This is the next post in the ‘Let’s talk investing‘ series. In this series, I write about my conversations with investment practitioners, people with real-world investment decision-making experience. My objective in these conversations is to understand their investment philosophy and process, to demystify, at least to some extent, what they do, and to walk away with some thought-starters to help all of us become better investors.
Note: These conversations are not meant to offer advice on specific stocks
There are over 35 Asset Management Companies (AMCs) in India. The typical AMC offers between 5 and 25 open-ended equity mutual funds with varying investment strategies to cater to every kind of investor. PPFAS is not a typical AMC. It offers just one equity mutual fund, Parag Parikh Long Term Equity Fund. My conversation today is with the Head of Research at PPFAS Mutual Fund, Raunak Onkar.
I have been following Raunak’s incisive sector presentations, on Auto, Retail and most recently on Media & Entertainment, specifically the impact of digital media, video and music streaming on traditional business models. Our conversation covered what a Research Head’s workday looks like, what a value investing philosophy looks like in practice, how consistent and varied reading forms an integral part of the investing process and the advantage small retail DIY investors have over large funds. Read on for an engaging conversation with quite a few takeaways and resources.
Anoop: Hi Raunak, Thanks for taking the time today. Can you start by talking a little bit about your background and the path you’ve taken up to this point in your life?
Raunak: Thanks for the opportunity Anoop. I didn’t plan to become a Research Analyst. I was into my Bsc IT Course & somewhere around second year my interest in finance & economics picked up. It helped to have friends around me who were also interested in it as a fringe activity. As I graduated I had a placement offer from one of the large-cap listed IT services companies.
I joke about it now that by that time I had made up my mind that I would rather own an IT Services company in the form of shares than work for one as an employee.
Investing crept up on me & I liked the challenge of studying business models & understanding how things worked. I attribute some of that thought process to my very short coding background.
Anoop: You have been a career investment professional. What about investing drew you to it?
Raunak: Apart from the initial interest, I really enjoy studying businesses. How they were founded, how they operate, how capital flows, etc. It seems naive to think in those terms but it helped to hold my interest during my early days.
After almost a decade of doing this, I think the most interesting part is that investing really helps us engage all our mental faculties to reach a decision.
I need to be aware not only about the objective aspects of the investment idea but also about my subjective behaviour towards that idea.
The process might be repeatable but the inputs are always different based on different circumstances. The ability to be comfortable with uncertainty based on objective decision making is also another side benefit of investing. Also, not a day goes by when I don’t learn something new, that’s a huge benefit of being in the profession.
I think learning something new all the time needs to be accompanied with some sort of application in real life, otherwise concepts can be easily forgotten.
For example, I love to read history of various things but lot of it doesn’t stick because it’s simply not relevant on a day-to-day basis. However, history of warfare or various history of empires sticks because it has a lot of parallels to the business world. Market share dominance in a saturated market is as good as capturing other empires through bloody wars. I loved playing games like Age-of-Empires when I was much younger but never realised it would be so analogous to how businesses scale by making specific capital allocation choices. I believe that concepts like cost of using resources in a certain way leading to specific outcomes would have been very hard for me to understand without these visualisations.
Anoop: Coming to your current role, what does a day/week/month in the life of the Research Head at a firm like PPFAS Mutual Fund look like? keeping in mind that for the regular investor, it can get confusing to differentiate between Fund Managers, PMS Portfolio Managers, Wealth Managers, Brokerage Research Analysts and so on.
Raunak: There’s a lot of reading & some more reading.
My workday is roughly organised with 90% reading & 10% of other organisational/team responsibilities. Reading comprises of reading Annual Reports, Company Filings, Media mentions about the industry & companies we are covering, trade journals & independent reports, reading/skimming relevant books & periodicals.
Occasionally meeting & speaking with industry experts/peers to understand certain nuances of the business or industry. Occasionally attending trade conferences or brokerage conferences to meet with company managements & promoters, attending company conference calls. Our firm has a learning mindset, so we learn not only from reading & meeting people but we also occasionally screen interesting documentaries and films to help us learn laterally about some topics.
For instance, a documentary like Katiyabaaz can help us understand the on-the-ground issues of running a DISCOM (electricity distributor) in a far more contextual manner than any research report on the power sector. Or a documentary episode from Netflix’s Dirty Money, on pharma called “Drug Short” can really help us understand how different players are organised in the industry and combined with company-specific research it paints a better qualitative picture.
For the Fund, we have a coverage universe of stocks. These are businesses that we wish to know & understand because they fit within our subjective quantitative & qualitative criteria. Having that list helps us guide our research focus on those companies, in a sector by sector manner. As Head of Research one of my roles is to maintain this focus by allocating sectors among the research team members and gradually, as a team, build in-depth competence to understand these businesses.
