Over the past two years, mutual fund managers had to navigate through two significant structural changes — Good and Services Tax (GST) and demonetisation. Following these, the micro environment improved mildly, but macro headwinds such as rising interest rates and crude prices were troublesome. Very few mutual fund managers managed to tide over volatility and deliver return. Among them is Shreyash Devalkar, fund manager of equities at Axis Asset Management, who is a stickler for quality and growth. He took charge of a fund that was spiralling down and turned it around by taking a contrarian call.
After the Narendra Modi-led National Democratic Alliance (NDA) took charge with a majority in 2014, a broader market rally took off between 2016 and 2017. But since the start of 2018, as the market went southwards, the focus shifted towards quality. Devalkar-managed Axis Bluechip Fund’s allocation and stock selection made for a perfect shelter to weather the stormy period. By picking high-quality growth stocks that are less susceptible to market volatility, Devalkar’s Axis Bluechip Fund has been able to protect investor monies and, at the same time, deliver 13.21% annualised return in three years.
Before Devalkar took over, between 2013 and 2016, Axis Bluechip gradually slid from the first to second, then to the third and eventually to the fourth quartile in terms of return. But post demonetisation, which sent shock waves throughout the financial sector, Devalkar’s investment call turned around the fortunes of the schemes — Axis Bluechip Fund, Axis Multi-cap Fund and Axis Mid-cap Fund. His decision to go overweight on financial services stocks such as HDFC Bank, Kotak Mahindra, HDFC and Bajaj Finance paid off.
Over the past two years, while the stock prices of HDFC Bank and HDFC have gone up by 70% and 59%, Kotak Mahindra Bank and Bajaj Finance’s share prices have increased by 58% and 179% respectively. “We took a call believing that financial services will benefit as more liquidity will find its way into the organised sector. And that’s why the exposure was taken, and now it remains,” says Devalkar.
Contrarian rewards
Devalkar’s investment rationale stands on four pillars — competitive advantage, sustainable growth, cash flow generation and a strong balance sheet. And according to Devalkar, his picks in the financial services sector tick all the boxes. “This is the only sector which is delivering on market expectations, which are relatively high commensurate to valuations. It’s seeing good growth and generating a high return on equity (RoE). We have a higher exposure to retail focused banks and non-banking financial companies (NBFCs) as we prefer B2C companies,” says Devalkar.
He isn’t afraid of taking large positions in high-conviction bets, with the aim of delivering greater outperformance. Apart from Axis Bluechip Fund, which has exposure of almost 39% to financial sector, Devalkar has allocated 37% to the sector in the Axis Multi-cap Fund.
Even as the valuations continue to rise, Devalkar sticks to his bet. In November 2016, at the time when Devalkar joined Axis Mutual Funds, HDFC Bank, HDFC, Kotak Mahindra Bank and Bajaj Finance were trading at the price-to-book value (P/BV) of 4.27x, 3.59x, 3.96x and 6.55x compared to 5.24x, 3.81, 4.33x and 8.34x currently. “It’s not only about absolute valuation. But it is about valuation for the right quality and growth. If there is a mismatch then only you have a sell call,” he says.
With the financial sector showing signs of improvement, others in the mutual fund industry are taking a cue from Devalkar. Several funds are betting on this sector now. Mutual funds hold 5.78%, 4.73% and 3.49% weightage in HDFC Bank, HDFC and ICICI Bank respectively.
Along with retail banks and NBFCs, Devalkar is also betting on corporate banks such as ICICI Bank. He believes deterioration of asset quality is behind these banks and they are finally getting their act together. A stickler for quality, he states that corporate banks’ RoE is improving, making them an attractive bet. “We are very particular about quality. Some of the corporate banks have RoE less than the cost of capital. If RoE is less than cost of capital we generally tend to avoid such stocks. Now, in some cases, there are chances that RoE will be greater than the cost of capital. If RoE is more than cost of capital, then obviously you will make money,” he says.
While he is bullish on corporate banks, Devalkar steers clear of public sector banks, which are trading at a cheaper valuation and prefers to stick to private sector banks and NBFCs where the asset quality is better.
He is also bullish on IT stocks, which account for 10-11% of the holdings as of December 2018. “There are several reasons to be bullish on IT such as US economy is doing well because of that top line growth is good. On top of that there is rupee depreciation,” he says. In Axis Multi-cap Fund, as well as Axis Bluechip Fund, Tata Consultancy Services (TCS) is one of the top ten stocks in the respective portfolios.
Sticking to investment rationale of choosing good growth stocks despite higher valuation, Devalkar has chosen to go with TCS instead of Infosys despite the former trading at a higher valuation and the bet paid for him with TCS delivering better results.
Apart from his successful bets on financial and IT stocks, Devalkar’s participation in initial public offerings (IPOs) such as of Avenue Supermarts and Endurance Technologies has helped his funds deliver superior return. Since listing, Avenue Supermarts and Endurance Technologies have gone up by 125% and 89% respectively. While some of these stocks did well immediately after hitting the bourses, he asserts that he doesn’t subscribe to IPOs merely for listing gains. “We selectively look at IPOs in niche businesses with sustainable business models and long-term growth potential. We hold several high quality names across businesses that were bought during IPOs.”
