Lalit Nambiar, Executive Vice
President and Fund Manager (Equities), Head – Research, UTI Mutual Fund talks
about his investment approach, his favorite book and more.
What is the investment philosophy of UTI
MF?
While we definitely look for growth, valuations have to still provide enough room in terms of risk-reward proposition. From a bottom-up perspective, apart from management quality and return on capital employed, a key differentiator for us in categorizing companies as good or bad, is the quality of earnings - in terms of its translation into operating cash flow. Our research indicates that stocks of good companies outperform those of bad ones over longer periods of time. Presumably, the DNA of a business changes (but rarely) and financial discipline in the past appears to have been a reasonably good predictor of superior business execution and consequently of stock performance in the future. Barring special-situation funds, this strategy is appropriate for the kind of risk-reward balance we want to achieve in our diversified portfolios.
The government has increased the investment limit for tax benefits in 80 C products from Rs. 1 lakh to Rs. 1.50 lakh. Do you think this hike will result in higher inflows in ELSS?
It has been more than a few months since the 80 C limit was raised and since it is not a sub-limit specific for ELSS, there are several other competing investing avenues which stand to benefit equally. Prima facie some of these may appear more attractive to the lay investor given the lack of investor awareness in our country. The higher limit will obviously help increase the size of the pie. But the ELSS slice of this pie will grow only with greater awareness regarding the true merit of investing in the equity asset class, especially through the mutual fund route.
In which sectors/theme/companies have you deployed the fresh inflows in UTI Equity Tax Savings Plan?
There is no doubt that we are poised for a cyclical recovery in the economy. Unfortunately, easy money, flowing in from the developed markets has prematurely raised the cost of capturing the translation of this recovery into earnings. We have a situation today where even before we have sales volume growth, stock prices have been elevated and managements are forced to talk about earnings two years hence to justify valuations. Having said that, from a top down perspective, we believe that the domestic sectors where the margin of safety in valuations is higher are those which are likely to lead the domestic recovery when it eventually arrives. By that logic banking and cement should be among the first to recover. The other issue which cannot be ignored is the global situation which appears quite calm on the surface at present. But it goes without saying that this is illusory. Considering the fundamental problems in EU, China and other parts of the world, volatility can spike without warning. In that context, the U.S. is the other island of growth apart from India and we think pharma, despite its recent run, and IT are the best sectors to play this. Then there are the mid cycle plays such as capital goods and industrials where we are being very selective on balance sheet quality. UTI ETSP will incrementally look to invest in these areas and from a bottom perspective it will be placing a greater emphasis on identifying companies poised to move to the next stage of growth.
Gold seems to have lost its sheen lately. What is your outlook on gold?
At the core, gold in India has been the common mans currency hedge from time immemorial and the tradition largely continues even today. There is also the aspect of gold being an attractive investment option for unaccounted wealth and increased action against tax offenders can impact gold prices. At the global level, gold is reasonable insurance against quantitative easing by various central banks. Investor interest in gold waxes and wanes versus other asset classes based on the global risk outlook. Just as we cannot wish away this risk, interest in gold will also never really go away. To my mind, the worst for gold seems to be over, although it may not be able to outperform equities over the next few years, unless there is a crisis, in which case all bets are off in any case.
You manage UTI Pharma & Health and UTI Banking Sector Fund which are sector funds. How do you mitigate risk in such funds?
The risk in a sector fund comes from the close correlation of the operations of the underlying investee companies. That said, both sectors have sub-sectors or business verticals with somewhat heterogeneous financial and risk characteristics, allowing us to reduce correlation to some extent, while maintaining the return characteristic. This allows one to diversify across cash flow profiles, geographies, market segments and also management styles including MNC, private and PSU. In banking, for instance, we have private sector banks, PSU banks financial institutions, housing finance companies, NBFCs specializing in various loan segments and soon we will even have insurance companies. In pharma, the universe of companies are a mix of US generic, domestic formulations, API players, niche generic R&D, drug-delivery R&D apart from CRAMs plays and healthcare providers.
How is UTI Banking Sector Fund different from other banking funds? Within the banking space, which companies look exciting at this juncture?
We follow a basket approach, with portfolio spread across baskets such as private sector, PSU banks, wholesale and retail NBFCs. There is a clear bias within the basket towards companies which creates robust systems for secular RoA (return on assets) expansion even as they improve their reach. This means, we may many a time give companies, which in our opinion have esoteric, obscure or non-scalable business models, a miss. This is because we think that as a philosophy, this approach is in sync with the risk-reward equation by which our fund represents itself to investors. As a category, new private sector banks continue to look good to us. They are one of the most efficient in the sector at deploying capital and have superior risk systems. This gives them a significant advantage in their fight for market share with PSU banks.
Describe your investment approach and how it has evolved over time?
At a very basic level, apart from financial parameters, I look for companies with sensible leadership, who have the experience and understanding to know what drives their business, the humility to admit and correct their mistakes and most importantly, ones who know their circle of competence and try to excel within that space. Initially I had a tendency to be swayed by market noise, looking at the most contemporary themes, but over time this has given way to a more sensible approach and this will always be an area of continuous work-in-progress for me personally.
How do you generate ideas and what is your selection process before an idea gets added to the portfolio?
We have a very experienced and astute research team and fund management leadership. The senior research analysts are vertical specialists with years of experience, most having seen at least one business cycle. When this large investment team interacts with companies, market and industry participants, we land up with an idea-bank which runs broad and deep. The hierarchy of risk-reward within a vertical from this idea-bank is built bottom-up, using the financial screening parameters I mentioned earlier. From there it is a question of matching this hierarchy of ideas within each vertical with the macro-cycle view to narrow down to individual stock picks and their optimal portfolio weights.
How do you rebalance the funds managed by you? What triggers do you look for when removing a stock from your portfolio?
Every stock is revisited for testing the validity of assumptions on a regular basis or even earlier in case of a significant corporate event. If the base assumptions made while buying the stock or the macro conditions change, we reassess the investment case and act accordingly.
What are your notable mistakes and what did you learn from them?
There was a particular point in time when I was quite taken in by the idea of MNCs as a category and tended to paint them all with the same broad brush. But events in recent years have taught me that they come in all shapes and sizes and that management quality and corporate governance can vary significantly across these companies. It was a slightly passive way of investing which has now become more discerning and as a general rule I try to keep away from thinking in terms of stereotypes as much as possible.
Your favorite book and why would you recommend it to others?
The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks of Oaktree Capital. I think it helps one unlearn a lot of fallacies about investing especially in equities and resets the baseline for understanding risk and reward.