I enjoy learning & I’ve stopped mentioning reading as a hobby, it’s a full time activity & continues well into the rest of my day when I’m not in the office. The reading content changes though.
For the confusion between roles, I think it’s easy to break down the roles based on titles but there’s a lot of overlap of activity. For instance, a fund manager also has to stay up to date about many micro & macro aspects of the companies owned in the portfolio & also those that aren’t. The research team helps in building that knowledge base. Another important activity a fund manager does is determining the allocation of stocks in the portfolio. How much as a % of portfolio can be put in one particular stock. This is an important decision & each fund manager will have a subjective way of doing this despite having a similar investment philosophy. Another aspect a PMS Portfolio Manager might have to worry about is to make sure all the individual accounts in the PMS get fair allocation of the investment idea. Because money comes in different accounts at different times the manager has to make sure he/she gives the benefit of the investment idea to all it’s PMS accounts. It can get tricky when you have a large number of accounts. In a mutual fund scheme, the money is deployed at its own time but the investor knows the entry point in the form of the daily published NAV (Net Asset Value) of the fund/scheme.
Anoop: Since you are an equity investor in a personal capacity, what are the key differences between investing professionally and as a retail investor?
The key difference is the size (market cap) of the idea I can focus on. I can look at far smaller companies with very limited liquidity which a large-sized portfolio can’t look at. It allows me to look at a promoter or management group which doesn’t have a long enough track record yet. I can also have a different portfolio allocation style than the professionally managed portfolio.
My initial learning about investment mistakes came from my personal portfolio when I went down the rabbit hole & made a lot of rookie mistakes. My investment style is oriented in the same direction as PPFAS Mutual Fund, so it helps to keep the distraction to a minimum. I also invest in PPFAS Long Term Equity Fund as my primary mutual fund investment.
Anoop: Investment managers not only have smart folks specializing in specific sectors, they also have access to management, fancy Bloomberg terminals, databases and tools the regular investor does not. Given these structural advantages, should retail investors even try doing their own security selection?
Raunak: I won’t discourage someone from learning how to invest on their own by studying the businesses by themselves. These tools help but in the end, the nature of work remains the same.
It’s like saying, does it make sense to make our food at home with limited cooking tools when there’s so many professional chefs running their own restaurants & fully equipped & staffed kitchens?
We have to understand that each activity requires its own time & rigour. Managing money is no different. A private investor has to spend time tracking the companies, industries & also deal with their day jobs & family responsibilities. Also, the most important thing I’ve observed in investing is managing our temperament.
Inability to control our urges of greed & fear are more damaging than reading one less annual report. Data & Insights can only help in building confidence, the decision making has to go through subjective & objective process.
I think investing is best learnt when its aligned with common sense. Not losing money, not overpaying for businesses & knowing the difference between good and bad quality managements and businesses is worth learning when you’re investing personally / professionally.
Anoop: Value investing has become a buzzword (or phrase) coinciding with Buffett’s popularity. What does it mean from a practitioner’s perspective? What are the criteria that make a company a candidate for your fund portfolio?
Raunak: Value Investing has become an identifier, like you said, for investing in good quality businesses run by good business managers & at a reasonable price. It does sound cliched to say the whole thing, but it’s the essence of what the phrase means.
To elaborate on this, from our fund’s point of view, we like to invest in businesses that:
- Have a long enough operating history (so we can study it)
- Have Managers who have run these companies for a while & are aware of the industry cycles
- Have Managers who understand basic capital allocation
- Have promoters who treat minority investors like partners & not trespassers
- Have some advantages like being the lowest cost producer, being a very efficient operator, having a dominant market share or a tried and tested business model.
- Are good businesses from the point of view of good return on capital across cycles.
- Are also easy to understand
- Are available at a reasonable price so that there’s some money to be made by investing in them.
The ‘reasonable price bit’ is the most difficult part of Value Investing because it’s subjective and as an investor we can get persuaded in many ways to believe a hype or fancy trend which is just a story but has limited scope of turning into reality.
Anoop: That’s a comprehensive real-world framework for value investing. What differentiates good capital allocation from bad? Can you give real-world examples?
It’s fairly easy to determine this. If we have a long enough financial history of the company, we can see how the capital has been deployed across cycles in the past in terms of what kinds of assets are getting accumulated. Post that we can calculate absolute returns made from such deployment of capital in the form of earnings/cash flows or we can also compare with industry peers across the same cycle to see how they’ve performed under the same conditions.
