This article has been written by Larissa Fernand, Editor of Morningstar.in, and Himanshu Srivastava, Senior Fund Analyst.
End 2015, when we decided to maintain our Gold rating on Prashant Jain’s funds, we faced severe criticism pointing to our “faulty judgment” in the face of the poor performance his funds put up that year. (Why we continue to believe in HDFC Equity and HDFC Top 200).
Whether a judgment is worthwhile cannot be known with certainty when making the call. But the ingredients for good judgement can be defined. And Prashant’s disciplined and rational approach to investing did have the virtue of reasoned logic, which convinced us to hold onto our rating.
Prashant is not contrarian for the sake of being contrarian; rather his stance is a derivative of his strategy. He always looks to buy reasonably managed businesses, of reasonable quality, which offer relative or absolute growth. But if he finds those stocks’ valuations out of whack with fundamentals, he opts out of the party.
In the late 1990s, he and Chandresh Nigam (now CEO at Axis Mutual Fund) were pilloried for passing by technology stocks and focusing on old-economy stocks. A brazen move, after all those who dared to do so saw their funds trail a market fueled by schizophrenic valuations.
In 2007, he decided not to own real estate or power utilities but purchased FMCG, pharmaceuticals and automobiles.
In the very recent past, he was constantly being asked to justify his stance in State Bank of India. Prashant believes that SBI is a high-quality business – solid retail franchise, stable market share, leadership position in a growing market. Despite being convinced of his hypothesis and boldly consistent too, he had to take it on the chin with regards to timing.
The sharp fall in steel prices in 2015 impacted bank stocks due to the large exposure of banks to this sector. (As of September 2015, the steel sector accounted for 21% of total number of corporate debt restructuring cases and the sector's share in total stressed accounts of scheduled commercial banks was 10-11% - Business Standard). Prashant hung on because he believed that the market was pricing in 100% loss ratios for the steel loans, which he did not believe was the case.
There is a fine line between rigidity and conviction, and many feared he was falling in the former category in his love for PSU banks. But he claimed that he found no merit in the argument on the possibility that PSU banks would lose market share to private banks due to the impact of NPAs.
Here is a summation of his thought process:
- Market share is less important for a bank as compared to balance sheet strength and profitable growth. Nevertheless, larger public banks have not lost any significant market share.
- Large PSU banks are sustainable and growing businesses that are undergoing pain due to asset quality challenges leading to depressed valuations. The pain of asset quality has turned out to be similar in private corporate banks compared to their larger public counterparts; it’s just that the public banks recognised the pain earlier.
- The stress is being resolved by asset sales. Many of the stressed groups are cash poor but asset rich. One has to thus differentiate between NPAs and ultimate loss. NPAs are an accounting entry, loss is permanent erosion of capital.
- An improving economic outlook, falling interest rates and high focus of government, central bank and lenders to resolve the NPAs will improve things steadily.
Evident in his strategy is how effortlessly he combines the top-down and bottom-up view when arriving at his investment thesis. He believes that the Indian market operates on the basis of cycles with clear sector leadership.
- 1995-2000: Infotech was the sector leader
- 2001-2007: Capex, Banking, Commodities
- 2008-2015: FMCG, Pharmaceuticals, Automobiles
The past few years were characterized by a weak capex cycle, high inflation, high current account deficit and a depreciating currency.
Prashant believes that the next cycle will be led by a recovery in capex, lower inflation, lower interest rates, lower current account deficit, stable currency, peaking NPAs, and depressed margins in corporates impacted by the slowdown in capex will recover smartly.
With that in mind, he shifted his portfolios closer to capex-related businesses. The sector leaders for this cycle would be corporate banking, metals and mining, and industrials.
As an investor, bear in mind that Prashant thinks long term and attempts to do so ahead of the market. So even if you are in complete agreement with his investment hypothesis, be prepared to undergo some amount of pain as he waits for his bets to play out.
Prashant Jain is the executive director and chief investment officer at HDFC Asset Management.
He manages two funds – HDFC Top 200 and HDFC Equity, each given a Gold rating by senior fund analyst Himanshu Srivastava.