The number of opportunities for equity investors have multiplied as more wealth-creating themes have emerged, according to portfolio manager Nilesh Shah.
That allows investors to generate as much returns on a diversified selection of stocks as they would expect on a concentrated portfolio, said Shah, founder and chief executive officer at Envision Capital Services Pvt. The firm’s portfolio management scheme has returned 50% gains in the last 12 months, nearly twice the advance in the benchmark Nifty 50.
Prior to the pandemic, Indian equity benchmarks were driven by heavyweights. That trend, however, reversed after Covid-19 struck. The rebound from March 2020 lows saw a broad-based recovery, driven by an unprecedented retail frenzy. And an accelerated shift to digital services as people were confined indoors brought the spotlight on newer themes. Companies pared debt and climate concerns are driving focus on ESG investing.
Envision Capital’s portfolio is a lot less concentrated, Shah told BloomebrgQuint’s Niraj Shah on Alpha Moguls series. “Earlier, the opportunity set of demographic dividend beneficiaries (stocks that stand to gain from a young population in India) is now not the only key pond in which investors can fish,” he said. “There are themes like digitalisation, deleveraging and decarbonisation, which can be wealth creators in the medium to long term.”
According to Shah, information technology remains at best a market performer, economy-facing sectors will perform selectively and he is not lapping up non-profitable consumer-tech companies.
What Shah prefers and why, watch the full conversation here:
Read the edited excerpts of the interview here:
How is that you are approaching the current investment climate and looking to build the portfolios, so that it can create significant alpha over the course of the next 12 to 18 to 24 months?
NILESH SHAH: What it looks like clearly is that, you know, unlike the past, when we were just one more emerging market, and we were in a way recipient of global liquidity and some of those I would probably say are the non-earning non fundamental factors. This time around the tailwinds are a lot more about the economy and earnings growth. And this is getting manifested in the fact that, for now, several months, in the last five to six months we have clearly seen foreign investors, FPIs, out there continuously coming in selling and being net sellers. And despite that the markets have been trending up, holding up and that to me is a reflection of the underlying strength in the economy and the earnings kind of environment, number one. Number two is that in the past, we have seen this whole market of trending so narrow, just one or two sectors, in a way, calling the shots and it was you being more of overweight or underweight in those kinds of one or two sectors. Reversed is that I am seeing a very broad base of participation from a variety of sectors. So, to that extent, as the portfolio manager, as an investor, I have lots to pick and choose from. This is not about being wedded to the consumer sector or to the private financials. This time it’s a lot more and that essentially is in a way driving our construction of the portfolio and driving our investment strategy. In terms of themes conventionally, India has been more around just to one D, which is essentially demographics, which means anything to do with India’s demographics became a good long term investment opportunity. And ofcourse this D, still remains, and I think it’s a story for the next several decades. This is not a multiyear kind of opportunity to multi decade opportunity.
In addition to this one D, I see the additions of three more Ds, which are essentially coming. The first one is around deleveraging, I have not seen corporate India so deleveraged and that clearly is a function of improving outlook, as well as strong liquidity and increased response by investors and therefore your ability to raise money from secondary markets, from IPO markets, by inviting strategic partners and giving them a share of your business. All of this is essentially leading to deleveraging. In that extreme, this deleveraging is basically creating capacity for future capex, future growth plans, so that’s the one. The second one is around the digitalization, that digitalization is helping the nation. It is helping the government, its helping enterprise because it is helping individual citizens and consumers. So, to that extent, that is providing the additional tailwind, helping the businesses to grow, helping consumers to come in. They are participating in the growth story. And the last is around decarbonization. That to me is in a way again creating a broad set of opportunities for investors. So, I clearly see a confluence of these four Ds, which are really playing out and essentially in a way, providing opportunities for investors like us, to basically invest, to cherry pick sectors, cherry pick businesses and invest, going forward. So, this is really the way I am seeing how I see the things that times are going to be very different versus what the times have been, over the last several years.
