It is a myth that small and midcap are not high quality, says NJ Asset Management's Rajiv Shastri in conversation with Sajeet Manghat.
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00:00 Hello and welcome to NDTV Profit, you are watching the portfolio manager and the person
00:15 I am talking to today is Rajiv Shastri who is the director and CEO at NJ Asset Management
00:20 which manages nearly 4000 crores under asset and the management in the PMF space.
00:26 Rajiv, thank you very much for joining us on NDTV Profit.
00:31 Let me start off by asking you what is the kind of approach that you are looking at with
00:38 respect to investments and how do you go about selecting your sectors?
00:45 Thank you for having me here.
00:47 So our approach to investment is what is called factor based investment or quant investment
00:54 or rule based investment.
00:56 It's known by different names but the basic thesis behind it is that if we use past data
01:04 and we are able to use that data to identify certain desirable characteristics in stocks
01:10 and use rules developed on the basis of that identification to identify stocks, then those
01:18 stocks should reflect the performance of those desirable characteristics.
01:23 So these factors which are popularly known, these characteristics are popularly known
01:28 as factors are basically there are four that are applicable in India which is quality,
01:34 value, momentum and low volatility.
01:36 So we use these factors to identify our stocks and then we invest in the stocks that our
01:42 models identify.
01:45 So we don't really go in for sector allocation in the traditional sense because we are identifying
01:51 stocks based on the presence of certain characteristics, the factors that we are looking at and we
01:57 aim to benefit from the performance of these characteristics rather than the sectors or
02:04 any such capitalization or any such slice of the market.
02:08 Since you look at factor based investing or quant based investing, how do you determine
02:14 what is the kind of return that you are expecting and at what time do you select, is it based
02:20 on data that you exit stocks as well?
02:24 So number one we don't really look at, we do backtest our models but it is not from
02:30 the perspective of what kind of returns to expect but rather whether these models have
02:36 proven themselves to be robust.
02:39 Robustness has many implications and robustness means that we use parameters to identify these
02:46 factors so these parameters have to basically show that the top slice or the best companies
02:54 based on that parameter are able to identify, are able to perform better than the second
03:00 or the third slice.
03:01 So basically we are trying to see whether these parameters are able to generate better
03:08 performance than stocks which we would not have selected based on this parameter.
03:13 Now there is a common sensical approach to these factors, the factors that I said were
03:18 like quality.
03:19 When we say quality factor, the thesis behind it is that high quality companies should outperform,
03:27 you know average companies are those with lower quality.
03:30 So that thesis is perfectly sound, what we are trying to do is trying to find a data
03:36 based way of implementing that thesis onto the existing stocks.
03:45 So if that is the case, how do you break up your portfolio into allocations based on large
03:53 cap or mid cap or small cap because if you look at quality, many of the large caps will
04:01 not be part of it but mid caps and small caps may fall short on that criteria of yours.
04:07 So how do you look at allocation of your money across these three asset class?
04:15 So firstly I think it's a normal belief that large caps are higher quality than mid caps
04:24 and small caps but what we have seen in our portfolio when we identify quality stocks
04:28 based on data is that there is a very reasonable mix of mid cap and small cap stocks.
04:35 So it's kind of a myth that there are no small cap stocks that are high quality or no mid
04:39 cap stocks that are high quality.
04:41 We do find high quality mid cap and small cap stocks.
04:44 So the mix doesn't happen, like I said we don't have any bias, we don't have any sectoral
04:49 bias, we don't have any capitalization bias, our only bias is the factor that we are seeking
04:55 to identify and that factor in our blue chip portfolio, we have two stock based portfolios,
05:00 the blue chip and multi cap.
05:02 Our blue chip portfolio is quality based, our multi cap portfolio is momentum based
05:06 but quality is like the underlying thesis of all our portfolios.
05:10 So even in our momentum portfolio, we do apply quality filters just to ensure that on the
05:16 basis of momentum we don't get stocks that are extremely low quality, which does happen
05:21 in many many bull runs.
05:25 Give me a sense of, once you do a bottoms up approach, you select the stocks and is
05:31 it then after that you bifurcate them into sectors to see what is the sectoral allocation
05:35 or you do look at some of the sectors which are running out, running up and then invest
05:43 in them?
05:44 So we do look at the sector allocation post facto, purely from an academic point of view
05:51 to understand what kind of sector allocation is resulting from it, what kind of capitalization
05:55 allocation is resulting from it.
