Low quality stocks have outperformed but don’t get fooled: Vinay Paharia, CIO, PGIM India MF
Vinay Paharia, CIO at PGIM India Mutual Fund, vouches for a disciplined, evidence-based investment approach over chasing short-term returns.
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What do you make of the current market scenario?
Let’s consider this from the lens of historical data. When we look at market returns versus earnings, and plot it over long periods of time, one-year returns are completely random. As we increase the investing time horizon, the relationship starts to show. This tells you that in the market, you need to zoom out. The more you zoom in, the more it appears random. This is the reason none of us really know what is happening in the near term. However, when you zoom out, there are a few things that you can see clearly. These are slightly long-term trends.One is that India’s growth has been significantly better and higher than almost all the other smaller or larger countries of its size. Second, this growth has been sustained even during very weak periods. Third, India’s broad parameters, be it monetary policy or fiscal policy, have been managed exceptionally well over the past many years. The result of all of this is that we are seeing a structural improvement in the underlying economy, and there is structural growth that is appearing in pockets of the economy. There are a lot of opportunities in many segments of the economy that are very attractive for long-term investors. I think this has not changed a bit. Hence, I would dissuade from even looking at what is happening in the near term.
Having said that, in recent years, we had significant outperformance by very low-quality and low-growth companies. Correspondingly, we also had very weak performance by high-quality and high-growth companies. The reason I’m highlighting this period is because of the magnitude of difference between both these segments of the market. This is where investors should be cautious. Over two decades of data indicates that low-quality, low-growth companies have delivered very weak returns in line with the underlying fundamentals. High-quality, high-growth companies have delivered superior returns in line with their underlying fundamentals. On an annual basis, two-thirds of the time, high-quality and high-growth companies have outperformed the overall universe. The remaining one-third period has been largely covered in the past three-four years. That is the real danger for people who are just looking at a single phase of outperformance. I think the tide has started turning from June 2024 onwards. We have started seeing some of the low-quality companies underperforming and high-quality companies outperforming.
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Has the market correction wiped out previous excesses?
No, we have not yet seen a complete wipe out of excesses. There have been significant excesses in previous years. We have clawed back from some of that, but it’s not a material portion.Your thoughts on valuations have changed over the years. How has your thinking evolved?
When I was raw and fresh out of college, I used to look at the PE multiple. The approach was very straightforward: low PE multiple is cheap; high PE multiple is expensive. However, over the years, the understanding has clearly dawned that the markets are not just looking at headline valuation. The multiples are actually driven by four factors—forward earnings growth, return on equity, riskiness of business and the underlying interest rates. This, in turn, is derived from a very simple financial equation—fair value of a growing annuity to perpetuity.Once you look at this kind of mental model, valuation becomes very clear. In simple terms, it means that the higher the earnings growth, the higher the fair PE multiple; the higher the return on equity, the higher the fair PE multiple, and so on. Whether or not a company is cheap or expensive should be judged in relation to its current valuation versus fair valuation, rather than looking at the absolute number.
In fact, without this framework, you would not be able to operate in the high-quality, high-growth segment of the market. Since there are companies trading at abnormally high prices, even based on fair multiples, it is very important for you to separate the wheat from the chaff. A nuanced approach like this helps us weed out the really expensive companies from companies that appear expensive, but are not.
Vinay Paharia
CIO, PGIM India Mutual FundAge
44 YEARSExperience
21 YEARSTotal assets managed by Paharia directly
Rs.22,969 croreTotal assets under Paharia’s supervision
Rs.24,247 croreRAPID FIRE
Q. What’s an investment tip you’d give your younger self?
Investing in a good business at a fair price is better than buying a fair business at a good price.
Q. If you were to meet Warren Buffett, what would you ask him?
How much of your current investment style is inspired by Fisher compared with Graham, and why?
Q. If you could invest in only one instrument for life, which one would it be?
Equity, of course
Q. Any good book you would recommend?
Common stocks and Uncommon Profits by Philip Fisher.
Q. If you could alter your career choice, what would it be?
I would not do it even if I were given the option.
Q. What is your personal asset allocation right now?
Balance of equity, REITs and arbitrage.
