Fund Focus: BNP Paribas Equity Fund

Proof of this process is the fund's performance

Anand Shah, CIO, BNP Paribas MF

20th April 2016

In a nutshell

Anand articulates his BMV process very clearly, including each metric within each parameter, to enable us to understand exactly how he and his team go about their job picking stocks for BNP Paribas' equity portfolios.

Proof of the BMV process is visible in the consistent outperformance of the flagship BNP Paribas Equity Fund - positive alpha every calendar year and 1st/2nd quartile position in each year.

Anand shares with us how the BMV process helps minimize errors and at the same time keeps the quest alive for multi-baggers, which every fund manager always hopes for.

What do percentiles and their colours signify?

Fund performance is typically measured against benchmark (alpha) and against competition. Performance versus competition is measured through percentile scores - ie, what percentage of funds in the same category did this fund beat in the particular period?

If a fund's rank in a year was 6/25 it means that it stood 6th among a total of 25 funds in that category, in that period. This means 5 funds did better than this fund. In percentile terms, it stood at the 80th percentile - which means 20% of funds did better than this fund, in that particular period. If, in the next year, its rank was 11/26, it means 10 other funds out of a universe of 26 did better than this fund - or 38% of funds did better than this one. Its percentile score is therefore 62% - which signifies it beat 62% of competition.

Most fund managers aim to be in the top quartile (75 percentile or higher) while second quartile is also an acceptable outcome (beating 50 to 75% of competition). What is generally not acceptable is to be in the 3rd or 4th quartiles (beating less than 50% of competition). Accordingly, we have given colour codes aligned with how fund houses see their own percentile scores. Green colour signifies top quartile (percentile score of 75 and above), yellow or amber signifies second quartile (percentile scores of 50 to 74) and red signifies 3rd and 4th quartile performance. A simple visual inspection of colour codes can thus give you an idea of how often this fund has been in the top half of the table and how often it slips to the bottom half. A great fund performance is one which has only greens and yellows and no reds - admittedly a tall ask!

WF: Your fund house credits the highly consistent outperformance of your Equity Fund to your BMV process. What exactly is BMV? How does BMV actually work and in what ways has it really helped you drive superior fund performance?

Anand Shah: Let me first take you through what BMV is and then how it has helped portfolio performance.

BMV stands for Business - Management - Valuation, in that order. It's a framework through which we filter our stock ideas. None of our stock ideas can become part of our portfolios till they go through a BMV filter - and in that order.

B - Business: What we are looking for is superior businesses. There are three key aspects we look for in a superior business.

First is growth - we are looking for businesses where the sector is growing faster than GDP and companies that are growing faster than the sector. Often there are structural factors that drive a sector's growth beyond GDP, and in some cases, a section of a sector's growth at a faster clip than the rest of the sector. Private sector banks as a whole for example are growing faster than the banking sector.

Second is moat - which is nothing but a sustainable competitive advantage. In every company we invest we are looking for one sustainable advantage which keeps the competition at the bay, which gives certain advantage to the business with respect to its competition to counter in difficult times and to thrive in good times.

Third is the competitive landscape in the sector. A sector which is fragmenting considerably usually leads to shareholder wealth destruction. On the contrary, a sector that is consolidating - where the number of competitors is decreasing and pricing power is getting concentrated, usually creates shareholder wealth.

M - Management: Once we like the business then we move on to the management. Within management we are looking for two leaderships:

Competence: does the management have all the key people and key ingredients to grow faster in the sector? Is the management and the Board focused on RoE?

Corporate governance: What is relevant is how they deal with minority shareholders and their overall attitude towards good governance.

V - Valuation: So once we like business and management, that's when we go to valuation. It can never go in the reverse. We don't start looking at a stock based on valuation. We are not in the business of buying cheap stocks. In valuations, we place a lot of emphasis on free cash flows. Balance sheet is as important if not more than the P&L. A critical question we ask ourselves is what is the valuation premium we are willing to pay for a moat that a business has built. If the moat is diminishing, we would not be ready to pay premium, if the moat is widening or steady, then we are ready to pay premium valuations.

