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- #QuantumIndia Arvind Chari on portfolio allocation
Sajeet Manghat in conversation with Madanagopal Ramu and Arvind Chari on 'The Portfolio Manager'.
- #QuantumIndia Arvind Chari on portfolio allocation
Sajeet Manghat in conversation with Madanagopal Ramu and Arvind Chari on 'The Portfolio Manager'.
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02:19 Thanks for tuning into the Portfolio Manager.
02:21 I am Neeraj Shah, and our guest today is Arvind Chari.
02:24 He's the Chief Investment Officer, CIO, of Q India UK,
02:27 which is an affiliate of Quantum Advisors Private Limited,
02:30 but effectively an old hand in all things investing,
02:33 and therefore lovely to have him to try and understand how
02:36 would he think about portfolio construction
02:38 at the current stage.
02:39 Arvind, great having you.
02:40 Thanks so much for joining us.
02:41 Thank you, Neeraj.
02:42 Thanks for inviting me.
02:43 Pleasure to speak to you.
02:44 Pleasure is entirely ours.
02:45 Just to set the context, you identify yourself
02:48 as a value investor working in a firm which
02:51 believes in value investing.
02:53 Would that be a correct description?
02:55 Correct.
02:56 So Quantum's history-- so Ajit Dayal started Quantum in 1990.
03:01 Between 1990 and 2004, we were advisors and providers
03:06 of research to global institutional investors.
03:09 And sometime in 2003, after SARS,
03:13 when the Indian markets were trading at seven,
03:15 eight times price to earnings, Ajit always
03:17 had intentions to manage money, manage
03:20 India-dedicated allocations for both global investors
03:23 as well as for domestic investors.
03:25 And we went about and did that, set up the SMAs
03:29 and went and raised capital from global investors
03:32 to investing into Indian equity in our strategy
03:35 and also launched the domestic mutual fund,
03:37 Quantum Mutual Fund, first direct investor
03:39 mutual fund in India.
03:41 But in terms of how we learned about research
03:44 and about investing, this style of value investing-- now,
03:48 value means different things to different people.
03:51 Every value people, as they say, lies in the eyes of the beholder.
03:54 So there are different ways of looking at what value is
03:56 and what value means.
03:58 But what we learned-- so Quantum had an arrangement
04:02 with a group called Hansberger Global Investors.
04:05 And Tom Hansberger was the original founder
04:07 of the Templeton group.
04:08 It should be called Templeton Galbraith Hansberger.
04:11 And Tom taught Ajit and Subbu-- Subbu is the--
04:14 he joined Quantum in 1996-- about the difference
04:17 between a value stock and a cheap stock.
04:21 And the difference is catalyst.
04:23 So there are companies and sectors
04:25 which are available at a discount to its long-term
04:28 intrinsic value.
04:30 But do you identify a catalyst that that catalyst
04:33 will play out?
04:34 Sometimes it could just be mean reversion of valuation.
04:37 Sometimes it could be acquisition.
04:38 Sometimes it could be margins.
04:40 It could be various things.
04:41 But you have to identify as a value analyst
04:43 that there's a difference between it remaining cheap
04:46 and there's value in the sense that there is a catalyst that
04:48 will unfold.
04:49 So we are in that stream of what we call value investing.
04:54 Got it.
04:55 And you, in some sense, you look at the global pie
05:01 of investors wanting to invest into India through Quantum.
05:04 Would that be a fair description?
05:06 Correct.
05:07 So about 90% of the AUM that Quantum Advisors effectively
05:12 manages, including Quantum Advisors and Quantum Mutual
05:14 Fund, comes from global institutional investors.
05:18 These are pensions, sovereign wealth funds, endowments,
05:23 those kind of crowd.
05:25 So that is a predominant AUM and predominant business
05:29 that we've seen.
05:30 But of course, we have the mutual fund,
05:31 which is Thomas Shukletal.
05:32 But yeah, 90% is global institutional investors
05:35 into India.
05:36 And does that form the basis of the foundation of your
05:39 India equity allocation?
