Fund Focus: BNP Paribas Equity Fund

Bouncing back to top of the league table

Anand Shah, Deputy CEO, BNP Paribas MF

1st March 2017

In a nutshell

After a string of Y-o-Y top quartile performances, BNP Paribas Equity Fund had a terrible CY16, but has bounced back very sharply in YTD CY17. Anand candidly takes us through what caused the performance slump, where he took corrective action, where he decided none was required and one key lesson learnt from the events of 2016.

Looking ahead, Anand sees two key structural trends driving equity returns: (1) organised sector gaining market share and/or pricing power post GST implementation and (2) household savings migrating increasingly towards financial assets.

All however is not rosy - Anand cautions us about the spectre of jobless growth in the country - which, if not corrected quickly, can derail our long term structural story.

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: After a string of Y-o-Y top quartile performances, CY16 was a big disappointment. Its early days yet in CY17, but fund performance seems to have bounced back sharply and is back into top quartile. What went wrong in CY16?

Anand: Until April 2016, our track record of delivering around 600 bps alpha over benchmark over a 5 year period was intact. Two things happened thereafter. We had an overweight position in telecom and competitive events in the sector between Apr-Sep 2016 changed the dynamics of the sector completely and impacted market cap significantly. We took a significant hit. We cut exposure in the sector as we don't see much sanity in the business models there at present - but our fund performance took a one time hit anyway.

Then came demonetization in Nov 2016, which impacted B2C businesses far more than B2B businesses, as cash crunch was immediately felt in households. Until Nov 8th, the outlook for consumer oriented businesses was very favourable on the back of 7th Pay Commission payouts, good monsoons and so on. Our portfolio has historically been geared much more towards B2C businesses, drawn by their secular growth prospects. Even within the BFSI space, we have been overweight consumer plays including NBFCs rather than corporate banking plays. Post Nov 8th, B2C businesses saw share price erosion and money flowed into B2B businesses where we were underweight - so we were hit by a double whammy, where the sectors we were overweight in fell and those we were underweight in rose.

We were clear that this was a transitionary pain for the sectors we owned, so we didn't make any changes in our portfolio. That conviction has borne out as these sectors stabilized and recovered in Jan 2017, aiding portfolio performance. What has worked for us in the past and what will work in future as well is identifying and owning sustainable growth stories. Earnings growth of the companies we own has consistently been 700 - 1000 bps faster than index earnings growth all along. From what we can see of earnings growth for FY18 and FY19 - for the index as a whole and for the stocks we own, we are convinced that this trend will continue in the future as well.

There continue to be some worries on demonetization impact in this quarter as well - in the Jan-Mar 17 quarter. But, there is no reason for us to make any portfolio changes on this account, as this is a purely transitionary pain for the stocks we own, which we believe continue to demonstrate earnings growth far ahead of the market.

WF: They say adversity is the biggest teacher. In that context, what were some of the lessons to be learnt from the events of CY16?

Anand: One big lesson for us was a reminder of a key principle - which is to invest in sectors that are consolidating and to avoid sectors that are fragmenting. We made an exception with telecom, after taking a calculated assumption that the new entrant would cause some price disruption, and were satisfied that the stocks we owned in this sector would be able to absorb the hit and yet continue on a long term earnings growth path. We anticipated aggressive pricing by the new entrant, but we were frankly not prepared for free pricing. Never say never - that's the key lesson for us when we build our hypothesis and test our portfolio stocks against them. When we look at what happened in the telecom space with a free pricing phenomenon, then we look at the rate at which e commerce players are willing to continue burning cash for such long periods of time, then we turn to price wars in airlines despite a 20% growth in passenger traffic, one observation that comes through is that irrationality is growing, and not reducing - and that is a worry. For a fund manager, this means more stress tests on portfolio stocks on more assumptions and on different eventualities - even if some assumptions appear irrational and far fetched. Never say never.

WF: There is a growing belief that "quality" has got priced out of the market and going forward, it will be cyclicals - which may not stack up as high on quality parameters - which will outperform the market. Do you agree with this view? How does this impact your stock selection philosophy?

