How to select equity mutual funds the Eighty Twenty Investor way – Part 2

In the last post here, we had selected fund managers for the value bucket.

Now we are left with the blended bucket and growth bucket. So, let us pick fund managers for these buckets today.

Picking fund managers for the quality/growth bucket

1.Axis Mutual Fund – Jinesh Gopani – Axis Focused 25

Axis MF in all its external communications have highlighted their quality & growth bias (vs say an ICICI where contrarian/value is the predominant bias)

While quality is a vague term, this is how they try to define it:

In their recent note Quality Matters (link), this is how they describe their investment philosophy

• Strong corporate governance/Strong promoter pedigree,
• Secular growth rate of the sector, which is anywhere around 1.5 to 2x of GDP;
• Strong business model, which demonstrates its pricing power in the product category and the business it is in, and ultimately
• Good ROE’s and cash flows

About 80% to 90% of our portfolio is based on this philosophy and have been continuing with it since our inception in 2009.

The key to note here is there is no mention of valuations. Usually most AMCs would have added the line that “we also buy quality and growth at reasonable valuation”!

It gives us a subtle indication of where their priorities lie.

Let us also hear it from their fund manager Jinesh Gopani..

“We concentrate on high quality stories with a long term view as such stories are able to sail through market ups and downs while containing volatility. We tend to stay away from any momentum or hope stories without any support of underlying earnings or fundamentals. Adding to that, we have always stayed away from highly cyclical and highly regulated sectors or stories. Market has rewarded our philosophy and helped us earn superior returns.

Source: https://www.valueresearchonline.com/story/h2_storyview.asp?str=45972

Similar to value investing, long term evidence supports outperformance for quality driven investing as well.

What is his investment style?

• Quality + Growth Bias
• Valuations take the last priority
• Concentrated portfolio (Top 15 stocks account for 70-75% of the portfolio)
• Buy and Hold

Wow Factors

• He really tends to buy and hold – (around 65%+ of the Axis Long Term equity portfolio stocks are held for more than 5 years)
• He sticks to his style – The quality bias is evident even if you cursorily glance either Axis focused 25 or Axis Long Term equity portfolio (both are managed by Jinesh)
• Since it is a concentrated portfolio it is easy for us to track and understand the portfolio

Performance across market cycles

Performance has been consistent and decent across time frames

However, Axis long term fund was started only in Dec-2009 and hence hasn’t gone through the bear market of 2008.

Communication

They have a nice website here where most of the details regarding their funds and investment philosophy are available.

Concerns

• Jinesh has been managing Axis Focused 25 fund only since Jun-16. His performance track record has primarily been built via the ELSS fund Axis Long Term Equity Fund (managing since Dec-2009)
• The fund manager is yet to be tested in a bear market
• Valuations of several underlying stocks are pricing in very high expectations such as Avenue Supermart, Page Industries, Maruti, Bajaj Finance etc (subjective opinion of course). Personally, I feel overvaluations can be the biggest risk to this investing style.
• The style is currently in favor. Need to evaluate how they adapt when the style is out of favor.

My View

• This fund will fit perfectly in the quality/growth end of the style spectrum
• While it is not fair to evaluate a fund by taking a view on the underlying portfolio stocks, since I have an inherent value bias some of the valuations of these quality names make me very uncomfortable
• That being said the good thing is that they have followed their investment philosophy to the tee and stuck to quality names despite high valuations
• The fund manager is yet to be tested over a bear market and this is a concern for me
• Summing it up, its an interesting fund with a solid fund manager. However given my concerns on valuation (maybe biased due to my inherent value inclination) and lack of bear market experience, I would give it some more time before considering it for my final list.

2.Motilal Oswal – Raamdeo Agrawal (guidance) + Gautam Sinha Roy (fund manager) – Motilal Oswal Multicap 35

Raamdeo Agarwal, Joint MD & co-founder, Motilal Oswal Financial Services Limited

While Gautam Sinha Roy is the actual fund manager, I have also considered the founder Raamdeo Agrawal as my guess is that he would obviously have a significant influence on the investment philosophy and process.

What is his investment style?