05:40 Because when I look at that slide, it probably places,
05:47 and when you think of portfolio construction,
05:49 as avoiding risks and pitfalls as the primary thing.
05:53 I mean, loosely put, would that be fair?
05:56 Yeah.
05:57 So we don't distinguish between client structures.
06:00 So even if you are a small foreign investor who's
06:03 investing in a fund structure that we have, if you're
06:06 a large global institutional investor who is doing what
06:08 we call separately managed account, SMEs, or if you're
06:11 an Indian retail investor who's giving us 100,000 rupees
06:15 of SIPs, the research and the portfolio and the ideas
06:18 and the strategy remains the same.
06:20 So if I look at how we build that, what we call the
06:23 Q India value equity strategy, which is our flagship,
06:27 which started in 2000, so we have a 23-year-old
06:30 track record for that.
06:31 If I look at it from a risk perspective, we don't see
06:35 risks as, say, standard deviation or correlation
06:38 or volatility or beta.
06:40 Those are mostly opportunities, but those are not risks.
06:43 What we define as investing risk are basically three,
06:46 and when any investor invests in India, or even a
06:49 domestic or a foreign investor, they increase
06:52 their risk profile.
06:53 Some global investors do not need to be in India,
06:56 but when they choose to be in India, they increase
06:58 their overall risk profile, and our job as a manager
07:01 is to manage that risk, and we define that risk
07:04 into broadly three.
07:05 One is the risk of liquidity, and you can look at
07:08 liquidity across asset class, so public equity,
07:11 private equity, real estate, infrastructure,
07:13 or within public equity, you can look at liquidity
07:16 in terms of large cap, small cap, mid cap,
07:18 in that way, or private equity venture.
07:20 And so there is underlying liquidity, which is available,
07:24 and that's a risk if you're very illiquid,
07:27 and the risk is not only about buying and selling
07:29 and price, the risk is also about capacity,
07:32 like that underlying liquidity, what does that allow you
07:36 to manage as an AUM?
07:37 So if you look at a lot of mid cap, small cap managers,
07:41 tend to have style drift when they do well,
07:43 and then they get more AM, because their style
07:46 of investing and the underlying liquidity and stocks
07:48 available can only manage certain amount of AUM.
07:51 So we have a threshold where we say that we'll only
07:54 invest in stocks which trade a minimum of a million dollars
07:58 a day average traded volume for the last one year.
08:01 So we need that, so that becomes the first filter,
08:04 so that's the first risk.
08:06 The second risk as a filter is governance.
08:09 So we used to call it shake hands and get five fingers back.
08:12 If you do not get it, stay away from that company.
08:14 So this is a different way of thinking about
08:16 what kind of governance, reputation, and headline risk
08:20 that you want to offer to your clients,
08:22 and if you're not comfortable as a minority shareholder,
08:25 just avoid investing.
08:26 There's no point in trying to price those risks.
08:28 So that becomes the second filter.
08:30 And then the third filter, as we say,
08:32 valuation in India can be a risk, as you know,
08:36 as a market professional, because in India you can
08:39 actually make a very simple argument that there is growth,
08:41 there's nominal GDP at 12, 13%, earnings and revenues
08:44 eventually compound at 12, 13%, so you can actually
08:46 justify any valuation because you have this underlying
08:49 growth that comes through.
08:51 But we do know that the Indian economy, the Indian market,
08:55 and the Indian valuations tend to be mean reverting.
08:59 You can go and see historical charts, you will always see
09:02 mean reversion of valuations and cycles.
09:04 So if you buy with that approach of buying at any price
09:09 or justifying any valuation, you can have bad outcomes as well.
09:13 Some of it, I mean, most growth markets have done very well,
09:16 but that's the way we think about risk
09:18 from a valuation perspective.
09:19 So after those two filters of liquidity and governance,
09:23 when we look to buy companies, we want a margin of safety.
09:28 And we define that margin of safety as a 25% to 40% discount
09:33 to what we believe is a two to two and a half year
09:36 forward intrinsic value.
