Finding Growth along with Value when markets are at all-time highs

Indian economy is bound to get back to track, demand and growth is coming back, and if one refers to the FY 21 numbers, there is already a rise in corporate earnings despite the pandemic. Hence, Mr. Sunil Singhania, founder of Abakkus Asset Manager LLP, believes that finding value in growth businesses is the way forward in the equity markets for investors chasing Alpha. Abakkus had launched its first All-Cap alternative investment fund in 2018, followed by an Emerging Opportunities Fund in 2019, and given the recent rally of 2020-21, especially in the small & mid cap space, the NAV of Abakkus Emerging Opportunities AIF (small & mid cap fund) has doubled in less than 2 years.

PMS AIF WORLD, which is one of the most trusted investment services platform in the space of Alternates, held a webinar with Sunil Singhania on this day to congratulate him, get guidance for investors regarding future performance. This webinar was conducted by Kamal Manocha— Founder & CEO, PMS AIF WORLD. In this very intuitive interaction, he tried and discussed in detail, some of the areas where investors always raise queries while exploring Abakkus’ funds as an investment option.

Abakkus Asset Manager was formed 3 years ago with the core ideology that ‘growth businesses that are undervalued’ will be the top performers. The AMC heavily relies on in-house research and analysis to identify such ideas. Mid and small cap stocks were out of favor from end of 2017 until mid – 2020 but Abakkus identified inherent value in this segment and had launched its Emerging Opportunities AIF in 2019, backed by its strong belief that those quality names which have growth potential in this segment will outshine sooner or later.

“If a company is growing at 10% on Earnings but is available at 70-80 P/E multiple, investing for the sake of perception of high quality is not our style. On the other hand, if a company is growing at 20% and available at 10 to 15 P/E multiple, sooner or later market will re-rate it and hence this is a value investing as per our investment style. Quality of business, financials, management is important to us, but value at which we invest is also equally important to us.” – Sunil Singhania

While receiving applauds during the webinar, Sunil Singhania highlighted that, it should be noted that such high returns (~ 200%) have been delivered by Abakkus Emerging Opportunities AIF at the time when equity indices have risen by 25%, given the pandemic in FY 21.  And, while consensus earnings estimate for FY21 were -30%, earnings, ironically, surprised us with +25%.

Also setting the investors’ expectations right for future performance, Sunil Singhania added that huge returns achieved over last 2 years will not be achievable in the near future. But, for future guidance of possible returns, one could follow expected earnings from the portfolio companies. Average portfolio earning is poised to grow at the rate of ~ 15%-18% with a minimum 3–4 year of time horizon, keeping any future waves of the pandemic aside.

Upon being asked the key traits that investors should relate Abakkus to, Mr. Sunil Singhania chose to answer the question in two parts.

• Being a part-owner of the company: If you have confidence in the company for the quality of its management, business, and financials for long period of time, it makes sense to be a partner in the company financially.
• The price paid today should be lower than the future profits expected from the business.

So, quality and value investing, both are crucial to Abakkus.

Abakkus is an alpha generator for its investors as it focuses on investing rather than allocating money. A sound in-house research team helps deep dive into universe of mid, small & large businesses to identify value in growth companies. Abakkus looks for value in growth stocks and investments are done in companies that have a P/E multiple of 14–15 times and are growing at 10% p.a.

Abakkus follows a MEETS framework; it stands for Management, Events, Earnings, Timing and Structural Studies, and provides guidance to managers towards superior returns. The management’s hunger, capability, and vision play a key role across all strategies in the fund. Corporate governance and succession planning have been effectively taken under the management part of the framework. Earnings can be unlocked where there is value and vice versa which keeps track of the earnings growth. It drives major investment decisions at the firm as the quality and sustenance of these numbers also play a vital part.

Events such as M&A and splits raise concerns or are catalysts in wealth creation. A close watch at government regulations will help fund managers to take a wise call. It is difficult for any manager to time the market, but it is a staunch belief at Abakkus that investments are timed correctly, especially for cyclical stocks. It is wisely put that rather than staying invested for the long term, funds should move efficiently in search of growth and the correct investment time. Structural studies deal in consumer centralism and stocks that have the potential to give returns. Lastly, a balance between the amounts paid today has to be far less than the future structural changes or growth that a company expects. The risk-return ratio comes in handy when investing large funds in small and mid-cap stocks.

Portfolio creation and generating alpha is a function of two things which are selecting the best stocks and avoiding stocks that eat into your returns.

The latter is skipped by many investors as losses more than consolidate the returns for an average overall return from a particular portfolio. The MEETS framework not only helps to select the best companies but also avoids companies that lack the potential.

Besides AIFs, Abakkus also offers 2 PMS options, All Cap PMS and Small/Mid Cap PMS. The Abakkus All Cap Portfolio consists of companies like ICICI Bank, HCL and LIC Housing Finance, Muthoot Finance, as these are some of those growth businesses which are available at relatively lower value to its peers like HDFC bank, Infosys, Bajaj Finance. It is a known fact that the above-mentioned stocks offer value, but it should not be ignored that over a period of 5 years in the past, their earnings have also considerably increased. There are things that have already taken place in the past, however, equity investing looks ahead and deals in the future.

