At the Morningstar Investment Conference held this month, Raamdeo Agrawal, Joint Managing Director at Motilal Oswal Financial Services, explained to the delegates his view on alpha. Below is excerpt from his presentation.
Our equity market is all about alpha. First you beat the benchmark, beat the expenses (the expense ratio for active fund management is high) and then make some money. That’s the real alpha.
Let's start with beta.
- The benchmark is fully invested all the times. Indices are fully invested 24x7.
- It is market-cap weighted which means that elephants get the highest weights.
- Intrusions into the index happen after huge success. Unless it is Rs 50,000-70,000 crores, it is not going to break into the Sensex or Nifty. So it enters the index after an impressive success, stays there for 5-10 years, and then exits after a big failure.
Our strategy for alpha.
We are fully invested. We don’t take cash calls.
We are pay-off weighted, not market-cap weighted, not growth weighted. So growth + current valuation + what the portfolio manager thinks he’s going to relish in the future.
We enter before a huge success. Yes, success is necessary for us to look at a stock, but we don’t wait for the stocks to become very mammoth successes – after it has been included in the index. The moment we see the first signs of financial success, whether it is Rs 5,000-10,000 crores, we consider it. We aspire that most of our stocks should enter the index at some point of time, but then we definitely run from them once we see that growth has tailed off or we don’t think that it has reached our investment objective or pay-off objective of the venture.
So there is a fundamental difference the way we design the portfolio for the alpha.
Alpha is focus, philosophy, patience.
- A focused portfolio approach rather than a diversified one.
So we look at 15 +/- 3 or 4. As Buffett said, diversification is protection against ignorance, it makes little sense if you know what you’re doing. To really understand the companies in your portfolio, it is difficult to spend quality time on 60-80 stocks.
The Sensex just completed 30 years. It has delivered 13-15% compounded over this period. Add the expense ratio on top of that. To beat 16-17% is not easy.
- Philosophy is one of our most important assets.
There has to be a very well-defined investment philosophy. Past performance is no guarantee of future performance. The only guarantee is how you walk, how you select a stock, how you invest – in other words, your philosophy. Ours is QGLP – Quality, Growth, Longevity, at reasonable Price in the same order. Quality of business, quality of management, quality of growth, longevity of growth, longevity of competitive advantage, and then finally reasonable price.
The biggest trap is growth versus quality. By only buying quality, you cannot make money. You cannot beat the index. So you have to have quality and growth. If you only buy growth without quality, it won’t work.
There are 600 odd companies above Rs 2,00,000 crores. We look at the index with the elephantine-like characteristics and say why is it not moving? If you put two elephants in front of a horse cart, it won’t work. You have to put horses there.
- You need a lot of patience.
People want to time the market round the clock. I mean they literally want to time every minute, every day, every quarter. Real money is made by patience. Not so much brilliant stock picking or brilliant kind of corporate strategy. It is just patience. The guys who have had maximum patience had the maximum returns.
A couple of years ago, we launched a portfolio strategy called Focused 35. The index has moved just about 14% over this period, and we have done about 33%. The alpha has not come in one day but over a period of time. Initially it struggled. It has done the best in the worst of the times. Again alpha is expanding as the market is slowing down.
A focused and determined philosophy with untiring patience offers the best chance of delivery of meaningful alpha. No magic. No luck.
