Transcript

Markets & Coffee Can Investing Masterclass with Siddharth Bothra- Ambit Asset Management

Aravind: Hello and welcome, everyone, to yet another episode of a fund manager interview with PMS Bazaar. I'm Aravind, your host from PMS Bazaar. Today, we're privileged to have with us a man who needs no introduction, Mr. Siddharth Bothra, Executive Director and Fund Manager at Ambit Asset Management.  Siddharth has over 25 years of experience in investments and equity research, and before joining Ambit Asset Management, he had a long stint of 18 years with Motilal Oswal Financial Services, across institutional equities and asset management. Welcome, sir.

Siddharth Bothra: Thanks, Aravind. Thank you for having me on the show. I'm delighted to be here and look forward to your questions.

The Journey into Investing

Aravind: Now, before speaking about markets, economies, and your flagship PMS, we'd like to know about you, sir, personally, professionally, and when you began your investing journey—eventually now managing large amounts of HNI, ultra HNI, and institutional investors' money.

Siddharth Bothra: Yes, Aravind, so for me, the investing journey started at a very early stage. I'm from Kolkata, and many people in my family were involved in the stock market. So, I remember even as a kid, when I was in Class 7 or 8, that's when I did my first investment in equity markets. You could almost say that equities was in my blood right from the beginning.

Having said that, the lucky break for me came somewhere when I was in the first year of college. One of the professors who was teaching there in one of the finance courses happened to be the head of research for one of the two or three equity research houses which were in Kolkata. I remember reaching out to him and asking him to take me as an intern. I got an opportunity to work for two years as an intern in that equity research house, and that was the beginning of my career in equity research or the equities market.

Subsequently, I got a great break where one of my reports led me to come to Mumbai and work with some of the bigger firms. That's where I got an opportunity to work for almost 18 years with Motilal Oswal. For the first seven years, I was on the institutional equity research side where I was largely looking at several sectors as a lead analyst.

Another lucky break came for me when I went to ISB to pursue my full-time MBA. Not only did that change my entire perspective on investing, the lucky break was actually there: I got an exchange program with NYU Stern, where I spent six months. There, I happened to attend all the classes of Professor Aswath Damodaran. I also happened to attend many of the strategy classes, and at NYU Stern, they had something where actual fund managers would come and take evening classes. So, I remember for the six months when I was in New York, I was virtually doing classes all day, from morning till evening. I think that was a very big break for me because I got to interact with some of the most leading fund managers and professors—people who were at the forefront of shaping thinking around investing.

When I came back from my MBA and the international MBA exchange at NYU Stern, Motilal Oswal was looking to start their active mutual fund. I got an opportunity to move from institutional equity research to the AMC side. For the next 11 years, we had a wonderful journey where we started with virtually zero on the active mutual fund. By the time I had moved off from there, we were almost close to ₹33,000-₹34,000 crore in AUM there. During that phase, I got an opportunity to be the lead fund manager for most of the funds there, from large-cap to mid-cap to flexi-cap, and at the peak, I was managing close to around ₹16,000 crore. So, I had a great journey there.

Over the years, another thing that happened is while pursuing my investing, which was largely focused on quality and long-term investing, I also happened to develop my style of investing, which is more about looking for companies with pricing power. The way I see it is that when you look at investing in quality, people do it in various ways. Some people are more moat-focused, some others focus more on brands and so on. In my case, I look for a combination of several factors and for companies where I think pricing power is either dialling up or getting recognized. That's been the way I have managed money in recent times. Even now, I've also got an opportunity to launch a fund which would be completely focused on this.

Outlook on the Indian Market

Aravind: That's a great way to start off the conversation, sir. Given your long experience, where would you place Indian equity markets in the current economic and market cycle? Are we close to a big consolidation phase, or do you think we are entering a new growth phase for equity markets?

Siddharth Bothra: If you look at Indian equity markets, I think when you look globally, there are very few markets which give you the kind of buoyancy or the kind of different opportunities across sectors that India offers. Other than the U.S., I think there are very few countries which would give you an opportunity across sectors, whether it be on the service side, on the capex side, or the commodity side.