Interesting, I will get to the nuts and bolts of some of these, just a brief question. I know, you construct portfolio not from point to point with twelve months perspective, but I am just trying to understand that in order to generate the alpha that you always look to, the return should beat the returns of the benchmarks. Do you reckon that the benchmark returns themselves will be a lot more moderate this year and therefore the return expectation that investors should have, whether through investing through experts like you or themselves, should be a bit lower, because we are coming off a period of 18 months of supersonic returns, so to say?
NILESH SHAH: Yes absolutely. I mean, If I were to look at the PMSs that we managed for the last one year, our returns on a one year rolling basis have been between 55% to 60% on our last one year. Not the last, one a half year. One and a half years is a lot higher, but last one year is around that number. Now that is something that is very unlikely to repeat itself going forward. And if I would basically look at last three to five years, the returns have generally been more like say 15 to 20%. My view is that while going forward, it’s quite possible that we may go through basically, a six to nine months of a very flattish performance. That’s quite possible. Over the next one-year returns could be very muted. It could probably be towards the low end of the double-digit returns. It’s always hard to be, in a way, project what it’s going to be, but my sense is that it will be towards the lower end of the historical range for the next one year or so. And I really believe that over the last one year I see several headwinds for the market one is to have itself run up, prices are higher. A lot of next 12 months outlook is getting factored in. There are X -factors like the U.S. Fed and Omicron, and those kinds of things play out, so the market needs some time to digest some of these risks or some of these headwinds going forward, which could basically in a way, dilute the returns. And then once I think we go through six to 12 months of this phase, then probably after that we get on to basically the kind of mid double digit return outlook. That’s why we are really seeing things shape up over the short period of time.
It’s a dichotomy that we have seen between how the construct of the large-cap indices are versus what portfolios could be, in themes or in markets when there is a large dominance of the broader perspective. Is that financials tend to lose the % edges compared to Nifty benchmarks so to say, just by virtue of the fact that as you said, plethora of opportunities in the non-Nifty side are so wide that those adoptions are just much more. My question is, when you are constructing your portfolio now, on the portfolio construct now versus what it would have been 12- 18 months before, is it remarkably different in terms the weightages that you are assigning to any large overweight? And in terms of the number of things present in the portfolio versus what it has been in the past?
NILESH SHAH: That’s a very pertinent kind of a question because all along these years we will just try to see that how we are going to look at the private banks, weightage in the large-cap on the process indices we used to be known as 30% more like 35% and things of that kind and therefore, saying is that actually is a tough call to make. Especially for investors like us who are more bottom up and are always looking out for some very fundamentally driven bottom up opportunities. And if you don’t take a call based on what the weights are on the benchmark. So, obviously, for portfolio managers like us who follow a very benchmark agnostic strategy, in a way, it used to be a bit more challenging in the past versus that I clearly believe now that given that so many opportunities have spread beyond the private banks, in a way is pretty positive and heartening, for benchmark agnostic strategy like ours and I clearly believe that private banks, not that we don’t own them, we do own HDFC Bank, we own ICICI Bank. But in a way I clearly believe that they have probably fundamental outlook, is going to be lot more challenged, going forward, in why I say this is because number one is within the private sector banks, it was just two banks who were in a way are really the most efficient versus that, so it used to be HDFC Bank, Kotak Bank and now it sounds ICICI Bank, Axis Bank, in a way, dealt with their legacy issues and are pretty much boost up for essentially growth. And you are beginning to see that the numbers, number one, number two PSU banks are, in a way also kind of engaged in substantial cleanup act, in terms of the asset quality issues. And if the privatization program happens, clearly, with the banking space dominated by two players, you certainly see the banking space now, this competition from eight to ten meaningful players, out there.
On top of that, you have FinTechs, who seem to essentially be raising billions of dollars. And finally in the lending business, what do you need? You need credit, you need capital, right? And if money so easily available to you, you will then lend at that time, so overall and then on top of that you have the payment guys who are coming in and finding the gaps in the chain and we know they are lending money to merchants and SMEs and all of that, so space is becoming hugely competent. So, in a way investors are loaded with private banks, in the sense that if you look at any of the large portfolios, large managers, what is the one sector on which they have enough. It is banks, okay? So, I clearly believe that in a way it is good. It’s heartening, honestly, its good news for bottom-up benchmark agnostic strategy like ours.
