India's Best Fund Managers 2020

Atul Bhole, DSP Mutual Fund | India's Best Fund Managers

DSP Mutual Fund’s Atul Bhole does not shy away from expensive valuation because the best don’t come cheap

Faisal Magray

Back in 2014, a TV commercial showed a man ignoring his wife’s order to step back into the house. Instead, he prefers to sit out and read the weather report. As luck would have it, the weather prediction for the day shows temperature soaring, low-pressure resulting in a hurricane followed by torrential rain and dust storm. Subjected to such harsh weather conditions, the man is left covered in grime and muck. However, his house continues to look as bright as new, thanks to an all-weather paint from Asian Paints. The ad, in a way, points to Atul Bhole, vice president, DSP Mutual Fund’s (DSPMF) stock buys — quality that does not crack, come harsh sun or rain. 

A man of few words, he makes each one count. Quality remains the cornerstone of all his bets, he says, regardless of the valuation or macro-economic factors. For this, he does not mind paying a premium if it will help him in the long term. “I strongly believe in what veteran American investor and fund manager Peter Lynch said, that good companies always surprise you positively,” says the fund manager.

This approach has clearly augured well for this connoisseur of ‘expensive’ stocks, who handles three funds at DSPMF — Equity Fund, Equity & Bond and Dynamic Asset Allocation Fund. The first, which he started managing four years ago, is well-diversified, has an AUM of Rs.30.20 billion and has delivered 9.38% CAGR return over the past five years. All three have been consistent outperformers, managing to beat the benchmark Index return, and consequently, catapulted Bhole into the league of India’s Best Fund Managers.

Upward trajectory

Coming from a working-class background, Bhole did not plan to enter the high-stakes game of investing. As a student in Jalgaon, a district in Maharashtra, all he wanted to do was pursue commerce. He moved to Mumbai in 1995 and began his foundation course for chartered accountancy while pursuing B.Com. But during his articleship, he realised that accounting alone could get monotonous and decided to pursue the more exciting MBA in Finance from the prestigious Jamnalal Bajaj Institute of Management Studies. 

It was here that he found his calling and Bhole knew that he wanted to be in the capital markets on the equity side. His first big break was at State Bank of India, where he worked as an equity research analyst in 2005. A year later, he joined Tata Asset Management as an analyst tracking banking, telecom and IT. Within four years, he became the fund manager. “Not much changes after becoming a fund manager. Even today, I spend 90% of my time thinking as an analyst and only 10% as a fund manager thinking about portfolio construction, changes or execution,” says Bhole, who then moved on to DSPMF in May 2016. Today, it is his middle-class upbringing that he partly credits for his single-minded focus on quality. “From the beginning, I have always been averse to making a loss,” he quips.

The 22-year-old fund managed by Bhole is a multi-cap equity fund, in which large-caps comprise a whopping 73.4%, followed by mid-caps and small-caps constituting 19.6% and 7%, respectively. “Last year, I was not getting a lot of mid-cap ideas and the space was challenging. So, I increased my exposure to large-caps. This year, I am again looking to increase my mid-cap exposure,” he says. The mood towards mid-caps has not been too upbeat over the past few years, especially after they ran up considerably till 2017, but Bhole believes, with expansionary monetary and fiscal policies, “capable businesses will get accustomed to new way of doing things and reap the benefits.” However, he will stick to sectoral winners and keep 65% of the assets under management (AUM) in large-caps. “When any company improves its competitive positioning meaningfully, its valuation looks very high in near term. Its numbers may not capture the structural change, but the market in its collective wisdom does,” he adds. 

Financial, construction and healthcare sectors constitute about 58.59% of the total fund. In fact, financial sector comprises 41.09% of his multi-cap portfolio. “I continue to remain bullish on bottom-up stories from financials and consumer side of the market, but even within financials, you will not see any public sector banks. It is mostly private banks, NBFCs and insurance companies. These can continue to grow at much better rate than nominal GDP,” says Bhole. He is also looking to increase exposure to pharma and cement sectors, which amount to 7.72% and 5.98% of his total portfolio. “Most of the [pharma] companies in my portfolio have strong India business that contributes to majority of the profit. The drag from US businesses in terms of high R&D and plant remediation expenses are also coming off,” he reasons.