09:38 So we set long-term median bands for different companies
09:42 in different sectors, and if a company is available
09:44 at a 25% to 40% discount to that two and a half year
09:47 forward valuation today, we'll be happy to buy.
09:50 If we do not get this, just hold.
09:52 And if it goes above the intrinsic value, we sell.
09:54 So this is the framework that we use, liquidity, governance,
09:56 and then valuation as a risk framework.
09:58 - And what kind of returns has such an approach garnered you
10:01 over the years?
10:02 Because here's the context of my question.
10:05 We have somebody on the show today whose fund or whose AMC
10:10 has got 20, 23 years of track record.
10:13 So if they have clocked in a particular percentage,
10:15 very likely that that approach might help people clock
10:17 in such a particular return as well.
10:19 So what is the kind of return that comes in?
10:21 - So if I again explain what we do in terms of,
10:24 and then that's how we think about potential returns, right?
10:27 So if I am looking for a 25% to 40% discount
10:30 to intrinsic value, effectively if I take an average of that,
10:33 that's about 30 to 35, right?
10:35 So effectively what I'm trying to do is whenever I buy,
10:39 I'm trying to do a 30% to 35% return, absolute,
10:42 over a two-year period, right?
10:45 That's the basis in which we build the portfolio.
10:48 And there's earnings compounding.
10:50 So we update that number.
10:52 So today as we speak, today is in December of '23,
10:56 we're already looking at March '26 numbers, for example,
10:58 for our valuation.
10:59 And then we move to March '24, we will move to the forward.
11:03 We'll keep rolling over every two to two and a half years.
11:06 So that's how the compounding plays out,
11:08 and we look at that valuation.
11:11 So about 30, 35%.
11:12 So if you look at on an annualized basis,
11:16 if I look at in INR terms, the strategy,
11:20 what we call the Q India composite,
11:22 which is managed by quantum advisors,
11:24 has done about 15.5, 15.6% in INR,
11:27 compounded for the last 23 years.
11:30 If I look in dollar terms, you should always shave off
11:33 two, two and a half percent dollar depreciation.
11:36 This is about 12.8% in US dollars,
11:40 which is fairly, given the risk framework that we use
11:43 and the valuation safety that we have,
11:45 we believe this is what we call a sensible,
11:48 predictable way of managing money.
11:50 Of course, there are better managers
11:51 who will generate more alpha than this,
11:54 but this is how we understand, this is how we can price,
11:57 and we can also have a very predictable outcome
11:59 to try and deliver this over cycles.
12:02 - Yeah, and which is what viewers, is the other aspect.
12:05 We'll get to the portfolio construction,
12:07 but the essence of these last seven, eight minutes
12:09 is to try to arrive at what they have done
12:11 over the last 20 years, to get the kind of returns
12:14 that they are, which Arvind says,
12:16 in our terms, about 15%, and frankly,
12:19 for people like you and me, if you are residing in India
12:23 and wanting to invest as a retail investor,
12:25 that's the kind of return that you do.
12:27 Now, Arvind, my last question before we slip into a break.
12:30 So therefore, with that framework in mind,
12:33 looking at the current market context,
12:35 what is the kind of portfolio element
12:39 that would be present in a typical portfolio?
12:42 It may change in the next three months, but as things stand,
12:45 how are you designing the portfolio?
12:47 And we'll get to the why on the other side of the break.
12:50 - So, the designing of portfolio, again,
12:52 comes from a bottom-up research perspective, right?
12:54 Valuations and, so if I look at my sectoral profile today,
12:58 we are about 30, 35%, 37% in financials.
13:02 When I say financials, it is banks, private banks,
13:06 insurance, general insurance, broking, asset management,
13:08 so the whole range of financials.
13:10 - Lending plus non-lending, bilake?
13:13 - Lending, NBFC, all put together,
13:15 financials about 37, 36%.
13:17 This is as of end November.
13:19 I don't have December end data yet.
13:21 And IT services will be the second overweight.
13:25 And we can talk about what we have done
13:27 over the last few years on that.
13:30 Consumer discretionary is a fairly big overweight
13:33 for us as a sector.
