A value fund with a global tilt

KALPEN PAREKH, managing director and chief executive officer at DSP Mutual Fund, discusses with senior editor Larissa Fernand, on what makes his value fund stand out.

There is a lot of misconception when it comes to value investing, with investors conflating cheap with value. How do you view value?

Invest in what is good. And if what is good is also reasonably priced, or cheap, still better. The quality of business is extremely important and must be viewed before the price is considered. Price must be the second filter, the first being quality.

Good investing or sensible investing is a) good business b) good price and c) good time horizon. All these three together make a good case for long-term compounding.

How does the DSP Value Fund stand out in the value space?

The portfolio construction starts with Charlie Munger’s principle: All I want to know is where I’m going to die so I’ll never go there.

  • 1st step: Elimination

Our benchmark for Indian stocks is the Nifty 500. Historically, the companies that failed to beat the benchmark were those with low intrinsic RoE, poor profitability, volatile profit growth rates, poor quality of management and governance, forensic accounts are questionable, and so on and so forth. The starting point is avoidance on a number of such parameters.

  • 2nd step: Quality

This will entail parameters such as higher RoEs, free cash flows, and dividend yields.

  • 3rd step: Valuations

The selected quality companies are put through a valuation model that takes into account the profitability and sector each company belongs to determine a reasonable valuation range. This approach ensures that quality-value companies are not penalized based on optically higher valuation multiples.

The Value Fund also does not invest in any lenders which are 30%-35% of most benchmarks as well as funds. We replace this with International funds making it the fund a uniquely complementary proposition as most Indian investors are over-exposed to financials and under-invested globally. This also helps the fund achieve a drastically lower risk profile without giving up potential upside.

So this is basically a rules-based fund.

Yes. This is a rules-based fund where human intervention is limited.

It is 95% algorithm based. Once the portfolio universe is identified based on the above parameters, then it comes to the investment committee, where the final selection is made. Judgements could be made on various factors such as past capital allocation, to give an example.

The DSP Value Fund has a global allocation to 5 stocks that are asset managers. Is that part of the investment mandate – that you will only invest in such stocks? How is it possible that you find no value in any other sector?

The Indian allocation is to stocks.

The global allocation is mixed. Our largest exposure is to Berkshire Hathaway. This really encapsulates the essence of value investing over the decades. A sensible investing style. A long-term track record. At times, contrarian bets.

The other four are feeder funds that are practitioners of value investing: Veritas Global Focus, Harding Loevner Global Equity, Heptagon WCM Global Equity, Lindsell Train Global Equity.

These are global boutique portfolio managers who respect value investing and share a similar thought process as we do for our India portfolio. When all these five are blended together – their individual styles and nuances complement each other in the portfolio. Even their geographical preferences differ.

Lindsell Train Global Equity is more focused on consumer companies in Europe and has gaming companies in Japan. Harding Loevner Global Equity looks at the culture of a company as the dominant determining factor apart from all the quantitative and qualitative factors and valuation. The portfolio is tech focused but looks at culture and cash flows. Veritas Global Focus have an investing threshold; they must be convinced that the company in the next 5 years has the potential to earn 6-9% excess over OECD inflation in dollar terms. This is “real return investing”, real rates of return over inflation. A very strong absolute return mindset.

These are five curated money managers with a demonstrated track record that spans decades, and brings a diversification not available in India.

The DSP Value Fund permits the fund manager to hold cash when suitable investments can’t be found. How much of cash are you willing to hold?

There are no cash calls as far as the global allocation of 35% goes. The cash calls are only with regards to the India-focused portfolio of 65%. Today, we have around 35 companies. Let’s say the market runs up without commensurate earnings growth, and valuations run up, maybe only 20 companies will qualify when run through the filters. Then cash would increase in such a situation. When we back-tested this, the maximum cash exposure stood at 22% in past peak valuation cycles.

That seems high. How much is the cash allocation now?

Right now, it is at about 8% in cash. This is not just another fund fully loaded with equity, irrespective, having a high beta in line with the market. This is meant for conservative, long-term investors, who are not comfortable with high volatility. Not only does the international allocation act as a sort of buffer against the Indian stock market, but so does the cash allocation.

When we launched the fund, we were cognizant of the fact that it is not a cheap environment or even fairly valued. Hence, we are happy to be a bit conservative in this fund.

For more information on DSP Value Fund.

Source: Morningstar India Website