But for the second part of the question, therefore, is the construct a lot more dispersed and widespread or could it be that your most overweight positions, a very large part of your portfolios even now, compared to what it was 18 months ago and why?
NILESH SHAH: So, in a way the portfolios is not as concentrated as it used to be. So earlier we would have a portfolio between 12 to 18 positions all against 15 positions, so it used to be as concentrated or as focused as that versus that of today its basically around 25 positions, have got a good spread as that because earlier you did not have enough opportunities in the digital space. Similarly, on the decarbonization side, the capex side, again you did not have enough opportunities. And obviously, the investment cycle itself was in a way more eventful for so many years. But now you have a world of opportunities there. And then third of all, even within financials, so many years back, you did not have a choice. I mean, apart from private banks, there was no meaningful choice, but today you have so many insurance companies listed as so many AMCs listed. You have so many well-run Housing Finance Companies listed out there and so therefore they are adding to the investment-able universe, and therefore you have the ability and the flexibility of kind of slightly more broad-based portfolio, than what we were running conventionally.
Okay, let’s talk about the digital theme, you mentioned it twice, thrice and we will talk about IT services too, in the second break of this conversation but first, this whole digitalization theme and there are multiple ways to play it, I reckon. Which is the path that you have chosen and why and how long or how long lasting, do you think this opportunity could be, compared to the valuations it offers?
NILESH SHAH: So clearly believe that digitalization essentially is, honestly again, probably the opportunity of this decade, and that’s clearly riding on the fact that India being a very large heterogeneous complex, diverse kind of market. It does one thing in a way which unifies or binds these different pockets of the market together, its technology and implemented and reach out to consumers. So, we have a couple of ways to do it. One is to say, okay, fine, I just kind of look out for size and scale. I don’t care if there are profits or cash flows. So, that’s one path. And some of the recently listed IPOs really falls into that bucket, when they have the size, they have the scale, but they don’t yet have the path to profitability. On the other hand, there are pockets which essentially which may not be huge, but these companies out there have been challengers and they are emerging to be champions. Home grown champions, are using capital more efficiently and they have profits; they have earnings, and they have the cash flows to fund future growth. And we are essentially taking the latter part, rather than the former, so we are still basically saying that ‘show me the money’ in the sense that we think that the total addressable market may be huge. But where is my MAT, which is margins after transaction, money after transactions, show me that. And that’s the path we are taking and therefore, we have been owning businesses, we have three to four companies in this space which essentially are challengers, champions in a way, one or two of them are leaders or our top three players. And they have a cash rich balance sheet, they have profits, and they have the cash flows. And that’s the path we are taking. It doesn’t mean that we are completely negating you know, the former set, which essentially is the guy who built the scale, but do not have a part from the profitability. If we, down the line, we see a path to profitability, we will be happy to take a slightly pre-emptive call and invest in them. But today, I don’t think we have yet built the conviction, to basically invest into them, number one. Number two, the valuations there are still way too high. There has been a party going on and I think there was to be an interruption in that party, we would be happy, at that point of time step in and take a more constructive view of that opportunity.
Am I to assume therefore that, I don’t want to get into names, I am just using them as an illustrative example and for now you are not fine looking at like Zomato/s and Nykaa/s of the world because the path to profitability not very clear, you are looking at another set of names, but it doesn’t mean that those are out of equation? Is that the summation, so to say?
NILESH SHAH: Absolutely, so to say, it has it, like, you can’t rule out anything. I mean I really believe in the investment world, all of us have learnt our lesson and I have learnt the hard way. And so, to that extent like 20-25 years back, people would say why should I own HDFC bank there? Is there and all of that guys who took their call and lived with it have paid a huge price for it, right? So similarly whether it is Paytm whether it is Nykaa, whether it is Zomato, these are outstanding businesses, what they have created is truly remarkable and some of these companies will clearly redefine or probably define the decade going ahead. But there will come a point of time, I mean, over the course of, maybe next two months, next few quarters, there will be some point of time when either the market gives you that opportunity or these companies themselves disappoint that they just have one or two bad quarters, you know, and then when the stock prices could correct meaningfully, which gives you a very attractive entry opportunity by getting to own them with a multiyear or multi decade, kind of an outlook. So, to that extent, we will watch this space and we will try and remain constructive.