Anand: More than quality, I think the debate is secular vs cyclical, and quality has been associated more with secular themes and stocks, especially in a world which is still trying to come out of a global overcapacity situation over the last decade. China's emergence as a major global supplier across a huge range of cyclical sectors from metals all the way upto textiles and chemicals, has caused all these cyclical sectors to underperform considerably in the last decade. China has been a key disrupter across several cyclical manufacturing sectors.

Our take is that this is now changing, and we have started adding a number of cyclicals in our portfolio in recent months. China has grown rich, they are now a lot more conscious about pollution, they are becoming more rational about closing capacities which are inefficient in production, they have been closing inefficient and polluting mines - so they are becoming a more rational global player. This offers a window of opportunity for strong domestic players in several cyclical sectors to do well, and we are participating in this opportunity by owning good cyclical stocks.

So I think there is space in portfolios for both - secular stories as well as good cyclical ones - and we have both in our portfolio. I believe India will have more money making opportunities in the next 3 years - across secular and cyclical stocks - than we've had in the last 5 years.

WF: From a bottom up perspective, does demonetization and the forthcoming GST implementation throw up near and medium term challenges to corporate earnings, which might negatively influence markets and the stocks you own?

Anand: GST implementation will have some teething troubles and there could be some near term impact, just like we had with demonetization. But looking beyond transitionary challenges, the big shift that is happening is that tax compliant organised sector players (which is where the listed space is), are becoming more competitive vs unorganised sector players. Tax arbitrage - across direct and indirect taxes - has been one of the big drivers of cost competitiveness of the unorganised sector. As this reduces, it can open up huge opportunities for organized sector players. Let's take just one example which most of us will be familiar with - which is spare parts for our cars. We know that the price quoted for "non branded" spares is much cheaper than supplies from OEMs. When the price differential narrows as both get subjected to the same GST, would you not be more tempted to go in for the "original" rather than the unbranded, unknown competitor?

There is an opportunity for tax compliant players to either gain market share or gain pricing power in a GST environment.

WF: Some experts are betting on the rural theme, others are bullish on infra. Looking at the stocks you like right now, what themes seem to be running common among these names?

Anand: We've maintained our overweight position on B2C themes - that stays as the secular theme is very much intact and looking strong. Within B2C we like financials, media, auto - there is a wide range, however we continue to be wary about consumer goods on account of valuations. Outside B2C, we like cement and metals - metals more from a global recovery perspective. We are underweight IT, healthcare and energy.

WF: What are risks we need to be watchful about for the Indian equity market?

Anand: The biggest positive as well as negative around the India growth story is the same - and that is jobs. If we are actually able to create sufficient jobs for India's young and growing demography, we don't have to worry about anything else that's happening in the world. The flip side - if we don't create enough jobs, we don't have a good story, irrespective of what is happening or not happening in the rest of the world. Ability to create jobs will either propel us into a strong structural growth story or into chaos. That's the big structural perspective.

Looking now at a more medium term perspective, there's a lot going for the India equity story. The ongoing shift in household savings from physical to financial got a further boost with demonetization. Domestic flows into equity markets remains very strong, which augurs well for the equity market. We are therefore quite sanguine about markets.

The material contained herein has been obtained from publicly available information, internally developed data and other sources believed to be reliable, but BNP Paribas Asset Management India Private Limited (BNPPAMIPL) makes no representation that it is accurate or complete. BNPPAMIPL has no obligation to tell the recipient when opinions or information given herein change. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. This information is meant for general reading purpose only and is not meant to serve as a professional guide for the readers. Except for the historical information contained herein, statements in this publication, which contain words or phrases such as 'will', 'would', etc., and similar expressions or variations of such expressions may constitute 'forward-looking statements'. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those suggested by the forward-looking statements. BNPPAMIPL undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof. The words like believe/belief are independent perception of the Fund Manager and do not construe as opinion or advise. This information is not intended to be an offer to sell or a solicitation for the purchase or sale of any financial product or instrument. The information should not be construed as an investment advice and investors are requested to consult their investment advisor and arrive at an informed investment decision before making any investments. The Trustee, Asset Management Company, Mutual Fund, their directors, officers or their employees shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages arising out of the information contained in this document.

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