Quantum Long-Term Equity has some defining characteristics. The fund is known for its value bent. Is market-cap agnostic. The fund managers unapologetically take refuge in cash when valuations hit through the roof. And they shirk from certain stocks irrespective of whether or not the rest of the market embraces them.
The fund recently completed 10 years and has delivered impressively over the long term - 14.17% annualised over 10 years and 12.74% over 5 years, to be more precise. The managers of the fund – Atul Kumar and Nilesh Shetty, explain their stance.
The year 2014 was not a good year for your fund. From May 2014 to April 2015, it was the worst performer in the flexi-cap category. How would you explain it?
This was due to our valuation calls which resulted in higher cash. The high cash levels in the fund during that period impacted performance.
The stock market started rallying in August 2013 and the Modi government came to power in March 2014. Prior to that, the Fragile Five crisis took place and valuations had dropped. We used that period to buy stocks and the cash level in the fund dropped.
Then came the liquidity driven rally.
The companies we met were not showing a major improvement in earnings. There was a substantial disconnect between what was happening to the P&L and balance sheets of companies, and their stock price. On the ground level, the picture was different from the stock market frenzy.
Our sell limits got triggered. We began to sell. So cash hurt us that year. Liquidity chases high risk companies. Highly leveraged companies and those with shaky business models began to do well. We don’t invest in such companies.
When sanity returned to the market we began to do well.
But even in 2015, your fund marginally underperformed the flexi-cap category.
The first half we got hit with the cash levels. Between May and June 2015 we began to deploy some cash. But the main correction took place late 2015, in the last quarter – October to December, when pharma, defensives and FMCG began to correct.
Do you deliberately decide to lower your cash levels when the market rallies?
Not at all.
We never look at market levels. If a stock has become expensive we sell. And if there is nothing in our buy range, we hold on to cash.
At one point, you went up to 32% in cash. That is quite high. What is your limit?
The internally set limit for cash in our fund is 35%. But let me explain why we went so high.
We are very disciplined in how we buy and sell stocks. So if a stock hits our sell limit, we take a look at the numbers. If we are convinced we have not missed anything, we go ahead and sell. Ideally, we would like to deploy that cash into other stocks.
But from March to May 2014, every stock was rallying. So stocks were hitting our sell levels, but we could find no ideas to buy at such levels.
Let’s say you put the intrinsic value of a stock at Rs 80. It goes up to Rs 90. But since we are in the middle of a frenzied bull run, it could go right up to Rs 150. So when will you decide to sell?
Let’s say the intrinsic value is X. The moment it exceeds X we will sell. We believe that if a stock is overvalued it will correct. Holding on to an overvalued stock puts investors’ money at undue risk.
So then at what levels do you look to buy?
We generally look for an upside of 40%.
And how long are you prepared to wait for it?
We peg the waiting period at two years. But at times we have to wait longer.
But let’s say we buy a stock which has a 40% upside. The earnings keep compounding. So the earnings after two years will be higher and our projections change too.
On the flip side, there could be instances where we reach our target within six months.
You have no qualms about getting out in an overheated market. So is there any particular market in which your fund will perform?
Our investment strategy is consistent, which means our behaviour is predictable over different market cycles. We have behaved in a consistent fashion over 2007, 2011 and 2014. In euphoric markets, driven by momentum, the fund will sell stocks which are overvalued and wait on the sidelines. In that period it will underperform. But over a market cycle it will catch up.
What are the types of stocks you tend to exclude from your universe? RIL seems to be a prominent one. Neither did your fund own Satyam.
We have a liquidity filter – daily trading must be at least $1 million. This is crucial because we have a scalable model. So as the assets increase, the portfolio must be scalable.
Corporate governance is another, which indicates how the company has treated minority shareholders and the skill set of the management.
Opaqueness of accounting is the third filter. This is one reason why we never dabbled in real estate companies.
When looking at a stock, we do not consider the standard deviation or beta. Instead, we ask: How honest is the management? Can we can trust its numbers? Is it executing right? Are contracts obtained in the right way?
So there are around 250 companies which meet the liquidity criteria. Within those we look at the other levels, which leave us with around 140 stocks. However, at any given time, our portfolio will range from 25 to 40 stocks, irrespective of the size of the fund. The same portfolio will be held if we have Rs 11 crores or Rs 500 crores or even Rs 5,000 crores.