The Mutual Fund Show: Here's Why PPFAS Holds 20% Cash In Flexi, Tax-Saver Schemes

Raunak Onkar: I think your question is quite relevant because every time there is a macroeconomic event which adversely affects the market movement, there is of course this question again there, does it really affect the companies that we own, so of course, we pay attention to all these macro events.  

Some macro events have a tendency to spiral into company specific issues, sector specific issues. So, we of course, keep track on macro events from that perspective, but from the point of view of the companies that we own, like you correctly said we have a bottom-up approach to looking at businesses.

So, whenever any macro issues happen, whenever the crisis that you mentioned about banks in the U.S. and even the Credit Suisse crisis right now, wherever those issues happen, the primary focus is on the portfolio companies we own, the sectors we know very well, and we try and understand whether these sectors will be unaffected or not by what is happening.

And if the answer is yes, the sectors will not be affected too meaningfully in the short term, then we remain holding them. The sectors don't fail the longer-term test as well. We say okay, these companies can be held, and the business models can be played out over a cycle, and we can remain invested in these companies.

So yes, it worries a lot. We look at different things and sometimes the headlines are very stark, and things are happening on a daily basis. But I don't think businesses will change that dramatically unless they are directly impacted by the happenings in the macroeconomic environment.

Raunak Onkar: I think a crisis of confidence requires all the above things that you mentioned. One is the management's ability to confirm to outsiders, the depositor, the shareholders, that the strength of the bank is sound, even the regulator's stepping in and guaranteeing some of these things can also help and we have seen that happen.

If you have seen the headlines in the past couple of weeks, you have seen that regulators have also stepped in, and it's been monitored on a day-to-day basis. We get daily updates of all these through the media, I think a lot of the things which we know of how banking industry works and the rules that the banking system follows.

These days we are seeing a little bit of unprecedented regulatory activity, trying to make sure that the system remains intact, and confidence remains intact, and which is, I think, a great thing because things don't so dramatically change.

The only thing we have seen dramatically change is the rate of change of interest rates from say, pre-Covid to during Covid times the interest rates reduced dramatically, and from the post Covid unlock time to current scenario, where interest rates have gone up quite dramatically.

So, I think any sharp moves in some of these macro events can cause disruptions in the asset books of many banks and I don't think it is unknown to the regulators or the bank management itself. I think the thing that you mentioned is the crisis of confidence, that is something the banks and the regulators will have to manage more meaningfully.

Raunak Onkar: So, one of the filters that we put in for any company we invest in is the indebtedness, or dependence on the outside capital markets for any company.

So, if a company that we like is constantly raising capital from the debt market or the equity market, then that's a difficult thing for that business to sustain because it does not have a sustainable stream of cash flows.

So, one of the filters is to have a sustainable cash flow, the company generates on its own, which can be redeployed and reinvested in growth and occasionally the business can tap into public capital markets like debt markets or equity markets to either raise capital periodically, but hopefully they don't dilute the existing shareholders too much. That is the expectations of these companies.

So, when you have such companies who generate cash on their own, they don't depend too much on the debt markets or the capital markets on an ongoing basis. So, in a way they are insulated, but at the same time, overall market can correct in terms of valuations and these companies being large businesses that we own globally.

They also have a regular valuation impact on just the market cap of these companies, but the underlying businesses will not be affected that dramatically, that is our anticipation.

Raunak Onkar: So, the parameters of value investing have evolved over a period, but they basically remained the same from the point of view of discounting future cash flows today.

So, most people are aware of the idea of a discounted cash flow model, where we can discount company's future cash flow earnings to the current price, and we can get an estimate of what this company's price today should be, and whether it's a fair price that we are paying based on our expectation of how the future will be.

So, when you look at that, we definitely want companies to keep generating cash flow and keep growing in the sectors that they operate in. So, from that point of view, value investing doesn't change. The only thing that changes is how much the rest of the market is willing to pay for that future payoff.

So, when the rest of the market says that they will pay whatever it takes to participate in that opportunity and bid up the price of the shares today, then we step away from that particular transaction. We say okay, we will wait and watch till the prices come in our comfortable zone, and only then we will participate.

So, from that point of view, we have about 20% cash right now in the flexi-cap fund, and even close to the 20% tax saver fund that we manage. And there's a reason for that because we are not finding attractive valuations for the companies we like and that does not mean there are bad businesses out there, it's just that the good businesses are built up by the market and there's not a good opportunity to invest in them right now.

