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WF: How would you describe the experience over the last one year in managing this unique fund?
Venugopal: The last year has been a satisfying one for the Fund given that it was a tough year and the economy is recovering from a very bad phase.Despite sectors like Healthcare and IT doing well in the year and the fund not having any exposure to these sectors, it delivered relatively strong growth. The only disappointment has been that the economy is taking time to recover.
WF: How did you position your initial portfolio and how has it changed over the last year, to align with evolving market situations?
Venugopal: The initial portfolio has not changed much over the last year. As the industrial capex cycle is likely to take time to unfold, we have increased exposure to sectors where there are tailwinds like the ones driven by government actions and spending. Also, as the rural economy and the property markets are slowing down, we have reduced exposure to the cyclical consumption and building materials sectors selectively.
WF: What parameters do you track to determine where in the business cycle we are, and therefore how your portfolio strategy should change to align with the cycle?
Venugopal: As articulated at the time of the fund launch, we track the business cycle using three different set of parameters.
First; the macroeconomic parameters like GDP growth, IIP growth, manufacturing data, PMI, inflation, etc. Secondly, as part of our research process, we monitor and analyse companies regularly. This gives us anecdotal evidence of how the economy is faring. Such evidence could be factors like capacity utilisation, pricing power, competitive intensity, working capital cycle, capex trends etc. Finally, we also track valuations of companies and the valuation differential between defensives and cyclicals.
These three sets of parameters together are what we would rely on to sense the stage of the economic cycle as it progresses. Initially, as the economy moves into an upcycle, the portfolio would have exposure to only cyclicals. As the economy moves closer to the upper inflexion point or the peak of the cycle in terms of performance, we will shift exposure to the defensive sectors and play the down cycle with these sectors.
WF: A year ago, most fund managers bet aggressively on cyclicals and deep cyclicals, yet in the last year, defensives like healthcare have vastly outperformed cyclicals like banks and infra sectors. What explains this market behaviour?
Venugopal: In the last year, healthcare has been one of the best performing sectors in the market. In my view, the market had run up on expectations that the economy would recover fast and therefore these bets on cyclicals.
However, in the current financial year, due to severe weakness in the global economy, commodity prices correcting significantly, the reform process taking time etc, the recovery in the economy has been disappointing. This has led to the market rerating the sectors which are showing more visible growth like healthcare etc. As the economy gains strength, one may expect cyclical sectors to outperform more conclusively.
WF: Global market volatility has caused a steeper sell off in cyclicals than defensives. How does a fund like yours, which focuses more on the domestic business cycle than global market factors, deal with such situations?
Venugopal: It is true that global markets have been volatile. In times like this, generally, cyclicals correct more than defensives due to the high beta nature of these businesses.
However while constructing the portfolio, we took into consideration the weakening global economy and therefore the fund had very limited exposure to global cyclicals which have fallen the most in the market sell off. Also to mitigate risk in the portfolio, given the global scenario, we have constructed a high quality portfolio thereby not taking exposure to leveraged companies. Also, using the past business cycles as reference and through constant interaction with companies and industry experts, we have tried to take varied exposures to sectors depending on the stage of the cycle and this has also helped in the last one year. Lastly in any market, stock selection plays a big role in fund performance and we have used a bottom up strategy to the maximum extent possible while constructing the portfolio.
WF: How confident are you about the economic recovery in India? Market participants have been waiting for a long while to see earnings momentum pick up, but it is yet to materialise in a meaningful way.
Venugopal: In our view, the economy is on a very slow and gradual recovery from the trough. In terms of GDP growth we are already seeing a small pickup. The recovery process has been dragged down by a poor monsoon and a very weak global economy.
India is a large importer of commodities like crude oil and thus the weakness in commodities is helping reduce inflation in the economy as well as improve most macroeconomic parameters. Interest rates are on a downward trend and there is increased capital spend from the government in the recent past. Urban consumption continues to be reasonably strong.
We believe that the Indian economy is getting stronger and is gradually coming out of a slow growth phase and moving into an upcycle.
WF: Which are the sectors that you are currently overweight on and why? Conversely, which are the couple of key underweight's in your portfolio and why?
Venugopal: We believe that the Indian economy is gradually recovering and is beginning to enter an upcycle. In this phase of the business cycle, cyclical sectors tend to do well. Hence we are overweight the cyclical sectors. Within the cyclical space we are more positive on private banks, capital goods and engineering companies which are not too dependent on the industrial capex cycle, cement sector, and companies focussed on railways, defence, construction, logistics etc. We believe that these sectors are more sensitive to the overall growth of the economy and are the ones which will benefit in this cycle. The earnings growth of companies in these sectors is expected to improve over time as the economy picks up momentum.
The fund currently has zero exposure to defensive sectors like Information Technology, Healthcare, Consumer staples, Telecom, Utilities, and Media etc. In an economic up cycle, the defensive sectors tend to underperform given its low sensitivity to economic growth. These sectors have done very well in the last few years when the economy was in a downturn and hence are now at expensive valuations.
The article (including market views expressed herein) is for general information only and does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this information. Investments in mutual funds and secondary markets inherently involve risks and recipient should consult their legal, tax and financial advisors before investing. Recipient of this article/ information should understand that statements made herein regarding future prospects may not be realized. He/ She should also understand that any reference to the securities/ sectors in the document is only for illustration purpose and are NOT stock recommendations from the author or L&T Investment Management Limited, the asset management company of L&T Mutual Fund or any of its associates. Any performance information shown refers to the past should not be seen as an indication of future returns. The value of investments and any income from them can go down as well as up.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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Fund Focus : L&T Business Cycles Fund