05:58 But if we are following an underlying factor thesis, let's take quality for example and
06:04 if I were to say that no I will always have a 10% allocation to lending companies.
06:10 Now if I am selecting companies based on quality, it is possible that I don't see any lending
06:15 companies in the top 20-25 companies that I want to buy.
06:20 So if I want to buy lending companies specifically because I have put that condition, I might
06:26 have to go down the quality ladder to identify those companies.
06:30 So I might just take the best lending company which might be 70th in number and the second
06:35 best lending company which might be 120th in number.
06:40 So instead of buying the top 25 companies by quality, I end up compromising the quality
06:45 of my portfolio by putting restrictions either capitalization based restrictions or sector
06:50 based restrictions.
06:52 So our focus is on identifying the factor that we are looking to identify and not looking
06:59 at trying to achieve a certain allocation as far as sectors are concerned or as far
07:04 as capitalization is concerned.
07:07 Give me a sense of your view on various sectors or stocks which are now forming part of various
07:14 sectors as I can see from your allocation.
07:17 You have financials in your multi cap which is basically 20% odd which is there.
07:26 Industrials which is nearly 19 and a half.
07:27 ITU is 12.4%.
07:31 So give me a sense of how do you see financials now because you have seen financial run up
07:34 happening quite a bit now 12 to 18 months run up which has happened.
07:38 PSUs have been leading the pack, private sector has been little sluggish but now we have seen
07:45 some kind of profit booking which is coming into this segment.
07:49 How do you see financials going forward?
07:53 So again it is very difficult for me to form an opinion on the sectors that we are on the
07:59 sector strategy or the sector allocation that results because that is not the goal.
08:05 All I can say is that to this extent is that in our multi cap portfolio which is a momentum
08:11 based portfolio, momentum is a very, it does not have much persistence.
08:15 So in the sense that you have to rebalance it far more frequently then you have to rebalance
08:20 a quality portfolio which is far more persistent.
08:23 Quality is a far more persistent factor.
08:25 It does not change over short periods of time whereas momentum can change over reasonably
08:30 short periods of time.
08:31 So what we do is that we rebalance the multi cap portfolio more often whereas we rebalance
08:36 the blue chip portfolio once in a year only.
08:40 So when we do the next rebalancing what will happen is that we will identify the stocks
08:46 that show the best momentum at that point of time.
08:49 Obviously stocks which are filtered on quality first which show the best momentum at that
08:52 point of time.
08:53 Answering another question that you asked earlier is that is there, do we use a data
08:58 based approach to move into sell?
09:01 If you look at our approach technically we never decide what to sell.
09:05 Every predetermined frequency we determine what we want to buy, what we want to own.
09:13 If that's already present in our portfolio well and good, if it's not present in our
09:16 portfolio then we have to buy it and stocks that we already own which are not coming in
09:22 the new portfolio we therefore have to sell them to buy the new stocks that are coming
09:25 into portfolio.
09:26 So sell decision is kind of automatic based on what we would like to own which comes from
09:32 a periodic rebalancing.
09:33 You look at the sector financials as a whole?
09:38 How do you look at the sector financials as a whole?
09:40 You see financials is a very important sector in the economy.
09:44 How it performs and how it's going to be performing over the next 3 months or 6 months honestly
09:48 I don't have a clue.
09:50 The fact that it is part of my portfolio means that it is moving part of my multi cap portfolio
09:56 means that it is moving robustly in a positive direction and we would like to benefit from
10:02 that movement.
10:03 We assume that it will continue for a while and we would like to benefit from that movement.
10:06 So that is the reason why they are there in the portfolio.
10:10 So the fact that financials are in the portfolio means that we feel at least the rules that
10:16 we apply believe that the financials will continue moving positively for a few more
10:20 months.
10:21 So you are basically saying that it is more of a rule based approach that you are doing
10:31 it but when you apply such rules do you also look at how the sector is performing as a
10:37 whole?
10:38 Well not at all.
10:39 In fact we apply the rules to a wide universe of stocks.
10:44 So we start with 300 stocks.
10:45 I will give you an example of a typical portfolio that we construct.
10:50 So we start with about 300 stocks, largest stocks by free float market capitalization
10:55 and then we whittle it down based on various quality factors to arrive at a reasonable
11:01 universe where we apply our prime factor that we wish to apply which is in certain cases
11:09 momentum and in certain cases we continue with quality.
11:12 So we are not really looking at a sector allocation or achieving a desired sector allocation or
11:17 even looking at a sector allocation with the index that we are benchmarked to.