Companies popularly called as consistent compounders are not where Abakkus believes to invest as they are priced to perfection already. Moreover, the best company does not necessarily mean the best stock, so to say. The companies exempted, give you Nifty kind of returns that are lazily managed by funds via ETFs, he added. But the mistake that most investors get caught into is that they sometimes define ‘best’ based upon perception and not reality. There is a stark difference between perception and reality. To put things into perspective, he mentioned that ICICI bank has performed really well in the last five years; but then so has Muthoot Finance, on the NBFC side. Investors should avoid perception taking over reality.

The pre-pandemic stock market was beaten down for small caps and mid-caps, but we have witnessed one of the sharpest rallies in this segment in FY 21. One needs to be careful of stocks that are overpriced and should not get caught in the greed trap of higher returns at current levels, as we speak in June 2021.

Talking about being careful, he also stated that trades based on hopes and stories need to be discarded at the first instance itself.

COVID has been a black box that has taken millions of lives affecting businesses on a large scale. The unorganized sector has been largely hit with local lockdowns and restrictions breathing down every part of life. Vaccines have helped reduce the cases in many countries and India has no different story. Liquidity is still available in plenty and is here to stay for a long period of time. Governments have planned to spend trillions on infrastructure with India pegging the number at $1 trillion for the sector. The recovery is quite visible in steel, metals, chemicals, and infrastructure for the Indian economy.

Exports have risen while import and PLI curbs indicate that factories need to expand business within the shores. The spot that inflation and interest rates are currently in, has helped many sectors. Reasonable expectations while investing in equities is the key to making double-digit returns.

At Abakkus, the NBFC investing sector is divided into two parts with the first one being funds-based investing that lends money to the economy. The second category entails to non-fund-based houses like brokerage houses, exchanges, and insurance companies as well. The mix of non-fund-based houses in their portfolio comprises of companies that have done very well post-COVID.

As for the portfolio strategy, the bottom-up approach has worked wonders for the fund along with a sectoral rotation strategy, with a bias to the former. Sector rotations have increased considerably, with government regulations easing capital flows in numerous sectors. The auto sector has been completely left out of the portfolio as margins are poised to turn out low with rising input costs. The steel sector is quite cyclical and hence entails a 3–4 year time horizon.

On the macro part, he believes that a company’s CAPEX, in contrast to the sector it is in, plays a key role. The declining interest rates has helped the housing sector unlike those not dealing in it. Hence a diversified portfolio combining both sector rotation and macro analysis is the way forward at Abakkus.

Having worked in the mutual fund industry, Mr. Sunil Singhania rightly reminded the investors that past performance is not a reflection of future performance.

As markets are forward-looking, equity returns are all about the future and hence investing in a fund solely on past performance could be hazardous. Yet again, an individual’s perception is different from reality. For both funds at Abakkus, the ROE stands at 18x while the debt-to-equity ratio at a meager 0.1. A company’s quality cannot be judged from its size as it does not have a direct relation with it. An investor who does not like his portfolio being volatile can invest in an all-cap fund that will mimic the Nifty volatility and returns. Moreover, investing in upcoming sectors that are yet to be tapped will be beneficial for the Indian youth that has just entered the stock markets. Reaping returns from investments in a niche company or a home-grown brand cannot be found in the Nifty. The returns have been decent from the larger mid-caps that have a market cap of Rs 1.5–2 billion. Emerging opportunities have the potential to return 130% as compared to large caps that provide 110% returns.

Equity markets are like a cardiogram wherein the doctor is not worried if it fluctuates up and down. Cautious investors are very well guided. Short and swift corrections can take place upon the breaking of crucial news and information. Deep corrections can be ruled out as uncertainties drive them to different places. Investors with a time horizon of 3–4 years need to be aware of the risk-reward ratio of investing in small caps and mid/large caps. A balanced portfolio is bound to stand out among the masses.

As Bollywood swears by Entertainment, Entertainment, Entertainment, markets go by Earnings, Earnings, and only Earnings.

A sound portfolio will be created when there is room for earnings growth. It will also happen when there is 3–4% cash available to grasp on to some opportunity. The fund has not seen a scenario where they have charged investors for just keeping the cash with the firm and not investing it anywhere. The cyclical exposure is minuscule at Abakkus as they continue to chase value in growth. Allocations have been made to IT/Tech/Digital companies that do not fall under the said category. The notion of investing in cyclical companies if you are chasing value is not true in its absolute sense.

The 15:15:15 approach to investing in companies, covers the fact that funds will be allocated to those having a P/E of less than 15, sales growth above 15%, and earnings above 15%. It was justified by stating another fact that to create a diversified portfolio a lot of hard work is needed and to that end, a small team of 14 members on the investments side has done well at Abakkus. The discovery process lasts for 5 days at the AMC, at the end of which the team comes out with 50-60 companies worth investing in. Global trends are factored into while shortlisting companies for a particular strategy to work in the fund. Calculated risks are necessary as they bring in disproportionate returns along with staying alert as to what the sector is currently returning to the investors.

Disruptions have led to model assumptions being skewed and hence diversification is equally important. Allocations are currently being made with 5% risk at the time of investing when markets are fragile. An investor’s conviction helps gauge risk numbers on a different scale altogether something that has been followed at Abakkus. Investing in 25–30 companies in a portfolio helps mitigate risks stemming from one or two companies.

Given India’s economic growth, there will be companies that will be priced cheaply and investors need to grasp their opportunity after weighing their growth potential and the value they have to offer. All-cap portfolio of Abakkus offers value to investors that hate riskiness in their investments.