Nilesh Shah, Managing Director of Kotak Mahindra Asset Management Company, shares with us his investment journey, the evolution of his investment philosophy and his portfolio construction style.
Nilesh Shah’s love affair with the stock market commenced during his articleship days in 1989. His lunch hour stroll daily was always towards the Bombay Stock Exchange,as all the noise coming from the trading ring intrigued him. “That was my first encounter with the stock market. Eventually, I was lucky to do my CA and move into the financial services business,” recalls Shah.
Shah subsequently carved a name for himself in the investment world and today, has over 25 years of experience in capital markets and market related investments. Through the years, he has held prominent positions at Axis Capital, ICICI Prudential Asset Management, Franklin Templeton and ICICI Securities, before he grew to become the managing director of Kotak Mahindra Asset Management Company. He has managed funds across equity, fixed income securities and real estate for domestic and foreign investors. During the course of this professional journey, his investment philosophy took a solid shape and helped him lead his team of fund managers with clarity. Not just this, a voracious reader, Shah aims to help educating investors on financial planning and has also co-authored a book on the subject, titled “A Direct Take.”
In this story for Beyond Basics, he shares with us his investment journey, the evolution of his investment philosophy, valuations strategy,portfolio construction style and more.
(Narrated in First Person)
Beyond Basics is published by Wealth Advisors (India). Visit us at www.wai.in for more information.
Investment philosophy and its evolution
If you are a value investor, you sometimes get trapped in companies which do not grow or you are unable to unlock its value. On the other hand, if you are a growth investor, you end up losing opportunities of investing in those value stocks, which have a lot of upside potential. So, as a fund manager my job is to simply make money rather than worry about the definition of how I make money. Let me give you an example. When I was investing in fixed income, others from my peer group didn’t take longer term duration calls and invested only with a three year to five year horizon. I thought there was more money to be made in a longer duration play and invested for 7 years to 10 years. Obviously it is more risky but as a fund manager, I am willing to take a calculated risk and this helped in our performance.
On the equity side, our focus is to make money on risk adjusted performance, remain opportunistic and explore every single avenue available. For instance, we invested in derivatives and also in one of the first warrant issues that came in India where we contributed more than half of the issue. But the core philosophy is that people pay money for your professional expertise and you cannot betray that trust by investing into businesses which are not real. For example, in 2000, when there was the technology, media and telecom (TMT) bubble, a lot of people invested in companies that had no clear business model.
Second philosophy is to invest in companies driven by fundamentals only and clearly differentiate between noise and actual facts. Finally, it is important to manage your risk(liquidity, concentration and reputation risk) efficiently.
With the benefit of hindsight
If I have to start my journey all over again today, I will divide my investment universe in to two boxes. Good industry, good promoter and bad industry, bad promoter. I will always avoid bad industry and bad promoter. I will put maximum money in good industry and good promoter and it will be huge bad luck to lose money in that quadrant. I will evaluate opportunity between good promoters in bad industry or bad promoter in good industry purely from a trading point of view.
This brings us to the question of how do you identify a good industry and good promoter.
Apply your smell test to identify a good promoter. As fund managers, we have access to their past track record. Understanding a good promoter is not hard and it is done by millions of people, for example, when they are finding a groom for their daughter. What is more crucial is to identify a good industry. One learning that we have had over the years is that any company which allocates its capital efficiently is a good company. Earlier,I used to say that any company that doesn’t need your money is a good company to invest in as it is utilising the existing capital to grow. Then, by definition, I have excluded many banks which need capital from a regulatory point of view to grow. But, over a period of time I have learnt that it is not the non-requirement of capital but the utilisation of capital which is critical.
Types of businesses that he admires
Professionally, I appreciate companies where the promoter or management believe in protecting minority shareholders. It is also important for the company to use its capital judiciously.
Required qualities of a fund manager
Most important thing is honesty. I will give my money to a person whom I can trust blindly. He may not be the smartest, but honesty pays over a longer time. Fortunately, today, you don’t have to worry about this and can almost take this quality for granted across my peer group.
I also will invest in a fund where the fund manager has invested his/her money. I want to see their skin in the game as much as putting my skin in the game.
Finally, I don’t want to bank an individual fund manager. Tomorrow he may decide to go to the Himalayas and become a sanyasi! I want to invest in a car which has an accelerator, which is the fund manager, and brakes and gears, in the form of management practices. It is critical to ensure institutionalisation of processes.
