In the latest instalment of the Coffee Can Investing series, Saurabh Mukherjea talks to Mahesh Patil, Co-Chief Investment Officer, Aditya Birla Sun Life Mutual Fund.
Patil joined the fund house in 2005, and has managed funds such as the Aditya Birla Sun Life Frontline Equity Fund, which has been amongst the top performers in its category over the last 10 years.
In this conversation, Patil talks about his investing journey, and how he helped build the fund house into one of India’s largest.
S: Let’s begin with the start of your career. What was it that attracted you to the stock market, given that you came from a middle-class background?
M: I came from a middle-class family. My father was a government servant. We used to discuss about stocks at home. My dad used to talk about his investments in companies like Castrol, Reliance Industries and Grasim.
S: This was is the early 90s right?
M: Yes. Most of these companies were acquired through initial public offerings (IPO). At that time, I didn’t know much about stocks. Home is where I initially got to know about stocks as my father used to talk about how he made good amount of money in some of these investments.
I always wanted to be an engineer and that’s how after completing my 12th I got into engineering at VJTI. I worked for two years at a computer firm CMC (which was amalgamated into Tata Consultancy Services on October 1, 2015). However, I yearned to do something more and the option was to do my Masters in Science abroad or an MBA over here. Since my dad wanted me to be with him, I thought it was best to pursue an MBA with Jamnalal Bajaj Institute of Management Studies (JBIMS). That is the time when I was exposed to the equity market. It was the year (1991-92) when big bull Harshad Mehta held sway over the market and that period saw most people having their first brush with equities.
While pursuing my MBA, I invested in the market with savings that I had accumulated while working over two years. During that period, the market went up almost 250 percent. It was a thrilling experience. I was doing my own research. Also, a lot of the projects I did during the second-half of my MBA also revolved around equity research and investing. It was around then that I decided to really pursue a career in finance.
I was very clear that this is an area where a lot of my analytical skills as an engineer and knowledge about finance could be put to use to really make good amount of money. That’s how I really veered towards getting into the stock market. At that time, I was not very sure what I would want to do, even though it was clear that I wanted to get into equity research. Initially, I got a job which was more into project finance in Tata Economic Consultancy Services (merged with Tata Strategic Management Group in August 2006). At that point in time, there were not many research houses. One of the research houses was Parag Parikh Financial Advisory Services, which was known for its unique style of research. I joined them and that’s how my journey really started in equity research.
S: You are one of the few people I know who has had the privilege of working with the late great Parag Parikh and also with Raamdeo Agrawal at Motilal Oswal. What were the learnings from that phase of your career as you worked with two of the most celebrated investors our country has seen?
M: At that point in time, early stage in the career, some foreign fund research houses had come in and they were like boutique firms like Parag Parikh. I started my career with Parag Parikh as a research analyst and as you know Parag Parikh’s style — unfortunately he is no more — was value investing.
S: Yes, he was famous for that.
M: He was a great value investor and at the early stage of a career, we also had a good research head Amarnath. Most of the guys in research who came in that point in time had background, say in the domestic financial institution ring. So, I think (we were) really focusing on hardcore research over there and Parag Parikh used to come and give his bit of knowledge about long term investing. He didn’t drive us to chase stocks just because of momentum or price action. So, it gave a lot of liberty to dwell into the companies, do proper research and take longer term view on stocks, not get carried away by the short term stock movements and during that time we used to also have interactions. There was a gentlemen called Chandrakant Sampat, I don’t know whether you know about him.
S: Yes, legendary investor.
M: Unfortunately, he is no more. He used to come and share his wisdom with us and really give us a lot of knowledge. He was known to really buy in to stocks… great companies, quality companies, brand companies – stocks like Gillette for example. So, [he would tell us] what he saw in these companies, how to really hold on to it.
S: He would come and share those with Parag Parikh analysts?
M: Yes, and he used to sit with us and share that knowledge with us. He used to also share with us books which he used to read. For example books like ‘Good to Great’ and ‘Built to Last’ by Jim Collins. One’s doing desk research for medium companies but the insights what you get from some of these legendary people in terms of the subtleties about investing and which nobody will teach you right in formal school is something which was a great learning experience. Especially with Chandrakant Sampat on how to really buy stocks which are very expensive. A lot of these quality stocks are expensive, so in a formal model, it might not look that great but when you look at cash flows they generate and the kind of brand power — which gives them long term enduring sustainable advantage — how to really price that in when looking at these companies is something which I learned immensely.
And then the second stint was with Motilal Oswal, I was there for four-and-a-half years. Raamdeo was not the head of research but really took a lot of interest on the research side while Motilal was more on to the management side. Raamdeo again has his own style. He used to talk about his own investments which he has done in his early stage. It was more about the practical way of investing. Identifying companies and looking at the big picture, looking at what’s happening at the ground level, getting insights into that. For example, Hero MotoCorp, how is the distributor doing, talking to distributors, getting feedback and then trying to really build a broader picture in terms of the outlook. So, that is something which I learned at Motilal Oswal and he was a big Warren Buffett fan.