11:22 We are completely agnostic to all of these and that is why our performance may vary very
11:27 widely from the index both positively and negatively.
11:31 So it is not necessary that our portfolio overlaps are very very small.
11:36 So if you see our portfolio overlap with the Nifty 50 you will see it either in single
11:41 digits or very low double digits.
11:43 Our portfolio overlap is going to be very very small.
11:45 So the idea behind it is to actually genuinely bring the underlying benefits of true active
11:55 investing to our investors where we are not bound by the index, we are not bound by any
12:01 sector or capitalization allocations.
12:04 All we are looking at is benefiting from the factors that we want to benefit by.
12:10 I was looking at your blue chip portfolio which is there.
12:17 You have the top guys, one of the stock that is mirroring both blue chip and the multi-cap
12:23 is HAL.
12:26 How do you decide on that and do you look at fundamentals of companies as well?
12:32 I understand you look at count numbers and how it is moving around and quality aspects
12:39 and everything, but from a fundamental point of view how do you look at these stocks?
12:48 So of the factors that I spoke about, quality is almost entirely dependent on fundamentals.
12:54 So what is the company P&L and balance sheet characteristics?
12:58 Value is a combination of fundamentals and market characteristics because the price element
13:02 comes in while the intrinsic value of a company can be decided based on fundamentals but then
13:11 the market is valuing it differently and we get a price for the company from the market.
13:16 So value is a combination of fundamentals and market information, market data.
13:22 Momentum and low volatility are almost entirely market data based.
13:26 So momentum is basically the direction of movement, whether it is positive, negative
13:29 and how strongly positive or negative and volatility is basically the standard deviation
13:34 of the daily movement and how volatile that stock is as it moves either positively or
13:40 negatively.
13:42 So as far as quality is concerned, it is almost entirely a fundamental factor and our definition
13:48 of quality is like I said based on data and to surmise it into one sentence, we think
13:55 that quality companies are those which earn a high level of profit consistently with low
14:02 levels of debt and distribute these profits to their shareholders.
14:08 So the four fundamental factors that we look at, the four fundamental parameters that we
14:12 look at are ROE which is profitability, ROE consistency which is consistency in profitability
14:19 across time, debt to equity ratio as we call it equity to total capital and dividend payout.
14:32 Dividend payout is not the same as dividend yield, we are not comparing the dividend to
14:36 the price, prevailing price in the market.
14:40 What we are saying is if you earn 100 rupees, how much do you pay out?
14:43 You know what is the percentage that you are paying out?
14:45 So we select stocks based on these four characteristics and we shortlist stocks based on these four
14:50 characteristics and these are the stocks which we say are high quality stocks.
14:55 Then we apply, you know, towards the end we may apply various other, we may use various
15:01 other factors to decide on weightage or you know to decide on weightage or to decide on
15:09 you know the final shortlist of 20 or 30 but the fact of the matter is that the quality
15:15 factor is predominant as far as blue chip is concerned and it is almost entirely based
15:20 on fundamentals.
15:21 In your top 5 sector allocations you have IT which is 24% and above I think 24.2% for
15:27 blue chip.
15:28 It is safe to assume that it is all the top 3 or 5 IT companies which have good profitability
15:36 as well as they have a good dividend payout ratio or they have a capital allocation policy
15:40 in place which allows money to be or profits to be you know given back to the shareholders?
15:48 So see out of the four factors, out of the four parameters that I laid out, if a company
15:57 you know goes through the first three layers which is ROE, consistent ROE and you know
16:03 debt to equity which you will notice that most IT companies do actually have high ROEs
16:10 and you know they are fairly consistent as far as their ROEs are concerned.
16:14 We also look at this data over a period of time, it is not just the last available data
16:19 but obviously we look at it over a period of time and you know the final factor that
16:24 we use, the final parameter that we use is dividend payout.
16:28 Now there might be in our portfolio certain companies that don't pay a dividend at all
16:32 but they have been very very strongly you know positioned as far as the first three
16:37 factors are concerned, first three parameters are concerned so therefore they continue to
16:41 be a part of the last portfolio.
16:43 The fact of the matter is that it is possible that dividend payout is zero.
16:48 I am trying to give an example of that such companies which you know which fall through
16:52 or which tick mark all other but except for dividend in large caps and you are part of
16:59 it because the factors are saying that you know it gives you good returns.