The filter 

Quality does not come cheap and Bhole does not mind. For instance, even when Bajaj Finance was trading at a steep price-to-book value (P/BV) of 5-6x three years ago, he invested in the stock. His call proved right with the company’s earnings compounding by 50% each year and, subsequently, the stock growing at 66% CAGR for the past three years. While many NBFC players witnessed de-growth and liquidity crisis, Bajaj Finance gained market share by finding pockets of growth and expanding presence across urban and rural India and also offering new products. It currently trades at Rs.4,650 and constitutes 9.02% of his portfolio. Similarly, he also bet on Avenue Supermarts, which had earned the moniker of being the world’s most expensive retail stock. Trading at a price-to-earnings (P/E) ratio of 88.68x on trailing basis in 2017, its rich valuation raised eyebrows. However, Bhole began accumulating the stock between Rs.600-1,000. Within two years, the stock, making up 2.89% of his fund, has more than doubled to Rs.2,280. 

Besides Bajaj Finance and Avenue Supermarts, he has also invested in Asian Paints, which has been a part of the portfolio since 2016 and currently trades at 47.6x P/E for FY21. It constitutes 3.45% of the fund and in the past three years, the stock has risen at a CAGR of 22.44%. 

“Some consider even 20x valuation expensive and risky. In comparison, my companies trade at valuations of 40-50x. However, I am confident about their quality. So, I am neither worried nor do I feel what I am doing is risky,” says Bhole. He says his strategy is simple, even captured in an acronym — BMG. It stands for three filters, Business, Management and Growth. 

In the first, he ensures a detailed study of the company’s balance sheet, with special emphasis on their cash generation, return on capital employed (RoCE) and return on equity (RoE). He steers clear of companies that keep raising capital. He believes a company should grow with the help of internal accruals. “While dilution brings in growth, the number of shares also keeps on increasing. As a result, earnings per share (EPS) does not go up,” he says. In the second, he relies on the integrity and competency of the management. “I ask the management what is under their control — what they are doing, what the competition is doing and how they can respond to competition or market. There is no point asking them about things that aren’t under their control — like the economy or the demand scenario,” he says. In the third, Bhole studies a company’s growth possibility. For this, he relies on company and industry reports, and discussions with other sector analysts. “Visibility of growth ensures return over a period even if one has to pay slightly higher in the beginning. Over the past 15 years, this belief has strengthened as I saw so many businesses fail. They were priced very attractively, but had growth issues,” he explains. 

Essentially, he adds that he is banking on the sustenance of business momentum and compounding of profit to get healthy return. If a company makes it through all three filters, Bhole does not bother about valuation. 

His confidence in this checklist led him to Aavas Financier, a stock that would have had any value investor think twice. Post the IL&FS crisis, NBFCs suffered the most from the liquidity squeeze. Investors were fleeing this space and taking shelter in big financial firms. That’s when Aavas Financier listed, in 2018, with a high valuation of 2.14x P/BV. Undeterred, Bhole bagged the stock and kept on adding — it amounts to 1% of his portfolio today. The stock has since risen multi-fold from Rs.800 to Rs.2,000 on the back of robust loan growth, stable asset quality and low gross NPA at 0.6%. Today, it trades at an expensive P/BV of 7.4x. 

Bhole says that often, cyclical and value stocks fall like a pack of cards under a negative development, however minor. “That doesn’t happen with high quality stocks. They mostly time-correct and fulfill the first principle of investing, which is not losing money,” he says. The BMG filter also keeps him away from cyclical sectors such as oil, gas and metals. “They often do not have a good business model or strong management. They grow for two to three years and then don’t perform well for the next five,” he states. 

