In growth we trust

Buy quality, be patient and let earnings growth take care of returns, say R Janakiraman and Roshi Jain

The buy and hold investing style for equity schemes of the Franklin Templeton Mutual Fund borders on indifference to external events. Despite the roller coaster ride of the broader markets in the past three years, it is no surprise then that key equity holdings of the fund have not been much different in the last couple of years.

The reason, according to R Janakiraman, who along with Roshi Jain, is the equity fund managers of the year, is the bottom-up approach with a focus on identifying good quality stocks that are long term compounders or companies which can consistently generate strong earnings growth. 

While this buy and hold approach which requires loads of patience means underperformance in some periods, the "boring" approach according to Janakiraman is the most optimal way over the longer period to outperform without taking too much risk and volatility.

The risk-adjusted returns of the funds the two money managers run is a proof that their system works. While the one year returns from the six schemes that the two manage are upwards of 30 per cent, the benchmark indices of the schemes have only managed to generate 11 per cent to 17 per cent.

  In line with large cap indices that track the broader markets, financials are a key part of the portfolio. However, given growth challenges and non performing assets, what are the risks in this space? A large chunk of its financial portfolio comprises private sector financials, where NPAs are not as much of a concern as they are for PSU banks. The top holdings include Yes Bank and Axis Bank which in the year ended June 30, 2015 have given over 50 per cent returns.

The fund house says that some of the private sector banks have well entrenched competitive advantages on the retail side of the business especially in the savings deposit side which are difficult to replicate and act as strong entry barrier. Given the significantly lower household debt in India as compared to peers, there is strong potential for the lenders to grow the business over the next 15-20 years, he adds. The only element which one has to track, according to Janakiraman who has been in the investment management industry for over 14 years, is execution.

The fund house has picked companies with a strong track record of execution which translates to higher business/earnings growth. While these are not cheap, they are fairly valued; steady compounding of earnings will help them give better returns over the longer term than the more cyclical part of the financial segment.

Slowing economic growth is a concern, but the building blocks in terms of low inflation, falling cost of capital and better fiscal situation are in place. Business growth will improve when sentiment recovers and discretionary demand is back, and this is only a matter of time, he believes.

In addition to the financials, the portfolio also includes export-oriented defensives such as Torrent Pharma, Dr Reddy's as well as stocks which are hinged to domestic consumption such as Amara Raja. All of them have doubled in value in the one year period prior to June 2015.

While most of the schemes have a large cap bias, the fund house also has a Smaller Companies scheme which is co managed by Roshi Jain, an IIM alumnus, CFA and CA. The fund, says Jain, seeks to provide long term appreciation by investing in smaller and mid cap companies. To minimise the risks attached to smaller companies, the fund house focuses on a combination of growth as well as a reasonable degree of free cash flow generation.

While the fund house does not emphasis on contra calls, the duo made bets in the past such as telecom which were out of favour. The fund house had an overweight exposure on the telecom sector in the last three years as the companies were executing well but it was not recognised by the market. The investments by the fund house in Idea and Bharti Airtel paid off.

Given the focus on growth and quality, the fund house is not too amenable to the deep value side of investing or the turnaround type of business. The fund managers however do not shy away from adding fundamentally strong business which are witnessing temporary setbacks. The other issue, the fund house emphasises is an attractive entry point or the margin of safety rather than when businesses are fully valued as subsequent returns might not be satisfactory.

One of the key issues for investors who seek quality businesses is the high valuations as typically they tend to price in a lot of the future potential. Valuing such a business can be a tricky affair as it is tied to the expected growth of business. The fund house had invested in Eicher Motors across its many schemes some years ago but was not able to predict the kind of demand and earnings growth that the company would be able to achieve.

The fund managers gradually reduced their exposure thinking that the business was overvalued. While predicting the hyper growth phase in any business is challenging, rather than looking in a narrow prism of valuations only it has to be seen in conjunction with earnings growth, say the duo.

Current valuations for the broader markets, according to Janakiraman, an IIM alumnus and a CFA are just about fair but going ahead, incremental returns will not come from re-rating anymore but will depend on earnings growth. He expects recovery to come through in the second half of the fiscal.