You have earned a reputation for helping refine equity strategies at some of the smaller fund houses. Is this where your strengths lie?
I have recently written a post on investment process versus performance. What it tells you is that the investment process is a system you follow day-in and day-out, while the investment performance is its outcome. However, if you target investment performance, the investment process is an outcome of that. Our industry is yet to grasp this because most people tend to confuse both.Suppose you want to get to the airport 10 kilometers away from your house in the morning. There are two sets of cab services. Let’s call one set of cab services ‘Super Cabs’, and the other, ‘Sober Cabs’. The Super Cabs’ service USP is that their drivers ensure you reach your destination either before time or in time. However, you cannot ask them how. Sober Cabs, on the other hand, has a policy wherein drivers are instructed to follow the rules. They have done a lot of statistical analysis and they know which lanes on the route are generally faster. They generally stick to that one particular lane. Due to this, they generally reach on time, not significantly early, not significantly late. Their deviation is not much. Now the question is, which service would you want to choose?
There is a very small possibility that if you choose the first service, you will meet with accidents. However, in the last three-four trips, the drivers have proved that they don’t meet with accidents. So you have to decide what you choose. You can’t choose both. Either you reach on time by cutting lanes and jumping signals, or you choose to follow the rules, allowing you to reach in or around your time.
When you follow a systematic approach, which is an investment process, it must be evidence-driven. The problem is, most investment processes are, what a fund manager would say, a process. No one checks the historical outcome of this process. If you only have some statistical data that generally one particular lane is faster, based on long-term historical facts, you will be satisfied that this is a possibility for me to reach on time, not just by taking the driver’s word for it. Similarly, an investment process must be driven by evidence. On the other side, performance is not driven by evidence. So, there is a thin, but very critical line between both. If you seek an investment process, remember, performance is an outcome, and you can only ask the manager to stick to that process at all points of time, in the short or long term. If you desire performance, then you should ask for performance in both short and long periods of time because you have not kept any guardrails. You have said, please deliver performance. My objective as an investment manager is to ensure that we have a sustainable, evidence-driven investment process, which is repeatable and can deliver a superior experience to many of our clients over a longer period of time.
How do you prioritise this process-centric approach when the market phase is against your style, as it has been for the last three years?
That is where the experience and structure of the investment manager comes in. Only if an investment manager has that experience will it help him stay true to label. Otherwise, anyone would definitely succumb to pressure. I would think that the role of an asset manager is exactly this—to stay true to mandate, not keep changing sales strategies in response to what happens in the market, and deliver a stable and superior outcome to investors over a longer period of time. The job of an investment manager is to resist the pulls and pushes of short-term returns demanded by investors.The funds taking cash calls have done well amid this market correction. What is your stand on cash calls?
I would encourage you to share with me any data historically that indicates there is a scientific method that generates superior alpha by increasing or decreasing cash. If there is no empirical evidence, then what you are chasing is only performance, not process.So, then, it is dependent on the skill of the driver and luck of the passenger to ensure that the outcomes are achieved. Both can keep changing. So we obviously stay away from this.
Do you feel that the skies look brighter for quality stocks for the next three-four years? If so, how will you make the most of it?
I would not look at it as part of a market cycle. It is a basic investment strategy that has worked day-in, day-out. There are some periods when it will not do well, but equally there are periods when it will do well. That is what we have published as a statistical research outcome. So we don’t think along the lines that next three-four years will be good. We think that only the past two-three years were abnormal. What is happening now is normal. We don’t think that there is any specific reason for this to change. We are not going to jump from one strategy to another. The objective is to have a stable, time-tested approach that will deliver superior returns over a longer period of time.Are there any specific themes or sectors that you are favouring currently?
We are positive on the telecom sector as well as the broader consumer sector, including consumer discretionary and staples. We are also positive on private banks and speciality chemicals. We are extremely overweight in the healthcare sector. In fact, that is the only sector where we have actually launched a thematic fund because we think that this is a long-term structural growth that we are targeting. Within healthcare, we are covering healthcare services, not the pure pharmaceutical companies. Apart from this, there are high-quality and high-growth companies across various sectors in the form of new-age companies.#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;}
This story originally appeared on: India Times - Author:Faqs of Insurances
