Transcript

Will the Market Rally Continue? PMS Fund Manager Aniruddha from 36-Year-Old Research House Answers

Ms. Bavadharani: Thank you for joining us, Mr. Aniruddha Sarkar, CIO and Portfolio Manager at Quest Investment Advisers. Let's start with the market, as that's what everyone is keen to know. The markets have been volatile and have recently reached an all-time high of 25,000. What are your thoughts? Do you think this rally will continue, especially considering Q1 results and Q2 expectations?

Mr. Aniruddha Sarkar: I appreciate your invitation. Regarding the market, I've consistently pointed out that while many expect a downturn, the reality is often the opposite. When everyone anticipates a market fall, it usually doesn't happen, which is why we're not seeing a correction. Over the past four to five years, there has been a significant influx of domestic money into equity markets. This support from retail and HNI investors is crucial; every dip is being bought. Currently, foreign institutional investors (FIIs) are not driving market direction. Our economic fundamentals remain strong compared to other emerging and even developed markets, which is reflected in corporate earnings and domestic investor optimism. So, while markets are high, the underlying support from these factors suggests a continuation of this trend.

Ms. Bavadharani: With respect to your portfolio at Quest Investment Advisers, how is your cash allocation? Are you fully deployed or holding some cash? What influences your decision?

Mr. Aniruddha Sarkar: On average, I maintain around 4 to 5% cash in my portfolio. Currently, that’s the level I’m at. There are occasions when I increase my cash allocation to 10-12%, particularly during market risks or significant events. For instance, around the elections, I held 10% cash, which I deployed after the results were announced. But right now, I’m comfortable with my average cash position.

Ms. Bavadharani: You’re known for sector rotation strategies. Could you share with investors how they might time entry and exit into sectors? What should be included in a basic checklist?

Mr. Aniruddha Sarkar: Many investors ask me about sector rotation, and I must clarify there’s no magic formula. It requires being connected to the market. We analyze over 400 companies and regularly interact with management and industry experts. This ongoing dialogue helps gauge whether businesses are in an up or down cycle. Furthermore, valuations are critical. If earnings don’t support high valuations, that’s a signal to exit a sector. I often hold onto sectors for a long time if the earnings justify the valuations. The combination of valuation assessments and management interactions informs our outlook on industries, guiding our decisions on entry and exit.

Ms. Bavadharani: When selecting stocks, do you focus on sectors first or individual stocks? How does your strategy work?

Mr. Aniruddha Sarkar: That's an excellent question. Both sector selection and stock selection are intertwined. You can’t just choose a sector and then look for a company within it. Insights gained from interactions with companies guide my understanding of which firms are positioned to perform well. When multiple companies in a sector show promise, it reinforces the outlook for that sector.

Ms. Bavadharani: Considering your portfolio, I noticed stocks like Zomato and Trent have risen significantly. Do you see further room for growth in these stocks? How do you assess their valuations?

Mr. Aniruddha Sarkar: For any stock, it’s crucial that earnings justify its valuation. For example, Tata Trent currently trades at about 2 to 2.5 times the price-to-earnings growth (PEG) ratio. When we first invested, the valuation was slightly higher due to lower earnings at the time. As long as earnings continue to grow, the current multiples remain justified, and I don't see a reason to exit either Trent or Zomato.

Ms. Bavadharani: Finally, what are your views on small-cap and mid-cap stocks? They’ve shown varying behaviors recently. How do you navigate this landscape?

Mr. Aniruddha Sarkar: There’s a lot of debate about whether small caps are overvalued or not. It's important to avoid generalizations across market caps. There are attractively priced small caps and expensive ones, just as there are with large caps. I take a bottom-up approach, examining individual companies rather than broad categories. Currently, I’m slightly overweight on small caps and believe that over the next 36 months, they will likely offer the highest earnings growth compared to large caps.

Ms. Bavadharani: You’ve mentioned being overweight on the auto and consumer services sectors while having a decreasing allocation to banks and other financial services. The index has given nearly 30-35% returns in that space. What’s the logic behind your allocation strategy?

Mr. Aniruddha Sarkar: Historically, banks have represented about 30% of the benchmark index. However, for the past four to four and a half years, I’ve consistently been underweight in banks, except for one year. This underweight position has actually benefited my portfolio. Instead, I've focused on non-bank financial services such as asset management, wealth management, insurance, and housing finance, as I believe that’s where growth is happening. Within the banking sector, I prefer Public Sector Undertaking (PSU) banks over private banks. Currently, I see that private bank valuations have corrected significantly, which presents less downside risk and good upside potential, especially if the Reserve Bank of India (RBI) eases its lending growth measures.