Now, the big change for Indian markets has happened in the last five to seven years, where the domestic money pool has become as big, or in many cases bigger, than the foreign institutional investors themselves. With that, the market has matured quite a bit. The institutional money, which includes both FIIs as well as domestic institutions, gives the market a lot more resilience and depth. If you take a 5- to 10-year view, I think we will probably see one of the best phases in Indian equity markets.

Having said that, if I were to talk about a very near-term view, say for the next one to two years, I think Indian markets could be a little bit challenging, and the returns could be a bit muted. The reasons are simple: we're coming on the back of multiple years of very strong returns. Because of that, the valuations across the board, whether you look at large-cap, mid-cap, small-cap, or even the broader market, appear stretched versus the long-term averages. As a result, when we look at the next two years, the earnings growth looks muted—more like early double digits—and valuations have room for correcting a bit. So, the overall returns will look muted, definitely when you compare it with what you have seen in the last few years. To my mind, even when you look at the long-term returns of the market, maybe the next two, two and a half years, the returns could be below that, but that should not take away the bigger picture, where on a longer-term basis, India continues to look very attractive.

Lastly, on this point, the beauty of the Indian markets is that while the overall market could have this view, Indian markets are a very bottom-up market most of the time. So, I believe there will still be many bottom-up ideas which will continue to do as well, or even better than how the markets overall have done in the last few years. So, for someone who's a very focused bottom-up investor, I think it continues to remain a very attractive market.

Market Evolution and Governance

Aravind: Got it, sir. You have even answered my second question based on valuations. Sir, how do you think the Indian equity market has structurally evolved over the past decades in terms of investor protection, liquidity, and corporate governance, and what do you think needs to improve in your view?

Siddharth Bothra: So, if you look at the Indian markets, it's come a long way. I remember when I initially started off in the equity markets, more in the mid-1990s, it was a very different place. Investor protection was a huge thing. There were so many losses just in the exchange of the physical stock certificates from the investor to the company and back. I think over the years, the markets have completely, dramatically changed.

I think the low point was when the Calcutta Stock Exchange went "belly up" in a way. There was this huge issue there, and from there on, I think SEBI has done an amazing job. There are two things which have changed Indian markets considerably: One is the electronic exchange when NSE came in. That took away much of the pain that was there in equity markets related to the physical stock certificates—the whole issue about transferring and moving the certificates and so on—and it brought in transparency, where everyone knew what the price was. I think the advent of the NSE and then the pioneering work that SEBI has done has over the years transformed the market.

Today, you could almost rate investor protection at par with many of the global markets in terms of transparency and investor awareness programs. Another key thing, I think, was the advent of domestic institutional investors. The whole focus that AMFI brought in on investor education was one of the most critical things in shaping up the equity markets as they stand today. If I were to go back in time, at that time, you would find very few actual equity investors. Most of them used to view equity markets more as a trading play or somewhere where quick money could be made. I think you have to credit the entire thing to AMFI and all the domestic institutions which spend so much time educating investors. As we stand today, I think the whole market in the last 20 years has transformed completely.

Today, most of the investors are so much more aware of things, whether you look at the media or all the other supporting pillars for the market. They are all operating and doing their work in a very efficient manner. As a result, Indian equity markets today would be as attractive in terms of liquidity and transparency as any other global market.

Private Capex Cycle

Aravind: So, are we finally witnessing a genuine private capex cycle in India, and how sustainable is this trend going forward in aiding the growth, and your thoughts on it?

Siddharth Bothra: Yes, so when you look at the private capex cycle, it's been a discussion point for some years now. I mean, people have predicted a capex cycle coming back right from before the COVID period. We have seen some periods, some bouts where it looked like capex is coming back, and for various reasons, whether it be COVID initially, then maybe the election time, or small geopolitical issues, the recovery has not sustained.

Our sense is that now we are sitting at a point where the capex cycle revival is almost imminent because if you look at most of the core sectors, including power, which accounts for the bulk of the capex, the utilization rates for most of the core sectors are at a very high level, where they will need to go for capex. Even if you look at the power front, capex is now really reviving. So, our sense is that it could take another three or six months, but the capex cycle does look like it's turning around, and the private capex cycle would come back pretty strong within the next one to two years.