But the moment we find something interesting, we can allocate a significant chunk of that cash immediately. So, I will give you an example in the past where this has happened a couple of times, where I think somewhere during the late 2017-early 2018 period, when we had a mid and small-cap rally in our domestic markets, the domestic market was so elevated that we could not allocate meaningfully to the domestic market.

So, at that time, we were in fact in higher amounts of cash flows of 25% to 27% of cash at that period. But gradually as the markets cooled off, the valuations cooled off, we started deploying that cash and even the same situation happened just before the Covid pandemic hit us.

We had about 11 or 12% in cash in the portfolio, and that helped us participate in ideas as the market crashed immediately after the lockdowns began and some companies are always on our radar, and we are waiting for the right prices for those companies.

When we evaluated the companies won't be impacted in the longer-term too much, we were able to meaningfully participate in them because we had cash on our books. So, the cash is essentially residual. It is not something we strategize that we should have some amount of cash in the portfolio at all points in time. It is just residual and if you see the fact sheets immediately after the Covid lockdowns hit, we were at 0% cash at that time.

So, there's a wide range in terms of how we look at valuations and based on valuations we will essentially determine if we want more cash or less cash in the portfolio.

Raunak Onkar: So, the parameters that we have for domestic as well as global stocks are actually the same. So, we don't distinguish in terms of the quantitative and qualitative parameters we look at.

So, in quantitative parameters, some of them are very obvious, those are longer-term trends of sustainable business growth in that particular sector, or that particular business has a very long runway ahead of it, and they are able to profitably scale that business in that particular segment.

In qualitative terms, parameters like the quality of management, where they have demonstrated a good ability of running their business, at the same time they are minority shareholder friendly, and they have a track record of that over a period of time, and other quality parameters is also the valuation of the business.

So, that business should not be extremely highly valued as compared to its peers or compared to itself over a period of time to participate in that same opportunity.

So the same parameters apply for both domestic as well as global stocks, but with the regulatory impact that we faced last year, when RBI had told the entire AMC industry not to invest or not to remit money abroad to buy international stocks, is because the industry limit of $7 billion had been breached, and which we complied with and interestingly, all the incremental money since then, since last year, has been deployed in the domestic market whenever we had a chance to invest.

So clearly, the domestic market is not looking very attractive in terms of valuations. Hence, we have a build-up of cash and somewhere closer to 27 to 28% was the average threshold of our international investments that has come down close to 16-17%, which is natural because those stockpiles also have fallen, at the same time our allocation to international stocks has reduced in this period of time, but both these parameters remain the same.

So, investment filters for both these geographies remain the same. It's just that the valuations in the domestic market are not very attractive, so we cannot deploy our cash very meaningfully at the moment.

Raunak Onkar: See, number one is that we need to work in the regulatory environment we are operating in. So, if permission never comes, we will have to incrementally invest only in domestic markets, which we have done for a long period of time.

So PPFAS has a history of only domestic equity, which is much longer than our trials or our investments in the global market. So that is number one and number two, yes, it's fine. So, the whole idea behind investing internationally is not to deliberately have a global focus, but the whole idea was to diversify the risk geographically and also participate in unique companies, which are not available in India.

So, giving an Indian investor ability to invest in INR terms and participate in the global companies which otherwise they will not be able to invest, and they can take their money out, getting their money out in INR terms, and we manage the currency risk at our end by hedging the exposure.

So that gives a very balanced, diversified portfolio for a domestic investor to invest in. That was the only intention for going abroad. It's not necessarily that such company is not available in India. There are great companies in India. We will always see new listings in India which are at par probably with some of the global peers.

But there are some global companies which don't have any comparison. Like for example, you won't have an Alphabet, you won't have an Amazon in India, at the same scale as we operate globally. So, some of those unique opportunities we will miss investing in, but that doesn't mean that domestic market is not vibrant and will not be able to invest in domestic market after that.

Raunak Onkar: I think the waiting game from a price point of view is very hard to predict. What I find a little bit easier to predict, or the trend is a little bit obvious nowadays, is that the whole era of easy money and low interest rates is behind us. So, any person or any investment decision that was based on having cheap capital available, I think that has to go out the window.

