When Fidelity Equity Fund's portfolio was first disclosed in October 2005, it raised many eyebrows. With over a 100 stocks, the portfolio was a crude reminder of the Morgan Stanley Growth Fund, which miserably failed to perform as its long list of stocks which promised the moon never delivered.
Another example of the damage a gargantuan portfolio can do was that of the umpteen schemes of the erstwhile Unit Trust of India. Most successful fund managers India have managed to beat the market with a foccused yet well diversified portfolio of carefully chosen stocks numbering not more than 40.
Why would Fidelity then follow the path less travelled? Two possible reasons. One, the fund manager could be trying to lessen the chances of going terribly wrong by creating a portfolio which captures a whole range of businesses. Two, the manager likes to test the waters by investing small amounts in a stock, before committing serious money.
Fund manager Arun Mehra does admit that the weightage of a stock in the portfolio is a reflection of his level of conviction. That is probably one reason Fidelity does not like to disclose its portfolio often enough -- because stocks at the bottom are likely to see further additions as the fund manager gets more convinced about the idea.
While most domestic funds disclose their full portfolios every month, Fidelity reveals its full holdings only twice a year. (It is another matter that Fidelity likes to go public only when it wants to. This interview has taken about two months to see the light of the day from the time The Smart Investor sent the questions for the first time).
Coming back to the portfolio, elsewhere in the world, especially in the United States, diversified funds do have larger number of stocks. And Fidelity's star fund manager Peter Lynch's success too came from his exposure to plenty of small growth-oriented stocks. We wish that Mehra would do a Lynch in the Indian markets.
So far Mehra's performance has been middling to say the least. Since inception the Fidelity Equity fund has given a return of 44.49 per cent. However, the fund has underperformed its peer group average and the Sensex as far as performance for past six months and three months are concerned.
While Fidelity managed a six month return of 26.77 per cent, Sensex returns for the same period amounted to 30.32 per cent, while the average diversified fund returns for the period was 28.28 per cent. Excerpts from an interview with Mehra:
Can you explain the investments strategy of the fund?
The investment strategy of the fund is based on our global investment philosophy of bottom-up stock picking. It aims at spreading your investment across a broad range of successful businesses and will contain a portfolio of more stocks than you would typically find in a mutual fund - as many as 75 stocks.
While the fund has no restrictions on individual holdings, in very very few cases I would look at holding more than 4 per cent in one stock. Since ours is not a high-risk-high-return fund, we would like to have solid diversification across a broad range of established companies, as well as smaller organisations poised for growth.
My investing strategy has no market cap bias, no trend bias, and no recent performance bias - just a conviction that each stock chosen has the potential to grow in value. I focus on buying companies with strong franchises. Having said that, we do not like or dislike any business. We would buy anything if the price is right.
What is the idea behind having such a lengthy portfolio?
While many diversified equity funds in India might have between 40 to 50 stocks in their portfolio, we do not get constrained by artificial caps on the number of opportunities we can incorporate into the portfolio.
There are more good investment ideas in the Indian market than meets the eye, and Fidelity has the expertise, infrastructure and research capability to uncover those ideas.
Also, the number of stocks owned is not as important as how diversified those companies are; if you look at the sector composition of the portfolio, you will see that we have invested across a wide range of different industries to bring about true diversification for the portfolio.
How big is your investments team in India?
I am supported by a team of five analysts in Mumbai, 16 analysts in Hong Kong who research companies in the Asia-Pacific region including India, and 11 sector specialists based out of our offices in Gurgaon. We are growing the team further and are looking at hiring more analysts.
On how many stocks does Fidelity directly have coverage?
We conduct our own research on every stock that is included in the portfolio. The final decision on a stock is always based on our own judgment and analysis.
How many company managements have you met personally?
We do not buy a stock without having met with the company.
How closely does the fund intend to track the benchmark in terms of returns?
The fund's aim is to outperform the benchmark, rather than track it, which is the province of index, or passive, investing. An active fund manager will always look to generate returns that are greater than the benchmark index, and by extension, the broader market. There could be periods of underperformance. But we seek to create long-term wealth for investors.
What about stock selection?
Our differentiation lies in the stock selection. Our stock selection is very different from that of the index. Whether a stock happens to be in the index does not matter to us. We look for stock that have good growth potential.
Is there a quantitative model that you rely on to build your portfolio?
Our methodology is based on extensive qualitative research. We aim to buy companies which have substantial competitive advantage and businesses which can grow over, say, the next five years.
Then we try and assess the management capability, how hungry are they for growth, whether they have a vision and their level of transparency and disclosure. We use quantitative models only for the purposes of analyzing balance-sheets, cash flows and income statements, and running sensitivity analyses. We do not do any macro forecasts.
With such a huge exposure to mid-cap stocks, don't you think you run a huge liquidity risk?
The fund's exposure to mid-cap stocks is only around 10 per cent. (Fidelity defines mid-caps as stocks with less than Rs 2000 crore in market-cap). I believe that these are businesses with strong long term growth potential which will deliver alpha (outperformance) over the longer term.
Does the growing size pose a threat to performance of the fund?
We are comfortable even if the fund grows larger than it is now. Globally, Fidelity manages funds that are several times larger - our Luxembourg based India Focus Fund, for example, has a corpus of over $3.0 billion dollars.
Basically, we are not strangers to size - as long as investment opportunities are plentiful, there will be room for the fund to grow. We are able to do so because our team in India enjoys the same infrastructure that our investment professionals have across the globe, and they have been managing large funds for a long time.
While you are saying that your philosophy is bottom-up, one gets a feeling that you actually following a portfolio approach across sectors. For instance, in banking you have invested in ten stocks, in effect, not taking a call on which of these will actually beat the crowd.
We pick stocks based on their individual merit. But then the crucial difference among the various stocks in our portfolio lies in the weightages we assign to them.
The weightages in some sense reflects our level of conviction in a stock. the weightages also represent the implied valuation or the risk to reward potential in various stocks. So we build bigger positions as our conviction level goes up rather than committing too much money upfront.
In the oil space too you are betting on upstream and downstream which usually move in opposite directions...
Again, each stock is there because we see value in the stock. We are not taking a call on crude prices to decide on which stocks to own in that space. We are looking at implied valuation and the risk to reward for different stocks.
Some are their because they offer high dividends yield, some other because of their high enterprises value or good long-term business prospects.
How do you approach new businesses?
Here, our global linkages actually help. Most new business here are actually established businesses outside and we have good insights and experience from other markets.
For instance, retail or aviation is established businesses elsewhere while these are a recent phenomena in the Indian market. All we need to know is how does this translate into India.
How often do you trade?
We do not trade at all. We buy stocks based on their long-term potential and sell when the prices have run up enough to factor in that potential.
Which sectors are you bullish on right now?
There are many sectors across the economy which look promising. Banking, for example, continues to attract a lot of attention because it's growth is a natural offshoot of , and indeed is central to, the expanding Indian economy.
However, we don't focus on sectors per se; our approach has always been bottom - up stock picking, which entails choosing stocks based on their own merits, not on what sectors they happen to be in.
It is important, when employing this method of investing, not to be blind-sided by the lure of the 'hot favorite' sector - look at what happened to people who over-invested in the technology sector in 1999/2000, for example.
Instead, if a business is fundamentally sound, has good growth prospects or is undervalued compared to what it should be, then we will want to own it regardless of which sector it belongs to.
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