India's Key Growth Drivers

Aravind: From your perspective, what are the key structural growth drivers for India in the next 10 to 15 years, and how different are they from the past decade?

Siddharth Bothra: I think the key growth driver for India is the increasing per capita income. If you look, the first $1,000 is more about your basic requirements. From $1,000 to $2,000 is where some of the smaller, discretionary items pick up. As we move from $2,200-$2,300 per capita to maybe around $4,000-plus, what will happen is the consumption basket will change significantly. You will have larger ticket items becoming more of a necessity rather than a luxury.

Also, certain basic things like BFSI typically in a phase where per capita income moves from $2,500 to $4,500, they are one of the biggest beneficiaries because for the first time, people have a surplus to invest in the market. They have enough assets to want insurance. That's when demand for say, an AMC or demand for wealth managers, all this goes up in a significant way. That's when more people want a loan for housing, more people want a loan for buying cars, and so on. So, across the board, you will see the consumption theme becoming more attractive, and I think most of the bigger opportunities would be in this particular theme.

The other big opportunity I see is that India, despite being a very large country, had been missing some of the larger global opportunities, whether it was in manufacturing or in the initial industrialization era. But this time, I think we are more at the forefront of that. I think manufacturing as a percentage is going to increase, and we will play a bigger, pivotal role in the upcoming sectors which are there. So, these are the two or three sectors where I think you will see tremendous opportunities opening up over the next 5 to 10 years.

Ambit's Core Portfolio Strategy

Aravind: That's very interesting, sir. Now moving on to your products. Your core portfolio has delivered tremendously in recent months. What are the strategic changes you have made in the portfolio which have given this kind of performance?

Siddharth Bothra: Yes, I mean, so you know when you look at Ambit Coffee Can, it's come back very strongly into the top two or three in its respective category. The two or three key changes we did were, when you look at the way Ambit Coffee Can was managed earlier, there was a little bit of rigidity in our creation of the universe where we had some quant filters which determined what our universe would be. This was like having a 10% revenue growth and a 15% gross margin for each of the last 10 years, and any break would mean that it would go away from the universe.

When we had something like that, what happened is that even if we had great companies—what we call "fallen angels"—where things were great but they had one or two not-so-good years, they would have an issue. Also, when you look at the life cycle of a company, the way Professor Damodaran explains it, where just like a human being, someone starts off as a toddler and then becomes an old age and then starts declining—same for a corporate—we felt in the current stage we were missing companies in the high growth or the early young growth stage.

Many of these companies by their very nature did not have the requisite criteria to be seen as a coffee can. But we felt we needed to have a combination of both emerging coffee can companies and established coffee can companies because we wanted to capture not only the matured growth segment of the life cycle but we also wanted to be on the high growth side, in the initial young growth, high growth stage where the actual J-curve recovery happens.

So, what we did is we said we will have 30% of our portfolio which would invest in the segment where we will meet all the qualitative criteria that we look for in a coffee can company. For the quant requirements, we said it should meet it in the next three years. Essentially, what we relied on is that when we look at companies, 70% of our weightage goes on qualitative factors, such as determining the attractiveness of the industry. When you look at the companies, look at the moats, whether moats are increasing, whether pricing power is there, and rating the management. But for the universe, it was purely quant-based, and in our investing decision, we used to put not more than 30% weight on the quant factors. With this change, we could make the fund more dynamic and more growth-focused. As a result, many of the companies we bought there, many of them actually went up to 3x or doubled and kind of led to this recovery for the Ambit Coffee Can.

The other key change which is related to that we did is we said that we didn't, you know, one of the drawbacks we saw in this kind of investing style, which is quality-focused, is we saw that there was too much focus on backward-looking and too much focus on what you call static quality. We wanted it to be a quality on a forward-looking basis. So, we said yes, quality first, but we want these companies to not only have multiple moats but these moats should be expanding. If you're looking for companies with pricing power, not just pricing power, but places where either pricing power is going to dial up or people are now going to recognize pricing power which they had not recognized earlier.

