imgbd Fund Focus: Principal Emerging Bluechip

Time to shift gears on earnings outlook

Dhimant Shah, Fund Manager, Principal MF



25th March 2017

In a nutshell

Domestic growth focused mid and small cap stock picks, disciplined GARP approach and profit booking at target prices have all combined to deliver robust fund performance in CY16 for Principal Emerging Bluechip Fund.

Its time to shift gears from a near term earnings outlook (which has been the focus in recent years) to a strategic and longer term earnings outlook on sectors and stocks to fully capture earnings potential and returns potential in the coming years.

Midcap valuations have moderated post demonetization. Budget 2017 gives a fillip to midcap stocks that participate in the affordable housing and rural development themes.

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WF: Your fund turned in a healthy performance in CY16, with a top quartile standing in a competitive field. What are the factors that drove this performance?

Dhimant: At Principal Mutual Fund, we follow a distinct investment process with a huge emphasis on bottom-up stock selection as a sustainable approach to long term alpha generation. We are benchmark-aware, but are not driven by it in portfolio construction, but we do have prudent sector and stock exposure limits internally which we strictly adhere to.

You could say that the portfolio construction is driven by the best opportunities in the market across themes and sectors and our conviction. There is great emphasis on in-house research and modelling, our own earnings estimates, especially for companies where we think differently from the market. Our preference is for companies with sustainable improvement in growth prospects and return ratios over the next 2-3 years, having a meaningful position in their respective sectors, scalable business models with a good management track record and trading at attractive valuations. We are happy owning companies that fit these criteria but are under-owned by institutional investors. As a fund house, we are very target-price oriented and while we do take a long-term view of companies, we are happy booking profits at least in part, if our target prices are achieved with no meaningful revision in fundamentals. We stay focused and aim to deliver superior fund performance over market cycles.

As regards contributors to performance specifically in the last 12-18 months, we have focused on mid and smaller cap companies that are geared to benefit from a significant pick-up in domestic growth. Sectors such as Auto, Auto ancillary, Financials, Oil marketing and select mid-cap pharmaceutical stocks have delivered good performance over the past year.

While the last few years have seen a slightly higher focus on the near term (typically next one year) earnings momentum but we believe the time is appropriate to take a slightly strategic and longer view for sectors and companies in order to capture their true earnings potential and hence potential returns.

WF: How are midcaps and small cap stocks looking now in terms of valuations and earnings momentum?

Dhimant: Indian markets are fairly valued at this point in March 2017, with valuations in absolute terms for the Nifty 50 Index forward PE is 20.4 and the Nifty Free Float Midcap 100 Index forward PE is at 20.6. While large caps look relatively cheaper, midcap valuations have moderated from peak levels in September 2016 in the aftermath of de-monetization. Further, midcaps continue to show good relative earnings momentum across many sectors and may benefit from the tail winds from the recent 2017 budget announcements related to affordable housing and rural development. We continue to focus on bottom up stock selection ideas linked to domestic themes with a "growth at a reasonable price" approach.

WF: In the back drop of the recent demonetization program and the 2017 Budget proposals, what is your current outlook on midcaps and how is your portfolio positioned?

Dhimant : De-monetization has impacted several sectors resulting in lower near term growth expectations and consequently moderated midcap valuations in February 2017. The recent 2017 Budget announcements has given a fillip to affordable housing, rural development, infrastructure, SME firms and the broader Indian consumer. We see many opportunities across themes linked to construction, infrastructure, agriculture, affordable housing and sanitation and the financial sector playing out over the next 2-3 years. Our portfolio is well positioned to benefit from earnings growth linked to these domestic themes over the next few quarters.

WF: What are the sectors within the midcaps space that you are now overweight on and why? Which positions have you rebalanced over the past quarter?

Dhimant: The fund is currently overweight on domestic themes and sectors with attractive relative valuations such as Autos, Cement, Construction, Chemicals, Fertilizer and Pesticides and select Industrials and Textiles as of March 2017.

We are currently underweight Financials, Consumer Cyclicals, IT and Pharmaceuticals due to a combination of richer valuations and the current earnings estimates and growth outlook that pose an unfavorable risk-reward proposition. Although we have initiated new positions in select stocks in the above sectors, we would wait till valuations are attractive enough to load up further.

WF: To what extent do you see global events in US or China impacting our stock market and mid and small cap stocks?

Dhimant: The recent developments coming out of the US does pose challenges for the IT and the Pharma sectors over the next 2-3 quarters. A strong dollar and weaker global exports of the Indian firms makes it challenging for export oriented companies. Oil prices have remained in band between USD 50 -60 due to good global supply conditions and a strong dollar. This continues to support India's overall macro position. China continues to be challenged with weak economic growth and with huge bad loan problems and this has put a cap to the metals rally.

More generally, any market corrections or heightened volatility on account of global events and would only present attractive buying opportunities in domestically oriented stocks.

The views expressed and information herein are independent views of the Fund Manager(s) and for informative purpose only and under no circumstances should be construed as an opinion or Investment advice. The information contained herein is not intended to be an offer to seek solicitation for purchase or sale of any financial product or instrument. Investment involves risk.

The information included herein has been taken from source considered as reliable, however, the AMC does not accept any liability with regard to the information being shared. Recipient of this information should understand that statements made herein regarding future prospects may not be realized. Investors are requested to consult their investment advisor and arrive at an informed investment decision before making any investments. The Sponsor, Trustee, AMC, Mutual Fund, their directors, officers or their employees shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages arising out of the information contained in this document.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.



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