What about the IT services, I have been meaning to ask this to you, not spoken for long, I hear varied arguments, all of which seem to be extremely strong in their own ways, both on the bull side and the bear side and I hear that companies, at least a mid-sized one or non-Nifty ones, will say that they see two three years of anywhere between 12 to 20% growth as well, certainly seem to be there for select band of companies. How are you looking at this space because it has suddenly turned out to be this world-beating space after everybody wrote it off.
NILESH SHAH: Indian IT services again has been a story of global digitalization. Businesses worldwide, consumers worldwide are adopting digital technology to basically pursue their interests and grow their businesses. Then clearly IT services companies have been partners in achieving that goal of achieving that innovation, if I may, use the word mission.
In the process, of course, some of these companies have done remarkably well. The sector, as a whole has done remarkably well partly aided or significantly aided by basic margins because they had not spent on marketing and travel and all of that to basically a strong dollar has given them the extra cushion in terms of margin. So, both these factors have been drivers of the margins. Going forward, the way I look at it, is that clearly valuations now are stretched, especially on the tier two names, you know, when I see companies trading at 40-50, 60-70 PE multiples to trailing earnings. These are high not just by historical standard, but their high just in absolute terms. And currently by the good outlook is very strong. But really, there will come a point of time, a year, two years, three years later, when the growth outlook may not look as resilient and robust, as it is now, I mean, keep in mind that today of course there is adoption of technology which is driving you know, business and driving revenues. But, at some point of time, the technology adoption will become more ubiquitous, more universal, more widespread and therefore, it would become a highly penetrated kind of in a way opportunity and wait for the next big leg of technology, which could again many years down the line. But there will come a period, a hiatus in between, where you know these businesses may not be able to sustain a double-digit growth and the markets will in a way, move ahead and price that accordingly. So, my view is that currently, I would probably be a more neutral on it, in the sense that in a way, positive on business outlook, but a bit cautious in terms of valuations. So, on the whole, I would probably just be neutral, if at all, there would be further appreciation in stock prices, maybe, it’s an opportunity to start trimming, start exiting and off course if there were to be a correction, in the stock prices, a meaningful correction, maybe, then that’s again an opportunity to basically load up and pile, to these things.
Okay, suffice to say that you are essentially playing the valuation game right down out here. Maybe you have companies which are not exorbitantly priced or egregiously priced. And if they were to move to that band you might be happy selling them, as well?
NILESH SHAH: Just one caveat here is that what I have seen is that there are still some of these midcaps or tier two companies which still are in a way bordering around margins of 13% to 14%. Now, if some of these companies can do a bit of inorganic acquisitions and in a way, create some additional skills sets or get some additional customers or gain some domain knowledge, number one and can move up their margins from 13%-14% to say 17%-18% over the next two to three years, because of a bit of, you know, a lot of things that they are having a bit of scale and all of those benefits coming, then maybe those will be exceptions to this outlook. So, I really believe that watch out for companies where margins are still sub 15% but still have the ability to trend up more towards the 18-19% kind of margin rate. If that were to be the case, maybe, they still remain buys.
You do notice that Nilesh is one of those earliest identifiers of mid-size businesses which have become great companies. Persistent I remember, you will remember that you were the first one back then, we look at this company closely on air by the way. Okay, the other point is deleveraging that you mentioned the other D. And please correct me if I am wrong but are you suggesting that because the corporate balance sheet is deleveraged, companies can do capex and therefore, sectors which are growth, all companies which cater to those whole capex theme, will turn to be big beneficiaries?