To kind of summarize the second point, I would say we wanted companies which on a three-year, five-year forward basis would become stronger or emerge as a coffee can or become stronger. So, a forward-looking quality is where we shifted our focus from a very static quality. These were the two key changes which I think helped in reviving our performance in a big way.

Identifying High-Quality Stocks

Aravind: That's fantastic, sir. Sir, your flagship Ambit Coffee Can portfolio's earnings have beaten the benchmark Nifty 50's earnings in 14 out of the last 15 years. So, tell us, how are you able to identify these kinds of businesses or, rather, size the good quality stock positions in your portfolio?

Siddharth Bothra: By very nature, when you look at companies where you're looking for companies which have a history, which have all the ingredients of being a quality company, what typically happens is these companies are more resilient. They have durability. The key thing in determining the value of a growth company or identifying growth companies is longevity. It's not what we would call high growth. So, longevity is the key factor. When you do a DCF of a company, what really changes the thing is how long can you continue with a more than average growth rate. So, a lot of these companies, when they have pricing power, they by definition have longer longevity, and these kinds of companies are more stable. They have pricing power, so whenever there's high inflation or medium-term issues, they are able to pass on price increases or absorb cost by lowering their cost. You don't see the kind of fluctuation in their margins and so on which you would typically see in a company.

So, they are more stable performers and continue to steadily grow at a steady rate which is over and above the market. As a result, the point you mentioned, where on a long-term basis, both on earnings and stock performance and all, they do better than the average market.

High Conviction in BFSI

Aravind: That's great, sir. Currently, our coffee can portfolio has around 40% allocation in financials. Tell us the reasons behind this high conviction in financial service businesses, and what is your outlook for the sector going forward, sir?

Siddharth Bothra: See, I think when you look at the BFSI sector, just go back six to seven months. Most of these stocks were available at valuations which were at par with or lower than the pre-COVID levels. So, for any good investment, the basis is that you enter into them when valuations are very low. So that was there, and this is a large sector with a tremendous opportunity. We had just discussed how whenever the per capita income increases from, say, $2,300-$2,400 to $4,000, one of the biggest beneficiaries is BFSI.

So, we felt the opportunity which was there in BFSI is that while the near-term concerns were known to all, we felt it was reflected in the price and reflected in the way the market was valuing these companies. What was not being taken into consideration is the fact that if you were to do the intrinsic value of many of these businesses, whether it's insurance or private banks, many of them have already had 30 to 35 years of history and are likely to be there for another 20 to 30 years. So, on a DCF, having a lower growth for the next one year or 15 months did not really move the intrinsic value of the company much. But I think the nature of the market is such that they want to look at the earnings growth for the next one year or something and use it as a momentum factor. If that's missing, they see it as a low-growth company, which I think is a wrong definition because even any high-growth company goes through one or two years or periods where growth is not as high or in line with the long-term growth that these companies witness.

The reasons for growth being low were very transient: the interest rates were falling, and some of the companies were going through a merger. And maybe the deposit growth rate had come down. Over a period of one year, 15 months, the prices had corrected so much that I thought most of these concerns were reflected in the valuations of these companies. So, we thought it was a great opportunity for any investor who has a longer-term view of at least three to five years. Fortunately, it played out very well for us in the last six to seven months, and we continue to have a very positive view on BFSI from a longer-term perspective.

New Product: Longevity and Pricing Power

Aravind: That's good to know, sir. This one is special, and we want to understand it deeply from you, sir. Could you walk us through the new product you are launching which is centered around the theme of longevity and pricing power? What is the core idea behind the strategy?

Siddharth Bothra: So, for us, as I was mentioning, the investing style is more based on finding companies which have pricing power and trying to create a portfolio which would be a mix of some hidden pricing power companies where people have not identified it, some of the companies where there is some kind of understanding issues, and equally, a combination of emerging as well as established pricing power companies.

