Businesses are getting disrupted faster than ever before

By Morningstar |  26-07-18 | 
 

Taher Badshah, CIO, Equities, Invesco Mutual Fund, talks to Ravi Samalad on the challenges in generating alpha in the current market.

Where are you seeing opportunities in the current market? Are you looking at entering PSU banks and pharma stocks which have seen a correction?

Opportunities exist across segments. In the last few years, we have found very few opportunities to take sector calls. Around 18 months back, we went overweight technology because of attractive valuations.

We look for opportunities within a sector because we have seen considerable divergence of stock performance within a sector. Take for example the automobile sector. We have seen Maruti performing well in the last three years but two-wheeler companies have not done so well. In oil and gas space, oil marketing companies did very well few years ago but RIL didn’t do as well. The trend has reversed over the last 18 months. Reliance has done exceedingly well and the stock prices of most oil marketing companies are down by 30-40%. The same is the case with banks. Public sector banks suffered while private sector banks gained. Thus, we are adopting a bottom-up approach.

We have been a bit circumspect about pharma. There are some specific stocks which are turning attractive. So we have increased our weightage in those stocks. But they are not our top holdings. Currently, the circumstances surrounding the sector are not clear. Nor are valuations that comfortable. They are getting better compared to one year ago but still not cheap.

IT stocks have run up. Are you still overweight on IT and how do you see the growth in this sector going ahead?

We took an overweight position in IT in our Invesco India Contra Fund about 18 months back. It was ignored back then. Vishal Sikka had left Infosys, rupee was appreciating, demand was weak and there were visa issues. From a valuation perspective, that call worked very well for us. Incrementally, we are now viewing this sector from a growth perspective as some of the headwinds are converting into tailwinds. We are seeing deal traction improve and challenges of business transition of the past few years appears behind improve and the valuations are reasonable. The sector can witness accelerated growth due to improving demand.

Which are your other contra bets in Invesco Contra Fund?

We have some corporate banks which we think are looking good from a two-year perspective. Banks like Axis and ICICI figure in this portfolio more prominently. This is the only fund where two pharma stocks (Cipla and Apollo Hospitals) are in our top ten holdings. This fund already had good amount of IT stocks. There are some contra opportunities in pharma, industrials and corporate banks. We have recently bought oil marketing companies after their collapse in the recent past.

What filters do you apply while entering stocks in Contra Fund? Is price correction a starting point?

Valuation and quality of the company are important filters. It should not be an expensive stock even if it has very good earnings growth. If things are going well for the company, it is not a contra idea in the first place. Stocks are not contra for us just because prices are beaten down while earnings have collapsed, which is the case currently with pharma. The valuations in pharma still do not appear cheap for them to qualify as contra. In IT, the earnings were growing at a lesser pace. But they were still growing and yet the sector was cheap on a standalone and relative basis. In case of pharma, earnings were however declining 20-30% and yet not cheap on valuations. Today, IT has become one of the favorite sectors to be in and the valuations have increased from 12-13 times to 18 times now.

Other parameters to look at are whether these companies are facing headwinds, are they beaten down, can the challenges reverse? Industrials, corporate banks, pharma to some extent fall in this bucket. If all these things put together along with valuations are cheap then it becomes an attractive contra play.

The Sensex is at an all-time high but that is not being reflected in fund returns. How difficult is to generate alpha in the current market?

We are going to see earnings recover but there is a good possibility that PE multiples may compress. In the last 2-3 years, PE multiples were expanding but earnings were not catching up. The evidence for better earnings growth is higher this year and we should get quality earnings this fiscal year. But there are certain challenges which are coming along with that growth. There are certain challenges like higher inflation, increasing commodity prices and forthcoming election. We expect PE multiples to take a knock and therefore returns will compress. Even if we get 15% earnings growth, and if you take away 5% from PE multiples, you will be left with 8-10% growth.  Clearly, it is not a market where we can easily generate alpha as the volatility is high. Market returns will be in the vicinity of 10%. In the past, the return has been healthier. Our expectation this year should be modest in the range of 8-10% in the next 12-15 months. Having said that, we will strive to generate 3-4% alpha across different strategies.

Which kind of other risks are prevalent today?

There are two kinds of risk which are affecting businesses today - regulatory and the risk of getting disrupted. For instance, Maharashtra government recently passed an order saying that multiplexes cannot overcharge and customers will be allowed to carry outside food in the cinema halls. Such risks are changing the profile of businesses dramatically. Our challenge is not as much about other factors like commodity prices, earnings or inflation. The pace at which existing businesses are getting disrupted is increasing. This is in every sector. In such a scenario, the value of a company goes down by 20% in no time. You find it difficult to reconcile to that reality. We are a lot more anxious about those kinds of challenges which is making alpha generation difficult.

Businesses which are getting disrupted are listed while those that are disrupting are unlisted. Thus, the market is gravitating towards safe heavens like FMCG and non-cyclical consumer stories where the risk of disruption is lesser, irrespective of valuations.

Can you minimize this risk?

We try to evaluate how much of disruption is possible. For instance, we don’t want to be in auto ancillary companies involved in transmission/internal combustion engine as electric vehicles could be the future. We are comfortable staying in tyre, batteries or ancillaries which will be relevant despite the EV surge. We are trying to find safe heavens within that and play the growth opportunities.  There are other segments like consumer product stories which might take a longer time to get disrupted. For instance, mass market retail where the tendency to go online is not as much visible. V Mart is one such example. Footwear is another example.

How do deploy fresh capital. Do you increase the number of stocks or increase weightage in existing holdings?

We typically own 20-40 stocks in our portfolios and no portfolio has over 40 stocks. That’s a decent range to operate. It gives a good combination of stability, diversification and alpha generation opportunity. In our portfolios, each stock is an overweight position which helps us generate alpha. Even if we are sector underweight, we will always be stock overweight. Currently, we don’t feel the need to expand our stock universe to accommodate flows. Every correction brings an opportunity.

Our fund sizes are still at a stage where we can grow them without having to worry about liquidity or becoming a significant part of equity capital of any company. We ensure that our coverage list does not expand significantly. Our team tracks 300 stocks of which we own 130 stocks across different funds. If we add two stocks to our coverage list, then we make sure we drop two existing stocks from this list. We have six analysts tracking approximately 50 stocks each. Beyond a point, if we keep adding to that number the efficiency and due diligence of the analyst will drop.

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