“You can either remain rational or outperform”: DSP CIO Anish Tawakley explains his contrarian approach to stocks, bonds and market irrationality

Do you feel the protracted market correction sets the stage for better returns in the coming years?

The reality is that the market, particularly the large-cap space, has been largely flat over the past two years. Earnings growth for the Nifty 50 basket has also been modest. So, if earnings growth is modest, it’s not surprising that the market hasn’t delivered great returns.

My view is that the economy is doing really well. Cyclically, we are at a point where demand is picking up, and there is still spare capacity (under-utilisation of existing assets) in the economy. That’s typically a good phase for earnings growth. This is because if there is still spare capacity, the Reserve Bank of India (RBI) does not need to step in and curb demand. It can allow demand to grow.

Earnings growth outlook is positive over a three-year period. At some point, the market will realise that earnings growth has picked up. There can always be some lag between economic performance and the market responding to it, but that lag is never permanent. So one needs to be patient about when the markets recognise it. There is no point in investing in equity for a horizon shorter than three years.


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Is the downside in the market limited from here?

We must recognise that while markets have moved slightly lower, earnings growth has also been modest. So valuations have not materially become much cheaper. But valuations are not outrageous either. If we get three years of decent earnings growth, even if the price-to-earnings multiple moves lower from 21 to 19, you will feel comfortable about the returns generated.

I am not saying the downside is limited just because the market is cheap. I am saying the downside is limited because I am positive about the economic outlook. My simple point is that, from a valuation perspective, the market is in a neutral zone. Now, when it’s in a neutral zone, your call has to be on the economic performance. You don’t take a call on multiples when the market is in a neutral zone. If the market is very richly valued, then even if the economy does well, you won’t make returns. If the market is extremely cheap, then even if the economy does badly, you will be okay. Today, the market is in neutral territory. So, you have to take a view on earnings growth.

What are your immediate priorities as the new CIO? What first principles are you looking to impose on the fund house’s processes and frameworks?

I was comfortable that I don’t need to make any root-and-branch changes. In general, I am very happy with the philosophy of investing here. There is actually a very high degree of alignment. I am very happy with the team we have. Any enhancement I am doing is about bringing in processes that help fund managers stick to the disciplines they already believe in.

It’s not like I want them to change how they think. It’s about giving people guardrails so they don’t accidentally get carried away. If you talk to any fund manager, he will say we should not buy after outperformance or follow a momentum strategy.

These are process-level changes that alert us when we deviate from our own philosophy. And the fund manager has to write an explanation for why he did it. This helps curb practices which cause drift from your own philosophy and hurt performance.

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Our core investing philosophy remains that markets are rational over long periods. But they are not rational at every single point in time. And if the market is irrational, or if some segment of the market is, a fund manager has to make a choice. You can either remain rational or outperform. It’s logically impossible to outperform an irrational market or market segment while remaining rational. So, the processes are around making sure that we choose to be rational. Even if it means sacrificing some performance in a market that we have agreed is irrational.

Another emphasis is on not getting into risky situations. We have a dedicated forensics team for this. We want to bring that forensic thinking into fund management decisions and get fund managers to own them.

How comfortable are you allowing style diversity across your fund strategies? What relaxations do you give to your fund managers?

Fund managers can have different styles. And I firmly believe that different styles work. The only thing that we don’t do is momentum. There are many ways to be smart in this market.

The one way to not be smart is to chase momentum. But if somebody wants to be a value investor, a growth investor, a contra investor or a quality investor, it is all valid. So, there is no style constraint on my end, provided it’s not momentum.

Every fund is different. But every fund has to be true to its label. So, there are high-deviation funds. There are low-deviation funds too. For instance, a focused fund has to take deviations. But it should be communicated upfront that this is a higher-risk fund. I myself run a large-cap fund, which is relatively conservative, and a business cycle fund, which is aggressive. Those two funds have different risk tolerances. So, that has to be clearly communicated.

You are coming from a fund house which is built on a contrarian philosophy. What are your takeaways from that experience?

When I say we are anti-momentum, effectively, the overlay is contrarian. So, a growth manager is allowed to buy expensive stocks, but not after they have moved up. Buy them after they have corrected. There is a contrarian layer, or foundation, which drives all decisions.

Ultimately, the market values businesses. The market is not creating value in businesses. So, you have to focus on the economic fundamentals of the business you are investing in. There is no excuse for not understanding the industries that you are investing in. So, a deep understanding of industries is a big learning.

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The second learning from the past is that corporate governance is pro-cyclical. So, at times, the market is very excited about financing businesses even when many promoters are selling. You have to be careful that some of the entities will be very forthcoming, transparent, and rational when they have to raise capital. But that behaviour will change once the capital has been raised. So, guarding against pro-cyclical corporate governance is a priority.

