High-Conviction Contrarian

In 2011, Mahesh Patil, co-chief investment officer of Aditya Birla Sun Life Mutual Fund, and his team were searching for contrarian bets. Post the 2008 financial crisis, fresh worries of a global economic downturn and local concerns over high inflation and policy inertia had pulled down the benchmark indices to a 14-month low in August 2011.

In those uncertain times, financials were seeing a turbulent churn. Deposits contracted in private banks but grew in public sector banks. Even the markets favoured PSU banks over private ones and NBFCs. But Patil chose to look beyond the obvious. He spotted the potential and promise in two lenders even before anybody else did. After carrying out a detailed research about Bajaj Finance and IndusInd Bank, Patil and his team met the management of the respective firms to learn about their vision and strategy. And he liked what he had found. “We were looking at companies doing something different in the financial services space such as using technology and pursuing robust risk management practices. We took a call on Bajaj Finance after meeting its top management. We saw a huge opportunity in the sector, and the company had the right processes in place to scale up. Importantly, the valuations were reasonable,” recounts Patil. He entered the stock which was then trading at 1.94x on one-year trailing basis compared to its current value of 8.76x. Bajaj Finance still is a part of his portfolio, accounting for 1.46% of the Frontline Equity Fund’s AUM. Similarly, Patil realised that the new management at IndusInd was taking steps to improve profitability and revive the private lender. In 2008, IndusInd had seen a change in the leadership team and was coming out of a turbulent phase, Patil felt it was worth having a look at it. “They were doing the right things to improve the profitability and build a CASA franchise. Not many funds owned the stock at that point of time. But we took a bet on the new management, and it turned out to be a good bet for us.” After discovering the potential of the lender, it was an easy call for Patil. The stock was trading at a price to book value of 2.96x in 2011 compared with its current valuation of 4x.

Value patience

Throughout his career in the stock market, Patil has stuck to the philosophy of betting on stocks with reasonable valuations and good growth potential. He divides his picks into two categories — contrarian calls and growth opportunities. According to Patil, a contrarian call is a stock that is ignored by the market, beaten down and with a bad near-term outlook. “We even buy cyclical stocks if we see intrinsic value — a company going through a bad cycle but fundamentally sound and cost competitive,” says Patil. Apart from contrarian bets, Patil is on the lookout for companies which have decent growth opportunity and strong management. For instance, post the global financial crisis, Patil decided to add good quality stocks such as Britannia and Godrej Consumer to provide stability to his portfolio. During 2011-12, some funds were well known consumer names and getting into cyclicals. But he and his team decided to build a position in the consumer space. “Britannia was a turnaround story which we identified quite early. There was a change in management, and there was a huge opportunity in the biscuit space. Also, the company’s margins were at historical low levels and there was scope for significant improvement,” says Patil.

And icing on the cake was that valuation was very attractive at 20x P/E with the company having good cash flow. Eventually, the bets paid off, with both Britannia and Godrej Consumer turning out to be multi-baggers. While Britannia shot up 16x, Godrej Consumer Products surged 5x, compared with 2011. Even though the current valuations are looking stretched, what with the stocks trading between 40x and 70x, they are still a part of his portfolio, albeit with a marginal presence. Britannia and Godrej Consumer Products account for 1.17% and 0.29% of the Frontline Equity Fund.

The core principles of investment — reasonable valuations and good growth — have helped Patil deliver stellar returns consistently. Aditya Birla Sun Life Frontline Equity Fund, Aditya Birla Sun Life Focused Equity Fund and Aditya Birla Sun Life Equity Hybrid ‘95 Fund — the funds managed by Patil — have delivered 18%, 17.72% and 16.81% return on an annualised basis for the past 10 years. “We have maintained a lot of discipline in the equity funds. In our flagship Frontline Equity Fund we were able to beat the benchmark index without taking any big risk and maintaining good diversity. Over the past 13 years, we were able to beat the benchmark every calendar year except one year. The strategies have worked out very well for us. Even on a quarterly basis out of 40 quarters, we were able to outperform in 75%,” says Patil with a hint of pride.

Early interest

Patil, an electrical engineer from VJTI found his fascination for stocks during his management days at the Jamnalal Bajaj Institute of Management Studies (JBIMS). “When I was studying in the college, the market saw this Harshad Mehta led bull run. Along, with a couple of friends in college, I used to invest directly in equities. We had a complete portfolio of investments,” recounts Patil. After completing his masters, in 1994, Patil landed his first job in the stock market with Parag Parikh Financial Advisory Services as a research analyst. It was an opportune time to enter into the field as several domestic and foreign broking firms were mushrooming in India. At the advisory firm, he rubbed shoulders with ace value investors. “I used to interact with Chandrakant Sampat who was an individual investor and who was known for his investments in quality and brand companies such as Gillette, Colgate, and P&G. He would often share his perspective of how to value branded companies with strong cash flows and long-term secular growth,” recounts Patil fondly. Parag Parikh was another ace investor who shaped Patil’s investment rationale. “We were focused on in-depth research, and Paragbhai used to guide us about long-term investing. He didn’t want us to chase stocks led by momentum or price action.” Patil continued his journey with Motilal Oswal Securities, where he was given the responsibility of tracking sectors such as capital goods, telecom, electrical, power, steel and utilities. Being from engineering background, he was able to predict the capex cycle and discover capital goods companies which would go on to deliver good returns. “I tracked capital goods stocks such as ABB and Siemens. Due to my background in engineering, I was able to better evaluate and understand the product range and potential of these companies. It was a boom time for capital goods companies in the late-90s. The stock recommendations which I made during those days established my credibility as a leading analyst at Motilal Oswal Securities,” recounts Patil.

