Fund Focus: Kotak Opportunities Fund

Don't chase momentum in a liquidity driven market

Harsha Upadhyaya, CIO - Equities, Kotak MF

23rd October 2017

A multi-cap approach with 65% in large caps, a well-diversified portfolio with 60 stocks and sharp focus on bottom-up stock picking with a GARP philosophy are the factors Harsha believes are contributing to Kotak Opportunities Fund's consistent performance. Cement, cap goods and oil and gas are his key overweights while he continues to stay away from several key sectors either on growth or valuation concerns. His advice to investors is simple and clear: stay cautious in the near term and don't chase momentum in a market that is largely driven by liquidity.

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: CY2014 and CY2017YTD are similar to the extent of healthy market returns, but very different in terms of fund alphas. A huge 12% alpha in CY14 got you a 2nd quartile place while this year, a meagre alpha of 0.45% gets you a top quartile positioning. Why is this year proving so much more difficult for diversified equity funds to generate substantial alpha?

Harsha: At the beginning of CY2014, the market valuation on 1-year forward P/E basis was around 15 times, whereas at the start of CY2017 the same was around 19-20 times. Obviously at lower valuation levels in 2014, the opportunities for large alpha creation were relatively more compared to that in CY2017.

WF: What in your opinion is driving the consistent 1st/2nd quartile performance of the fund in recent years?

Harsha: Over the years, we have stuck to investment philosophy (Growth at Reasonable Price) and investment mandate of the fund irrespective of market phases. The investment focus has always remained long term, with relatively low portfolio turnover. These simple rules have enabled us to register consistent outperformance against benchmark.

WF: Do you look for opportunities in this fund from a sectoral perspective or a stock specific perspective? Do you operate a focused, high convictions based big bets strategy or a broad based diversified strategy?

Harsha: The fund follows multi-cap approach, with at least 65% invested in large cap stocks. The fund adopts a pure bottom-up stock selection approach with no sectoral constraints. We seek to limit overall equity risk by constructing a diversified portfolio of up to 60 stocks. We prefer to invest in companies that have scalable business opportunities. Focus is always on steady cash flow generation and efficient capital allocation. Typically, we look for compounding characteristics of earnings growth at reasonable valuations, and build portfolio around that strategy.

WF: What are the sectors/themes that you are placing significant bets on now and why?

Harsha: The key overweight sectors for us are - Cement, Capital Goods and Oil&Gas. Government's continued focus on affordable housing and infrastructure creation should aid demand in Cement and Capital Goods. Oil&Gas sector is likely to deliver one of the more consistent set of earnings growth in the market, and is also reasonably valued.

Some other sectors such as Pharma, Telecom and IT are facing structural headwinds and earnings are under pressure. We do not envisage any improvement in the short to medium term in these sectors. Valuation-wise there are many other sectors such as NBFCs, FMCG etc which are trading at rich multiples, and therefore could pose risk.

WF: Concerns around potential deterioration of macros amidst impatience on missing improvement in micros are casting some doubt on market direction for the near and medium terms. How do you see markets shaping up over the next 12-18 months in this context?

Harsha: Overall market valuations continue to remain elevated given delay in corporate earnings recovery amidst strong flows driving the market higher. While we remain constructive from a medium to long term perspective, we are advising investors to exercise caution in the short term and not chase momentum in a market largely driven by liquidity.

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