in the manufacturing sector are also benefiting from exports. This includes auto-ancillaries as well.

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