So that’s where we learnt a lot about Warren Buffett — whatever he (Agrawal) used to share with us — Berkshire Hathaway annual report, letters to the shareholders. They used to give us a compendium. That’s how actually we got a sense about how to really simplify things about investing the way Warren Buffett did. That had a pretty lasting impression in terms of how we analysed companies besides your normal analytical research which one would do.
S: Capital goods and telecom were two sectors you covered when you were an analyst. Both sectors have been under the cosh over the past few years. Since you have a keen interest in these sectors, has it affected your investment style?
M: Capital goods is a cyclical sector and getting the cycle [right] is very important in order to make big returns. While tracking that sector, I realised that there you could bet on only a few companies like ABB, Siemens and BHEL. In any cycle, these were the companies, which would grab market share. So, if you are able to time the cycle and the huge operating leverage which these companies had, that’s where the big delta happens not only in earnings but also in PE multiples. This learning helped me later on when I joined Birla Sunlife Mutual Fund in 2005 when it was beginning of the big capex [cycle] from 2003-2008, both in the capital goods as well as the infrastructure sector.
I was quick enough to really identify some of these stocks, build the portfolio and it helped me to set my foundation there in the early stage because some of the winners were from the capital goods sector.
S: You said if someone is dabbling in a balance-sheet heavy sector like capital goods, one needs to time the cycle right. Is there any specific indicator you have used to figure out the right time?
M: The challenge in some of these sectors is that your near term earnings will never justify investing. So, one has to see where there is value because normally in a down cycle, these stocks get beaten down and get a pretty good value and then you have other indicators like order book, movement in order book inflows. In the early stages, we didn’t have big models in terms of capturing some of these cycles but over the period of time, we built certain models looking at some of the macro indicators like how capacity utilisation levels are shaping up, how demand growth is picking up, etc.
S: So, basically you wait for capacity utilisation to hit 75-80 percent?
M: 80 percent.
S: You know then capex will begin and at that point you press the trigger on capital goods?
M: Right and then you monitor how the order inflow is starting to play out in that sector, to see which are the companies, which would start to build in, because that would really give visibility to long term sales growth.
S: There are two financial plays where you were very early. You were at least four years before they became consensus buys – IndusInd Bank and Bajaj Finance. And I remember broking these stocks in 2010-11 and you spotted the potential and the promise of these two lenders before anybody else did. What gave you the conviction to press the trigger quite so hard on IndusInd and Bajaj Finance?
M: It was a different story for both IndusInd and Bajaj Finance. IndusInd was a company, which had gone through some kind of turmoil and there was a change in management and typically whenever there is a big change in the company it is worth having a look at it and then meeting the management. Understanding whether the change they are trying to make is something much more sustainable.
So, IndusInd was about change in management. When we met the management team, they had a clear vision in terms of how they wanted to transform the bank. Coming in from a very mediocre performance, how numbers such as return ratios would change. It was a bet really on the management at that point in time, on the CEO and his vision, how they could do it. And evaluation was always in your favour when the company is kind of in the woods. It is a question about how much rerating can happen and how much growth can the company deliver.
S: So, this was fundamentally a play on Romesh Sobti and his team.
M: Yes. I would again give credit to the analyst who was working with me, who had done a lot of research earlier. It helped us build more conviction over there.
In case of Bajaj Finance, it was a company, which already had some kind of track record. The company went through a kind of crisis, but it came out of that and we thought this company was doing something good on the technology side, which was kind of new at that point in time in terms of digital.
S: This is the 2009-10?
M: This was somewhere in 2011-12. So in the financial services space, it is something which we thought we had a big opportunity in. This was one company which we heard would be trying to do something more with technology and digital. Trying to use that in their framework to reduce cost, trying to reduce the cycle time for consumers, but also [improve] on risk management.
So we decided to spend one full day with the management, the CEO, the other leaders down the line and it gave us a conviction that this is a company which is trying to do something different. It is trying to build some kind of moat, which is very important, which is more on the risk management side, because finance is all about how you manage risk. Your job is to lend, but how you manage risk and monitor that and at the same time, how you use technology to reduce cost, how you reduce your time to go to the consumer and that was a big transformation we saw in this company.
S: Talking to Rajeev Jain and his team gave you that conviction that they would have this ability to use technology?
M: Yes. That was one of the reasons and again when we looked at the stock fundamentally, once you like a company it boils down to the valuations. So, valuations were reasonable and we know what has happened over there. The way the company has grown to deliver consistently and despite now at this size, they are growing at around 30-35 percent or so. But again, the idea is to spot it early, spot the big change and then capture not only earnings growth, but also PE re-rating or the price-to-book value in the case of Bajaj Finance, which lead it to be a big multibagger over a period of time.
