"It is about polarizing capital into strong business trends. And this strategy helps create wealth for investors" - Kenneth Andrade

With around 15 years of experience in Equity Research and fund management Kenneth Andrade has been associated with Kotak Mahindra AMC, SSKI Investor Services, Nimbus Communications, LKP Shares & Stock Brokers and Meghraj Financial Services before joining IDFC Mutual. In his capacity as Head Investments Kenneth has been a very important part of the fund management team at IDFC Mutual for quite some time now. He shared with us the funds basic philosophy which helps create an alpha for investors.

Can you describe your investing philosophy to us?

Our investment philosophy revolves around picking growth assets in the Indian economy. This is achieved by concentrating on underlying shifts in the changing economy and creating a portfolio of companies that capture this trend. We do not deviate from our core philosophy of allocating capital to companies which are consolidated businesses, thought and market leaders and companies which are financially solvent (low leverage).

On an overall basis we drive the investment team to look for changes in the environment which are structural and are at the beginning of the cycle. These opportunities have to be scalable.

We ensure that the bottom up process conforms with the environmental changes with significant stress on buying good value in and early part of the entire cycle. In our experience concentrating on underlying shifts in economy and creating a portfolio of companies to capture this shift helps create wealth for investors.

What was your first big investing idea and how did you develop it?

I think staying out of the investment economy and participating with consumers at that point in time paid rich dividends The underlying economic environment i.e rise in per capita income was moving faster than the overall growth in the underlying economy with budgetary allocation showing a disproportionate shift to increase the standard of living of the population. We built a portfolio around this shift. Stocks that did well were ideally a fall out of the larger trend.

What are the most crucial signals according to you which would determine the entry and exit point in stocks?

We have different portfolios with different investment strategies. IDFC Premier Equity currently our largest in terms of Assets invests into ideas early in their lifecycle. Our focus thus is on gauging underlying shifts in the economy (Top down) and creating a portfolio of companies that will efficiently capture this shift (Bottom up). The focus is not essentially market timing but is more about buying into emerging and good companies when valuations are right.

We would exit at any sign of fragmentation, business loosing pricing power and /or any capital allocation which is ROE decretive. Other parameters that may become important here include any significant change in the external environment, like economy, regulatory or exchange rate which may impact the business metrics of the company and impact earnings and thus valuations.

Do you meet managements and are you constantly in touch with them till the idea is a part of your portfolio?

Meeting managements is a core part of our process. The entire investment team meets company managements to understand whether the companies have the business matrix to enable them to capture the underlying business growth / trend in the economy. These companies should have the right product / service / distribution which will help them grow ahead of their respective Industry growth rates and gain market leadership. Additionally we look for management thought process to assess its ability to ride the wave of growth in the economy and reach a scale. Regular interaction with managements helps us identify companies with great business models geared to capture the underlying structural trends.

Have you gone wrong on your investment ideas sometime after having generated them and followed them?

We have had our fair share of losers in the portfolio. Some of the learning has been never to allocate capital significantly to any niche industry if there is no significant value chain. Apart from that we have had companies that have executed badly even in a good cycle. Net net it is always about getting 60 – 65 per cent of the portfolio right. We can never be on the right side of that number.

How important is the selection of a correct sector in a stocks performance?

Here I would like to quote two time periods 1998 onwards - It was a phase where the underlying fundamentals were very supportive of the IT services sector (Y2K opportunity and the India Demographic Dividend). This led to a re-rating of the sector and we saw peak P/E multiples supported by strong underlying themes and superior company performance.

Similarly 2004 onwards was a time when underlying fundamentals were in favor of the Investment part of the Economy (Policy, Low interest rates and low corporate leverage) and we saw this segment of the market reach peak P/E corroborated with superior ROCE and peak margins.

Our portfolio construction has thus revolved around picking a right market opportunity and buying companies around that opportunity. In other words it is about polarizing capital into strong business trends. And we believe this strategy helps create wealth for investors.

How high a position are you willing to take in a sector that you feel strongly about and at what point does it become too risky?

We are guided by our internal limits and also the regulatory limits. We are never significantly concentrated in any particular sector. The buy and hold concept is widely followed and preached by mutual funds.

Is this concept completely foolproof according to you?