13:34 And typically in two-wheelers and autos
13:36 is the consumer discretionary,
13:37 but we are getting some consumer durable names
13:39 into the portfolio.
13:40 Broadly, these three, from a large overweight,
13:42 healthcare, utilities, as a value manager,
13:45 we'll always have some regulated utilities
13:48 in our portfolio, and that has also played out.
13:50 So, this is the current positioning
13:52 from a sectoral perspective,
13:53 but happy to chat on that in a bit.
13:55 - Yeah, and we'll do that, just that,
13:57 on the other side of this very quick break.
13:58 Stay tuned, Arvind.
13:59 In fact, stay on with us.
14:00 Viewers, stay tuned.
14:01 We'll come back and talk to Arvind
14:02 about each of these.
14:04 In some sense, to a lot of sectors,
14:06 they're marrying the benchmark, if you will,
14:09 financials, healthcare, you can argue even on technology.
14:12 And the question would be,
14:13 what within this universe does Arvind Chari believe
14:17 can do well or cannot do well?
14:20 We'll try and talk about that
14:21 on the other side of this break.
14:22 Stay tuned.
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15:33 - Back with the portfolio manager right here
15:34 on NDTV Profit in conversation with Arvind Chari.
15:36 Arvind, now we've established your style at least,
15:41 value, discounting intrinsic,
15:43 buying stocks that are discounted
15:45 to the intrinsic value two and a half years out.
15:47 If you're 36% in financials,
15:49 I presume you find such a large number of opportunities
15:53 which are at a 25 to a 40% discount,
15:56 circa two and a half years out in that space.
16:00 Now I'd love to know within financials,
16:02 where is it that, which segment,
16:04 which bucket do you find such discounts?
16:07 - So as I said, financials is fairly broad, right?
16:10 In terms of what we own.
16:13 Private banks, we are seeing significant discount
16:17 to long-term median valuation.
16:19 Some people can debate and decide
16:21 what long-term median valuation,
16:22 whether things have changed.
16:24 But we've seen cycles, we've seen managements,
16:26 we've seen changes and we've seen how they responded.
16:28 These are all quality franchises.
16:30 They've seen their own different patterns.
16:34 So private bank is definitely one.
16:36 Insurance, very surprisingly,
16:38 we'd never thought that typical growth plays
16:40 like insurance, asset management.
16:43 But given the disappointment or the competition
16:46 or the supply of alternatives,
16:48 has ensured that we're also getting
16:49 some life insurance plays, general insurance plays.
16:53 Not everything in the current portfolio will have that,
16:56 so that 25 to 40% discount is while we buy.
16:59 So when we initiate a position,
17:00 we want that margin of safety.
17:02 And then as it plays out,
17:04 the upside potential will change
17:06 depending on how the stocks are performed.
17:08 But largely, private banking.
17:10 So there is a growth aspect of credit,
17:13 but there could also be another aspect of industrial credit.
17:16 So we are hearing all these private CAPEX,
17:19 pickup and all those things,
17:20 but we haven't seen that in say bank balance sheets.
17:23 Term credit has not picked up as much
17:25 as the wind of the anti-capital CAPEX stories.
17:30 But it typically is a lag.
17:33 So you might see certain amount of CAPEX,
17:36 say the import substitution CAPEX
17:37 that is happening in the country,
17:38 will get funded by these private banks.
17:41 So right now it is predominantly retail and personal,
17:44 but it can move to industrial credit.
17:46 And over the next maybe 12 months, 18 months,
17:48 you should see that happening,
17:50 if the CAPEX story actually picks up.
17:51 So there are different aspects to that.
17:54 But for us, it is just pure,
17:55 right now just pure valuation comfort
17:57 on what we see on our long-term median valuations.
18:00 - Within financials,
18:01 there's a lot of focus on non-lending financials.
18:04 Insurance you mentioned,
18:05 but capital marketplace as well, wealth management.
18:08 Everybody says operating leverage will come into play.
18:10 - Correct.
18:11 - Now are you a believer of this?
18:12 And do you like asset managers, capital marketplace,
18:15 be it brokers or be it the utilities, if you will?