What do we essentially mean by pricing power? You know, Warren Buffett has this famous quote where he says that if you find a company with pricing power which is able to increase prices and not have their demand impacted or competitors taking away the market, then you have a great business. So, these businesses have the following advantages: First, during times of inflation or any temporary blips, they don't suffer as much as a normal company because they are able to pass on price increases or they are able to absorb costs because they have a significant cost advantage versus competitors. At the same time, these are very stable compounders. You look at most of the pricing power companies globally, like Mastercard, Visa, or S&P, or many of the top tech companies, or across the board, like an Apple or a Coca-Cola.

These companies enjoy either a cost advantage or they have the ability to increase the willingness to pay or the price advantage. In very extreme cases, once or twice, you find companies which have both these advantages. So these companies keep compounding, and they are less volatile than the rest of the market. They are more stable and they don't have the volatility that you see in other companies. Lastly, once the market recognizes these companies, they on a very steady state have a valuation which is significantly higher or higher than the average market.

So, if you can identify companies which are at the initial stage of getting recognized as having pricing power or kind of establishing their pricing power, that's where you get the maximum delta because then you can get all the levers that you look for: volume growth, price growth, margin expansion, as well as valuation expansion, which is what you want to do.

So this product, as you rightly mentioned, would be focused on finding a combination of different pricing power companies, which is some are hidden pricing power companies which people normally don't associate with pricing power. Some of them would be emerging pricing power companies. I remember when we had bought Zomato two years back and we used to call it a pricing power company, people often used to laugh at us because their impression of it was that it is a loss-making company, and everyone had different things to say about it. But over the years, now people realize that it's probably one of the most strong pricing power companies that we have in India, which has an advantage both on the cost side and the price side. So it would be a combination of these companies.

Essentially, we look for "forever companies"—companies as Warren Buffett describes them—that have a significant advantage and are the kind of companies you would want to hold for a long period of time. When we have a combination where some are established pricing power, some are emerging, some are hidden, some are not yet recognized, that's when the portfolio has the ability to create long-term alpha.

If you look at a long-term alpha, it's created by two key things. If you want to create alpha over a 5- to 10-year period, what are the two or three things you need? One is that the most important thing in creating alpha is how you do on a drawdown. So when you have a portfolio which is so focused on quality, pricing power, and top-quality management, in a drawdown, they do significantly better. The other thing is the way you earn alpha is that on a long-term basis, you need two or three big winners because that changes the characteristics or the very nature of your portfolio. So when you invest in say, 20-25 companies which have all the characteristics of forever companies or very growth-longevity companies, typically two or three of them surprise you significantly on the upside. The way to create alpha is to limit your downside and have all the ingredients where the optionality can work for you. Over a three- or five-year period, even if two or three of these companies do very well, that's how we look to create a sustainable, superior, long-term risk-adjusted outcome.

Identifying Companies with Pricing Power

Aravind: Very interesting, very, very interesting. So, a follow-up question is what are the key quantitative or qualitative filters you will use to identify businesses with superior pricing power, and how do you evaluate their edge to have that ability to have superior pricing power over time, sir?

Siddharth Bothra: A very interesting question. So, we have talked about it in great detail. We've also written newsletters on it. But let me give you a quick insight as to how we do it. We typically say that we have a combination of both quantitative and qualitative factors, where we give 30% weight to quantitative and the majority, which is 70% weight, on qualitative factors.

On the quant side, it's relatively easy to figure out what are the things you will look for. Say, you look for companies on the margin side. So, you want companies which have high gross margins, margins which are very stable. Whatever the ingredient, whatever the narrative that you build for a company, you want to see whether the numbers are throwing that up. If you say a company has pricing power but their margins are lesser than their competitors or lesser than the industry average, or their ROE doesn't reflect the pricing power, then your narration is not correct.