NILESH SHAH: Well absolutely, I believe that what deleveraging does is of course, that in a way on one hand companies which are leveraged and are going to pursue leveraging as the capability to expand and grow and therefore, I believe that the suppliers or vendors of capital equipment, essentially are going to be huge, in a way opportunities, for investors like us. That’s one and two is on top of that, if there is an overlay of decarbonization then that’s the icing on the cake, because then companies need to essentially have a decarbonization strategy and that’s going to drive additional investments. So, in a way, a bit of deleveraging and decarbonization go together and decarbonization now has become a corporate imperative. So, these two opportunities put together in a way are materializing around the same time. In the sense that where companies need to invest, and the balance sheets have become more accommodative because of deleveraging. And on top of that, the cost of capital has come down. I never feel interest rates were as low as what they are right now. So, all in all, number one, the need to invest, the ability, to raise capital or borrow capital and seize the cost of capital. Essentially, all three factors are playing beautifully at the same time. And therefore again, presents a medium-term kind of an opportunity, for investors.
I can understand the capital equipment supplier’s piece. You have spoken about decarbonization now twice or thrice? Can you talk a bit about that? Because I think people would even know how to play about this, should they be direct or be indirect, could be financial, if you can talk a bit on this?
NILESH SHAH: Yes absolutely, I mean, if we were to look at decarbonization, I mean at the first level, this is more about its not just ESG but obviously something which is more specific and in a way of borders is clearly a part of safety energy producers. And companies which are dealing with crude and dealing with thermal energy and all of that. And this is clearly now a need and of course, India as a nation has announced that it basically has set some very nice deadlines regarding decarbonization and becoming carbon neutral nation and things of that kind, so what you see now is this incredible number of investments happening around renewable energy, solar, wind and in terms of basically, they are creating an entire transmission distribution network, to basically be able to transmit that kind of energy. So, those are the kinds of players which essentially will be significantly beneficial. And I will just give an example that we own and that’s essentially our largest (14 of BMS), which is called ABB power products, which is now called Hitachi Energy. And this is a company which essentially of course at the core level, just makes basically transformers. But keep in mind the transformers you need not just to keep producing thermal power, but you need them if you are producing solar power, wind power or any other forms of power, in some way, even if they wont produce power from hydrogen, which again, if I were to kind of, look at all the top three or four or five industrial houses of India, all of them essentially, in a way, have a role to play, announced plans to basically participate in this journey. And therefore, a company like Hitachi energy becomes usually hugely beneficial, because of the demand for their production solution, which are essentially going towards in a way of transmitting this power and managing the grid and things of that kind, in addition that of course, they are also trying to have solutions around mobility and data centers and all of that as well. So, to that extent, I clearly believe that one needs to pick a business like this, where the strong backing of a parent, which brings to it technology, brings to it global markets bring to it a lot of differentiated service offerings. And on top of that, of course, the pristine balance sheet, so that’s the way we are participating this whole decarbonization.
So much like how a lot of people are not buying real estate coming in directly but buying the ancillaries, you are not betting on the companies which are doing the power capex necessarily but the beneficiaries of the same.
NILESH SHAH: Yes absolutely, because the former which you mentioned about alluded to essentially, we will need loads of capital to invest. And therefore, and of course, the outcome could pretty much be delayed that between two setup announced capacity that produces an X megawatt, gigawatt of power from solar or whatever it is, or from hydrogen, these are going to involve long gestation periods of three to five years. And so, to that extent you can probably see your gratification may be many years down the line. Whereas, we may not have the private equity investors, we probably think, a bit like them, but we don’t have that kind of time frame. Our investors don’t give us those five – ten years kind of horizons, to invest. But having said that, this is way more in a way more predictable, a bit more linear and relatively more visible, as well. So clearly, we think that these kinds of illustrations, in a way, tick the boxes that we are really wanting. kind of do.
Last question and last two, before we let you go. You mentioned the demographics part, right? Now. it’s been six or nine months or at least 12 months that people have being saying let’s play the opening up theme and it consistently gets hit by a roadblock after the other the latest has been safer really shooting to let it be and bet on it. Even if you don’t catch the bottom and you miss a few % points early in the rally. Is this a better approach? Maybe or not?