You need to rework all these plans and make sure you factor in the current interest rate scenario going ahead and once that happens, then you will see which are the better business models that will survive, which will thrive in that new interest rate period.

So, there's prolonged easy access to capital available across the world and that has suddenly disappeared. So many companies who relied on that business model, they will really have to come up with a sustainable cash flow generating model from their own.

And that is the advantage of being a bottom-up investor where you can actually track these changes based on the macroeconomic events rather than focusing on the macro first and then trying to drill down top-down that which sectors, or which industries will be beneficial across because the changing regime.

Good businesses always remain good. So, if somebody figures out a way to have a sustainable cash flow generating model, they will survive. I mean, there is no doubt about it and these companies are around, these examples are around.

So, any stock market historian will tell you that companies who sustainably generate free cash for a long period of time do better for investors and they return money to shareholders at a much faster rate than some of the other companies who are dependent constantly on the generosity of the capital market. 

Gurmeet Chadha: I think while you are getting a value approach, because the growth has stopped, you know, performing them, this is grossly underperforming after eating value over a prolonged period and typically that also coincides with interest rates, and we were so used to zero interest rates and money printing by the central banks, starting 2008 leading up to various crisis right up to Covid and the war.

That growth took precedence, for market started buying in value growth. There was no alternative to the TINA factor because the fixed income yields were so low, which is also the discount factor. So, whenever interest rates have gone up historically, the discount factor goes up, because now today the cost of not doing anything is 7.5% in India, buying a government bond, two years, 10 years.

Same for the U.S., you had a two-year bond at 5%, so, 5% in dollar terms virtually just find the U.S. Treasury. So, I think that's why I am more on the camp of having a blended approach, more in terms of value at a reasonable price, or growth at a reasonable price.

So, too much value chasing can also lead you to being stuck and confusing price direction with that. So, a lot of these new age companies collecting 2-3% don't make the value buys. Credit Suisse is what 95% down now, before it was taken over a further 60-70% cut.

So, I think a blended approach is what you should have, as a portfolio should reflect different styles because different strategies do well for a period of time. So, it is not this versus, some parts of the portfolio will underperform, which actually is the sign that we are diversified.

The cycles are shorter, and you never know what can work and rotate very fast. So, I am more in the camp of blended approach and looking at value in correlation with other values.

Anant Ladha: I will try and point out some of the data points which are very interesting to watch out for. It is from the international market, but it will give us perspective about growth versus value.

There is something known as Russell 1000 growth and Russell 1000 value. If we check out data from 1979 to 2020-2021 and compare both the indexes, we find that both have almost equally performed, both have given returns around 12 to 13% but there have been different patches of returns.

For example, Russell growth outperformed between 1989 to 1999 and then it outperformed in 2009 to 2020. Russell value outperformed in 2000-2008 period, and it outperformed in 1979 to 1988 period. So, we have to understand that there are cycles of growth and value.

As an investor I personally have three options. First is, I can randomly choose any of these styles, I can go with value, and I can go with growth. Second, I can tactically choose a style if I have basis study behind the selection. I can tactically choose a style which I think can perform significantly in coming times.

And third option as an investor which I have is that I can combine both the approaches and choose a blend of two approaches. There is risk in all the three options. In the first option, you need luck on your side, in second option you need to skill on your side that you should be skillful in selection of which style can outperform in coming times and when you are choosing a combination of both, then probably you will always have some of the underperformers in your portfolio.

So, there is something very interesting which has come as Gurmeet rightly mentioned, growth at reasonable price, that is looking to buy growth companies which are giving good results, good EPS growth, good sales growth at reasonable price and not overpaying for that. So that is something which we can look at.

Gurmeet Chadha: So many of them in this industry for more than 18 years now. So, Naren actually underperformed quite a lot in the growth phase, where you have high growth people have very high growth segments like Motilal, or Axis or some of the other fund houses which did very well and Naren was always on the value side.

So, if you look at this company as an example, it's not a recommendation. If you see the top holdings, you will find ONGC in the portfolio, you will find some of the PSU banks, you will find Bharti Airtel. In I.T. you will find a Tech Mahindra. So, his approach was to pick something which looks more reasonable, which is fundamentally good, but the market is under appreciating it for a while.

There's another guy whom I have tracked very closely, SBI Contra, another very good guy that very well last year, in fact if you look at his portfolio positioning, he is more contrarian, I will not call him pure value because again, it's a bit of a plan.