Good & bad are relative terms, if I think 15% return on capital is enough for the businesses I own, then I will use that as a benchmark to evaluate the business performance over the long run based on the framework mentioned above.
Of course, there are a lot of hidden costs of doing business like environmental costs or quality improvement costs which were not factored in the past operations which change the future outlook of what returns the business can generate.
For example, if you take a look at the Indian Generic Pharma space, it’s been a great example of manufacturing medicines at scale. For the longest time in the history of these companies, they just grew organically like a typical manufacturing business that gets export & domestic business. Now as the complexity of the products has increased since returns from easy to manufacture products have shrunk, the industry has had to resort to inorganic growth or invest heavily in R&D. This has changed the capital allocation to some extent. Still, if you calculate the Incremental return on capital for many of the scale manufacturers, they’re still healthy but not like what they were in the heydays. It’s all about our personal benchmark of what the return on capital of a business should be. It can fluctuate within a narrow range, but if it deviates too far from the mean, then it’s also visible in the market value of the company over time.
Anoop: One of the factors you mentioned is finding companies with one or more advantages, also popularly called moats. In many cases, a high historical ROCE is presented as evidence of an advantage, but that’s like saying “This person is rich, therefore he must be smart and hardworking”. How do you identify advantages that will sustain in the future?
Fair point. I think high ROCE without growth doesn’t hold too much meaning. A business needs to keep growing at high ROCE to truly benefit its shareholders because with each passing year it will create more value.
There will be countless businesses, even our neighbourhood stores like a hair salon, etc may have a very high ROCE but they’d rarely grow on a year-on-year basis unless they change something dramatically in the way they operate. It’s very hard to retain a high ROCE when you’re scaling because lot of expenses scale differently. That’s where words like “moat” make an appearance in our vocabulary.
There’s a paradox here which we are seeing in the market. A lot of tech companies (apart from the established ones) don’t have a high ROCE profile but they’re growing very fast. Their valuations are driven not by traditional business performance metrics but by metrics like market share, wallet share, etc. which in theory can bring in higher incremental ROCE in the future. That’s a very hard problem to deduce with logic alone especially when we see companies pouring 10’s of Billions in scaling their business knowing full well that it is generating a low return on capital at the moment. This discussion by @a16z is instrumental to understand the difference between traditional business performance and the market dominance logic embraced by a lot of tech companies.
Anoop: In a world with multiple schools of investing; value, growth, momentum, thematic, what is the rationale behind offering one flagship equity mutual fund to investors?
Raunak: It’s good to be able to do what you’re good at. There are many styles of investing & many investors have done well in those styles. But it is important to understand what we can do well & keep doing it in a responsible manner. Also it becomes easy to communicate with our investors when we have only one product where we put our own money too. This is what we understand and this is what we do.
Anoop: To you, is “value” absolute (a set of conditions that stay consistent through time) or relative (dependent on prevailing market conditions)? Can you illustrate with an example?
Raunak: The value of anything is never an exact, decimal accurate number. It is usually a range of expected value. It can also be looked at in a relative manner compared to some other company in the same sector. As long-term investors, it is a challenge to use current market conditions to dictate our ability to look at value in the long term. Some set of conditions like I mentioned above have to exist in the business for us to determine whether it’s worth our time.
For example, one of our largest holdings is a company called Alphabet, the parent company of Google. Based on the business & management characteristics it’s an investment we are comfortable to make. But we also need to keep an eye on how much we’re paying for this business today when we choose to invest in it. We can value it relatively by comparing with other technology companies but initially, we need to understand if the business is generating adequate cash flows, earnings, & returns to justify what we are paying. Once we are convinced with the sustainability of the operating parameters then we also need to focus on the risks that the business faces. These can be business specific risks or even regulatory or sector-specific risks. After considering all this, we have to make up our mind to allocate a certain amount of the portfolio towards this business. So the value is never going to be exact, it has to also incorporate the possibility of us making a mistake in valuing it. Hence we need to have some margin of safety as well.
Thinking of value as a range of outcomes rather than an exact point estimate helps a lot in decision making.
Anoop: With trailing Indian Index Price-Earnings at or above all-time highs, isn’t value investing a paradox in today’s market? How do you reconcile your investment philosophy with existing valuations?
Raunak: It’s simple, if we believe some business is too expensive, we will not invest in it. The scheme is designed in such a way that we can look for investment opportunities anywhere in the world & at the same time, have some ability to hold cash as well.
Our CIO Rajeev Thakkar, gave an interesting presentation on how to think of valuations, especially from the current market point of view.
Anoop: A slightly uncomfortable question, to what would you attribute your biggest investing mistakes?
