Why this fund manager is bullish on NBFCs

Alok Singh, Chief Investment Officer at BOI AXA Mutual Fund, chats with Ravi Samalad on what aided his funds' superior performance last year.

You started managing BOI Axa Large & Mid Cap Equity Fund from 2015. The fund has beaten its category performance by a wide margin in the last one year. What would you attribute the fund’s turnaround to?

It’s not that we have done anything different over the last year. In equity investing, you have to have foresight and be patient. You cannot expect returns in the short run.

So I would list two reasons: A supportive market and bottom-up stock selection.

Since you speak of bottom-up stock selection, tells us about the stocks you added to the portfolio.

At the start of 2017, we were heavy on Financials with a 40% exposure, especially bullish on Non-Banking Finance Companies. Then we began to see that these companies were finding it difficult to maintain the margin requirement due to high interest rates. So we lowered the exposure to 25% towards the end of 2017 and shifted the allocation to Materials, Metals and manufacturing related ancillaries.

We played Metals through ancillary companies. For instance, instead of buying Tata Steel, we chose companies feeding into steel companies. Whenever the cycle turns for an industry, it is the ancillary suppliers which get the highest margin benefit because they are the ones which get squeezed the most during a downturn. In automobiles, Maruti has done well but Motherson Sumi has even better. 

How are you currently positioning the portfolio of your large and mid-cap fund?

Insurance is a sector where we have added position.

We are increasing weightage to Financials.

Why? The interest rate environment has not changed and there would still be margin pressure.

There has been a lot disruption in Banking. It would be difficult for banks to involve themselves in serious business due to headwinds. In this scenario, NBFCs will have an upper hand. Though they are expensive, imagine if they are able to double their balance sheets. With this amount of low activity from banks, I think it will be easy for NBFCs to clock 30-40% growth rate.

You are avoiding public sector banks?

Private and public sector banks. We have consciously been avoiding corporate lenders for around 30 months.

The return metrics for these companies was low because of the provisioning norms. Their business models and thought process was more equipped towards corporate lending. If you look at the last three years, every bank, especially PSUs, is focusing on increasing their retail book. But their books have not changed much. Retail is still a significantly low portion of their overall book. Their businesses are more equipped towards wholesale lending. The moment their balance sheets recoup, they will again go back to corporate lending.

On the other hand, NBFCs have doubled their balance sheets during the same period.  Also, we will taper off some positions from Industrials to invest in Financials.

What gives NBFCs an edge?

There is no compulsion for NBFCs to participate in government initiatives. For instance, the government announces capital infusion and asks banks to participate in the Bharatmala plan. NBFCs don’t have such compulsions. They can pick and choose what is right for them which allows them to have a better handle on their portfolios. They don’t have to deal with farm loan waiver, priority lending, and such issues.

Their cost of funding is higher than banks but that gets compensated by lending at the right rate. Most NBFCs are gaining size. Some of them have books of over Rs 1 lakh crore. They will be in a better shape because banks are not active right now. 

So what is your play in BOI AXA Manufacturing and Infrastructure Fund? It has beaten the benchmark and peers by a wide margin over a 1-year period.

The fund can invest in all sectors except Financials and Services. In this fund, we are playing the entire manufacturing theme which includes Pharma, Auto, Defense, Metals and so on. The fund’s investing universe is diversified.

We are overweight on EPC* companies because the road contract of one lakh kilometer has been assigned and land is acquired. The project will be implemented irrespective of which government comes to power. 

In BOI AXA Tax Advantage Fund, the allocation towards mid and small cap stocks has increased from 16% to 62% over the last 5 years. You continue to see value in that space?

There is a lot of value there because there due to the huge amount of growth happening. It is not right to say that these stocks are expensive because of the average. Average also includes underperformers. You cannot penalize the performers for underperformers. The performers deliver growth.

Take HDFC Bank. It has never been cheap ever since it was listed. But there is not a single quarter where it has faltered big time. So expensive stocks can continue to be expensive as long as they perform. If the opportunity size is X, and you already reached that then there will be headwinds. But in a sector where you can grow substantially, these companies look attractive.

We have decent exposure to Road EPC*, Consumer Discretionary, Metals and Minerals in this fund. We are not taking a broader call. We are not looking at hope stories. We are looking at companies which have a long way to grow and are generating cash. We invest only if companies show sustainable numbers.

You see a lot of value in the mid- and small-cap space. Would you say that generating alpha in the large-cap space is getting to be a challenge?

Large caps are discovered stories. As people’s understanding about large-cap stocks mature, the inefficiencies diminish. So it is more of a beta play, it’s not about alpha generation. Which means your allocation has to be right. It’s all about how you allocate money to different sectors within the large-cap universe.

In developed markets, investors are moving towards passive funds because active funds are unable to generate alpha. This trend will come to India. Ten years back, Indian large cap funds were able to outperform their benchmarks by 4%-5%. Today, the best performing large cap funds generate an alpha of 1-2%.

It’s not that fund managers have become inefficient. It’s just that the markets have become efficient. The information flow is more efficient. As a result, professionals are not able to take advantage of it. As fund manager’s value addition reduces, cost comes into focus. You will not be able to justify the costs going ahead. So investors will move to exchange traded funds.

Which IPOs have you avoided?

We have not participated in some of the recent IPOs because they were not rightly priced. We avoided ICICI Securities. Neither did we participate in the IPOs of insurance companies.

Would you look at them at a later date?

Of course.

The good thing is that many new sectors are being generated with the new IPOs coming in. On the flip side, the problem with IPOs is that you don’t have long term data to rely on. But after a year or so, we would have a lot more information available.

We added a few insurance firms in our portfolio this year. It’s a function of how comfortable we are with understanding the dynamics of the business. That takes time. Sometimes that information is available by virtue of your association with the industry.