Advisors often tell their clients that SIPs are boring, but very effective in creating long term wealth. In much the same vein, Soumendra Nath says he does not believe in trying to do exciting things with the L&T Equity Fund - he does not believe in trying to be an outlier on the upside, and that helps him prevent costly blunders that can take him to the bottom of the performance league table rather than the top. He is a firm believer that if a fund consistently is ranked every year at a high second quartile, it will become a long term top quartile performer, on the dint of its sheer consistency. Read on as he shares how he is steering L&T's flagship equity fund on a low volatility path to long term wealth creation.

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: Will you categorize the L&T Equity Fund as a go anywhere fund or is it closer to a multi-cap strategy? Do you have indicative weights or ranges for large, mid and small cap exposures? How has the fund's exposure to large and mid caps changed from the beginning of 2014 to now?

Lahiri: I can speak about the fund since we took it over 2 years ago. At that time, it was around 90% in large caps. Over these 2 years, we have progressively got the balance to around 75% large caps and 25% midcaps. That's the kind of balance we would like to maintain in the fund, going forward too.

You can say this is a multicap strategy, though some people also call it large cap plus. Regardless of the name you give it, I would say a 75-25 ratio between large caps and midcaps is what we would like to maintain in this fund.

One of the reasons for this ratio is also the size of the fund. Given that it's a 2500 crore fund, we cannot slant it too much towards midcaps. A 1% holding in the fund will be a 25 crore exposure, and for us to take at least that kind of exposure if not more in the fund without impacting liquidity of the stock, we will need to look at more liquid names, which we find in large caps and the larger midcaps.

There are a couple of stocks that we are carrying in the portfolio from its older days, which are not very liquid. These are legacies that we are dealing with. We want to ensure that going forward, we don't forsake liquidity in the quest for higher alpha.

WF: Over the last 10 years, the fund has more often than not been a second quartile performer. From an investor's and a distributor's point of view, one can perhaps summarize it as a fund that rarely disappoints, but does not excite too often, either. Is there a conscious strategy to be relatively risk averse? What in your opinion accounts for this pattern in fund performance?

Lahiri: I will reserve my comments to the period of the last 2 years since we took over the fund, as it would not be fair to comment on fund strategy of the years when we were not managing the fund.

Our endeavour is clearly to be a consistent performer, to avoid as far as possible, any shocks to the investor. I believe that if you are consistently a high second quartile performer year on year, you will be a top quartile performer in the long term.

We try to curb over enthusiasm in good times and over pessimism in tough times. We don't shoot for becoming an outlier on the upside, which also helps us from falling into an outlier on the downside.

The point I am making is that in fund management, trying to be the outlier on the upside carries a significant risk, which perhaps investors may not be comfortable with. Being consistent helps create long term wealth, more than trying to aggressively hit the top of the performance league tables.

WF: 2014 has been a good year so far for you, considering the robust alpha that the fund has delivered. What are some of the stock and sector calls that have driven this outperformance?

Lahiri: Our three sector calls - which I refer to as A-B-C, are helping drive performance of the fund. A in the A-B-C stands for auto and auto ancilliaries, B stands for banks, particularly private sector banks and C stands for cement. We pared our positions in IT and pharma from overweight to neutral some time ago and went overweight in A-B-C. All three benefit from cyclical recovery and have strong structural growth stories in place as well.

Our call on oil marketing companies did well for us, though we have now trimmed positions here. Some of our underweights also helped as they have underperformed, in line with our expectations. These include metals, utilities and telecom. Metals are getting impacted by the global commodity cycle, and with China slowing down, near term prospects for commodities continues to be challenging. Utilities earn a fixed return on capital employed - not a sector you want to bet on when the overall environment is gearing up for earnings expansion. And telecom currently has many challenges to deal with including spectrum issues, license fees, new autions and so on - these uncertainties keep us away from telecom.

WF: What is your outlook for markets for 2015? Are you expecting markets to pause for breath or maintain their upward momentum? What are the key drivers for the markets, going forward?

Lahiri: It's a difficult call, especially given the backdrop of a very strong 2014 that we have seen. What's working for the markets now is that the macro picture is getting stronger. Falling oil prices are a big positive for India. I think what everyone is looking forward to is evidence of the investment cycle taking off. That will sustain earnings momentum in the medium to long term.

From a near term point of view, perhaps the market will be looking towards the Budget with some anticipation, even as earnings takes some time to build momentum. We should perhaps see an uptick in earnings momentum in the second half of next year - towards the 16-17% growth, up from the 12-13% levels we are at.

On the valuations front, while we are no longer cheap, we are not expensive either. Bull markets in India are known to take PE multiples to the 24-25 range - we are now at 16-17 times 1 year forward earnings. So, there is no reason to get unduly worried on valuations, especially when you are looking towards earnings momentum building from here on. Earnings, as we all know, is what finally drives markets.

WF: Which themes are you most excited about from a 3 year perspective?

Lahiri: If I look at broad themes, I think urbanization in India is going to be a very significant theme over the next 5-10 years, and this will be the driver for many sectors. Home construction, home furnishings, cement, building products - all of these should benefit from urbanization.

Agricultural productivity is going to be another big theme. Crop protection, fertilizers, agricultural equipment, mechanization of farming - all of which contribute to enhancing agricultural productivity - should do very well in the years ahead.

E-commerce is clearly a big trend, and will continue to grow, though as yet we have few listed entities to meaningfully participate in.

Apart from these broad themes, businesses that benefit from resumption of the investment cycle, businesses that have high operating leverage and cyclically sensitive businesses should do well as the economic cycle turns.

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