17:02 But often I don't have the data because it is a small group of 25 you know 20 stocks
17:08 in the blue chip portfolio so often I don't know which of these companies don't pay a
17:12 dividend at all but since it is just 20 companies I assume that all of them would be paying
17:16 dividend.
17:17 We have a larger portfolio that we do on a mutual fund side okay which is a 50 stock
17:21 portfolio where it is possible that you might get a couple of companies which don't pay
17:26 dividend.
17:27 But mostly in these companies you would be, we would assume that they would all be paying
17:30 dividends.
17:31 So, if you know if investors are looking at your fund what all they should be looking
17:37 at because from a normal PMS point of view they have the other approach which is look
17:43 at the sectors, look at fundamentals and approach but you have a bottom up approach which is
17:47 there.
17:48 So, it becomes little tough for some of them to understand how exactly you are you know
17:52 making your portfolio and how what is while it will be giving you returns which is which
17:57 may be at par or more than the benchmark but you know understanding the philosophy of the
18:04 fund or the portfolio becomes little difficult for them.
18:07 Yeah, it is extremely important that people do understand the philosophy that we are pursuing
18:11 because you know it will give them an idea about what to expect from the portfolio.
18:16 What in a you know in a very short manner if I were to describe it, if you look at our
18:24 portfolio you know our goal is to make sure that you don't feel uncomfortable with any
18:29 of the companies that are there in the blue chip portfolio.
18:32 You look at the company then you look at the name then you say yeah these are good quality
18:35 companies I don't mind owning them.
18:38 If you don't mind owning companies then the market volatility whether the price goes up
18:42 or down becomes a secondary factor because you are convinced about the quality of the
18:46 company itself.
18:48 The price might go down but then you know that if it is a high quality company it is
18:52 a temporary phenomenon and the price will go up eventually you know if I continue holding
18:58 on to it.
18:59 So this is the basic thesis that we intend to follow.
19:01 The basic thesis is that we want to own you know high quality stocks.
19:05 Now if you look at our portfolio and you see high quality stocks right and you look at
19:10 the company names and you say yeah these seem to be I don't have a problem with you know
19:14 these companies all of them are high quality companies then at least you will have the
19:17 comfort of knowing that we bought companies that are good.
19:22 If over a long period of time it has been demonstrated across the world that higher
19:27 quality companies outperform benchmarks.
19:30 So if I own these for a long period of time I am confident that these companies will outperform.
19:35 Over short periods of time there may be periods of underperformance there may be periods of
19:39 ridiculous outperformance which we have seen both of them in the past and but my basic
19:45 goal of owning high quality companies and being secure about the fact that my companies
19:49 are not you know questionable in any nature is being met.
19:53 Is the average holding period for you in large caps because you said in multi cap it could
19:59 be as low as quarterly rejig which can happen?
20:04 So in the blue chip portfolio we rebalance it once a year.
20:08 We try to ensure that all the profits we generate all the gains we generate along the gap we
20:13 have and you know there is no interim churn in the portfolio.
20:16 So because quality is a very persistent factor.
20:19 See you can't have a company which is high quality for 10 years and then suddenly becomes
20:24 low quality the next year.
20:26 That's not the way it works.
20:27 So quality is extremely persistent if a company is high quality it continues to remain high
20:31 quality for reasonably long periods of time.
20:34 We rebalance the portfolio every you know every one year but that doesn't mean that
20:39 the entire portfolio changes every one year.
20:42 So there is a remarkable level of consistency persistence in our portfolio as well.
20:46 About 20 to 30 percent of the portfolio changes on an annual basis but you know 60 to 70 remains
20:52 the same.
20:53 So if you look at that churn our average holding period ideally would be between you know 3
20:58 to 4 years for each stock that we own.
21:00 There are some stocks that will last only for a year but then there are some stocks
21:03 which would last for you know more than 4 years as well.
21:06 Would you have made the most of the PSU rally in this market?
21:10 I think it has contributed.
21:14 It has contributed but it's contributed I think more on the momentum side than it has
21:20 on the quality side.
21:22 So you know while HAL has been a kind of a company which has both shown momentum and
21:28 quality other PSUs may not have shown the high degree of quality that you know we experience
21:34 in or we see in other companies that are there in our portfolio.
21:38 That was Rajiv Shastri, Director and CEO at NJ Asset Management.
21:42 He was talking to us about his portfolio.
21:44 Thank you for watching the Portfolio Manager and joining us on NETB Profit.
21:49 Thank you.
21:54 (upbeat music)