18:19 - Yeah, so we don't have the utilities,
18:20 but we have the brokers and the asset management companies.
18:22 And so there is, of course,
18:24 the secular story of financial savings and investments
18:27 and how formalization of financials is happening
18:31 in insurance, asset management, broking.
18:33 And we are playing all aspects of it.
18:36 It was much higher valued maybe three, four years before
18:41 in terms of valuations.
18:42 The valuation comfort is there now.
18:44 So that's why we are kind of,
18:46 I wouldn't say we are very bullish,
18:47 but we have the margin of safety
18:49 and we see the long-term story will continue to play out.
18:53 So operating leverage will come through,
18:55 just the formalization of financial savings
18:57 will come through.
18:58 And so right now we have the valuation comfort
19:00 and we hope that these things will play out.
19:03 - Wouldn't one, the competition,
19:06 but two, more importantly,
19:07 also the regulations squeeze out margins consistently
19:12 from asset management?
19:13 Because this story of more people putting into AMCs
19:17 has always been there.
19:18 And yet we've seen what's happened in the last two years.
19:20 So can it be the dampener?
19:22 Or do you think that is now factored in?
19:24 - I think you should factor that in.
19:26 So when we look at long-term earnings multiples
19:29 or long-term margins,
19:30 we will take that into consideration.
19:32 So there is squeeze in margins.
19:33 We've seen that globally, right?
19:35 Expense ratios, because of passive allocations,
19:39 the expense ratio for all equity,
19:41 active equity managers have gone down.
19:43 In India, actually, it's even more dramatic, right?
19:45 Today you have direct plans at such low fees.
19:47 So you should expect,
19:48 and that is already built in,
19:50 in the model and the estimates.
19:52 It's not that we are not blind to that fact.
19:53 - Of course, of course, of course.
19:54 - And after that,
19:55 if you still get the margin of safety valuation,
19:57 then we are happy to play out the cycle.
19:59 Now that catalyst might not, as I said,
20:01 we are valued as some value investors.
20:03 We'll actually buy in early
20:05 and then we'll wait for the cycle
20:07 or the near-term headwinds to kind of play out.
20:11 But if that thesis is right,
20:13 of financialization,
20:14 and that is, you can assume
20:17 all those margin compression competition.
20:18 India is a hyper-competitive market in any space.
20:21 You can see that in consumer durables, right?
20:23 Look at the valuations of consumer durables.
20:25 There is a growth impact,
20:26 but there's also a significant competition
20:29 across different companies.
20:31 And we are seeing that
20:32 and we should definitely price that.
20:34 So when we look at that two, three-year, five-year number,
20:37 we kind of normalize margins.
20:39 So if the margins were, say, higher in the previous cycle,
20:42 we will say, "What is long-term sustainable margins?"
20:45 And we'll bring that down
20:46 and then see where is the valuation.
20:48 If the margins are lower,
20:49 then we actually upgrade margins and say,
20:50 "Okay, this is at a lower margin level
20:53 "and the normal sustainable margins are these,"
20:55 or profitability or whichever metric you choose.
20:58 And then we try and value companies
20:59 and then see whether there's discount to that.
21:01 - So you believe that there is value.
21:02 - There is. - There is value.
21:03 Okay, just one quick question.
21:04 I know too much of financials, but why not utilities?
21:07 I'm just using names as an example,
21:09 but people talk about how CAMS or CDSL, et cetera,
21:12 all have monopolistic businesses
21:15 which will last the test of time.
21:17 You don't find value there?
21:18 - No, right now we don't.
21:20 Otherwise, it would have been in the portfolio, right?
21:22 Because we cover them.
21:23 - So it's not like you don't like the businesses?
21:24 - Yeah, of course we love the businesses.
21:26 As you said, monopolistic,
21:28 and they're also playing one part of that.
21:30 It could be valuations, it could be that we missed out.
21:33 - Got it, got it.
21:34 - While we were evaluating, we didn't get it.
21:37 So it could be a mix of that,
21:38 but we do cover them and very actively cover that space.
