Harsha Upadhyaya, CIO, equity, at Kotak Mahindra AMC, told Mint that maintaining investment discipline across market phases and focusing on long-term bets selected after rigorous fundamental analysis helped their equity funds book top spots in their categories. He said this is a good time for patient investors to build long-term equity portfolios since market valuations seem to have discounted most of the pain in the economy.
Many of the Kotak equity funds have been in the top and next quartile in their respective categories over longer tenors. If you did an attribution analysis what would be the biggest contributor to the returns?
Our investment approach is a blend of top-down and bottom-up investing. Both sector allocation and stock selection have contributed equally well for consistent long-term performance. Another key contributor to our performance over the years has been the fact that we hold on to winners for a longer time as compared to the ones which drag our performance. More importantly, we have stuck to investment discipline across market phases and have focussed on long-term bets based on rigorous fundamental analysis.
The Kotak Standard Multicap fund has traditionally had a large-cap focus. But in the recent past, you spoke about the emerging opportunities in the mid- and small-cap space. Will this fund see a shift in focus? Does the large size of the fund impact portfolio construction decisions?
Kotak Standard Multicap has always had a large-cap tilt. Historically, the large-cap allocation has remained 65-75% of its portfolio. Currently, it is towards the upper range. We find valuations in the mid- and small-cap space potentially more rewarding for long-term investors. In line with this, we have been looking to increase allocation to this basket gradually over time. The large-cap tilt and long-term investment style have helped in creating consistent outperformance over the benchmark, with relatively lower volatility. Portfolio churn has always been low. We do not bet on event or tactical plays. Portfolio construction discipline in terms of selection of stocks, sizing of bets, diversification etc. have remained intact despite the increase in portfolio size and change in market conditions. We believe that this disciplined approach will aid performance even going forward.
Which themes and sub-themes look interesting in the Indian markets at this point in time?
We continue to focus on investment-driven domestic economy recovery plays in our portfolios. Recent policy initiatives from the government also focus on investment-driven recovery rather than a consumption-oriented one. We like domestic cyclicals with high operating leverage. We remain overweight on capital goods and cement sectors. In the cement sector, we expect pricing scenario to turn favourable going forward, given continuing strong volume growth. The fortunes of the capital goods sector are also brightening up gradually. In addition, there is not much debt on the books of most capital goods and cement companies. The profitability improvement is going to be much stronger once demand picks up on a sustainable basis. We also expect government spending to continue in infrastructure creation and private capex to pick up gradually, given lower tax rates in future, which augurs well for these sectors.
What has the fund house’s experience been with SIPs? While the industry has seen steady SIP inflows through the difficult market, is the level of discontinued SIPs a matter of concern?
Our SIP book has also been growing in line with industry trends. The MF industry collected over ₹8,200 crore in SIPs during August 2019. The net monthly SIP flows at the industry level have remained fairly steady despite some discontinuations. Data from the Association of Mutual Funds in India data shows that the MF industry added, on an average, close to 10 lakh SIP accounts each month in FY20.
Managing downside risk is seen as an important activity in an actively managed fund. How do you manage this in equity funds?
We like businesses that have proven business models, which are scalable in nature, where capital efficiency is high and that have reasonable competitive edge in their respective areas of business. We also keenly look at the management track record and its quality. The final filter is valuation in every case. Typically, we look for compounding characteristics of earnings growth at reasonable valuations, and build a portfolio around that strategy. We do not like sectors and stocks that require capital on a regular basis and those with a high degree of leverage. We also tend to avoid companies that have a high level of policy or regulatory risk. We avoid betting on event-based tactical plays. Our focus has always been long-term bets based on analysis. Following these principles over market cycles has enabled us tide over some challenging times.
Will measures such as rate cuts and corporate tax cuts translate into resumption of consumption and spending in the near future or is there some more pain left for the economy?
The decision to lower corporate taxes meaningfully is a key structural measure to support India’s growth outlook. One of the key objectives of the sharp cut in corporate tax rates is to make India globally competitive. This step significantly boosts medium-term investment potential in the economy. The focus of fiscal stimulus is capex-driven rather than consumption-driven and thus poses limited risks to macro stability. Similarly, the current monetary policy is also supportive. However, we believe consumption recovery is going to be more gradual in nature.
Do you see a contagion effect in equity markets of the debt issues troubling companies and causing distress in debt markets?
There has already been a contagion effect over the past year or so. Over the next few months, we expect things to gradually normalize as the focus has shifted to monetary transmission and making liquidity available to deserving and creditworthy businesses. While volatility in equities may continue for some more time, it is also a great time to build a portfolio from the long-term perspective. Broader market valuations seem to have discounted most of the pain already. For patient investors, it is a great time for stock picking.
Given the low inflation and low growth phase in Indian economy, is it time to reset return expectations for equity investors?
The cost of capital for businesses is coming down significantly. Apart from that, domestic inflation band has also got reset downwards. Given these conditions, even low double-digit equity returns over the long term should be viewed as great returns. However, equity returns can never be linear and, hence, during good times the returns could be larger and vice-versa.