NILESH SHAH: Yes, absolutely. The unlocking themes are for real is probably back to normal, in a way and we all know that India has achieved tremendous amount of progress, in terms of the vaccination program. And so even if there were to be Omicron or the next variant or something of that kind, I don’t see those very stringent long lockdowns that we have seen in 2020 or a bit of 2021. So, to that extent there would be some bit of restrictions here and there, but it will not be very long-lasting restrictions. There will be more of precautionary kind of restrictions, rather than something which is up there in a way for the complete stop to travel and movement and all of that. So, from that perspective, I really see 2022 in a way, a start to basically the normalcy that we were used to, prior to 2020 and I think on top of that, consumer in a way, you could call them, as revenge shopping or revenge travel or revenge entertainment or whatever is the right word. But I really see up there a whole bunch of businesses which have in a way consolidated themselves, strengthen themselves and in a way improvised the business model to become hugely relevant, very growing massive consumer. And these are their increases across travel across hospitality, across a lot of other discretionary spending, which I believe are very meaningful businesses to bet on, from at least a three to five-year horizon.
Okay, so what we did that are you looking at travel beneficiaries? Are you looking at the mall shopping? QSRs what is it that works, for you?
NILESH SHAH: Its more around the discretionary spending around travel hospitality, so to be on the second largest OTAs online travel aggregator, which IPO went public six months back , we own that name, we like the fact it has steadily been gaining market share and essentially, is obsessed with profitability, which I think is a kind of DNA that you look for, driven by first generation entrepreneur, essentially, the ambition, the agility and the ability to win out there and make the difference, we have been owning India’s largest vacation ownership company which owns 40-50 tourist resorts on a pan India basis, with a few 1000s keys in the bag and part of a very elite group very respected. So, we own that mid income developers out there and again, we like what they do, like their focus, and we think clearly that we as Indians are aspiring for larger homes, given work from homes and learn from homes in order to becoming a reality. These kinds of businesses, we don’t yet own any more operators yet, because some of thee QSRs we still see that they are not yet profitable. Competitive intensity is increasing from just having just one publicly listed operator out there. We now have maybe half a dozen publicly listed QSR operators. So that’s basically the challenge that we see versus that we do own one company which went public last December, which essentially is a supplier or a preferred vendor of funds to some of these QSRs. We are playing proxy to that opportunity out there which is again a good mix of the QSR opportunity as well as the core consumer staples business in terms of the biscuits and breads. So, this is essentially looking at the entire demographic, with an overlay of unlocking and back to normalcy.
Back to the final question. While you did refer to owning some will give reference somewhere in history, the whole economy in a way or what about a large old economy pockets steel which had a fabulous cycle, from the lows or cement or oil and gas , wherein a common refrain that I see in all reports is that only the companies are pricing oil at $40 to a barrel but actually it is $ 70 per barrel so the profitability go up , gas profitability go up so on and so forth, so what are you doing with this old economy pack?
NILESH SHAH: The old economy is a bit of a cyclical kind of a stuff. Its cyclical as well as capital intensive, so we are essentially not been terribly overweight in this segment. But if we are owning a cement company, which we have been trimming in these recent rallies because we clearly believe that valuations are heavy, we have been owning a company called Carborundum Universal, which makes the factory in abrasives and electromagnetic minerals but allow valuation to have done you know, any pitch now trading at almost 50 times trailing earnings. So, we have essentially chosen to take money off the table and give that completely. We are trimming for a while, but we have not completely exited that position. So, I clearly believe that’s in a way, a space that we no longer as optimistic or constructive as we were 12 to 18 months back. But if you can just use the word old economy, I think one segment that if you could call it as old economy is the auto and auto components back is something which we are being constructive about and we will be more and more pump about it because we clearly believe that once the chip shortage issue is behind the industry, we believe that this space essentially is going to fire up again there exists a pent up demand out there. So, we are getting very constructive on both OEMs as well as essentially the auto pumps. And off course there is the new economy kind of formulate that which is in the form of EVs. So, some of these companies will have a very strong EV strategy and we would want to participate in that and then of course, they will their preferred vendors of auto component companies will essentially have a very clear-cut EV strategy to partner with these OEMs and we will want to essentially in a way, participate in that growth opportunity, as well.
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