We can never figure out why it can ever be different. If it takes a company environment, like economy, regulatory or exchange rate which may impact the business metrics of the company and impact earnings and thus valuations.

Do you meet managements and are you constantly in touch with them till the idea is a part of your portfolio?

Meeting managements is a core part of our process. The entire investment team meets company managements to understand whether the companies have the business matrix to enable them to capture the underlying business growth / trend in the economy. These companies should have the right product / service / distribution which will help them grow ahead of their respective Industry growth rates and gain market leadership.

Additionally we look for management thought process to assess its ability to ride the wave of growth in the economy and reach a scale. Regular interaction with managements helps us identify companies with great business models geared to capture the underlying structural trends.

Have you gone wrong on your investment ideas sometime after having generated them and followed them?

We have had our fair share of losers in the portfolio. Some of the learning has been never to allocate capital significantly to any niche industry if there is no significant value chain. Apart from that we have had companies that have executed badly even in a good cycle. Net net it is always about getting 60 – 65 per cent of the portfolio right. We can never be on the right side of that number.

How important is the selection of a correct sector in a stocks performance?

Here I would like to quote two time periods 1998 onwards - It was a phase where the underlying fundamentals were very supportive of the IT services sector (Y2K opportunity and the India Demographic Dividend). This led to a re-rating of the sector and we saw peak P/E multiples supported by strong underlying themes and superior company performance.

Similarly 2004 onwards was a time when underlying fundamentals were in favor of the Investment part of the Economy (Policy, Low interest rates and low corporate leverage) and we saw this segment of the market reach peak P/E corroborated with superior ROCE and peak margins. Our portfolio construction has thus revolved around picking a right market opportunity and buying companies around that opportunity. In other words it is about polarizing capital into strong business trends. And we believe this strategy helps create wealth for investors.

How high a position are you willing to take in a sector that you feel strongly about and at what point does it become too risky?

We are guided by our internal limits and also the regulatory limits. We are never significantly concentrated in any particular sector.

The buy and hold concept is widely followed and preached by mutual funds. Is this concept completely foolproof according to you?

We can never figure out why it can ever be different. If it takes a company over 3-5 years to complete a cycle how can anyone make or lose money if you do not stay with this investment over that life cycle.

How do you tackle a bad phase?

Equity markets are all about cycles. We stick to fundamentals both in the up-cycle and down-cycle. If a company is not steering away from the core fundamental reasons of our purchase and is moving towards the broader goal of attaining scale and market leadership we live through the bad phase with the company.

Is it possible to recognize a bear market before it is too late?

It is possible to get a sense of buildup of excesses in the system and gauge when market valuations are running ahead of fundamentals and take corrective action.

Any investment that stands out in your mind?

We would still like to see some companies in our portfolio go on to becoming economically material businesses. Till then success is only very limited.

What would be the most important advice you would give to a layman?

Stay with your investment over a cycle and diversify risk. We would advise our investors to follow proper asset allocation and invest regularly

What sectors would you say are currently offering attractive investment opportunities and in what areas should investors take caution The emergence of leveraged balance sheets is one of the biggest challenges that corporate India had encountered in the last decade. The big winners have to come from there. In the near term in absence of any risk appetite the of excesses in the system and gauge when market valuations are running ahead of fundamentals and take corrective action.

Any investment that stands out in your mind?

We would still like to see some companies in our portfolio go on to becoming economically material businesses. Till then success is only very limited.

What would be the most important advice you would give to a layman?

Stay with your investment over a cycle and diversify risk. We would advise our investors to follow proper asset allocation and invest regularly.

What sectors would you say are currently offering attractive investment opportunities and in what areas should investors take caution?

The emergence of leveraged balance sheets is one of the biggest challenges that corporate India had encountered in the last decade. The big winners have to come from there. In the near term in absence of any risk appetite the market is polarising capital into the so called safer “zero leveraged” businesses in the consumer led opportunity. We are not adding any new names in that space though it has got significant momentum. Our reasoning is that if you are buying a stock/ company at its all-time high somewhere there is low margin of safety. If you pay heed to this any investor will tend to do well.

But all this comes with its own challenges. Regulatory excesses and policy uncertainty will keep markets volatile. Time horizons in these cases will get extended.