So, we go through all the nine filters on the quantitative side. We have filters to first figure out whether the company has quality. The next filter within that would be to see on the growth side as to whether they are growing higher than what's happening on their market share. Within that, then for longevity, we look at whether the "Lindy factor" is at play here. And then obviously on the pricing side, we look at the intrinsic value. So, we have nine filters on the quantitative side. The more important one is the filters on the qualitative side because that's where you have an edge. While quantitative factors like capital allocation, margins, and profitability can be mimicked, the qualitative aspect is truly an art and very difficult to replicate. We begin our process by identifying companies that have dominance. This doesn't necessarily mean they have to be a duopoly or an oligopoly. For instance, if you look at a company like Eicher Motors, their overall market share in the two-wheeler industry might be only 4% or 5%, but in their specific segment, their market share could be as high as 87% or 90%. So, we look for companies with dominance in whatever they're doing.

The second key factor, which is our primary qualitative filter, is looking for businesses or industries where there's a significant variance in the key variables that a consumer values highly. To give you an example, in the hospital sector, the two or three most important things for a consumer are the doctors, modern equipment, and location. Other factors, like pricing, are often not critical. We look for industries where some companies are very weak on these key consumer variables, while others are very strong. Another example is organized retail. A company like D-Mart has an entire cost of operations of about 6% to 6.5%, while for many of their competitors, their rental cost alone is 8% to 9%. This kind of advantage, once it starts compounding, creates a powerful flywheel that is very difficult to beat.

We also have a series of six other qualitative factors, and we make sure that these are reflected in the quantitative side through superior margins, superior return on equity (ROE), or superior capital allocation. The final piece is that all of this must be available at a price that we believe is intrinsically cheaper than what it should be.

Aravind: That's a great explanation. You mentioned the importance of a moat. How do you continue to follow a company after you've invested in it?

Siddharth Bothra: That's a very important question. It's not enough to simply identify if a company has a moat or pricing power. The critical question is, "Is it expanding?" Is the moat expanding? Is the pricing power expanding, or is it in a state of contraction in the medium to long term? That's where we get into the micro details and look at forward-looking numbers. This is our secret to identifying these companies—we are too focused on lead indicators that suggest whether the moat or pricing power is increasing or decreasing. This is how we bring the entire thing together.

Aravind: That's a perfect answer. Now, how does this fund differ from your existing offerings at Ambit in terms of investment philosophy and risk framework?

Siddharth Bothra: When I compare it to the Coffee Can PMS, there are a few key differences. First, the Coffee Can is a PMS, and this is an AIF (Alternative Investment Fund), so the structure is different. An AIF also has some advantages. Second, our Coffee Can is a large-cap product, with a mix of 80% large-cap and 20% mid and small-cap. This new fund is a flexi-cap fund, which gives us a huge amount of flexibility to invest across market caps. Third, it doesn't have any of the legacy issues that were present in the Coffee Can, so we can have a larger proportion of what we call "emerging pricing power plays." The final point is that in our AIF, SEBI regulations allow us to have 20% to 25% in unlisted stocks. While we have no current plans to do so, it gives us the flexibility to invest in a stock that might be about to be listed, which we cannot do in the other fund. In terms of the core philosophy of finding pricing power companies and our risk framework, those things are intrinsic to our process and do not change.

Aravind: That's great. Now for a new section, a set of rapid-fire questions. Just give me the one-word answer you like or prefer. First, what is more important to a business: profits or cash flows?

Siddharth Bothra: Cash flow.

Aravind: What is more dangerous in investing: an error of omission or an error of commission?

Siddharth Bothra: Error of omission, clearly.

Aravind: Which style of investing do you like: value or growth?

Siddharth Bothra: If I have to choose one, it would be growth. But my sense is they are not different. There's nothing like growth or value investing. Everyone is a value investor. You want to buy something that is priced less than what its intrinsic value is. Some people find value in assets, while others see growth as a value factor. If a company is growing very fast and creating a lot of value in the future, you discount that back to the present. To my mind, any investor who buys something at a price they believe is less than what it should be is a value investor.

Aravind: That's a key takeaway. And finally, a tough one: coffee or tea?

Siddharth Bothra: Of course, Coffee.

Aravind: Thank you so much for gracing in our show sir. We absolutely loved it, sir.

Siddharth Bothra: Thank you, Aravind. It was a pleasure and an honor to be on this show. Thank you so much.