Fund Focus: HDFC Capital Builder

This fund seems to be living up to its name

Miten Lathia, Fund Manager - Equities, HDFC AMC

12th July 2016

In a nutshell

HDFC Capital Builder has generated healthy alpha over the last 3 calendar years - each of which have seen very different market environments. Each year's attribution analysis throws up different sectors as key alpha contributors - a key pointer towards the bottom up nature of portfolio construction. Miten takes us through key performance drivers of a fund that seems to be living up to its name - by building capital year after year, his portfolio strategy and key current over and underweight positions he's running in the fund.

What do percentiles and their colours signify?

Fund performance is typically measured against benchmark (alpha) and against competition. Performance versus competition is measured through percentile scores - ie, what percentage of funds in the same category did this fund beat in the particular period?

If a fund's rank in a year was 6/25 it means that it stood 6th among a total of 25 funds in that category, in that period. This means 5 funds did better than this fund. In percentile terms, it stood at the 80th percentile - which means 20% of funds did better than this fund, in that particular period. If, in the next year, its rank was 11/26, it means 10 other funds out of a universe of 26 did better than this fund - or 38% of funds did better than this one. Its percentile score is therefore 62% - which signifies it beat 62% of competition.

Most fund managers aim to be in the top quartile (75 percentile or higher) while second quartile is also an acceptable outcome (beating 50 to 75% of competition). What is generally not acceptable is to be in the 3rd or 4th quartiles (beating less than 50% of competition). Accordingly, we have given colour codes aligned with how fund houses see their own percentile scores. Green colour signifies top quartile (percentile score of 75 and above), yellow or amber signifies second quartile (percentile scores of 50 to 74) and red signifies 3rd and 4th quartile performance. A simple visual inspection of colour codes can thus give you an idea of how often this fund has been in the top half of the table and how often it slips to the bottom half. A great fund performance is one which has only greens and yellows and no reds - admittedly a tall ask!

WF: The last 3 calendar years have seen strong alpha from your fund. What have been the key contributors to this consistent performance?

Miten: In CY13 the Fund was overweight in the technology sector that helped it to outperform. The Fund had strong contribution to performance from mid-cap IT companies. In CY14, the Fund's outperformance was aided by the mid cap stock selection across sectors. In terms of alpha generation the year 2014 was a major one for the Fund with excess of 14% over benchmark. In CY15, the Fund's stock selection within pharma sector help generate alpha. Overall, it was the bottom up stock picks which contributed over these three years consistent performance. The number of stocks in the fund increased from ~40-45 earlier to 50-55 over this period to take advantage of the opportunities in the broader market. We have been avoiding commodity stocks especially those into metals sector. We invest in reasonably priced companies which have strong business position, management, efficiency of operations and promising growth prospects.

WF: This calendar year has got off to a somewhat shaky start. What's different about this year, compared to the previous 3 years?

Miten: We are only half way through in the current year and it is too short a time frame to look at the performance data. In terms of specific sectors, the recent weakness in some of the pharma companies in the market has affected the performance of the Fund. However, we believe these businesses have strong fundamentals, are available at great value currently and we are persisting with our holdings. Having said that, we are watchful of the happenings in the overall macro scenario and our bottom up selections and are ready to make suitable changes as and when required. We would also like to add that we do not buy a stock for the short term which can be seen in low portfolio turnover of around 38% last year. Hence, measuring performance over short periods may not be a correct way.

WF: What in your view has weighed more in delivering performance in recent years in your fund: sector calls, nimbleness across market caps or individual stock calls?

Miten: There are a host of factors but a lot of it is due to Individual stock calls as we predominantly follow a bottom up approach. Sectoral deviations against benchmark have been limited except in those cases that we believe is either extremely undervalued or overvalued. Given the mandate of the fund we will continuously evaluate opportunities across market caps. Further, we believe in effective portfolio diversification and are not focused on generating returns out of a few "multi-baggers". We follow certain risk management practices including single stock exposure and single sector exposure.

WF: In your fund presentation, you say that your sectoral allocations over time display a "stable yet active" stance. Can you please explain this?

Miten: If you look at our Sectoral weightages over a period of time, you can observe that there have not been large deviations vs. benchmark and thus have been 'stable' (not stagnant). 'Active' refers to bottom up stock selection within the sector while overall sector weightage may or may not change.

WF: Your stated philosophy is to invest in strong companies at a reasonable price. Does this lean more towards value investing or towards GARP - growth at a reasonable price?

Miten: Our strategy predominantly follows GARP or Growth at Reasonable Price. Within this framework, we try to balance growth and valuation. We tend to avoid high growth companies if the valuations are unjustifiable to us.

However, there are occasional cases of absolute value emerging in low growth but high quality businesses that we may add as part of the portfolio. The cyclical stocks that are in the portfolio are mostly those with a strong penetration opportunity that could result in good growth for a reasonable period of time.

WF: While market participants are getting increasingly comfortable with the economy's growth prospects, "reasonable price" seems to be a challenge in a market that trades at 18x current year earnings. Where do you see value in today's market?

Miten: We believe P/E is one of the measures to value the stock but not the only one. It needs to be adjusted for the point of time in the business cycle and interest rates. Further, it is in a market situation that is not extremely cheap is when there is a larger need for bottom-up stock selection.

We believe, relative value exists mostly in bottom up stock selection without any sector bias. We have around 350 companies in our coverage universe which we monitor and it will not happen that all of them are reflecting their intrinsic values. From a sector perspective, we are being overweight on industrials and infrastructure related businesses, while betting less on the more expensive consumer stocks.

WF: What are the key risks you see to the Indian equity bull market and how are you positioning your portfolio to mitigate these risks?

Miten: Inflation has been quite low in recent years thus there is a probability of higher inflation owing to a low base, which is a risk. The fund is overweight on private sector financials because of their better under-writing and higher growth prospects. To avoid any sector specific risk, we have diversified our portfolio. Currently, we have 50-55 stocks across various sectors with top 10 stocks constituting only 40%-42% of total portfolio.

DISCLAIMER: The views are expressed by Mr. Miten Lathia, Fund Manager - Equities of HDFC Asset Management Company Limited (HDFC AMC), as on 8th July, 2016. The views are based on internal data, publicly available information and other sources believed to be reliable. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information given is for general purposes only. Past performance may or may not be sustained in future. The replies are given in summary form and do not purport to be complete. The views / information provided do not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this information. The information/ data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on our current views and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Stocks/Sectors referred above are illustrative and not recommended by HDFC Mutual Fund / AMC. The Fund may or may not have any present or future positions in these sectors. HDFC Mutual Fund/AMC is not guaranteeing any returns on investments made in the Scheme(s). Neither HDFC AMC and HDFC Mutual Fund nor any person connected with them, accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.

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