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Subbu's Solution

Value or Nothing

Mr. I. V. Subramaniam, Director, Quantum AMC Pvt. Ltd. was recently interviewed by Value Research. The Interview is published in the latest copy of Mutual Fund Insight. In this mailer we share with you an interesting excerpt of the interview.

The Quantum rule book

Question: With liquidity filters, won’t Quantum miss out on small caps – the superstars of Indian bull markets?

Subbu Answers: “There are some small-caps and mid-caps which tend to have good liquidity and at attractive valuations, we will buy them. But there are some stocks that are not liquid and a small amount of money in them can push them higher. We don't want to chase them. Nor do we want to alter our stock selection criteria for different market conditions. When we went to investors, we went with the mandate of investing in the liquid names in the market, mostly from the BSE 200. Now, if we break that rule to invest in small-caps, our team will be in uncharted territory and we will be doing something other than what we promised. We don’t want to do that. So, we are okay with losing out,” says Subbu, reiterating the Quantum play-by -the-rules credo.

Quantum managers swear by value investing. And they’ve told me that they like to buy stocks at a 40 per cent discount to their estimated fair value and sell them when they hit the fair value. But does such choosiness work in frothy markets?

Subbu admits that Quantum funds will underperform in a frothy market. “We know that. If we start tweaking our strategy based on market movements and remain invested in a stock just because the markets are great, then that will be going into uncharted territory. We had high cash positions in 2014, 2015 and 2016. Despite all this, our long-term track record looks good.”

The ever-cautious Subbu qualifies this though. “When you hold cash because of high valuations, you need to be prepared for quick turnarounds, too. For instance, in February 2016, we had to very quickly deploy the cash when the market collapsed. Bounce backs also happen very quickly. At the end of February 2016, we saw an upside potential of nearly 60 per cent on our portfolio over a period of two years. Right now, the market has already given 44 per cent return since then. If at that time we did not move, we would have lost out. So holding cash also means moving very fast when corrections happen. And there will be times when we will have to sell early and wait.”

Cash dilemma

Question: Given Quantum’s strict rules on discount to fair value, have there been long periods when the fund did not find any stocks to invest in?

Subbu Answers: “We think of that 40 per cent discount as ideal, but there are situations where we are ready to take a lower discount. We are also aware that in some sectors, we will never get that 40 per cent discount to fair value, for instance, in consumer staples. These are good businesses, great brands and are cash generating. So there’s a margin of safety and so we can accept a lower discount. I remember, in 2014-15, after the Modi win in the elections, valuations started galloping and our cash position increased to as high as 30 per cent. For a year, I think, we were not able to make any significant new investment. Only in January-February 2016, when the market corrected, were we finally able to buy. So that can happen. You may find the odd stock, but not many stocks.”

What about the other problem that most value investors have; selling too early and missing a big move? It can happen, says Subbu. “If buying a falling stock is like catching a falling knife, selling it thinking that is it reasonably valued can sometimes hurt, too. The market may continue to reward it.”

Does value work?

Question: Many fund managers in India say that there’s nothing called value investing for this market. What you get when you try to buy cheap stocks is value traps. Can Quantum cite examples of deep-value investments that have worked?

Subbu Answers: Neither shaken nor stirred, Subbu patiently responds – “In my view, value traps are cheap stocks with no real catalyst to unlock value. It is important to identify the catalyst, but it may take some time to deliver. You have to be patient. In 2015-16, we made good profits on oil marketing stocks. A few years ago, the valuations of one of the stock under our research was at a deep discount to its replacement value. The catalyst was that the government was changing its policies on retail prices for petrol and diesel and decontrolling them. Such a thesis may take one year or even two to play out. But eventually, it did happen and the stocks did extremely well.”

But what about the cases where the thesis flops and we are really stuck? Subbu is pragmatic in this. “Simple, if the catalyst doesn't work, then it is a value trap. But you do get selling opportunities. In the 2008 era, for instance, we picked up many stocks that seemed to offer value. Some had immediate triggers for unlocking; some didn’t. So eventually, we reshuffled our portfolios towards stocks that had catalysts that were immediately unlockable. We owned couple of textile sector stock which had value but one had a catalyst which was more visible. So, we booked out of one and accumulated the other.”

Disclaimer:

Subbu's Solution is authored by I. V. Subramaniam. I. V. Subramaniam is a director of Quantum Asset Management Company Private Limited. The responses expressed here are strictly for information and explanation purpose only. The responses are meant for general reading purpose and not to be considered as an investment advice / recommendation. The responses are not intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or units of the Mutual Fund. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. The Sponsor, The Investment Manager, The Trustee, their respective directors, employees, affiliates or representatives shall not be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in the responses.

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Please visit - www.QuantumMF.com to read Scheme Specific Risk Factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the scheme's objective will be achieved and the NAV of the scheme(s) may go up or down depending upon the factors and forces affecting securities markets. Investment in mutual fund units involves investment risks such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the Sponsor / AMC/ Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited (AMC). The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

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