How do you read the impact of the coronavirus outbreak and the sharp correction in the past few days?
The current consensus is that the intensity of the spread might reduce over the next few weeks, driven by the proactive isolation and social distancing measures. Hopefully by the end of May we might see a significant drop in the incremental number of cases. However, the economic implications of the virus are expected to be significant and several countries may face a recession, which can be deep, if not prolonged. IMF estimates that World GDP would contract by 3% in 2020 with the advanced economies shrinking by about 6.1% in 2020.
Sectors such as airlines, travel and tourism, entertainment, retail and autos have borne the brunt. The Banking system is expected to see a number of corporate defaults or applications for restructuring of loans even though the central banks globally are pushing huge liquidity into the system and in some cases, buying stressed assets.
This effectively means that once the dust settles, the world will have to deal with new challenges surrounding the economy at least for the next 3 or 4 quarters. Some economies will suffer more than the others and there is likely to be a massive shift in the world order. Globalization could take a back seat as more economies start looking inward, putting pressure on global trade, supply chains may get disrupted and some industries like airlines and parts of the entertainment industry will continue to face some stress over the medium term.
You have seen multiple bearish phases in your career. How different is this one?
In the last 3 decades, the markets have corrected on multiple occasions. The market corrections during earlier crises like the Dotcom/IT Bubble in 2000 and Global Financial Crisis in 2008 took place over a few quarters. However, the recent correction has been unprecedented as it has been relatively steep and has occurred over the span of a few weeks. This speaks to the severity and suddenness of the impact of the Covid 19 on the population and its consequential impact on the economy at large. The economy has suffered an external shock, one which has wide ramifications on a number of industries and on ways of doing business as said above. The broad damage to consumer and business sentiment will take time to recover. There may be a tendency among both to save more, which itself may prolong a recovery.
What is your view on the valuations in each segment of the market – large, mid, small cap stocks?
The sell-off in the equities has been broad based across market capitalizations and sectors leading to multi year lows for many stocks. With the recent correction, there are several good quality businesses that are available at attractive prices in each segment of the market. We expect a consolidation and a continuing shift form the unorganized to the organized segments of the economy and companies with less leverage, a strong balance sheet, steady and robust business models, and good management quality to gain as they will weather the storm better than others.
Principal Focused Multicap fund has outperformed its benchmark across the 1-year, 3-year, 5-year and 10-year time horizon. Take us through the investment and product strategy that has worked for it.
The portfolio follows a bottom up stock selection approach with a high conviction, concentrated portfolio of 30 companies, focusing on companies with good return ratios, having sustainability of profits, with a management team which is focused, avoiding reckless diversification and executing well. The portfolio is currently weighted towards large cap companies. Despite the low number of companies, the portfolio is diversified across sectors with the top 5 sectors constituting about 58% of the portfolio. The portfolio is largely weighted towards Bank and Financial Services, Consumer Non Durables, IT, pharmaceuticals and energy.
What are the challenges of managing a focused fund when there is a broad-based market rally instead of a polarised market rally?
Given the concentrated nature of the portfolio, individual stock selection and the performance of these individual companies would be the key driver of fund performance. Hence if the stock selection in the fund has been proper, the fund should mostly do well even if there is a broad based movement of the market.
Why do you think a focused fund makes sense in every investment portfolio across market cycles?
The Principal MultiCap Focused Fund is a multicap portfolio with a maximum of 30 stocks. The market cap composition of the portfolio is an outcome of the stock selection process. We believe that multi cap funds have the potential to perform across market cycles given the ability to move across market segments and sectors. However, they may be more volatile than more diversified over shorter time periods and to that extent investors should consult their advisors on the suitability of a focused fund in their portfolio.
Do you think a diversified stock portfolio does not reduce risks?
A diversified stock portfolio reduces the risk from price movements in individual stocks. However, for that, it should be ‘properly’ diversified, i.e. we also need to consider correlation of individual stocks with each other, diversification across sectors, market cap segments as well as exposure to the various sections of the economy. A well-diversified portfolio across stocks, sectors, market segments should be less volatile.
Nearly 60% of this fund’s assets are allocated to large cap stocks and 19% to mid-cap stocks. Post the recent sharp correction, how do you plan to change the allocation across market segments?
About 62% of the portfolio is currently invested in large cap companies. The market cap composition of the portfolio is largely an outcome of our bottom up stock selection process. We do not actively target an allocation for specific market cap segments. The fund’s mandate gives us the ability to focus on and find value wherever available, irrespective of market segment. The recent market corrections have resulted in good quality companies available at reasonable valuations across market caps. We continue to monitor and evaluate these opportunities for addition / increase into the fund.
How should advisors position this fund to their clients?
Principal Focused Multicap Fund is a multi-cap fund with relatively concentrated positions in high quality companies. The portfolio is well diversified across sectors and market cap segments. The companies under this portfolio are high quality businesses in their respective sectors with proven track record and strong balance sheets. For an average investor, a multi cap fund, a large cap fund or a large and mid cap fund should form the core of his/ her portfolio. It can hence be positioned as one of the core funds in an investor’s portfolio.
Over 30% of this fund’s assets is in banking and finance stocks. Why are you overweight in these sectors?
The fund is actually underweight banks in its portfolio. Banks and Financial Services combined have the highest weightage in the benchmark index (S&P BSE 200 TRI) of the fund. The fund also has the highest weightage in these sectors. Financial services stocks are weighted towards quality HFCs, NBFCs and insurance companies. The composition of the stocks with these sectors (both in quantity as well as quality) is markedly different from the benchmark. We believe that as the COVID issue settles and as the economy gradually moves towards normalcy, this sector could see significant consolidation (especially NBFCs) and the strong companies with strong balance sheets and good quality management are expected to benefit.
Which are the other sectors that you are overweight and underweight at this point?
As on 31st Mar 2020, the portfolio was overweight on Consumer Goods (mainly consumer durables and Retail), Industrial Products and Chemicals. The main sectors that the portfolio was underweight were IT, Oil & Gas and Metals vis-à-vis its benchmark, i.e. BSE 250 Large and Mid Cap Index.