Now lets come to the second part of your question - how BMV actually helps us deliver performance. If you look at the last 5 years, in a market where earnings growth has been an issue, our portfolios - whether it is our Equity Fund or Mid Cap Fund - have not had any issues with earnings growth. The businesses we own have been growing very well - the earnings growth of our portfolios have been consistently 800 to 1000 basis points faster than the benchmark and that's what leads to the consistency of the fund over a longer period of time vis-à-vis benchmark. So superior and sustainable earnings growth of our portfolios is the outcome of the entire BMV process, and it is superior and sustainable earnings growth that has enabled superior fund performance.

Secondly the obsession with quality and good governance has really helped in difficult times. Our portfolios deliver high alpha in tough markets, and retain most of it in good times, thus outperforming over a cycle.

WF: Would you say that one of the key strengths of your BMV process is that it enables you to avoid costly blunders?

Anand Shah: Yes. What happens is that in tough times, it is businesses without strong moats which suffer the most. They are the ones that get sold off significantly in the markets and erode a lot of wealth. For example, one of the persistent recent trends is import influx from China. If you are in a commoditized business without moats, you suffer a lot. Good businesses are the ones with moats, which can withstand tough times. Second aspect is bad managements get punished a lot more in tough times than good managements.

Staying focused on BMV enables one to identify genuinely good businesses and avoid others that may look good on one or more parameter, but which fail a rigourous BMV analysis.

WF: Does BMV allow you to "unearth" relatively undiscovered opportunities or is it more of a safety mechanism that prevents one from making costly mistakes?

Anand Shah: What BMV does is to significantly improve the team's strike rate. You make far fewer mistakes, if any, and that helps in delivering consistent performance.

When it comes to newer companies, many get tracked in our BMV process. But most get eliminated on one parameter or the other. A few do make it through - and we have had several such cases over the years - both IPO as well as non IPO. What we find is that these newer businesses that made it through our BMV process have actually remained in our portfolios for years and have delivered significant value. Some of these include early investments in Jubiliant, VRL Logistics, IndusInd Bank and others - which have all turned out to be multi-baggers. So, while it is a fact that very few of these relatively new/unresearched companies make it through the BMV filter, those that do have much better prospects of delivering multi-bagger returns.

WF: CY2016 has started on an uncharacteristic note for you, with a small relative underperformance to benchmark. Are there any changes you have made to portfolio composition or strategy this year? How do you plan to maintain your Y-o-Y positive alpha track record?

Anand Shah: In 1QCY16, some of our midcap stocks underperformed - but I think this is more a cyclical issue rather than any structural issue that should worry us. When we dig deeper into the companies that underperformed last quarter, we find that they continue to do just fine. I believe this marginal underperformance is transitional, and does not really merit any portfolio rejig.

WF: You have been underweight commodities and private sector capex, which are now seen as promising turnaround candidates. Are you reviewing your stance on these sectors now or do these businesses not yet make the cut on the BMV template?

Anand Shah: We continuously review our stance for overweight and underweight on all our positions and to me personally both private sector capex as well as commodities which are little bit interlinked will continue to suffer due to slower global growth. Global commodities continue to suffer from an oversupply situation and it is going to take a while for this imbalance to be corrected. In a way, this is also negatively influencing private sector capex growth. So, at this point of time, there continues to be a negative bias towards both.

We have pockets of the economy which are doing well and getting better, whereas we still have pockets of the economy which are over leveraged and which continue to suffer. We have reached a point where we are getting out of a phase of very low growth. Capex in roads and railways and the pay commission will give healthy boosts to GDP growth. One needs to identify the right companies that will benefit from this recovery in growth and which will reward shareholders. Stock picking will continue to be key. There are some cyclical stocks that will benefit from this recovery. It all boils down to individual stocks more than sectors and themes.

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