Ms. Bavadharani: Given your sector focus, what are your favourite sectors or themes for investment in the near to medium term?

Mr. Aniruddha Sarkar: My top sector allocation right now is urban and semi-urban consumption. This part of the economy has been performing well. Within that sector, I’m focusing on several sub-sectors:

1. Real Estate and Ancillary: While I’ve been slightly underweight here recently, I was bullish on real estate for a long time.
2. Auto and Auto Ancillary: This sector continues to show promise.
3. Consumer Discretionary: This includes leisure activities like dining out and shopping, which are integral to our lifestyle.
4. Hospitality: The hotel industry is experiencing significant growth, providing strong cash flows.

The second theme I'm bullish on is the industrial sector and capital expenditure (capex). A lot of private and public capex is taking place, marking a multi-year story rather than just a one-year trend. Historically, public capex has built the infrastructure; now, it’s time for the private sector to lead, which will also create job opportunities.

Ms. Bavadharani: You mentioned that the industrial sector is a multi-year story. Some people have mixed reviews about the current capex cycle. What are your thoughts?

Mr. Aniruddha Sarkar: It’s true that private capex hasn’t picked up significantly yet, and we all acknowledge that. A significant portion of it was waiting for the elections to conclude. Public capex has been the main driver in recent years. Private capex typically picks up when capacity utilization exceeds 75%, which is a rough benchmark. Currently, Indian capacities are running between 70% and 80%, suggesting we’re at the right juncture for private capex to start gaining momentum across various industries.

The good news is that the plans are in place, credit lines are established, and corporate balance sheets are healthier than they’ve been in the last two decades. Leverage isn’t a major concern anymore, and cash flows are strong. I anticipate a solid capex cycle in the next four to five years. If the U.S. Federal Reserve cuts rates and the RBI follows suit, it will further stimulate corporate borrowing and capex.

Ms. Bavadharani: Speaking of the RBI, what are your thoughts on their approach to interest rate management?

Mr. Aniruddha Sarkar: I believe the RBI has done a commendable job managing interest rates. We’ve increased our rates much less aggressively compared to the U.S. Federal Reserve. I don’t expect the RBI to drastically cut rates like the Fed in the near term, but gradual adjustments will happen over time. This will provide corporations with the impetus to borrow and invest in capex. If the interest rate cycle turns, it will create a win-win situation for everyone involved.

Ms. Bavadharani: Your funds have delivered nearly 50% returns over the past year, and even in the five-year timeframe, both funds have delivered around 20-25% returns. What has contributed to this success?

Mr. Aniruddha Sarkar: Consistency has always been my key focus area. I believe that a portfolio should deliver consistent returns. The last year has been exceptionally good, but if we look at the past four to five years, there has been notable consistency in returns. This can be attributed to being slightly more active in selecting sectors and market caps. It's about determining which market caps I'm bullish on and which I want to underweight.

Additionally, it's crucial to pick the right companies at the right valuations. This ongoing process involves focusing on sectors, market caps, and the right companies within those sectors. One aspect I always keep in mind is to avoid making mistakes; one misstep can take the good work of four or five successful investments to recover from. Thankfully, there have been no accidents in the portfolio, which has helped generate these returns.

Ms. Bavadharani: That’s great! Now, whenever we discuss entry points, there's always a conversation about exit strategies. Could you explain how your exit process works?

Mr. Aniruddha Sarkar: Both my entry and exit strategies are gradual rather than one-time events. I typically build up my positions over time, and similarly, I gradually exit or decrease my positions. The reasons for exiting can vary: it could be that I've reached my valuation objective, there may be external factors that have altered my investment thesis, or I might see limited upside potential in a company and find a better alternative to invest in. These factors essentially guide my exit decisions.

Ms. Bavadharani: You’ve recently launched an AIF as well. The allocation appears somewhat similar to your PMS, with some overlap. How is this AIF product different, and who would be the ideal investors for it?

Aniruddha Sarkar: The debate between AIFs and PMSs has been ongoing. However, I’m noticing that high-net-worth individuals (HNIs) prefer moving towards AIF platforms due to the ease of operations and the hassle-free tax implications at the end of the year. This is a significant reason why we've launched the second series of our Quest Smart Alpha Sector Rotation, following the success of the first series we launched in May 2022. The first series delivered exceptional returns post-tax and expenses, around 5% alpha over the benchmark. We expect the new series to follow the same style and philosophy of sector rotation.

Ms. Bavadharani: Thank you so much for joining us today. It was a pleasure speaking with you and gaining such valuable insights!

Mr. Aniruddha Sarkar: Thank you! It’s always a pleasure to interact.