'Currently, I'm happy to underperform'

If fund management were as popular as cricket, Rajeev Thakkar would be a household name. In investing circles, though, he is.

Beneath a shy demeanour is a reputed fund manager known for his clear, articulate and insightful views on the market. These traits are clearly reflected in our recent interview, as he gives his take on the current market, new-age companies, PSUs and the hugely popular but currently trailing Parag Parikh Flexi Cap Fund. Here is the edited transcript.

Can you walk us through your investment framework? How do you decide when and what kind of stocks to add to your portfolio?

India differs slightly from other Western markets, particularly the US. In the US market, diverse stakeholders hold a significant stake in most companies. If the CEO is not performing well, activists may step in and attempt to replace the current management. Even if the decision-makers don't prioritise minority shareholders, they will still take some action.

However, in India, the majority of companies have their shareholdings concentrated in the hands of individuals known as 'promoters'

Now, the promoters could be Indian families, the government in the case of public sector companies or foreign entities in the case of MNCs (multinational companies). These promoters typically own between 50 and 70 per cent of the company, leaving the minority shareholder with limited options. Due to this issue, it is very important to invest in companies where you have faith in the management. Because you cannot do any activism in India, and you have to live with what the promoters and the managers do. Therefore, it is crucial to prioritise investing in companies with high-quality promoters and management.

The second point is that, despite the positive outlook for various industries at different times, many sectors in India have proven to be wealth destroyers. So, there have been sectors where almost all the companies have gone bankrupt in the past. It's also crucial to avoid sectors with significant volume growth but weak pricing power or intense competition, as these situations can lead to financial losses.

Finally, a high level of borrowing has damaged many companies, so that is to be guarded against. We also look at valuations before making any decision.

We've seen more public sector companies in your portfolio recently (since 2021-22), like Coal India, Power Grid and NMDC. The government has proven it's a bad owner in the long run. What attracts you?

In that sense, the government is a very strange promoter. At one level, the government has implemented numerous processes not present in the private sector. In the private sector, a director can request an EOI (expression of interest), issue a request for proposals and select a single bidder if deemed necessary. In the public sector, the tendering process and the presence of the CAG (Comptroller and Auditor General of India) provide all necessary safeguards.

Simultaneously, the government may prioritise voter interests over shareholder interests, potentially implementing populist measures. For example, in 2007-08, when oil prices were high at $140-145 per barrel, oil marketing companies didn't raise petrol or diesel prices. I would say that such practices are wrong from the perspective of shareholders. While voters and the general public may find such actions acceptable, these actions lead to significant wealth destruction in PSUs (Public Sector Undertakings) over an extended period.

But in recent years, we have seen oil prices fall from their peaks, and the government has already raised petrol and diesel prices. The government, in my opinion, believed that these companies should have the opportunity to generate some profit to offset their previous losses. So, at least these days, you have had announcements on minimum dividend payouts, some capital allocation policies and things like that. I believe there have been some changes, but it's important to remain vigilant. (Further), PSU companies' valuations had fallen so low that there was hardly any downside.

Your international positions - Alphabet, Microsoft, Meta, Amazon, among others - have played out well. If RBI permits investment in them again, will they still find the maximum possible position in your portfolio? Is there enough value?
It completely depends on when the limit increase happens and the prices or opportunities at that point. If we open up the limits, we could potentially increase our foreign allocation. We would like a 70 per cent allocation in Indian equities and 30 per cent in the overseas market.

Your flexi-cap fund has performed exceptionally well in recent years, but it lagged a bit behind its peers last year.

There will be periods when we underperform, and we have communicated to our unitholders. Currently, I am actually happy to underperform. To give a sporting analogy, we recently had the T20 World Cup. So, let's say you are batting to win the match, and you need to make five runs from six overs with one wicket in hand. Now, will you hit six or be content with running singles? During a period of stretched valuations and market froth, it is advisable to proceed cautiously. This is not the moment to take risks; it's not a post-Covid scenario where you should invest every last rupee in your bank account. In this market, it is beneficial to keep some cash for opportunities, be a bit conservative regarding stock selection, and be mindful of the valuation you pay.

You mentioned that longer-term returns are good. Despite underperforming, we are around 39 per cent (one-year returns), while the index (BSE 500) is marginally higher. Now, on an absolute basis, the 39 per cent returns also look amazingly good. So, if the portfolio does not keep pace with the index or the other peer group, so be it. We are trying to do well across the cycle and not lose money for clients.

What about the stocks that didn't work out (like Noida Toll Bridge)? Can you share some of the major mistakes and the lessons learned?

First, let us define what a mistake is. Those interested in this topic should read Annie Duke's 'Thinking in Bets'. The outcome does not determine whether it was a mistake or not, but the process determines whether you were correct in your approach. Therefore, equity investing differs from chess; it's akin to playing cards, where you can only see the cards in your possession, unaware of what others may be holding.

When you do equity investing, you can do a management quality check on past behaviour, check industry trends based on publicly available data and apply valuation filters. But can you predict whether Covid will happen or not? Can you predict what the courts will do or what the competitor is likely to do going forward? There are a lot of variables outside your control, and many times, those will result in some of your investments not working.

In any period, out of 20 stocks that you invest in, five may not do well, but that doesn't necessarily mean your process was wrong.

So, the biggest mistake is making an investment where the corporate governance is not great. Mistakes occur when you fail to incorporate publicly available information into your investment process, leading to financial losses. These are the types of mistakes we continuously strive to improve upon. The process today, I would think, is much better than what it was 10 years ago, but we don't necessarily obsess over any one particular stock that worked or did not work.

You've been holding significant cash (around 16 per cent in debt). When will you start deploying this money?

We try to invest whatever money is there with us, and when we don't find great opportunities, some money lies in the bank account.

One thing to realise is that we are making 7.5 per cent on the bank CD (certificate of deposit) in the current environment. Now, equities over the long term have given returns anywhere between 12 and 15 per cent. So, on an annual basis, we are giving up around 7.5 per cent. During a 12-month period, if there are fluctuations, not in the overall market but in individual stocks, such as a stock falling 10 per cent due to adverse news, this presents an opportunity for us to make investments.

For instance, during the first week of June, following the announcement of the exit polls, certain individual stocks experienced an increase, only to see a 13 per cent decline the following day. If you have some money in your bank account, you can take action. However, if you consistently invest all your money, you won't be able to take advantage of any attractive opportunities. Therefore, we encounter numerous such opportunities throughout our journey.

In your opinion, which market segment is overvalued right now, and where do you see excessive speculation?

On average, start-up companies listed in recent years seem expensive. They will perform poorly as a group, but one or two companies may excel. From a valuation point of view, consumption-oriented names, retailers and FMCGs (fast-moving consumer companies) look expensive despite some price corrections in the last few months. Broadly, smaller companies have had larger price increases, and a few of them are looking very expensive.

What's your take on the new-age tech companies?

We keep watching them, but we haven't bought them yet. Nevertheless, some of them make for interesting business models, and we follow them.

Also read: Meet Rupesh Patel, an engineer who became a Rs 43,000 crore fund manager