The third learning is that processes are very important for implementing an investing philosophy. Otherwise, it is very easy to drift. Most mistakes are ones caused by that drift.

Lastly, I have got more comfortable with phases where I recognise this market is irrational, and I must stay out; I don’t have to chase; I don’t have to outperform. I’ve become more comfortable taking a call that at some points, this fund doesn’t need to outperform.

Why are you against momentum?

The risk is that when you play momentum, you feel happy for a while and then you don’t get out at the right time. In fact, many negative investor experiences with sector funds stem from coming in late. I don’t feel comfortable betting on the greater fool theory. As a general rule, if you like something at ` 100, you should like it less at Rs.200. If you are repeatedly liking it more at Rs.200, there is a problem.

Some argue that they like a stock more after it has moved up because there is clarity. My point is that clarity is the enemy of performance. You have to buy when there is a lack of clarity. In very few cases is this justified. If you’re buying something which has already gone up by 10%, were you sleeping earlier? What was it that prevented you from acting earlier?

What big calls are you making currently?

Even six months back, I was confident that the economy had the resilience to withstand the Middle East shock. I’ve held on to the call, and that has driven a preference for domestic cyclicals, of buying sectors that do well when the economy does well.

Among the sectors we are avoiding is Information Technology (IT), where I’ve taken the view that Artificial Intelligence (AI) is not the problem. Rather, it’s about the loss of market share to global captives (in-house technology and operations centres that multinational companies run in India, instead of outsourcing the work to listed IT firms) operating in India. My view is that Indian IT exports are doing very well. It’s just that the listed companies are not doing well. So, we are not losing business to AI. We are losing business to the captives. That probably means the margins are higher than they need to be to be competitive with the captives. If you are losing business to somebody, you need to do something. There’s a set of people who believe that IT companies will be able to do more work with the same number of people. And that will drive their needs. My argument is that if they do more work with the same number of people, the benefit will go to the consumer. They will not be able to charge more for that work. So, I’m taking the view that for revenue growth to materialise, headcount growth has to precede it.

Second, I don’t expect industrial commodity prices, like steel and aluminium, to hold at these levels. I expect a major correction given that demand in China is shrinking.

What do you make of the current bond markets?

You have to distinguish between recurring inflation and a one-off price spike. I think this is often missed by the markets. If oil prices go up from $60 to $100, that’s a one-off price change. That’s not a recurring price change. Monetary policy should ignore that and look at core inflation. Because these shocks are normally driven by oil prices or agricultural commodities, which are one-off changes.

At this point, I don’t think they should go up much further. Because the inflation we are seeing is one-off. And there is still spare capacity in the economy. There is no reason for the RBI to raise real interest rates. So, my view is that the RBI will probably stay the course longer than the market is expecting. So, I’m a little bit more comfortable taking some duration. I’m taking the view that the RBI will ignore the one-off inflation caused by the oil price.

Are higher US bond yields a risk for India?

We overstate the importance of foreign capital. In a good year, the Indian investment rate is 36% of GDP. Thirty-four per cent of that comes from domestic savings. Only 2% comes from foreign capital. Even if foreign capital falls to zero and the investment rate drops from 36% to 34%, it will hardly affect the GDP growth rate by 0.25%.

I don’t know why we spend so much time thinking about foreign capital. It’s much more important to create the right environment for domestic capital to be mobilised. Domestic capital is by far the predominant source of investment funds.

Remember that current account and capital inflows are, more or less, mirror images of each other. Any country that attracts a large amount of foreign capital is also saying that it wants to run a large current account deficit (CAD). We don’t want to run a CAD of more than ~ 2% of GDP. Whenever our CAD exceeds 3% of GDP (and we need to finance it with foreign capital), we get worried.

When you attract foreign capital, you can either build reserves or run a current account deficit. Reserves have a cost. There is no virtue in holding endlessly higher reserves. It’s like holding money in your current account. It has a cost. We already have adequate reserves; we don’t need to build more.

RAPID FIRE

Q. From research analyst to fund manager to CIO, what role gives you more joy?

Research underpins everything. It is the core. It is why I enjoy being in this industry.

Q. If markets could talk, what would they say to investors today?

Be careful when promoters and private equity investors are selling or diluting.

Q. Sum up your portfolio in one sentence

The more things change, the more they remain the same.

Q. A trend or theme you think investors are underestimating?

Mean reversion of profitability.

Q. Any recent market narrative that makes you cringe?

The use of the word TAM (total addressable market). It is a cocktail party concept, not an economic concept. In economics, you have the term ‘demand’, which is desire backed by the ability to pay.

Anish Tawakley

CIO, DSP Asset Managers