He's like 13% on cash and he's been on cash now for a while because he thinks that because of the the wave, central banks are tightening the cash, also will give a lot of opportunities. In fact, he uses index futures also to hedge which are not seen, very few fund managers to do that. So, his net long position of the fund was just about 77-78% and past one-year return is actually double digit.

So, I see there are a lot of them who have done well. We have seen even stock wise, you know, ITC underperforming and now being the darling. That's why I said I think a blended approach is better. It's not that growth is good, and value is bad.

And I agree to what Anant said is that interest rates are going to be high for a longer period of time, and fixed income also has become equally attractive and now gold also picking up, the kinds of volatility in banks. There is no harm in keeping a central part of the portfolio where you can increase weightage by 5-10-15 % depending upon your view on the market.

Anant Ladha: I also like these two funds because they are being managed in quite a different style. For example, Naren is managing Discovery since it is a Rs 20,000 crores plus fund, it is mainly focused on large caps.

They are heavily weighted on large-caps versus if I talk about SBI Contra, they have almost 40 to 45% in mid-cap and small cap, and they are taking that exposure. So, both these funds are in the same segment, but managing these funds differently gives a good blend.

And looking at the present market scenario, depending on the risk appetite of an investor, I think combination of both growth and value can be a good thing to look at especially something like 60% in growth and 40% in value is something which we can look for, but completely dependent on the risk appetite. 

Gurmeet Chadha: Somebody said that cash is also a position and if it becomes a position if it's yielding you 7% return in the liquid money market fund when you are uncertain about how things are going to pan out. I am more a believer on staggering it than timing, because what happens is that if you hold it for too long, you also need cash and courage both to take advantage and while cash will be there, sometimes the courage disappears.

When you see large movements, the courage to deploy goals of this which, it's good to stagger it, and then if you are not good at it, there are funds which can do it in the hybrid parts.

In fact, I personally think that there's been too much discussion on balance advantage, I think even a pure hybrid fund, which is like the 70-30 kind of a combination, because a balanced advantage fund will have to use arbitrage and the expense ratio can catch up.

You are paying a lot for taking an arbitrage position to find a pure balance fund with a 70-30, 75-25 with that also attractive, and likely to remain that, could also be a decent combination.

Gurmeet Chadha: I think the SIPs should definitely continue, whether it's an SIP in stocks or funds should continue. Overweight or underweight should be dependent on liquidity, so don't disturb the discipline.

I think the mistake I made in 2008 was I disturbed that discipline. I got carried away. I used to work for a fund house, and I saw queues of investors lining up in 2018, it was overwhelming for me, and I realised one of the SIPs could not be stopped. There was some technical error that gave me the best returns.

So, I think never stop the SIPs, never stop the discipline because it takes the emotion out of the equation on incremental money is on. I mean, as I said, personal finance support. So, if you are getting too jittery, I might just continue with the monthly discipline and if you have seen cycles, I think a better strategy is to stagger.

Anant Lodha: I have two points to discuss over here firstly, before giving you any good returns, be it SIP returns or be it mutual fund lump sum returns or beat direct stock equity returns market will always test you.

If the market has not tested you yet, I am very sure that you have not made big money out of this market. So, the market will always test you before giving you big returns. Right now, I think it is only the quarterly exams which are going on.

We are seeing that maybe 1.5-year SIP returns are almost equivalent to zero, they are not giving any returns but there might come a situation that five years down the line we see that our SIP returns are yielding less than maybe FD returns from maybe yielding less than what do you say, is even negative.

But that is the time when you have to stick with your SIPs given the long-term vision in mind and that is the time the market is probably getting ready to give you big returns. So that is one thing, SIP is a systematic approach which you have to always make sure that you are following in a disciplined way.

Secondly, if we talk about cash, obviously you can take out some of the cash positions from your portfolio in good times. Usually what happens is we try to cash when the market has already corrected. We feel that now let us take out some money and keep some amount in cash. This is not the right time to take out your money, the right time is when you are seeing above 15 to 20% return on almost all your funds.

You are very happy with your portfolio, you are probably thinking of double your SIPs, that is the time, if you think that you can time the market, or can take that tactical call where you can gain maybe some extra returns. That is the time when you need to move some of your portfolio into cash, not when market has already corrected.