Their entire investment philosophy is explained in detail here

You can also check this link by the super awesome Venkatesh Jayaraman (@VenkateshJayar2) which has a compilation of all Raamdeo Agrawals interview here

This interview below also provides a lot of clarity on how they manage their funds

Wow Factors

• Brilliant communication: Their communication is one of the best and their investment philosophy is crystal clear and well articulated
• Their chairman Raamdeo Agrawal, CEO Aashish Sommaiyya ,PMS fund managers and MF managers frequently write articles and provide public interviews – thereby helping us keep a tab of what is their current thought process
• Not averse to closing their funds if size becomes large: They also close their funds if their funds become too big to manage – sometime back they closed their mid cap PMS offering citing size constraints (read their newsletter with the rationale here)
• Equity Focus: The fund house is equity focused and has few but clearly differentiated products
• Easy to monitor: Since it is a concentrated portfolio it is easy for us to track and to understand the drivers behind the performance
• Skin in the game: The promoter to show their conviction in their strategy moved their entire prop book into their 3 funds (predominantly the Focused 35 scheme) in 2015 (source: Forbes article)

 “Moving our proprietary money into the mutual fund was the best way to tell the customers about our conviction in the product,” Motilal Oswal

Recently, their CEO had tweeted that the promoter investments in their funds are a whopping Rs 2800 cr!

While skin-in-the-game doesn’t indicate future performance, but gives us a sense of how serious they are about the money being managed.

• Proactive in communicating when performance drops: They are also extremely proactive and communicate even during times when there is a drop in performance. This is very important as it helps us derive conviction and stay put with the investment style during periods where it is out of favor. Check out a sample of how they communicate here.

Performance across market cycles

Their mutual funds were launched only in 2013-14 period, which means their funds are yet to be tested over a bear market.

However, their PMS strategies have built a long term track record of 15 years as seen below since Mar-2003

To put the performance of Value Strategy in context, this is the returns of top 10 diversified equity mutual funds during the same period

The first 4 funds are mid cap funds. Considering that Value Strategy was a multicap strategy the returns over the 15 years is comparable to top notch fund managers such as Prashant Jain of HDFC, Siva Subramanian of Franklin etc.

Concerns

• In twitter, there were some concerns raised on the fund house not sticking to the “sit tight” portion – in the current portfolio almost 60% of the portfolio has been held for more than 3 years which seems fine. So while we need to monitor this metric, I don’t see any issues here as of now.
• Also keep a watch on the twitter account by the name @contrarianEPS who constantly raises concerns on MOSL Funds. While he does not undermine the long term returns, his primary thesis is that MOSL follows a momentum investing style to derive returns (which is not wrong) but markets itself as a value driven style which in his opinion is not right. Usually his tweets get a response from the equally vocal and active MOSL AMC CEO @AashishPS . While I don’t see anything to worry as of now, but I would keep a watch for his tweets and the response from the CEO.
• The recent issue of Manpasand Beverages was obviously blown out of proportion despite the small weightage in the overall portfolio. All fund managers will have few stocks going wrong or otherwise you don’t need a portfolio. So I think we need to keep in perspective the mistakes vis-a-vis overall portfolio returns over the long run. That being said, the focus should be on trying to understand the process better whenever such accidents happen – what went wrong and how did the particular company get past the fund manager’s quality filters? How did the fund manager manage the scenario? How does the process adapt to avoid such events going forward?
• The fund is getting larger in size (currently at Rs 14,000 cr). Given, the style of running a concentrated portfolio, size might start impacting portfolio construction some time in the future.

My View

• This fund will fit perfectly in the quality/growth end of the style spectrum
• They have built a solid long term track record by following their investment philosophy of Buy Right – Sit Tight
• Skin in the game with a whopping investment of Rs 2800cr provides us with significant conviction on their seriousness and integrity.
• Their communication is top notch with clear communication both during times of outperformance and underperformance
• Concentrated portfolio makes it a lot easier to track the fund performance and understand the strategy
• Summing it up, its an interesting fund with a solid investment process. I would add it to my final list under the growth/quality bucket.

Other funds following this Quality/Growth strategy with good communication

UTI Equity Fund which is managed by Ajay Tyagi has also recently repositioned itself as a quality/growth style fund.

You can read about his investment style here and here.

While this fund house ticks my checklist on clear communication, I have not included the fund as the fund manager is relatively new – only two years of managing the fund.

Its an interesting fund to keep a watch on and I would wait for a market where the style is out of favor and monitor on how the fund manager behaves during that period to build my conviction.

The Final List

Now that we have filled our “growth/quality” bucket, the selected equity mutual fund list looks like this

In the next week, I will fill the remaining “Blend” bucket and we shall be all set to build our portfolios.

Till then, cheers and happy investing!

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Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments