bl.portfolio caught up with Kalpen Parekh, MD and CEO, DSP Mutual Fund, recently. In this conversation, he elaborates on his investment philosophy as well as the fund house’s. He believes mean reversion to be the iron law of markets and a counter cyclical approach to investing, followed by the fund house, would help use this principle in their favour, he reasons. Excerpts:
What is your investment philosophy?
I want to be a permanent investor — an investor every month, every year for a decadal/ multi-decadal time horizon. Every day, week or month, something or the other will happen as markets are integrated with the rest of the world. I don’t want to respond to all that because I have so far never been able to predict what will happen nor will I be able to do it in future. However, two things are generally predictable with a reasonable amount of certainty. One, if you buy an asset class at higher bands of valuation in its cycle, generally future returns are lower and vice-versa; two, if you buy good-quality asset class or good-quality businesses, your chances of survival are higher.
With this very simplistic philosophy, I try to do my investing. When equities are expensive, I will be more into hybrid funds. If markets are cheap, even if there is bad news floating around, I will probably prefer to be more aggressive in my equity portfolio.
What are the metrics you look at, to judge whether markets are cheap or expensive?
In history, we have seen the valuation boundaries for the Nifty from 12 times in a bear market to 25-27 times in a bull market peak, with the middle somewhere at 17-18 times. In the last 10 years, the average has been closer to 20 times, among the key reasons being that India has relatively better macro variables and prospects than rest of the world. So, a lot of money is chasing a few good stocks and instead of 17-18 being the average, it has moved up to 21-22 in the last decade or more.
But when you buy something at an aggregate of 25 times, the earnings yield is lower than what it is at, say, 15 times. So, the room for valuation re-rating is relatively lower. And if the room for valuation re-rating is lower, then I have to rely on only one pillar for returns, which is profit growth. If I look at the 25-year history of our markets, generally we are a country with 15 per cent return on equity and around 12-13 per cent profit growth. So, if you were a single company earning 15-16 per cent and are really growing at 12-13 per cent over long periods of time, then 17-18 times is the multiple one would have given. Vis-à-vis that, we are higher now. So, at such points in time, it’s better to be slightly prudent. Overall, in my portfolio, I would have 65-70 per cent in equities. And the balance would be in bonds and gold.
Of course, there will be exceptions where companies at high valuations still make money, but mean reversion is a very big iron law of markets.
As a fund house, do you believe in contrarian investing? Your launches in recent years are all focused on beaten-down themes and your mid-cap fund has been an underperformer at a time when the segment has done very well…
We do not want to have any labels. We try to do what makes sense to us at any point in time. Many times, we realise that our brain wants to invest in past returns because that gives us comfort. But those returns have already happened. So, you can say that we are a slightly cautious/ conservative fund house and launch counter-cyclical funds because mean reversion, like I said, is a very fundamental force. The idea is to exploit mean reversion in our favour rather than becoming victims of it.
On the mid-cap fund, particularly in the last three-four years post Covid, we are not happy with our outcomes. I completely admit that we have underperformed relevant peers. Having said that, in the last four months we have caught up very sharply. But that’s too short a period to really say much about.
We missed some turning points in the market. There has been a bias against investing in PSUs because we have seen long stretches of poor capital allocation. They were cheap for a long period of time and when they started moving up, we were a bit late in catching up on that. Besides, some themes, like engineering and industrials, we were very early to get in and also early to get out. So these are two areas where maybe we could have been better in our execution.
Besides, generally, we are very long-term investors. If we like the broad history of the company and the management, even if they’re going through a rough patch in their business, we believe that they have the acumen to take the right decisions and turn it around (and hold on).
This time around, that has not completely worked. There is a decisive slowdown in many sectors which is taking longer to turn around than what it has been in the past. We have improved our tools and techniques to be a bit more agile and which is reflected in our returns in the last few months.
®
In recent quarters, support to bottom-line growth from lower commodity prices has weaned off. Going forward, do you expect demand to pick up and support the bottom-line or are you expecting a slowdown in earnings?
Incrementally, we are seeing a slowdown in both revenue and profit growth, and hence we feel that for at least in the foreseeable future, overall profit growth will come down closer to 10-12 per cent and not stay at the 18 per cent levels we have seen in the past. Very long-term profit growth rates for the country are around 12-14 per cent, as discussed earlier. We are now moderating on revenue as well as profit growth and that’s why we have been a bit conservative in our approach on either product launches or on guiding investors to invest for the longer term and not expect similar rates of return that we have seen in the last few years.
On private capex, as much as the government seems to be pushing and the balance sheets also seem ready, what is preventing the private sector from going all out?
While the private sector is in the best of its shape from a balance sheet point of view to do large-scale capex, lack of visibility on consumption trends or a strong consumption cycle may be preventing them. Secondly, I think a lot of companies have become more disciplined or more respectful of capital allocations. They are looking to maintain higher cash flows, operate at lower leverage and focus on higher ROIs (return on investments) and which is what markets are supporting through higher valuations. Also, post Covid, we have seen leverage across households rise on the one hand and employment growth also has not been very strong. A large part of that employment reversal post-Covid, has happened in agriculture, which is giving a weak input to consumption trends. So, we should not extrapolate just that because government capex has happened, private capex also will happen at high growth rates.