7 questions for PPFAS

Sep 25, 2020

Rajeev Thakkar, the chief investment officer at PPFAS Mutual Fund, shared his insights during a webinar with Morningstar.

Here is an excerpt from the interaction.

  1. How do you navigate a turbulent market?

Let us say that Rip Van Winkle went asleep on February 1, 2020 and woke up today. Would he call the market turbulent?

When you are too close to the market, when you check stock prices day-to-day, you internalize the volatility. If you evaluate your portfolio every 6 or 12 months, it is less scary.

Zoom out. Reduce the news flow which can get overwhelming. Stepping back helps you think calmly and make rational decisions.

If you lost sleep in March or April, then probably you are overweight in riskier asset categories and you are taking on more risk than you can stomach. Proper asset allocation helps you withstand such turbulence.

There are sectors getting thrashed. But in the ecosystem, there are winners too. As one loses, another gains. A lot of the trends we are currently witnessing were gaining ground earlier. The pandemic has just accelerated their progress. Ecommerce. Cloud computing. Work from home. Digitilization of various businesses.

  1. How do you navigate stocks?

Focus on the balance sheet and not just the P&L account.

Beware of leverage.

There has been a polarization of the market. A small set of companies are driving the indices higher. It is increasingly becoming a winner-takes-it-all marketplace for businesses. In a sector, 1 or 2 or 3 players corner a disproportionate share of the revenue or profits. For example, in the cell phone market, the market share of APPLE may not be high in terms of number of phones sold, but the profit share is disproportionately higher.

Investors are betting on companies that they believe will come out the pandemic intact and gain market share.

Why Rajeev Thakkar does not care for dividend paying stocks

  1. How has your concept of value changed?

When Benjamin Graham started off, it was in the post-Depression era when businesses were available at throwaway prices, at less than cash on balance sheet. Picking up stocks based on the cheapness of the company worked well during that era of depressed prices.

Warren Buffett started off similarly but moved to a qualitative style of investing.

When academia defines value, they typically look at one measure of value - book-to-market, the reverse of the price-to-book ratio. They look for low PB stocks. But with inflation, book values have stopped being comparable. A company founded 50 years ago will have a different BV from one founded last year. Market values will be different too.

In a traditional, statistical, cheapness approach you are dependent on a catalyst to unlock value. This could come about due to shareholder activism, very common in the U.S.

Some businesses are asset light so the return of capital can be very high if they have a proper addressable market. On a small asset base, they can grow their businesses dramatically. Google, Microsoft. Asian Paints. These are some examples.

The concept of margin of safety and equity being the ownership of a business continues from Graham, but the main focus is now on cash flows and future earnings prospects rather than BV.

Cost of capital in today’s world is very different from the cost of capital many years back. The Discounted Cash Flow has a discounted rate for a bond or equity share. What is the cost of capital today? In the mid-90s, government bonds were trading at 14% per annum. It is now 6-7%. A big portion of sovereign bonds globally are giving negative yields today. 10-year U.S. Treasuries are somewhere around 0.7% levels. So we cannot go by past valuation metrics. Those PE ratios will be eliminated in a low capital cost world. While we must be aware of the environment that cost of capital is low, we must be careful not to buy into froth. So margin of safety and permanent loss of capital must be considered.

  1. How do you view your global allocation given that the U.S. tech space is overvalued?

The objective of a global allocation is NOT to time or predict which market will do better. The reason to have a global allocation is to reduce portfolio volatility. And scout for opportunities not available in India.

Flipkart was incorporated as an overseas company and now owned by Walmart. Make My Trip and Yatra are listed in the U.S. market. Uber and Ola. These are emerging items of consumption not listed in the equity space in India.

To say U.S. tech space is to use a very broad brush. If you look at Microsoft, Alphabet and Facebook, they are 35 times earnings. So not nosebleed valuations. But other companies with start-up characteristics in the tech space, either loss making or miniscule profits, have stratospheric levels of valuation. We go stock-by-stock. We look at certain trends too - cloud computing, work from home, e-commerce, streaming media consumption.

When we look at opportunities abroad, we look at sectors and companies not available in India; our aim is to add to diversification. We would not buy traditional businesses abroad, such as a bank, as there are options here.

Are NASDAQ stocks really overvalued?

  1. How do you view the pharma sector which has done extremely well but your allocation is very low?

We have had a mix of pharma companies, but the total weightage has been a maximum of 7% of the portfolio. It is an attractive sector. However, there are higher risks too with regards to products and companies: FDA actions, import alerts, ban on certain plants, molecular price wars, side effects discovered on a drug resulting in withdrawal of approval or doctors not prescribing it anymore. That is why we prefer 5-6 companies with small weightages, but no high-conviction single company investments.

We run only one equity scheme, the other being an ELSS. Multi-cap fund has always had less than 30 stocks. We could choose any category such as a focussed fund category. But we will keep the investment mandate and current investors in mind.

  1. How do you view ESG – Environment, Social, Governance metrics?

We do not have a formal ESG mandate, but these factors are at the back of the mind when we evaluate a business. Let’s say a coal miner is attractively valued. A pure ESG fund would bypass it. But if we invest in such a stock, we would be aware that the business is short lived and won’t have a future in a world moving towards renewables. If we did invest in it for whatever reason, the weightage would be low. But we do prefer to be on the right side of ESG.

  1. How do you view the Covered Call strategy?

The attempt has been to keep the mandate flexible to avail of opportunities.

Last year, we amended our offer document to permit us to invest in REITs and InvITs.

This year we enabled the writing of Covered Calls.

In June and July, due to the heightened volatility in March and April, the option premiums shot up dramatically. Some were giving a monthly yield of 4%. So occasionally, there are mis pricings in the options market. And we would like to avail of it when that happens. It is incidental to the overall process not the main component of what we do. We will use it occasionally, if at all. And even if we do, it will be to a very small portion of our portfolio.

You can read this much more in detail in What the Covered Call strategy in PPFAS’s fund means.

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