At Kotak, we have taken a voluntary pledge that whenever we want to invest our money, we will put that into our mutual fund schemes. I have no choice but to assure investors that whatever I am preaching to you, I am already practicing.
One of my biggest issues is that I cannot move in to cash, as our investors track the NAV on a daily basis. None of my investors are khumbakarna who will wake up after 14 years to check what I have done. And hence, I have to deliver on a daily or a short-term basis. I don’t have the opportunity like Warren Buffet who can sit on plenty of cash without answering anyone. This is the game of relative return, which is a boon and a curse. The curse is that I will be judged on a daily basis and it is a boon as I will always be judged against the benchmark index. If the index is down 50 per cent and you are down by only 40 per cent, then you have done a good job. And similar is the case if your fund has outperformed the index, which has, say, gained 40 per cent.
Our valuation philosophy has been evolved over this: Are you buying something which is more expensive than the market, or are you buying something which is less expensive than the market. We are overcoming the complex problem of figuring out the valuation, through relative valuation. Many people focus on one aspect of valuation which is PE ratio or price to book ratio, while we identify other aspects like price to earnings growth. Even if there is some under performance in the immediate term, we aim for long term out performance. So, wherever we see long term potential, we start building our position slowly and steadily. Though we may end up paying a little more over the short term, over a long term, it works out well.
The opportunity in India
From 1991, when I started my career in the capital markets, till today, economy has grown from US $200 billion dollar to US $2trillion. Market capitalisation has also grown from US $200 billion to US $1.6 trillion. In some sense, the economic growth and the market capitalisation growth is correlated over a long period of time. There is an expectation that over the next ten years our economy will double in size and so the US $2 trillion will become US $4 trillion. If we increase the size of economy, market capitalisation may follow. Effectively, I believe, whatever wealth we have created in the stock market from 1991 to 2016, a potentially similar opportunity is available in the next 10 years. What worked in last 25 years is that, when you picked up good companies and good promoters, it worked. And, that fundamental concept will not change.
Views on “disruptive innovations”
Disruption is the game of life and it occurred even earlier. Automobile disrupted horse carriages and industries related to that; computers disrupted manual processing, and so on. There is disruption in other segments also. Even in simple thing like shirts, we get wrinkle free shirts now. You may get shirts which will make you cooler or warmer in terms of temperature. What we have to really focus on is who is leading this disruption and is it worth backing the person leading the disruption.
Interesting themes to bet on
There are two interesting opportunities.
From a sector point of view, I believe, the pharmaceutical sector is a great opportunity. An SIP of amount equivalent to medical insurance premium in Pharma stocks may yield investors better returns over a longer term. But medical insurance also has its place in personal finance planning.
Today, we are moving from roti kapda makhan economy to healthcare and wellness economy. When we were earning below US $1500 per capita GDP the focus was on roti kapda makhan. Today, a large segment of the population is above US $1500 per capita GDP and they are moving towards healthcare and wellness. People are also following a very sedentary lifestyle. Their health is deteriorating and pollution, stress and lifestyle is taking a toll. Consumption of pharma products is going to increase in such a situation.
In the very near term, lot of Indian companies lost their factory registration to export generic medicines to the U.S. This results in a lot of opportunities for the pharma companies : One, Indian pharma factories will get registration or approval from USFDA. Second, they will build a pipeline of applications to export their generic medicine to the U.S markets. Third, when these applications will be approved for product launches and tremendous earning potential of these products.
These three distinct trends will evolve over 36 to 48 months. And hence, it might be worth investing in the pharmaceutical sector in the long term taking some underperformance in the near term to generate out performance over a longer period of time.
Second opportunity is the monkey to guerrilla strategy. Everyone wants kingkong in their portfolio – a stock which has transcended from a small cap to a mid cap to large cap, giving maximum returns. But it is difficult to identify a kingkong. It is easier on hindsight than on foresight. So, it is better to rear a bunch of monkeys, some will grow to become guerrillas while some others will die. Invest more in companies that have grown to become guerrillas and hopefully, one of them becomes kingkong.
It happens daily when the market teaches me a new thing. In 25 years of experience, I cannot take the market for granted and say that I have mastered it. Every time my arrogance takes me higher, the market will humble me.
The biggest challenge is to not to take anyone’s bad wishes. We are not managing money but people’s dreams, trust and confidence in us. It is important for us to behave in a responsible manner so that the trust and confidence continues