Fund Focus : UTI MNC Fund 14th October 2014
Outperforming Nifty at half its volatility
Swati Kulkarni, Executive VP & Fund Manager, UTI MF
 

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UTI MNC Fund has an impressive alpha generation track record and has outperformed Nifty with just half the volatility of the Nifty index. What does Swati do to generate superior returns at half the risk? The answer, Swati says, lies in the nature of businesses that the fund owns. Are MNCs a good segment to be in a bull market? Aren't they expensive? Read on to understand Swati's perspectives on why she considers the UTI MNC fund a great portfolio diversifier and a must have in the core holding of any equity portfolio.

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WF: Your MNC Fund has outperformed Nifty, at half the volatility of the Nifty index - which is a commendable achievement. What in your view are the factors that have enabled the fund to deliver these results?

Swati Kulkarni: I think as far as the volatility is concerned it is because of the nature of these companies in terms of the sustainability of earnings, the balance sheet quality and also in terms of the cash flows - the operating cash flows and free cash flows. Also, if you look at typically the capital allocation decision of these MNC companies, they have been far superior and that is reflected in higher ROCE. Because of these characteristics if you look at the beta of the MNC companies, it generally tends to be lower.

The other perspective is that it gives a differentiated exposure compared to a typical large cap index in India which has a much higher allocation to banking, energy and IT. The MNC index has much more allocation to sectors like consumers, industrial manufacturing, pharmaceuticals and automobiles. So in that perspective if you look at in the last 5 or 7 years, some of these sectors have tended to outperform banking sector and typically banks have a much higher beta. And these sectors have much lower beta. So the risk adjusted returns stand out clearly.

WF: MNCs are generally perceived as defensive and tend to outperform the broad market in more difficult times while domestic cyclicals are seen as the best bets in a bull market. Is this a fair comment? Do MNCs offer good opportunities to participate in bull markets?

Swati Kulkarni: As far as the cyclical nature is concerned I think even in MNC space barring the pharmaceutical and consumer stocks, the other sectors like industrial manufacturing or automobile or metals or chemicals - they are all cyclical in nature. So here you have cyclical stocks, which, in addition to the domestic market, also have the ability to put their produce onto the export market. We have numerous examples of these cyclical MNC companies having more than 20% of their turnover coming from exports. To this extent, they are able to cope with domestic business cycles better than others.

Now let's come to earnings growth which is what finally fuels long term stock performance. Because of low leverage on the balance sheet, the benefits of operating leverage - which typically come in when the economy turns around (demand picks up and that helps in apportioning the fixed cost in a much better way) - flow directly to the bottom line and are not consumed by financial leverage. Companies with a lot of debt on their books will find the initial increases in operating profits from higher volumes getting consumed to service interest payments and only the residue flows to profits. MNCs typically have low debt on their books and therefore the entire benefits of operating leverage go down to boost earnings. What this means is that when the economy turns around, MNCs are well poised to grow profits at a rapid clip and fully participate in a growth driven bull market.

WF: There is also a perception that MNC stocks are generally expensive. Is this a fair comment?

Swati Kulkarni: If you are just looking in isolation in terms of the price earnings multiple it might appear so. But this is actually very misleading. If you look at ROE of the MNC index, it is at 45.6% versus Nifty at 16.6%. And, if you look at ROCE, for the MNC index its 59.1% against 9.1% for CNX Nifty. Debt-equity ratio for MNC index is 0.2 vs 1.2 for Nifty. These are all Bloomberg figures.

What this means is that with superior profitability, when you look at PEG and not just PE, or in terms of EV to EBITDA, the valuation differential between CNXMNC Index and CNX Nifty narrows considerably.

WF: Some observers believe that MNCs are attractive only because of strategic interest / special situations - ie when the parent company goes for a buy back at a premium or looks to delist the stock. In your experience, are most of the gains in your MNC fund driven primarily from this aspect?

Swati Kulkarni: Honestly, when we buy an MNC stock, we never actually know whether or when any such event will take place. We buy mainly based on all the valuation parameters I discussed. Whether the foreign parent decided to go for a buy back - that's mainly a prerogative of the top management of the parent. In my experience it always comes as a surprise. But it acts as a sweetener for investors, no doubt.

I think the investment case for MNCs is more to do with earnings growth and the portfolio diversification, rather than these strategic opportunities.

WF: Why do you believe this fund is a better portfolio diversifier than most typical diversified equity funds?

Swati Kulkarni: There are two parts. One as I mentioned earlier, the MNC index is itself quite different in sectoral composition from any of your large cap indices - Sensex, Nifty etc. That itself means you get a differentiated portfolio. Second, if you look across most large cap oriented funds, perhaps 50% - 60% of stocks will be common with varied weights; whereas a portfolio with predominance of MNC stocks provide meaningful exposure to MNCs which may be under owned.

WF: Going forward, what do you see as the main investment argument for an investor to invest in this fund?

Swati Kulkarni: Main argument I think would be about having exposure to companies which are having good entry barriers in their businesses. These are typically wide moat businesses, to use market jargon. These are the companies where the investments would likely span for the long term - in the sense it's not a tactical call. This is a fund that provides exposure to high quality businesses from excellent brands. It is a fund that meaningfully diversifies a typical equity portfolio. It is a fund that should be a part of the core holding of any equity portfolio. That said, this is also a fund that should complement a diversified equity fund and not replace it, as its sectoral composition does not have significant exposure to some domestic cyclical sectors like financials and energy, which are sizeable constituents of our markets.




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