At the Morningstar Investment Conference, Sankaran Naren, CIO at ICICI Prudential AMC, shared his views on moats during a panel discussion.
What do you need to do consistently in a country such as ours to create wealth? What is the essence of smart investing?
Warren Buffett runs the world's biggest closed-end fund. Most individuals in this room are running closed-end funds of a size which is much smaller – when they run their own money. So, a moat-based strategy will work beautifully.
The moat-based strategy has proven itself over 50-60 years. But Buffett sits on cash for long periods of time. He waited for the 2008 crisis to peak and then invested Rs 60,000 crores. He again waited for a crisis in 2011-12 to put in a lakh of crores. That kind of cushion a closed-end fund has I don't have with an open-end fund.
When you're managing other people's money, it’s different.
I'm of the view that if you look at cycles, you're in a much better shape. There are periods of time when moats work; periods of time when growth works; and periods of time when only fixed income works. So, if you're able to identify what cycle you are in and what cycle got overextended, you bet against that cycle which has got overextended and focus on what you think is likely to work. This works when you're managing other people's money.
Lets' say there is a business which has unproductive assets, the assets are – maybe a hole in the ground worth a hell of a lot of money, cash on the books, and it's trading at a significant discount to any incredibly conservative estimate of what those assets are. Would you pass those opportunities by? Special situations?
We have to have different styles. If one decided to only stick to a moat style in 2007, he would have been wiped out. If one did not have a growth without quality style, which is what worked between 2004 and 2007, he would have been wiped out.
A niche AMC can decide that it will be only in moats and will operate on a 10-year framework. But as CIO at ICICI Prudential Mutual Fund I have to create different strategies. Different strategies work at different points of time. That's the way we can move forward and it is just that we have to ensure that the customers/wealth manager understands the strategy.
Are moats always in fashion?
When managing other people's money, one must realise that everyone may not have a horizon long enough.
In my experience as a fund manager, there was a period between 2004 and 2007 where moats didn't work, but growth did. The infrastructure companies of 2007 did not have any moats. Post 2007, there was a 6-7 year period where moat-based strategies outperformed everything else.
So, you're saying it's like rising and falling hemlines. I mean, things come and go out of fashion…..
Yes. That's what Howard Marks says. If you look at the U.S. experience – most of the Nifty 50 stocks way back in the late 60s and 70s were moat stocks. They were all supposed to be quality stocks. That's why they got P/Es of 50 and 70. Today, more than 75% of them have gone bankrupt or are not in existence.
In my mutual fund career, there have been periods of time when people said only moats matter; there have been periods of time when they said only growth matters and moats don't …
Let’s say a company had an unbelievably high ROE 20 years ago, and it stayed that way over 5 to 7 years. Since then it's steadily gone down year after year after year but remains at a high absolute level. Is this a sign that the moat is breaking down?
There can be disruptions.
Let’s say I was in the U.S. and invested in Walmart. Walmart met many of the tests of moat investing. But over the last one year, its moat has proved to be brittle and Amazon seems to have just taken off in market cap relative to Walmart.
You're seeing the same thing in print media. When do you say print media is no longer a moat investment? For 40 years Buffett believed that the print media had a moat.
An advantage in India is that we can follow the global trends and developments. We see that print media has lost its moat; we see that retailing has lost its moat even when you have scale of the size of Walmart.
How and when do you identify that the moat is shrinking, coming under stress, breaking down and then relate that to what you're willing to pay? In Infosys the multiple has gone from 80 to 20.
In India, technology was disruptor to the world, but today, in 2015, Indian tech is an incumbent.
So, how strong is their moat with every quarter's results?
Frankly the sector seems to be having a much inferior moat compared to five years back, because in digital it doesn't appear that the moat is in India whereas five years back it was very clear that the disruptor was an Indian company.
I would say that we all have our own challenges and if investing was so easy, we would have converted it into formulas.
Is technology changing the way the moat has been defined? We have this new technology coming and Walmart has gone nowhere in that sense.
I guess that's why Buffett believes that it’s safer to buy a toothpaste stock because toothpastes, soaps and detergents are things which haven't changed for 50-100 years. He has been pretty reluctant to look at things which can be affected more by technology.
But I'm sure when he had Walmart or when he was invested in the print media, he never realized that some other sector technology could go and disrupt what he thought was a beautiful moat-based company.
So, I think clearly in the last three years the advent of technology has kind of shaken up the moats of sectors. If you had asked anyone in this room in 2007 whether a retailing story in India could get affected by technology, most would have said “No, there is no connection between technology other than good logistics software or good inventory tracking software.”
But so many things have changed. The way we live with our mobile phones today is so different from 2005. But go back to what Buffett says, pick the sectors which haven't changed for 100 years. Those sectors are always safer from a moat perspective than sectors which have changed every 10-20 years. For example, the car industry has changed substantially over the last 200 years. He always worries much more about those sectors.
Some believe that value investing no longer works. Evidence from 2009 to 2014-15 indicates that we have been destroyed by the franchise investor. If you did anything other than buy franchises you would have been like heap in the dust by now.
In 2007 people said to me: what’s the use of a moat? What's the use of the pharma sector? What's the use of the consumer sector?
Today, I can have a metal stock with huge reserves of, say, zinc and most of it will be in cash and people would say, how can you ever make money in this stock?
So, if you look at where we are in 2015 and where we were in 2007, we are inverted.
So your margin of safety is now in the price?
Yes. In 2007, pharma had huge margin of safety because the price was much lower.
If you think investing can be that easy that you will be able to look nice all the time, then it's not for you.
