Fund Focus: Canara Robeco Emerging Equities Fund

Large caps in a structural bull market? Think again.

Kartik Mehta (Fund Manager) and Ravi Gopalakrishnan (Head Equities), Canara Robeco MF

14th February 2017

In a nutshell

1. Large caps usually outperform in bear markets while midcaps deliver better returns in structural bull markets. Canara Robeco believes we are in a structural bull market now.

2. Allocation between large caps and midcaps must therefore be done after careful analysis of the risk profile and return aspirations of investors.

3. Canara Robeco Emerging Equities Fund had a disappointing CY16 after several years of strong alpha generation. Proactive steps to consolidate positions in high conviction ideas is helping the fund come back to its winning ways in recent months.

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 several consecutive years of strong alpha generation and superior quartile performance, CY16 was a relatively disappointing year for the fund. What contributed to this relatively weak performance and what steps have you taken to get the fund back to its winning ways?

Kartik and Ravi: After rallying a lot during CY14 and CY15, a lot of the midcap stocks came under pressure due to market volatility and delayed growth in the economy. CY 16 started with the devaluation of the Chinese Yuan, which created huge turbulence in the emerging markets including India. As a result of this, there were massive FII outflows also. From April 2016, we made some changes to the portfolio and added to sectors such as NBFCs (due to falling interest rates), building materials due to recovery in consumer spending (due to 7th Pay commission spending, better monsoons etc.), consumption oriented sectors, and certain export themes (particularly speciality chemicals etc.). We saw a good recovery in terms of performance by October 2016, however, the impact of demonetisation was quite severe across most of these sectors during November and December.

However, we have taken advantage of this sharp correction and consolidated our positions with certain high conviction ideas which is reflected in our top 10 holdings. With the markets recovering post demonetisation, the fund's performance is coming back on track as can be seen from the latest performance numbers.

WF: Large cap vs midcap is a perennial debate in the market. What is your perspective on when each of these really make sense to invest in and their relative positions in investor portfolios?

Kartik and Ravi: Just like we allocate funds between Equity, Fixed income and other asset classes based on the investor's risk - return matrix, investment between Large Cap and Mid caps is largely an asset allocation call. Typically, Large Caps outperform mid-caps during bear markets, while reverse is true during bull markets. With the economy showing signs of a turn around and corporate earnings expected to pick up from FY 18, we believe India is in a structural bull market. While both Large Caps and Mid Caps are expected to do well over the next 3 to 5 years, mid caps may outperform large caps given the various differentiated opportunities that are available within the mid cap space. However, the asset allocation between large and mid caps should be determined based on the investor's risk-return profile and it is very important to stick to this discipline and not deviate from it based on short term market movements.

WF: Where would you advise to tactically invest today - large or midcaps - and why?

Kartik and Ravi: As explained earlier, as a long term investor, we do not recommend short term tactical shifts in portfolios, given how event based this market has become. It is important to determine the right large cap-midcap mix and maintain the asset allocation over the long term.

WF: What are some of the themes you are optimistic on in the midcaps space and why?

Kartik and Ravi: When it comes to Midcaps we always believe in bottom-up stock picking. However there are a few themes where we are optimistic, particularly in areas such as specialty chemicals, urban consumption and Industrial recovery. The Indian consumption story is a well established thesis and within that urban consumption was identified during worst period of demonetization. Amidst benign inflation and controlled fiscal deficit, supported by focussed government spending we should see the infra/ Industrial space revive again. Indian specialty chemical players have established themselves as a respectable brand in the international space due to their ability to provide niche, IP based customised molecules in a cost effective manner. Hence, we are seeing increasingly higher growth in exports numbers of most of the chemical players. Also, most of the sales are largely granular to multiple countries without taking any specific geographic risk.

WF: What is your overall outlook on markets over the next 12-18 months, now that the Budget related uncertainties are behind us?

Kartik and Ravi: While the India macro story is gradually gaining momentum, the growth is expected to be slow and granular. While inflation is slowly declining, interest rates in the economy continue to remain elevated, because of which capex cycle recovery will be gradual. Also, the 1Q of FY18 will see fair bit of uncertainty due to the expected transition towards GST. Further, with global situation facing a lot of uncertainties, markets are likely to remain volatile but with an upward bias, given the positive outlook on the earnings trajectory.

WF: To what extent are the global uncertainties prompted by Trump's recent actions and intentions really a cause for concern - for global markets as well as for India?

Kartik and Ravi: There is still a lot of uncertainty surrounding some of the policy announcements from the newly elected government in the U.S. These will have to go through a number of legislative changes before they get implemented. Many of these legislations may get diluted as we go along and this may not have a significant impact on markets. India's position is relatively better as we operate in two of the sectors, IT & Pharma, where we hold some unique strengths in terms of skill sets which cannot be replicated very easily. While the political rhetoric might continue to impact these sectors in the near term, longer term it may not have any structural impact.

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