21:41 - Got it, okay, I just wanted that clarity.
21:43 The other aspect is information technology.
21:45 You have 15% here.
21:46 Now, is it, the commentary very likely
21:49 is not gonna be very constructive
21:50 even in this current quarter.
21:52 It's difficult to pencil in when Exeter came in in December
21:54 and said that things are not looking that great,
21:56 that suddenly in Jan things will start looking
21:57 very dramatically beautiful.
21:59 Why such a high weightage on technology, relatively?
22:03 - If you see the sectoral weight,
22:04 actually changes a lot for us.
22:06 So we are value long-term, but we are not silent.
22:09 I mean, we do have portfolio action.
22:11 So we did trim our IT exposure earlier last year.
22:16 Maybe we should have trimmed a bit more
22:18 from having, you know.
22:20 But how we see over a 12-month, 15-month period,
22:24 we don't see, we are not as bearish
22:26 or as despondent as the street seems to be right now
22:30 at the current juncture.
22:32 We think, we have seen this place of,
22:34 you know, say in 2014, '15, the worry was digital.
22:37 Digital will come and disrupt IT services.
22:39 They're actually a very big beneficiary of digitalization.
22:42 Maybe they'll be a reasonably big beneficiary of AI also.
22:45 That seems to be the worry, plus the global slowdown.
22:47 We see that, we see over a period of time,
22:50 it should normalize.
22:51 And hence, we still have that reasonable worry.
22:54 Valuations are, from a median,
22:56 long-term median perspective, valuations are okay.
22:59 - And is it only IT services,
23:01 or are you present in ER and D as well?
23:03 Because product companies, ERD companies--
23:04 - IT services mostly.
23:05 - IT services mostly, okay.
23:06 Yeah, again, the value bias would probably make you there.
23:10 Finally, one of the large weightages,
23:13 at least as of November,
23:14 seem to be consumer discretionary.
23:16 I heard you mention that Durables have also now found a play.
23:19 Two-wheelers and auto ancillaries are there.
23:21 Tell us what's the context here?
23:23 And for somebody buying into Durables currently,
23:26 what is the argument, what is the story?
23:28 - So, on auto, as I said, two-wheelers were our major play.
23:31 And we've held them for some time.
23:33 So, it was slightly painful when the,
23:37 you know, I think before COVID,
23:40 you could have seen some recovery,
23:42 and then COVID delayed that recovery.
23:43 But now it has played out very well.
23:45 So, we have to wait for,
23:47 there's nothing dramatically different
23:49 in what we expected, it's just the time.
23:51 And we have to just patiently wait,
23:53 take the underperformance, and then wait out.
23:56 We've been trimming out of a bit of that auto,
23:59 two-wheeler space, because stocks have done so much well.
24:04 Consumer Durables, again,
24:06 we have one stock right now that we've got,
24:09 and we are evaluating very closely.
24:11 It's again the same point that
24:13 today you have a consumption slowdown.
24:16 Generally, you're seeing consumption slowdown,
24:18 and plus there is a competition.
24:19 At what level can you, do you want to price that
24:23 competition margins and the consumption recovery to come through?
24:27 So, that is the, the comfort is purely on from that perspective.
24:30 We do not see a very major increase in, say, growth,
24:33 because we still see consumption remaining weaker,
24:36 even the government's focus is more,
24:38 still more supply-driven and not demand.
24:40 But in that space, you are getting some
24:43 discount to long-term interest rate value.
24:46 So, that's the only place that eventually as the growth recovers
24:50 and as competition kind of settles on,
24:52 and/or growth is enough for other people to also materialize,
24:56 then you will see some normalization of margins and revenues.
24:59 And that's the reason we are doing it.
25:01 Got it. Great.
25:03 Arvind, thank you so much for taking the time out
25:05 and being with us today on the show.
25:07 And as you go back to cold London,
25:10 wishing you warmer times and wishing you a very happy 2024.
25:13 Thank you so much, Ira. Pleasure.
25:15 And viewers, thanks for tuning in to this episode of The Portfolio Manager.
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