S: So, one of the most interesting aspects of your investment style is that other than buying great franchises and holding them for long periods of time, you have also made lots of money from large opportunistic bets. Two examples which come to mind are DLF in 2015 and Vedanta in 2016…
M: When you invest in the market, as you rightly said, you want to have your long-term winners, which will continue to compound and give you good returns. So, they form the base of the portfolio. You don’t really tamper with them unless there is a big change in the fundamentals. But at the same time, there are a lot of opportunities because of the market, the greed and fear cycle, you see lot of stocks get beaten down at valuations which are attractive. The only challenge there is, you don’t want to get into a company, which is too highly levered and is not able to bounce back. So, at times you spot those opportunities. For example, DLF was the case where the company was going through some kind of pain after the big run in the real estate cycle, we saw a big downturn in that period and the stock was quoting at significantly below book value, but there was still some challenge about debt over there. But when we met the management, we got comfort that the management was serious about deleveraging because they had good assets like rental assets, which they could have easily monetised to bring down debt. So, while the debt looks high, there is enough asset backing it.
Normally, when you take those kind of bets, it is only to really play out the specific value. Once you realise the target, discipline has to be really to get out of this because they are not really long-term value creators. So, that was what triggered DLF.
In Vedanta, again, it is a classic cyclical commodities [play] where commodities went through a pretty bad phase in 2015-2016 and we saw a huge crash. Some of the global stocks like Glencore went down almost 50-60 percent. During our research process, we also started tracking global macros. We also had an international fund and you get some of these cues for global commodities when you track some global stocks — how they are behaving. And when we saw Glencore was kind of coming out of that cycle and Vedanta again as a proxy to the commodities space, we thought this was the beginning of the commodity cycle and this was a good company to play at that point in time.
Though again, the leverage was higher but they were across multiple sectors. And again, it was more a macro call rather than on Vedanta. Vedanta was just a vehicle to play that.
S: So, basically the metal cycle in a way.
M: Yes, the metal cycle. So, we have been tracking global macros and we have tried to institutionalise that in our investment process. That helps take some of these macro calls, which, if they work in your favour, make a big difference. And it doesn’t matter which company you play but if you are able to bet on the right company within that, the returns could be much bigger.
S: So, let’s move to the institutional processes that you built. As I said in the beginning, there is you and only one other fund manager I know who in the last 10 years who has been part of the building of a massive asset management house in India. The traditional leadership — the big three or four AMCs in India — were stable.
S: The rise to prominence of Aditya Birla Sun Life over the last 10 years has been remarkable and you are managing $3 billion in equities today. What catalysed this success? There aren’t too many other success stories of this ilk in the last 10 years in India and, especially given that your house doesn’t have a bank bolted on to it and you can’t really follow the bancassurance model of distribution, it’s even more impressive. What were the processes? What were the cultural improvements you sought to catalyse in the last 10 years?
M: The journey with Aditya Birla Sun Life has been really great and as I said, when I joined over here there was a total transformation in the investment team. We had a whole new team, which in a way is good. You have people who can get built and can come along with you, and we had tough times during the global financial crisis but that was the time when we actually got things together and built a lot of things around processes, systems, trying to relook our whole investment process. But the most was in terms of risk management framework. We built a robust risk management framework in terms of what kind of risk we would want to take at the stock level.
So, all the fundamental pieces were really put in place and during the time of the [financial] crisis. We actually took time to really build some of these things. Because normally in a bullish market, returns come easily, you don’t have time to focus on the processes, systems and that really helped us in good stead when the market started to recover from 2013 onwards. So we built decent performance in terms of our funds across and we are managing different category of funds and more importantly, built the team. We had a lot of these star fund managers earlier. Institutions were based around individuals, I clearly believed that it was the team really, which contributed to the whole fund house success. And the research analysts whom we groomed internally and who were part of the journey had a significant role to play in terms of developing us as a fund house. In fact, we were the first ones who actually started research analysis-based fund at that point in time. When I had gone abroad, I had visited MFS, which is one of our parents, which is one of the oldest institutions in the US. They have global research funds managed by analysts. So, we started that concept as a trial where analysts were managing the fund, they were putting their high conviction ideas in the fund and that again became a good success, and it also gave a lot of voice to the analysts.
So a lot of integration took place between the analysts and the fund managers. Lot of things which the analysts were doing were getting replicated in the fund. And that cohesiveness of working as a team really helped us to do – normally you would have one or two funds, which would do really well and you want to really ramp up those funds. But fortunately for us, all of our funds, because of the strong internal process – the way the analysts were contributing, and the way you are integrating that, ensured that a lot of funds were doing well. So, during the good times, we could ramp up lot of our funds and get a larger share of the pie.