Such sectors, including infrastructure, which are dependent on policy announcement, call for a top-down approach. But Bhole swears by bottom-up. This ensures that he has companies that can deliver growth even when the environment gets challenging. It is a lesson he learnt the hard way. In 2017, prompted by the announcement of huge investment in the sector, he invested in three infrastructure companies. “I chose good companies within that space. However, the call didn’t go right,” he recalls. Government’s failure to execute, weakening economic growth and land acquisition cost were among the primary reasons. “Fortunately, I could exit at the right time, by end of 2018, and avoided a loss,” he adds.

That said, Bhole likes cement as a play on India’s infra and real estate story. “Due to their cleaner business models [compared to infra and real estate], cement companies provide an opportunity. The sector is also benefitting from better cement prices and benign raw material prices,” he adds. For instance, he invested in Shree Cement, which makes up for 2.17% of his equity portfolio. The company has managed to grow despite a turbulent market. While the cement industry has been seeing volume growth of 5-6% over the past decade, Shree Cement has reported 13-15% volume growth, double the industry average. It did that by steadily increasing capacity while controlling operating expenditure. The stock trades at 13.5x estimated FY22 EV/EBITDA and analysts expect it to see sustained growth in the coming quarters.

Meanwhile, though management gurus insist on diversification, Bhole is wary of it. “When a company or management seeks multiple businesses, they lose focus on the core business and it degrades,” he says. Plus, diversification also means capex, a long gestation period and possible accumulation of debt. Bhole likes sticking to companies that use cash and profit to strengthen their core. For instance, TCS, which forms 2.62% of his portfolio, generates plenty of cash every year that it hands out as dividend. Similarly, Relaxo only focuses on selling footwear under its brands Relaxo, Flyte and Sparx. The company has been growing at 15-20% every year since 2011 except in FY17, and Bhole added that stock to his portfolio last year. 

Tackling turbulence

While 80% of his portfolio satisfies the BMG checklist, he shares that 15-20% is based on tactical ideas. This is where he takes risk and it is here that he needs to know when to leave. “If we don’t see growth for three to four quarters, we exit. For core companies, we wait it out for longer,” he says.

For instance, DSP Equity Fund picked up Eicher Motors in January 2017. But, the company seemed unlikely to sustain volume growth in the long term, so the fund walked out. The stock was already under pressure at the start of 2018, and has fallen from Rs.29,000 in January 2018 to Rs.20,000 in January 2020. Similarly, in May 2018, they picked Nestle India near Rs.7,500, but sold it in September 2019 after it almost doubled, as rising food and milk prices could likely dent margins and profit. Even though they got out with a considerable profit, Nestle India has continued to grow and the stock currently hovers near Rs.15,000. 

Cautioning against looking for cheap value, Bhole shares one more experience of investing in a tyre company. He says that it had a strong brand and distribution network. “Since the company was executing sizeable capex plans for long, I thought the capex would be completed sooner than later,” he recalls. He hoped that the company would start generating decent cash flow and deleverage its balance sheet. But none of that panned out. “I ignored the fact that no tyre company can afford to lose market share and hence, they would be forced to keep on spending in new capacities even if internal accruals don’t permit it,” he says. Bhole booked a small loss, but doesn’t regret exiting the stock, which he says is trading lower than his exit price even after a year.

Another chink in Bhole’s smooth track record is Arun Kumar-promoted Strides Shasun. In 2016, the company decided to exit branded generics in India, undertook multiple restructuring and started seeing dwindling sales in its institutional business. That led to depressed earnings and margin, and the stock fell by 60% in Bhole’s portfolio. “I didn’t exit immediately… After the big loss, I kept waiting for a slightly better price to exit, but that didn’t happen, and it was a mistake,” he says. 

Despite the hiccups, it is evident that Bhole’s weather-proof strategy is ideal for these uncertain times. His sector allocation may keep fluctuating, but his focus on quality will not waver. He adds that he is not against value investing and respects some of the most prominent value investors, but believes one must identify their strengths and play with those. To that effect, quality and growth are his. “We need quality companies. Globally, growth is scarce, interest rates are low and market participants have become discerning over the past two decades. Takers for cheaply valued companies are few,” he says. This is the time to chase real value and not cheap buys, Bhole insists.