Learning curve
Before entering the world of stock markets and taking on the mantle of a fund manager, Devalkar worked in different sectors including engineering. After completing his graduation in chemical engineering from UDCT College (now Institute of Chemical Technology), Mumbai, Devalkar landed a job with Larsen and Toubro as a project manager in 1999. The learnings from his first job have helped him select stocks in the engineering space. “After working with an engineering and construction company, you tend to appreciate what is value addition in the sector. It helps when you have gone through the process, in appreciating the ability of a company to add value, its competitive advantage, and then assigning the right relative valuation for the same,” says Devalkar.
Taking a leaf from his past experience, he believes that the capex cycle is not in the favour of the industry. Deciding to take only a marginal exposure to the engineering and construction sector, Devalkar says that between 2002 and 2008, the capex cycle was driven more by power, metals, mining, oil and gas, which required heavy engineering equipment and complex project execution skills. “Execution of which has better return profile, since there is a lot of value add. Hence, the companies fetched a higher multiple then. In the current cycle, capex is being spent but it is happening in industries where the scale and complexity of the capex are much less. Hence, this time, our portfolio’s exposure to the sector is only marginal,” says Devalkar. In Axis Multi-cap Fund, he has allocated only 1.71% to Larsen and Toubro.
After his two-year stint at one of biggest engineering firms in India, Devalkar decided to get an MBA in finance from Jamnalal Bajaj Institute of Management Studies. Following that, he decided to venture into finance and bagged a job with the Saint-Gobain group. He then moved to Calyon Bank and JP Morgan, where he was a credit analyst between 2003 and 2005. “As a credit analyst, you learn to focus on cash flow and critically understand sensitivity of variations in them on the debt servicing capability of a company. I understand why value of businesses that can grow without raising capital is higher than the ones that always need debt for growth. You would have noticed that companies in my portfolios are very low on leverage. These things you learn from a high focus on cash flows and internal generation of funds, for fuelling growth.”
In 2005, Devalkar got his first job in the equity market with SSKI Securities, which was taken over by IDFC. He says he owes a large part of his success to his learning as an analyst at IDFC Securities and IDFC Mutual Fund, where he tracked a range of sectors such as oil and gas, pharmaceuticals, engineering, IT, and telecom.
“More sectors you track as an analyst it’s better for you. As an analyst, one goes through the nitty-gritty of many sectors. I have worked on both sides — a broking company and a mutual fund house tracking different sectors. Generally, you tend to look at sectors bottom up, in-depth, and learning about them in detail helps build an overall perspective,” he opines.
In fact, he believes ‘fund manager’ is merely a tag. He still carries out tasks that an analyst does on a daily basis. “I have worked as a credit analyst, sell-side broking analyst and equity analyst – all of which has helped in shaping my investment philosophy.”
Bucking trends
It’s not only the large-cap space in which Devalkar has made his name, even the Axis Mid-cap Fund managed by him also has an enviable track record.Over a three-year period the fund generated a return of 12.49% outperforming the benchmark Nifty Mid-cap 100.
While his rationale when picking small and mid-cap stocks remains the same, Devalkar spends more time researching about this space. “The process for large, mid and small-caps is the same. The only difference is that for small and mid-caps you have to do a lot more due diligence. As a fund manager, I spend more time on my mid-cap and small-cap companies as they are not well researched. A significant amount of information is available on large-caps as more analysts are working on researching these stocks.” He adds that he meets mid and small-cap companies’ managements before taking a call since it is important to understand the promoter’s vision, management bandwidth and value addition done by the business.
Even in the mid-cap space, Devalkar has decided to stick with financial services followed by consumer goods and industrial manufacturing. While he has allocated 27% to financial services, consumer goods and industrial manufacturing account for 11.91% and 10.28% respectively. NBFCs such as Gruh Finance, Mahindra & Mahindra Financial Services and Bajaj Finance make up almost 12% of the fund. And despite the NBFC space losing steam due to a liquidity crunch, an unperturbed Devalkar states that the recent correction only provided an opportunity to buy and he is unwilling to change his stance on the space. “During demonetisation, asset quality of retail-based NBFCs got tested. But many NBFCs emerged unscathed due to superior asset quality. During the liquidity crunch last year, the companies were severely tested. Barring some of them who had to grapple with a huge ALM mismatch, the rest came out clean. These events helped in separating the men from the boys in this sector.”
Value Traps
Devalkar’s recipe for success has been simple — stick to quality and avoid value traps such as public sector banks and pharma. “I only took a marginal position in pharma in 2017 because it was undervalued. The US generics space wasn’t doing well, and hence we focused more on domestic companies,” he says.
He prefers price-to-earnings growth (PEG) over absolute P/E. This is because Devalkar picks a stock only if he believes its growth will compound irrespective of valuations. For instance, if a company is trading at 20x P/E with 10% growth and another company is trading at 40x P/E with 20% growth. The PEG of both companies is 2x, but Devalkar would choose the company with a higher P/E multiple. “Just because absolute P/E is lower, we would not end up buying it. Growth matters more than absolute price to earnings multiple. There can be one or two lacklustre years but if there is enough room to grow, then the numbers will catch up in the next year.”
During the recent IL&FS crisis, Devalkar’s investment rationale faced its litmus test and he managed to come out with flying colours. The financial services stocks in his portfolio, with strong asset ALM practices and prudent norms, withstood the market onslaught and emerged stronger. And, as the market continues to move towards quality stocks to weather the bouts of volatility in an election year, Devalkar could just turn out to be Mr. Dependable.