Raunak: It is not uncomfortable to talk about mistakes when we know how we made them & survived to talk about them. It is easy to blame inadequate data or some lack of understanding. I think it’s part over-confidence & part bad luck. Over-confidence comes from having done the work to understand something and believing it to be enough. I spoke about building conviction here
Most of our mistakes are not because of overpaying for a business but due to our inability to understand the business or people better than we should have. I wrote a blog post to highlight some of those errors of judgement. In the end it’s not right to beat ourselves too much for making mistakes.
Mistakes are unavoidable. We need to learn from them, avoid repeating them & make sure we follow a portfolio approach so that a mistake doesn’t hurt us too much.
Anoop: Legendary investors like Buffett and Lynch have advised: “invest in what you know”. At the same time, home country bias (the tendency of investors to prefer companies from their own country) is considered to be one of the most prevalent biases. With Alphabet Inc. and Facebook among your top holdings, how do you think about this?
Raunak: Why limit ourselves to our own country in spotting good businesses when we can do it all over the world? Agreed that things that are closer to us are sometimes easier to understand & easy to track, but that doesn’t mean companies listed outside are not.
By investing outside India, we get to invest in companies or industry trends that don’t exist in the Indian listed space. Where can we invest in an Alphabet like company in India or where can we invest in the growing digital advertising trend in the Indian listed space?
Our fund can invest up to 35% of its assets in companies listed outside India. This not only allows us to invest in unique opportunities but also allows us to diversify from country-specific risk. Also domestic & international stocks may not move up or down at the same time, which also helps in reducing the portfolio volatility to some extent.
Anoop: You have written and spoken about technology and trends in digital media at length. Recently you spoke of Netflix and Spotify. What came first, your interest in the space, or the emerging disruption in the media & entertainment space? What can a retail investor interested in building her own portfolio take away?
Raunak: I’ve always been interested in the technology space. I’ve been lucky to get an opportunity to track the sector as part of my job. As a business analyst, it is an interesting time in the tech and the media space where the distinction is blurring. Tech companies are becoming media players and media companies are embracing technology.
For the retail investor or any investor in this sector, it is becoming very difficult to see the past trends repeat themselves.
There are many good companies in the industry, but each media company has to adapt to the pressure of diminishing and limited attention span of its target audience and use technology to cater products accordingly. The old rules are changing to some extent and wise capital allocation today will determine where these companies will stand 5 or 10 years down the line.
Anoop: Who are the top three investors and books that have influenced your investment-thinking the most? How have they influenced you?
Raunak: There are too many books & people that have influenced me & will continue to influence me, so listing 3 of each is tough. However I’d like to acknowledge the role of Late Mr. Parag Parikh (Paragbhai) in helping me believe in my ability to learn investing. Our CIO, Rajeev Thakkar, has been exemplary in giving a good operating framework to how investment analysis should be conducted & how to think & behave in difficult situations. There are countless friends and peers who I constantly learn from. Most important learning for me has been to be open about my learning & communicate with others so they can point out my mistakes. Keeping myself open to constructive criticism without taking it personally, has been a big learning experience for me.
I believe recommending books is an exercise in recency bias. Some of the books I keep re-reading are books on Stoicism, Seneca’s letters, or Meditations by Marcus Aurelius. They speak a great deal on temperament & conducting ourselves in tough situations. Translations of the Geeta are also illuminating & if that’s too tough to read, do pick up translations of the Mahabharat to get it in story form. Also Tom Wolfe’s A Man in Full or Catch 22 by Joseph Heller helped me to visualise some oddities in human behaviour. I think reading fiction has helped me in creating a framework to understand other people & their actions more empathetically.
Capital Returns by Edward Chancellor was interesting to understand the importance of thinking in terms of capital cycles, within industries or companies. 100 to 1 in the Stock Market by Thomas Phelps helped me learn about the importance of taking a long-term view in investing. Of course not to forget reading Howard Marks letters, Buffett Letters & countless material curated by many websites. Vishal Khandelwal’s Safal Niveshak or Joe Koster’s Value Investing World are great resources for any investor.
Anoop: Lastly, what is the most counter-intuitive piece of advice you would give an investor looking to learn about investing in Indian markets?
Raunak: Counter-intuitive is tough.
I’d say don’t take our ability to understand things, too seriously. There are so many ways we can be wrong & we may not be aware of them. Leave some margin of safety before making decisions. I’ve seen this work in life as well as in investing.
Anoop: This has been brilliant. Thanks, Raunak, for sharing your perspectives.
Raunak tweets @oraunak
Click here for my conversation with Gautam Chhugani, Senior Analyst at Alliance Bernstein