Fund Focus: Principal Emerging Bluechip Fund

3 reasons why midcaps still make sense

Dhimant Shah, Senior Fund Manager, Principal MF

3rd October 2016

In a nutshell

Principal Emerging Bluechip's underweight in financials caused it to hit a speedbump in CY15, which Dhimant quickly corrected this year to come back strongly into top quartile. Sharing his perspective on the debate of stretched valuations in midcaps, Dhimant says there are 3 reasons why he believes valuations will sustain: (1) Midcaps are relatively less exposed as compared to large caps to the significant headwinds from continuing weakness in global trade and demand (2) They continue to deliver strong growth by catering to the growing domestic market, and (3) The midcaps space is yet to see interesting listings in big growth themes like renewable energy and e-commerce.

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: Performance in CY16 has been strong on a YTD basis. This contrasts with a somewhat disappointing show in CY15. What caused a relative slump last year and what steps have you taken to bring performance back on track this year?

Dhimant: Underweight in financials hurt performance last year which we corrected.

WF: What does your attribution analysis suggest as key alpha drivers for YTD CY16?

Dhimant: Key Attribution analysis is partly explained by the key overweights / underweights in the sectoral exposure, within which, stock specific contributions has been helpful. We chose to during the year, somewhat realign exposure to certain cement, construction material and chemical stocks. These were key contributors in terms of the generation of alpha.

WF: Your sectoral stances are well explained in the table above. What were the key changes that you have made in your sectoral weights this calendar year, in response to evolving market situations?

Dhimant: We took certain stock specific exposure like increasing some weight in defense, cement, chemicals (organic and inorganic) and maintained underweight in the staples, pharma and IT. Stock selection within some of these themes played a sizeable role in helping performance.

WF: Mid and small caps are seen as overvalued and many advisors are taking profits from these funds. At the same time, mid and small caps are also seen as the best proxy to the India growth story. How does one make a case for investing in this segment, in the context of these seemingly conflicting views?

Dhimant: Agreed that these are conflicting views, especially given the fact that sectors like ecomm/ renewable energy in the form of solar despite being a huge opportunity finds no major representation in any of the indices. These would at the initial stage or growth stage be typically classified as midcap or small cap. Secondly, most of the large caps were facing headwinds from a depressed global trade / demand cessation. Lastly some of the midcap small cap names have continued to deliver better growth owing to either better domestic demand or their relative positioning being favourable compared to the larger peer group. Hence, the valuations have sustained above the larger peer group valuations.

WF: If you were to pick one theme which you think holds the maximum potential over a 5 year perspective, which would it be and why?

Dhimant: It would typically be "consumer discretionary" owing to huge additions to workforce, favourable demographics and relative under penetration of themes like payment banks, ecommerce, telecom data, etc.

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