After establishing his credentials, Patil joined Aditya Birla Sun Life Mutual Fund as a fund manager in 2005. Initially, he was given the task of managing Frontline Equity Fund along with the multi-cap and balanced funds. He was also responsible for tracking capital goods, telecom and infrastructure. “From 2005 to 2008 period, stocks in these sectors did very well helping the fund outperform its peers and win many accolades,” says Patil. With the Indian economy booming, the cyclical sectors such as capital goods, infrastructure and cement were doing well. “I had a good hold on these sectors since I had been tracking them as an analyst earlier. We had bagged a few winners such as Siemens and L&T, which contributed to the fund performance.” 

Tough lessons

 Inevitably, as every other mutual fund manager, Patil, too, has taken a few bad calls. In late 2016 and early 2017, he and his team decided to load up on commodity stocks such as Vedanta, Tata Steel and Hindalco. The sector was beaten down after the ‘taper tantrum’, and the market had also sharply corrected. “We found some of these large companies were at attractive price to book value. At the same time, some of the global commodity stocks such as Glencore were bottoming out. We spotted the trend early and invested in these stocks,” says Patil. However, after initially doing well in 2017, commodity stocks have been under pressure owing to global growth concerns and US-China trade war. “We continued to hold on because these companies were generating good cash flows and were deleveraging their balance sheet. But the stocks underperformed in 2018 because of global growth concerns and trade war.” And as uncertainty looms, Patil is reviewing his position in this sector looking at how China growth plays out. Currently metals and mining stocks account for 6.2% and 6.3% of Frontline Equity Fund and Life Focused Equity Fund, respectively. While jumping on to the commodity bandwagon when the macro conditions were deteriorating dented the performance of the funds, the decision to stay underweight on big index drivers such as Reliance Industries and TCS also cost Patil and his team dearly. Five blue-chip companies — TCS, HDFC Bank, Reliance Industries, HUL and Maruti Suzuki — drove 97% of the stock market’s rise till August 2018. Patil had bought Reliance at an early stage in 2017 but when the price appreciated significantly and valuations were looking stretched, he decided to go underweight. “We did not think that telecom venture will yield returns so fast. We hadn’t attributed much value to it, but the market started doing that. At the end of 2017, we trimmed our holdings, but the stock continued to outperform thereafter,” says Patil.

Similarly, he was also underweight on TCS owing to valuation concerns. “We were underweight on IT sector, and it turned big in 2018. Specifically TCS, one of the leading stocks in the sector got re-rated quite a bit and went significantly higher than its long term average valuations. We corrected our underweight when we got an opportunity to enter at a more reasonable valuation,” explains Patil. With the fund delivering a stellar performance, Frontline Equity’s corpus grew from Rs.30 billion in 2015 to Rs.200 billion. This made it challenging for Patil and his team to move nimbly. “When the fund became large, we diversified further and increased the number of stocks to manage liquidity. We had an excellent period between 2005 and 2017. But 2018 was not a particularly great year for the fund as we were underweight on some of the large index based stocks such as Reliance and TCS, which outperformed during that period. Also, the mid-cap part which is 14% of the portfolio underperformed against the Nifty,” says Patil.

Discipline and focus

But these are mere ups and downs, and the underperformance of some of his funds in 2018 has not perturbed Patil. He plans to stick to his philosophy of taking contra calls and sticking to long-term winners. And if certain index stocks are denting the performance, he won’t shy away from betting on them. Currently, most of the funds managed by Patil — except Aditya Birla Sun Life Pure Value Fund — are overweight on the financial sector. For instance, he has given more than 10% allocation to HDFC Bank and ICICI Bank in Aditya Birla Sun Life Focused Equity Fund and Aditya Birla Sun Life Frontline Equity Fund. Currently HDFC Bank and ICICI Bank trade at price to book value of 4.27x and 2.3x, respectively. He has turned positive on corporate banks. Patil has not only increased allocation to ICICI Bank but has also added Axis Bank to his kitty. “Six months ago, we took a call that NPA cycle has peaked out. The reforms, which have taken place with Insolvency and Bankruptcy Code (IBC), are working well. Some of the large NPAs have been sorted out, and that will help to reduce pain on the balance sheet. And these banks have a change in leadership which has also infused confidence. With incremental stress coming down, there will be an improvement in core profitability of the banks over the next two years. Valuations are also very reasonable and below their long-term average,” says Patil. Apart from the financial sector, Patil is also betting on the consumer segment. He had bought Britannia and Godrej Consumer at 25-30x P/E in 2012 and continues to still hold on to them. “We like India’s consumption story because of long-term stable growth driven by favourable demographics, urbanisation and premiumisation. The companies which we are betting on, have got strong moat and will continue to outperform their category” says Patil. He is also positive on consumer discretionary (consumer durables) because of low penetration, shift from unorganised to organised and rising per capita income. Stocks such as Titan and Crompton are some of the key picks in the segment. He is taking a contra bet via NTPC and Coal India. He sees value in beaten down PSU stocks and believes that utility stocks are well placed to grow. With valuation support and decent business model, they provide stability to the portfolio generating absolute return. With an eye on short as well as long term, Patil continues to remain bullish on financials and consumer segments. Last year was tough for most of the mutual fund managers, including Patil. But he is confident of making a comeback as he has done often in the past. “There are periods when we underperform, but we make a comeback. If you look at five-year or 10-year performance of the fund it will be best in that category despite the recent underperformance,” says Patil.